Private Equity

In virtually every acquisition or merger agreement there is a section that contains certain contractual statements of purported fact concerning the company or asset being acquired. Those statements have been famously described by then Vice Chancellor Strine, in ABRY Partners V, L.P. v. F & W Acquisition LLC, 891 A.2d 1032, 1035 (Del. Ch. 2006), as the “factual predicate[s]” for the parties decision to enter into the deal.  In the United States, deal convention dictates that the person making these contractual statements introduce them with the phrase “represents and warrants,” while in England deal convention is that the introduction only include the word “warrants,” but not “represents.”  The reason for not using the word “represents” in English agreements is purportedly to avoid potential tort liability that can arise from a representation, but not from a warranty.

Despite our shared common law heritage, this recognized distinction in English practice has never caught on in the United States.  Indeed, despite warnings from some U.S. commentators that these distinctive terms are not in fact synonyms and have different consequences even in the United States, U.S. deal convention persists in using these distinct terms as if they were synonyms (for a discussion of this debate see footnotes 47 and 140 of this author’s 2014 article, as well as Ken Adams’ 2015 article, and Professor Sepinuck’s 2015 view on the subject).  This author’s consistent position on this subject is to continue to bow to current market convention in the U.S. because it’s only worth bucking convention when it matters, and a purported statement of fact denominated as only a warranty in the U.S. will not necessarily shield the maker of that statement from being deemed to have nevertheless made a representation for tort law purposes.  This is especially true when the allegation is that the maker made the statement of fact to the counterparty prior to entering into the contract, intending that the counterparty rely upon that statement in entering into the contract that contained that same statement as a contractual warranty with limited remedies.  Instead, this author has consistently suggested the use of prescriptive non-reliance and exclusive remedy provisions that limit exposure to tort-based claims premised on extra-contractual statements and whatever factual predicates are agreed as the basis for a deal with contractually capped liability for any inaccuracy in those agreed factual predicates (see e.g., prior Weil Insights blog posts here, here and here).

But a recent English decision has once again addressed the distinction between a “warranty” and a “representation” under English law and provided another opportunity to address this issue.  In  Idemitsu Kosan Co Ltd v Sumitomo Corporation, [2016] EWHC 1909 (Comm) (July 27, 2016), the Judge granted summary judgement in favor of the seller despite the buyer’s claim of misrepresentation based upon allegedly untrue statements of fact concerning the purchased company that were contained in a schedule of “warranties” made by the seller in a share purchase agreement.  And this case should be of interest to lawyers on both sides of the Atlantic because of the creative arguments made by the buyer in an effort to avoid the limited remedies available for breach of warranty contained in the share purchase agreement.

Pursuant to the terms of the share purchase agreement, the buyer was required to make any warranty claims within 18 months after the closing of the purchase of the shares.  Having failed to do so, the buyer’s contractual claims based on breach of warranty were barred.  The buyer nonetheless argued that the warranties “were matters of past or present fact relating to the Company.”  And while the contractual warranties set forth in the share purchase agreement may have been warranties and not representations when made in the signed agreement, the buyer argued that the statements of fact concerning the company contained in the schedule of warranties had been communicated as representations in drafts of the agreement prior to the signing of the share purchase agreement.  In other words, because the warranties set forth in the draft share purchase agreements contained statements of fact concerning the to be purchased company, and were communicate to and relied upon by the buyer in entering into the share purchase agreement, the draft warranties were pre-signing representations that could form the basis for a tort-based misrepresentation claim.

The idea that pre-signing exchanges of draft agreements could constitute statements of fact upon which a tort-based claim of misrepresentation could be founded was recognized by the Judge:

It seems to me right in principle that language found in the communication of a negotiating position, or in draft wording for a contract, or in an entire draft contract, passing between the parties during the negotiation of a contract, might amount to or form the content of a pre-contractual representation capable of being actionable under the 1967 Act.

But because the draft share purchase agreements (and the final version) denominated the warranties as warranties and not representations, the Judge refused to find that any pre-contractual representation had been made at all, notwithstanding that the warranties were statements of past or present fact.  According to the Judge:

When a seller, by the terms of the contract under which he sells, “warrants” something about the subject matter sold, he is making a contractual promise. Nothing less. But also I think (and all things being equal) nothing more. That is so just as much for a warranty as to some then present or past matter of fact as it is for a warranty as to the future. By contracting on terms by which he warrants something, the seller is not purporting to impart information; he is not making a statement to his buyer. He is making a promise, to which he will be held as a matter of contract in the sense that any breach of the warranty will be actionable as a breach of contract, subject to any other relevant terms of the contract and to general principles of the law of contract, for example as to remedies.

And the act of a seller in proposing to enter into a contract with a buyer containing specific contractual warranties concerning matters of fact is not, according to the Judge, the actual making of a statement of fact by the seller to the buyer regarding the truthfulness of the proposed contractual warranties to thereby induce the buyer to enter into the contract.  Instead, “[t]he act of concluding a contract is constituted by, and amounts to a communication only of, assent to and intention to be bound by the terms agreed.”  And if the communicated terms are only warranties and not representations, then those communicated terms cannot thereby serve as a basis for a claim of misrepresentation.

All well and good based on the accepted English convention of only using warranties, not representations, in agreements (including in the exchange of drafts during negotiations), and the English courts’ acceptance of the clear distinction between the consequences of using only warrants but not represents to introduce factual predicates in an English transaction.  But what about a U.S. agreement where the convention is to introduce the factual predicates to an agreement by using both represents and warrants?  Some U.S. cases have held that the fact that a statement is made contractually does not preclude it from also having been made pre-contractually in a manner that would support a tort-based claim of misrepresentation.  In other words, the contractual remedies for the contractual statements will not necessarily preclude a counterparty from recovering tort-based remedies for misrepresentation based on such pre-contractual statements.  In the U.S., however, the solution is not to stop using represents and warrants as the introduction to the factual predicates in the draft agreement (at least in the absence of U.S. case law demonstrating that the distinction between the terms has the clear differences ascribed by the English cases). Instead, the solution is to ensure that the counterparty clearly states in the final agreement that it has not relied upon any pre-contractual statements and that its reliance upon the contractual statements is subject to the bargained for contractual remedies.  An example of such an approach is set forth below:

Non-Reliance of Buyer. Buyer acknowledges that no officer, agent, representative or employee of the Selling Stockholder, the Company or any of the Company’s Subsidiaries has any authority, express or implied, to make any representations, warranties or agreements not specifically set forth in this Agreement and subject to the limited remedies herein provided.  Except for the specific representations and warranties expressly made by the Company or any Selling Stockholder in Article [_] of this Agreement, and subject to the specifically bargained-for exclusive remedies as set forth in Article [_], Buyer specifically disclaims that it is relying upon or has relied upon (1) any representation or warranty, expressed or implied, at law or in equity, made by any Person in respect of the Business, the Company, the Company’s Subsidiaries, or any of the Company’s or its Subsidiaries’ respective businesses, assets, liabilities, operations, prospects, or condition (financial or otherwise), including with respect to merchantability or fitness for any particular purpose of any assets, the nature or extent of any liabilities, the prospects of the Business, the effectiveness or the success of any operations, or the accuracy or completeness of any confidential information memoranda, documents, projections, material or other information (financial or otherwise) regarding the Company or any Company Subsidiary furnished to Buyer or its representatives or made available to Buyer and its representatives in any “data rooms,” “virtual data rooms,” management presentations or in any other form in expectation of, or in connection with, the transactions contemplated hereby, or in respect of any other matter or thing whatsoever, and (2) any Person providing or not providing any information not specifically required to be provided or disclosed pursuant to the specific representations and warranties set forth in Article [_] of this Agreement.

Of course the following provision, while not absolutely necessary, helps further clarify that the factual statements set forth in the representations and warranties (or even just in the warranties in English practice) are not intended to be assertions of truth but rather contractual promises with bargained for remedies in the event of their inaccuracy (i.e., contractual risk allocation devices):

Nature of [Representations and] Warranties.  All [representations and] warranties set forth in this Agreement are contractual in nature only and subject to the sole and exclusive remedies set forth herein. No Person is asserting the truth of any factual statements contained in any [representation and] warranty set forth in this Agreement; rather the parties have agreed that should any [representations and] warranties of any party prove inaccurate, the other party shall have the specific remedies herein specified as the exclusive remedy therefor.