REPRESENTATIONS, WARRANTIES AND INDEMNITIES IN M&A TRANSACTIONS

REPRESENTATIONS, WARRANTIES AND INDEMNITIES IN M&A TRANSACTIONS -Riddhi Mahajan (LL.B) GLC

A brief overview:-
A thorough set of representations and warranties (R&W) supported by indemnities is a standard component of M&A deals in India. R&W divides the risk of the accuracy of specific representations between the acquirer and the seller, target company, or both (warrantor or warrantors).
In a sale and purchase agreement, a seller may offer warranties and indemnities as legal safeguards. The buyer will unavoidably have relied on information that was given to him by or on behalf of the seller, as well as a number of assumptions, in order to agree to make the purchase and to the purchase price. The buyer will typically demand that the sale and purchase agreement include warranties and/or indemnities regarding the shares and the underlying business and its assets and liabilities in order to protect him in the event that the data or assumptions on which he is relying turn out to be false.
R&W are given as a persuasion to engage in a transaction, and their inaccuracy may entitle the promisee to relief under the terms of the contract as well as under the law. An indemnification is the preferred contractual remedy for R&W's accuracy. But the absence of indemnification does not bar remedies in the form of compensation for damages or specified performance.
For vendors, representations and warranties provide a sizable potential source of liability that might significantly lower the final purchase price. Target companies and their shareholders, in particular, need to fully understand what representations and warranties are, what representations and warranties are being requested, whether those representations and warranties are true and correct and can be given either on an unqualified basis or only with the necessary qualifications, and whether those representations and warranties can be given. Parties to a M&A transaction should also be ready to fight for the necessary qualifications.

What are warranties and representations?
Representations:-Representations are assertions of historical or contemporary fact or situation. Essentially, a truth or event that the party causing the other to enter into the contract asserts is true at the time of the contract's entry and/or has been true in the past. As a result, representations are regarded as sacred to the agreement, and a breach thereof gives the non-breaching party multiple contractual or legal remedies, such as the right to ask for the agreement to be declared void or the right to indemnification for losses incurred as a result of the misrepresentation.
Warranties:-In the Indian context, the term “Warranty” is a stipulation, collateral to the main purpose of the contract and the breach of which gives rise to a claim for damages but not a right to reject the goods and treat the contract as repudiated as per the provision of Section – 12 of the Indian Sale of Goods Act, 1930 (“SGA”). The extent of coverage of warranty differs from case to case.
Statements concerning the present and future condition are warranties. It is a requirement of a contract that a condition (quality) be true and/or continues to be true for a certain amount of time (often the term of the agreement). This is a statement of the present and the future. The claim might be accurate when the guarantee is made, but it might be falsified later on in the relationship. In the event of a warranty breach, the non-breaching party may be entitled to damages as a result of the violation, and frequently, a contract may outline particular remedies for a warranty breach (e.g., commercially reasonable efforts to repair). Contrary to a representation, a breach of warranty does not, at the decision of the party who was wronged, render the contract voidable.
The difference between a "warranty" and a "representation" is that a "warranty" is an assurance of the continuation of a specific state, whereas a "representation" is a statement of fact related to a current or past event on the basis of which an acquirer is induced to enter the contract. Technically speaking, there are differences between a "representation" (a statement of fact as of a particular time) and a "warranty" (a promise by a party providing a statement of fact that the statement is true). Despite the fact that the terms are frequently used interchangeably, they have different legal implications if they are inaccurate.

Qualifications to warranties:-
Materiality and actual or imputed knowledge standards frequently qualify warranties in whole or in part.
Disclosures:-Parties making representations may disclose facts that contradict those representations. If the other party is aware of these facts, they cannot make claims that these facts contradict the representations made. In order to limit the defence’s scope, acquirers prefer disclosures of this kind to be as specific as possible. However, warrantors want to include information that is accessible to the public in the scope.
The disclosure schedules annexed to the agreement identify exceptions to the warranties made, in contrast to the common practice of stating warranties in broad, general terms. As a result, a party may assert that the entity is not involved in any pending legal proceedings other than those disclosed in the disclosure schedule. A breach of the transaction document and potentially significant liability to the selling company or its shareholders could result from a disclosure schedule that is either incorrect or incomplete. Acquirers sometimes resist warrantors' requests for the right to update their disclosures regarding events that occurred between the signing of the contract and the conclusion of the transaction. Post-closing claims that the selling company violated its warranties will be greatly mitigated by a well-drafted disclosure schedule.
Knowledge:-When negotiating an agreement for mergers and acquisitions, the buyers and sellers take various approaches. By limiting the representations and warranties to the best of its "knowledge," this is one example. With reference to their specific knowledge of the subject, warrantors attempt to limit certain representations. This is because it may not be possible for the warrantor to be aware of certain things, like claims that have been filed against it but no notice has been received or latent defects. If there is a breach of a representation that the warrantor is unaware of, the acquirer cannot claim relief because the representation is limited to knowledge. As opposed to the acquirer, who seeks to define knowledge as constructive knowledge, warrantors define knowledge as actual knowledge.
Materiality Qualifier:-The materiality qualifier is significant from the seller's perspective. The seller adds the "materiality" qualifier, which means that a statement can be changed if it doesn't significantly affect the company's assets or business. The buyer can't walk away from the deal before it closes or file indemnity claims after it does because of a false or inaccurate statement because of this qualifier. By using the term "material" in the representations and warranties, warrantors attempt to limit acquirer claims to only material claims. A monetary threshold is agreed upon, and claims below this amount cannot be brought against the indemnifier due to the subjectivity of the term "material." It is possible to apply such a threshold to a single claim or a group of claims. The ability of the indemnified party to seek indemnification for claims below the threshold when aggregate claims exceed the agreed threshold, also known as the "tipping basket," is frequently observed. Either a specific number or a percentage of the consideration value is used to express the thresholds.
What are indemnities?
An indemnity is a pledge made by the seller to compensate the buyer for any loss incurred by that party as a result of a specific occurrence or specified conditions. It is a contract that binds the seller to an initial, separate obligation to make good on a loss. As long as the indemnity is sufficiently broad, the buyer will typically be able to recover all losses covered by it because the contractual standards of remoteness and foreseeability won't be relevant. For instance, it is conceivable to write an indemnity against damages that were only indirectly related to the trigger event. Express language may necessitate the payment of losses that cannot be recovered as breach of contract damages.
Section 124 of the ICA defines indemnities as a contract in which one party promises to protect the other from loss incurred by the promisor or any other person. However, the majority of contractual indemnities cover a wide range of events, both within and outside the promisor's control, that go beyond a person's behaviour.
Key concepts and scope of indemnity
Any transaction contains a commercial risk and it is very important for the parties to mitigate that risk and this is the role that indemnity plays.
 There are 4 key concepts in indemnity:-
1)    Indemnifying parties: - In a typical share sale of transaction typically the sellers will provide the indemnity however in a subscription agreement the company or the promoters or the majority shareholders provide the indemnity also if there is more than one indemnifying party then the concept of joint and several comes into existence the idea of joint and several is that the indemnified party would be able to pick and choose as to against which party, they want to make a claim.
2)    Indemnified parties: - By the seller side perspective the indemnity is tried to be kept narrow and we will see that the buyer is the indemnified party however by a Buyers side perspective. The indemnity is tried to be expanded and the indemnified parties would be the affiliates, employees etc.
3)     Losses: - Indemnity is provided for losses these losses are generally defined in the agreements. In this case the buyer would try to include all kinds of losses, damages and attorney fees and by the seller side perspective the seller would try to limit the indemnity and say that while he’s agreeing to indemnify there should be certain limitations to the indemnity.
4)     Indemnity events: - Indemnity events are often the trigger events like loss arising in relation to breach of representations and warranty, breach of covenants fraud and specific indemnity.
Limitations to Liability:- While the seller agrees to offer indemnity, the indemnity must have a cap; it cannot be unlimited. Liability limitation can help with this. Limitation like setting up a monetary limit, time limit etc can be the solution for unlimited liability.
Monetary limit:-
1.    De minimus-The de minimis amount establishes the minimal level that must be met by a single claim in order to qualify for indemnification.
2.    Basket- A tipping basket establishes the amount that must be exceeded by the total of all claims before a party may assert any claim for indemnification. Putting together all of the claims that meet the de minimis criterion is another way to phrase it.
3.    Overall Cap- The maximum amount that an indemnifying party may be forced to pay is capped.
Time limit:-
1.    Fundamental fraud- there is no time limit for a fundamental fraud
2.    Specific indemnity- the tie limit in this case depends upon the events.
3.    Business and tax- there are different time limit that are agreed upon because of different risk perceptions etc.

Conclusion:-
Representations and warranties are safeguards designed to protect a party from any apprehensions regarding such a transaction. Any acquisition agreement must contain representations and warranties. The parties (especially vendors) must understand what representations and warranties are being requested and make an effort to ensure that all of the representations and warranties are true, correct, and can actually be given, even though the specific wording of the representations and warranties is typically negotiated between the legal counsels for the respective parties. Indemnities protect against losses, whereas warranties give assurance about the state of the party's affairs. Strong warranties and sufficient indemnity protection are crucial from the buyer's point of view, while from the seller's point of view, qualifying the representations and warranties and limiting indemnification responsibilities are the most important elements. In an M&A deal, disclosures, exclusions, and liability limitations are crucial. The balancing act is essential to completing an M&A deal.