Representations and Warranties in a Business Sale: What Buyers and Sellers Are Really Agreeing To

A business purchase agreement does much more than state the purchase price.

It also contains statements about the company that the buyer relies upon when deciding to close the transaction.

These statements are commonly called representations and warranties.

They can cover financial statements, taxes, contracts, employees, ownership, litigation, intellectual property, compliance, and many other areas.

If an important representation later proves inaccurate, the agreement may provide the buyer with contractual remedies.

The exact legal consequences depend on the transaction documents and applicable law, so buyers and sellers should obtain qualified legal advice.

What Are Representations and Warranties?

Representations and warranties are contractual statements made by one party to another regarding specified facts or circumstances.

In a business sale, the seller may make representations about the company while the buyer may make representations about authority, financing, or other matters.

Why Do Buyers Require Them?

Due diligence cannot verify everything perfectly.

Representations help allocate risk around information the buyer relies upon.

They can establish what the seller is confirming about the business at signing and closing.

1. Organization and Authority

The seller may represent that:

• The entity exists validly
• The seller owns the interests being sold
• The transaction has been properly authorized
• No undisclosed person owns competing rights to the equity

2. Financial Statements

Representations may address the preparation and accuracy of financial information supplied to the buyer.

This area can become significant when the buyer’s valuation relies heavily on historical earnings.

3. Undisclosed Liabilities

The buyer may seek assurance that material liabilities have been disclosed appropriately.

Potential liabilities can include:

• Debt
• Tax obligations
• Claims
• Employee obligations
• Contract liabilities

4. Taxes

Tax representations may address:

• Returns filed
• Taxes paid
• Audits
• Liens
• Withholding

Tax matters can have specialized survival and indemnification treatment depending on the deal.

5. Material Contracts

The seller may provide information about important contracts and represent whether those agreements are valid, in force, or subject to known defaults.

Contracts can include:

• Customers
• Suppliers
• Leases
• Licenses
• Loans
• Employment agreements

6. Litigation and Claims

Buyers may require disclosure of pending or threatened disputes.

Known claims should be evaluated carefully rather than assuming they are too small to matter.

7. Employees and Labor Matters

Representations may cover:

• Employee arrangements
• Compensation
• Benefits
• Employment disputes
• Worker classification
• Compliance matters

8. Intellectual Property

If technology, branding, software, inventions, content, or proprietary processes are important, buyers may seek statements about:

• Ownership
• Licenses
• Infringement claims
• Employee-created intellectual property
• Domains and trademarks

9. Compliance With Laws

Purchase agreements may contain representations regarding compliance with laws and regulations relevant to the business.

The appropriate scope depends heavily on industry.

10. Environmental Matters

For businesses involving property, manufacturing, chemicals, or regulated operations, environmental representations can become significant.

11. Customers and Suppliers

The seller may need to disclose major relationship changes, terminations, or disputes.

This can be important when a small number of relationships represent a large share of company revenue or supply.

What Are Disclosure Schedules?

The seller may qualify representations by providing disclosure schedules.

For example, the purchase agreement might state that there is no litigation except as disclosed on a particular schedule.

The schedule then identifies the known matter.

Accurate disclosure can therefore be as important as the wording of the representation itself.

Why Sellers Should Not Treat Disclosure Schedules as Clerical Work

Disclosure schedules can determine whether a known issue was properly disclosed before closing.

They should be prepared carefully using information from management, accounting, legal records, contracts, employees, and other relevant sources.

What Does “Knowledge” Mean?

Some representations may be limited to the seller’s or management’s knowledge.

The agreement may define:

• Whose knowledge counts
• Whether reasonable inquiry is required
• Which individuals are included

This language can materially affect risk allocation.

What Is Materiality?

Representations may be qualified by concepts such as materiality.

The agreement may distinguish between any breach and a breach significant enough to trigger specified remedies.

The actual wording should be reviewed carefully.

How Long Do Representations Survive?

Some representations may expire after a specified period following closing.

Others may survive longer.

Different categories can have different survival periods depending on the negotiation and applicable law.

How Do Representations Connect to Indemnification?

If a representation is breached, the purchase agreement may provide an indemnification framework.

That framework can address:

• Covered losses
• Caps
• Baskets or thresholds
• Claim procedures
• Survival periods
• Escrow

Escrow Can Backstop Seller Obligations

Part of the purchase consideration may be held temporarily to support certain post-closing claims.

Representations, indemnification, and escrow should therefore be reviewed together.

Representation and Warranty Insurance

Some larger transactions may use representation and warranty insurance as part of risk allocation.

Availability, coverage, exclusions, retention, cost, and underwriting depend on the specific transaction.

Buyers Should Still Conduct Due Diligence

Representations do not replace diligence.

A buyer should not rely on contractual remedies as a substitute for understanding:

• Financials
• Customers
• Contracts
• Taxes
• Employees
• Legal risks

Sellers Should Begin Preparing Before the Purchase Agreement Arrives

Waiting until final drafting begins can make disclosure preparation difficult.

Before going to market, sellers can organize:

• Corporate records
• Contracts
• Tax information
• Employee records
• IP documentation
• Litigation information
• Compliance records

Do Not Agree to Statements You Cannot Support

A seller should understand what each representation actually says and whether company records support it.

A buyer should ensure that the representations address the risks that matter to the acquisition.

Transaction counsel can help both parties negotiate scope, qualifications, disclosure schedules, survival, indemnification, and related remedies before closing.

Frequently Asked Questions

What are representations and warranties in a business sale?

They are contractual statements made about specified facts or circumstances relating to the business, transaction, seller, or buyer.

What is a disclosure schedule?

A disclosure schedule identifies exceptions or additional information relating to representations in the purchase agreement and can be important in determining what was disclosed before closing.

What happens if a representation is false?

The consequences depend on the purchase agreement, indemnification provisions, applicable limitations, available insurance, escrow, and governing law.

Do representations replace buyer due diligence?

No. Buyers should still conduct appropriate diligence because contractual remedies may be limited and do not substitute for understanding the business before closing.

Representations and warranties allocate important transaction risk around financials, ownership, contracts, taxes, employees, intellectual property, and other business matters.