[Expert Corner Series] Representation & Warranties in Due Diligence in the context of M & A in India by Aditya Prakash- PART-VIII | Corp Comm Legal on Corporate Law

I.                   Introduction
The words representations and warranties are often used together in an agreement be it an Asset Purchase Agreement or Share Purchase Agreement. These two words sound synonymous. However, there is a lot of confusion surrounding the exact meaning and scope of these two words. In theory and practice, the two words are separate and substantially distinct from each other having different characteristics. They also provide for different remedies under the law. Understanding the differences between the two terms is very essential to ensure that the right remedies are attached to the right terms in an agreement. It is particularly important for non-lawyers to understand these terms and the repercussions this clause may have on their rights and remedies if, in future, a dispute arises. In the end, it is ultimately the buyer and seller who negotiate the terms and conditions of a contract live with it for the rest of their lives.
In this article, let us discuss an overview of the representation and warranty clauses particularly in the context of mergers and acquisitions. We start with a general distinction on the two terms, followed by their relevance and importance in mergers and acquisitions, qualifiers which act like an exception. If representations and warranties are beneficial from the buyers’ point of view, the qualifiers or also known as “carve outs” lies in the sellers’ interest. After all, negotiating parties want to be in a win-win situation. We will discuss some of the typical representation and warranty clauses that are stipulated in purchase agreements and certain qualifiers that come with these clauses. The common thread which runs throughout the chapter is the important connection between representations and warranties and due diligence. In the end, we discuss the implications of these clauses when seen together with the due diligence exercise conducted by the buyer through two of the cases decided upon by the Indian courts which is then followed by a conclusion.
II.                Representation
The word “representation” is not defined in the Indian laws. Blacks’ law dictionary defines representation in similar terms as “A presentation of fact either by words or by conduct made to induce someone to act, especially, to enter into a contract.”[1] The most assertive take is that given in Model Stock Purchase agreement and Model Purchase Asset agreement both published by ABAs section of Business law which defines representations as “statements of past or existing facts.”[2] Looking at these positions, we can conclude that representation is a statement of fact about the past or present, which the person making it, asserts to be true to induce the other party to enter into a contract. An example of a representation is Hence, we can say that representations are sanctimonious to agreements and a breach thereof, provides the seller with multiple contractual and legal remedies.
Though, the laws in India do not provide for a definition of representation, the Indian Contract Act, 1872 under sections 18 and 19 does provides for what amounts to misrepresentation and the remedies for a misrepresentation. Section 18 of the Act lays down three situations that amounts to misrepresentation. First, any positive assertion of a fact, which according to the information available is unwarranted though, the person making it believes it to be true is misrepresentation. Second, any breach of duty which prejudices a party or anyone claiming under him so as to benefit the person making it and anyone claiming under him will amount to a misrepresentation and third, causing, a party to make a mistake as to the substance of the thing which is the subject of the agreement will amount to a misrepresentation. In both the second and third situation intention is not relevant.
Section 19 of the Act lays down the remedies for misrepresentation. These remedies are three-fold. It entitles the non-breaching party to, avoid a contract, claim specific performance and seek restitution for the unjust restitution by the other party. However, it must be noted that the entitlement to avoid a contract is not an unfettered right and section 19 provides for an exception to the general rule, i.e., that if misrepresentation or fraudulent silence is capable of being discovered by ordinary diligence by the aggrieved party, then the contract cannot be avoided by the aggrieved party.
III.             Warranty
Warranty, unlike a representation, is a promise of fact.[3] It is a contractual stipulation that the statements made with respect to the present and future condition is true and/or will hold true in the future. It is an assurance made by one party to another a promise of indemnity. It is a core term of the contract and is forward looking. Together with representations, it provides a guarantee to the buyer. When a warranty is given, the non-breaching party relies on the condition to remain the same during the warranty period, and it requires strict compliance by the party making the statement. In the Indian laws, it is defined under the Sales of Goods Act as a stipulation collateral to the main purpose of the contract, the breach of which gives rise to a claim for damages but not the right to reject the goods and treat the contract as repudiated.
IV.              Relevance of Representations and Warranties in M & A
It will be trite to state that the seller of any business will have more knowledge about it at any given time than any prospective buyer. The buyer, even if it conducts thorough due diligence will always be at an informational disadvantage and exposed to potential risks. This may also lead to a failure of the deal not to mention the amount of time and money the buyer invests in learning about the business of the seller. One way in which this situation can be avoided is that the parties allocate the risks among themselves. The buyer and seller can allocate this cost between themselves with the use of representations and warranties. Through representations and warranties, the seller can disclose information that he/she knows about the business and answer the buyer’s specific questions. By combining these representations and warranties, the buyer given a guarantee about the fact stated therein with respect to the target company and its promoters for an agreed amount of time. The buyer invests in the target company in reliance on these representations and warranties.
The specific representations and warranties are unique to each transaction and these conditions are included in the transaction agreement. Each of these items can be further described in detail in a supporting schedule or exhibit to the transaction agreement.[4]
The process of drafting a representation and warranty clause can be a tedious and time taking process. It involves several rounds of negotiations. The buyer will try to include as much information as possible in the representation and warranty clause and try to word it broadly. The seller on the other hand, will try to limit these clauses to a few specific issues since it exposes them to substantial liabilities.
However, the benefits of including a representation and warranty clause cannot be overemphasized. Some of these benefits are:
·         assisting the buyer in understanding the business it is purchasing
·         protecting the buyer from not having full insight into the business that it is purchasing, since, even the most experienced and resourceful buyer may also miss out on minute but important details
·         enabling the buyer to recover damages if the seller’s representations and warranties materially or fraudulently misrepresent the financial reality of the target business.[5]

V.                 Qualifications to a Representation/Warranty Stipulation
As stated above and seen in the last section, the seller seeks to narrow down the scope of representations and warranties because of the potential risks it exposes itself to if these later on turn out to be false or materially altered due to intervening events between the signing and completion period or post completion. Generally, the buyer would provide for contractual remedies for such events. The remedies range from broadly worded indemnity clauses, price adjustment clauses or termination. On the contrary, the seller will try and limit these exposures by negotiation certain qualifiers which exempts it from liability or diminishes the risks. The most common among them are discussed below: 
A.     Materiality Qualifier
A considerable amount of time passes between the signing date and the closing date. Between this intervening period, there may be a material change or an immaterial one which can prompt the buyer to change its mind about the deal. He may wish to recut the deal with the information. To ensure its remedies in such circumstances, the buyer often provides for price adjustments or termination clauses if the representation turns out to be false or inaccurate depending upon its impact. To prevent a buyer from walking away from the deal or claiming indemnity, the seller generally puts a materiality qualifier in the contract. A materiality qualifier is very significant from the seller’s point of view. These qualifiers allow for changes to a statement made if such changes do not affect the business or assets of the company significantly. There are numerous ways of stating the materiality qualifier. One such way is to include it in disclosure schedule with the qualifier that “the target company is not involved in any material litigation.” Another application is during the submission of the documents for due diligence to the buyer where only insignificant contracts with having no impact on value are not included. The question regarding such qualifiers is the way in which “materiality” is defined in the contract.
A.     Knowledge Qualifier
Another tactic which the seller uses to limit the scope of its representations and warranties is to include “knowledge” qualifiers. A knowledge qualifier limits the reach of a contractual provision so that the provision only applies to what the relevant party “knows.” An example of a knowledge qualified representation is: “The Seller has no knowledge of any breach or anticipated breach by the other parties to any Contract to which the Company is party” or “To the best of sellers’ knowledge, there are no………….,. A buyer’s agreement to a knowledge qualifier is not the end of the discussion. There are two principle negotiating points to a knowledge qualifier. First, whether the seller’s knowledge will be limited to actual knowledge or will it extend to constructive knowledge as well? Second, whether such knowledge is limited to the seller’s knowledge alone or does it extend to the knowledge of other persons? This depends upon how the knowledge qualifier is defined in the contract. The buyer will obviously try and enlarge the scope of the definition so as to include constructive knowledge and knowledge of other management personnel of the seller. On the other hand, the seller will try to narrow watertight and narrow definition of knowledge.
B.     Disclosure Schedules
The representations and warranties are in most cases qualified by a disclosure letter. Disclosure schedules serve as a road map for due diligence.[6] Anything listed on the disclosure schedule qualifies R & W. The disclosure letter lists out the facts that may contain exceptions to the representations and warranties. For example, a party may represent that “there are no outstanding debts save as disclosed in the disclosure schedule.” Hence, the representation made will be subject to the disclosure schedule. Sometimes, the information provided in the disclosure letter can prove to be contentious. An inaccurate disclosure schedule could result in significant liability to the selling company or its shareholders.[7] Hence, the parties need to be extremely careful and conduct thorough due diligence. Due diligence helps in identifying these facts and enables the buyer to make an informed decision. Representations and warranties and due diligence cannot be seen in isolation. None is a substitute for the other. A well-drafted disclosure schedule will provide substantial protection against post-closing allegations that the selling company breached its representations and warranties.
VI.              Typical Representation and Warranty Clauses
The opening words of a representation and warranty clause is generally “The buyer represents and warrants to the seller that …….. .” The specific representation and warranty conditions are unique to the subject transaction, depending on whether the transaction is in the field of telecom, pharmaceuticals, real estate, e-commerce, construction et. cetera.  They are tailor made according to the needs and wants of the parties. However, listed below are few typical clauses that generally fall under every agreement.
A.     Due incorporation, Organization and subsistence
“Due Incorporation” clause states that the target company was duly incorporated by taking all necessary steps as required by law and “due subsistence” clause states that the company is a going concern and has the ability to do business. “Due organisation” clause gives assurance about the organisational structure of the company and assures that the company and that organisational matters have occurred and that it complies with the requirements imposed by law such as issuance of shares, appointment of directors, board meetings etc.
B.      Due Authorization
“Due authorization” clause gives assurance to the buyer that the seller is duly authorised to contract and requires no further consent or authorisation of a third party or any governmental authority. It states that the agreement will be valid and binding on the person entering the contract according to its terms.
C.     No Conflict
A “No Conflict” clause basically tells that the transaction is not a breach. It gives the buyer an assurance that the execution and delivery of the contract will not be in contravention to any law, court order, judgement or decree, constituting documents (Memorandum of Association or the Articles of Association) of the company, its bye-laws and they do not interfere with the rights of any third party.
D.    Books and records
This clause basically tells that all the documents provided by the company such as books of account, minute books, stock record books and other records of the company are complete and correct in all respects and that nothing which is missed out will have a material adverse effect.
E.     Target company’s assets, such as real property, inventory, other tangible personal property, intellectual property rights such as trade names, trademarks, copyrights, patents and patent rights, trade secrets, and other intangible property.
These clauses pertain to the relationship of the vendor to the properties being sold, and the status of the properties themselves. It lists and states that the properties and assets of the company are free from any encumbrance and the seller holds marketable title to them. It also gives many assurances with respect to intellectual property rights. It states that the Seller’s company does not infringe any IPR rights such as trademark, trade name, patents and other intangible property or violates any license. It also states that it has entered into valid and binding agreements with employees who have helped in the development of intellectual property rights regarding confidentiality and proprietary information.

F.      All debts, obligations, and liabilities of the target company
This clause states that the seller has provided the buyer with all the current financial records prepared in the ordinary course of business and in accordance with the mandated accounting standards (For eg. Indian Accounting Standards). It states that the documents fairly present the financial position of the company and the company does not have any undisclosed liabilities except that what is disclosed in the disclosure schedules, that which is reflected in its balance sheet or liabilities that it may have incurred in the ordinary course of business since the date of prepared current balance sheet.
G.    Tax returns and audits of the target company
In a nutshell, this clause states that the company has filed all the tax return pursuant to applicable laws and regulations (Income tax Act, 1961 or GST among others) and there are no outstanding dues. The Company is not facing any liability with respect to any tax not assessed.
H.    Existing contracts
Such a clause generally gives a description of each and every material contract that the company is party to or makes a reference to the exhibit or annexure where such contracts are listed including employment contracts, government contracts and licensing agreements. It assures that the such contracts are validly entered into and are in full force and effect and that the company or the other contracting party is not in breach of it.
I.        Compliance with relevant authorities
This clause states that the company at present and in the past years has been in compliance with all applicable laws, permits and court orders. It states that except what is disclosed or set out in the agreement no written or verbal notice or claim exists in relation to the company, its affiliates, employees or shareholders.
J.        Existence of known or impending litigation
The litigation clause states that no, suits, actions, proceedings, investigations, claims or orders pending exist in the knowledge of the company or threatened against it or affecting the company or any of its properties or assets, any of the officers, directors or key employees of the company, or to which the company is otherwise a party, before any court, any municipality or any other governmental authority.
K.     Statement of full disclosure
It is a catch all clause wherein the Seller states that it is not aware of any fact, condition or circumstance that may materially and adversely affect the assets, liabilities, business, prospects, condition or results of operations of Seller or the Business that has not been previously disclosed to the Buyer in writing. Further, it states, that whatever it has stated is true, accurate and not misleading.
VII.          Case Studies
After having discussed the Representations and Warranties clause, it becomes important to understand the approach of the Judiciary towards these clauses. The buyer and the seller dynamic raise several important questions. The most pertinent among them being whether due diligence of the target company dilute the representations and warranties made by the seller which dilution is normally sought on the grounds of the above-mentioned qualifiers. Discussed below are few case laws which have shaped the Indian landscape in this regard.
A.     GWL Properties Ltd. (Formerly known as Gordon Woodroffe Ltd.) v. James Mackintosh & Company Private Limited[8]
In this case, the appellant sought to challenge an arbitral award made in favor of the respondents. The respondents took the help of the Bombay Consultancy Group (BCG) for carrying out due diligence exercise as a preliminary to acquisition of GWLL. BCG made a report. After the Due Diligence Report, further negotiations were held between the appellant and the respondent and finally a Share Purchase Agreement (SPA) was arrived at between the parties. As usual for these agreements, a few representations and warranties were given by the appellant to the respondent along with disclosure material which showed a large part of the outstanding debts were good. Later, it turned out that a substantial portion of the receivables were bad debts which the petitioner must have truly disclosed to the respondent. Appellant contended that since a detailed due diligence exercise was held by the group of consultants hired by the claimant and the due diligence report was available to the claimant before the signing of the SPA, it was not open to the respondent to allege that any documents or material facts have been suppressed. The relevant representation and warranty clauses in question was: “Clause 7.1-The Seller hereby represents and warrants to the Acquire that: (d) Financial Statements:- The Financial statements of the company have been prepared in accordance with generally accepted accounting principles in India applied on a basis consistent with that of the preceding period and present fairly in all material respects, the assets and liabilities and the financial position of the Company as reflected in the audited Financial Statements as on March 31, 2004. Excepting as otherwise disclosed or provided for in this Agreement there has not been any material change in the financial statements of the Company other than changes in the ordinary and usual course of business.
The Bombay High Court upheld the view of the Arbitral Tribunal which had discarded the submission of the appellant that all changes in the receivables was disclosed to BCG and would fall within Clause 7.1(d) of the SPA and the words “otherwise disclosed”. It said that the Tribunal was right in upholding that the appellant cannot get premium of its own wrong by relying the DDR which is a document of the respondent. The Arbitrators had found that as the loss is caused to the respondents because of inaccuracy, breach of representations and the warranties and, therefore, the appellant was bound by the indemnities contained in the SPA. Most importantly, the tribunal said that the importance of specific clauses and the representations so made in the agreement no way can be diluted at the instance of the Petitioner on the basis of BCG report which was prepared at the instance of the Petitioner.
B.     HSBC PI Holdings (Mauritius) Limited v. Avitel Post Studioz Limited[9]
In this case, HSBC had invested an amount of 60 million USD in Avitel, and entered into a share subscription and share purchase agreement with Avitel. The subscription agreement included a warranty from the promoters stating: “The information provided to the Investor prior to and during the preparation and negotiation of this Agreement was provided by the Company and the Promoters and/or its representatives and advisors in good faith and is true, accurate and not misleading.” Further, the agreement also confirmed that HSBC did not conduct an extensive due diligence and had relied on the representations and warranties given by Avitel contained in the agreement. It was HSBC’s specific allegation that Avitel had misrepresented that it was entering into a animation contract with BBC and had already entered into a Memorandum of Understanding with them which contract would have the effect of substantially increasing the  potential revenues to be generated in the future. According to HSBC, this was one of the main reasons that they entered into the contract with Avitel. Avitel on the other hand, claimed that extensive due diligence was done by HSBC. HSBC had initiated arbitration proceedings in against Avitel in Singapore and this was a petition for interim relief under S.9 of the Indian Arbitration and Conciliation Act, 1996 restraining Avitel to withdraw any amount from the purchase price.
The Court after perusing the terms of the contract recognized that it revealed HSBC did not have any opportunity to conduct an extensive due diligence into Avitel and had relied upon the representation and warranties given by them. Notably, the court also considered the undertakings given by Avitel at different meetings to be a part of the parties’ representations which gave HSBC an assurance that the contract formation between Avitel and BBC is in progress. It was also found out that in fact, the correspondence on record prima facie indicated that there was no meeting between Avitel and BBC and Avitel had misrepresented to HSBC about the contract. In the end, the court concluded that HSBC had good chances of succeeding in the arbitration proceedings and granted the interim relief.
VIII.       Conclusion
Representations and warranties serve an important function for any deal. Their importance cannot be overstated. They reduce the transaction costs, help in moving forward with the deal and mainly help to allocate risks between parties. Many purchasers are of the view that the necessity for due diligence is minimized where comprehensive representations and warranties are obtained. This is a dangerous belief.  It is of utmost importance, that the buyer does not take the representations and warranties at its face value as the proverbial saying goes that prevention is always better than cure.
Representations and Warranties have little significance after closing unless the purchaser has some form of hold back or other security. The most that he can expect from a representations and warranties clause is an action for damages or termination of the contract. Here, it is needless to say that any seller will not indemnify the buyer out of good faith. The fate of the purchaser then depends on whether he is successful in getting a judgement or an award in his award. The facts of the case leading to the dispute can be complex. In the backdrop of this, it may be the case, that billion-dollar companies do not bring out a claim to save itself public humility, time and the huge amount of money involved.
Another possibility maybe that the seller himself does not know about the true state of affairs or it is impossible for him to know every detail given the size of its operations. To make matters worse, there may be a communication gap between the people responsible for making these representations and warranties on the sellers’ side. In both these cases, the buyer will land up in trouble.
The qualifiers can complicate the matters further. An insertion of one qualifier or a broadly worded indemnification clause can cost their clients huge sums of money. For example, if the disclosure schedule contains an exception to the representation and warranty clause which if overlooked by the opposite party, can have the potential of incurring huge liabilities for it. Another example can be a clause in an agreement which says that the purchaser's rights in respect of breach of warranty should not be affected by any investigation made by it or on its behalf into the affairs of any group company (except to the extent that such investigation gives the purchaser actual or constructive knowledge of the relevant facts or circumstances). In such an instance, the buyer will not be able to claim later on that it did not have knowledge of a particular circumstance when in fact, the buyers’ accountant did do an investigation or the seller provided such material that would have the effect of resulting in the buyer having a constructive knowledge of  such circumstance.
Therefore, it is advisable that as far as possible careful due diligence should be done of the information provided in the representation and warranty clause. No material, whatsoever, that is provided during the course of negotiations should be overlooked. Due diligence and representations and warranties go hand in hand.

The author of the post, Aditya Prakash is a law student at Maharastra National Law University, Mumbai and currently intern at Corp Comm Legal under Mr. Bhumesh Verma.

[1] Garner, Bryan A and Henry Campbell Black. 2009. Black's Law Dictionary. St. Paul, MN: West
[2] Adams, Kenneth A. "A Lesson in Drafting Contracts: What's up with 'representations and Warranties'?" Business Law Today 15, no. 2 (2005): 32-37. Accessed April 8, 2020. www.jstor.org/stable/23295469.

[3] Id.
[4]  John C. Ramirez, Aaron M. Rotkowski, and Irina V. Borushko, The Importance of Sellers’ Representations in M&A Transaction Purchase Agreements, 18 Bankruptcy transactions and structure heights, 2014
[5] Weil, Frank, Hughes, and Wagner, eds., Litigation Services Handbook; The Role of the Financial Expert, 4th ed., 25-7 and Mergers and Acquisition Disputes (New York: American Institute of Certified Public Accountants, Inc., 2012), chapter 5.
[6]Mr Anshuman, Non-Disclosure by a seller- an analysis, The Practical Lawyer (Eastern Book Company).
[7] https://archanabala.com/2016/12/16/representations-and-warranties-in-the-context-of-ma-in-india/
[8] 2012 SCC OnLine Bom 404
[9] 2014 SCC OnLine Bom 102

  • To Read, Due Diligence: A practical overview by Anshul Ramesh and Avesh Harshan- PART-I, Click Here
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