Key Takeaways

  • Representations are statements of fact made before or during a contract's formation to induce another party to enter into the agreement. False representations can lead to misrepresentation claims and potentially rescind the contract.
  • Warranties are promises made within a contract that certain facts or conditions are true. Breaching a warranty usually results in a breach of contract claim, but it doesn't necessarily terminate the contract unless it's a condition.
  • Legal Implications: The breach of a representation can result in rescission or damages, while breaching a warranty typically leads to a claim for damages.
  • Distinction Between Warranties and Representations: Understanding the differences is crucial for effective contract drafting and risk allocation. Misclassifying these terms can lead to significant legal consequences.

What are Representations and Warranties?

Representations and warranties in business contracts provide facts (representations) and security against loss (warranties) if the statements made are not true. Representations and warranties may also be shortened to "represents and warrants" in a contract.

If the representation in the contract is found to be false, it is called "inaccurate," while a false warranty is considered breached. Representations always refer to past information, as it is impossible for a company or individual to present future information as factual.

Every contract between two parties includes representations and warranties. For example, if you decide to go to an auto dealership to buy a car, you would enter this transaction with several representations, such as:

  • The car is actually what the seller represents it to be, in terms of model and make
  • The dealership is legally authorized to sell cars to consumers
  • The car will actually work when used properly

The warranty made by the dealership is that all of these concepts are valid. If it turns out that one or all of these representations are not true, the contract to buy the car may be cancelled. Another warranty made by the seller might be to repair any defect that arose because of the misrepresentation.

But the warranty may not last forever. In this example, the seller or manufacturer of the car might offer a period that the unit will work without any defects. Beyond that period, the warranty is no longer in effect. However, some warranties do last for the life of the product. In this case, the buyer in the agreement can expect the seller to repair or replace the product any time it malfunctions.

Warranties help provide protection to consumers on products, and they are subject to federal laws and the Uniform Commercial Code. If the seller offers an extended warranty, it must protect the product beyond the initial agreement made between the buyer and seller. A warranty is a form of insurance and is subject to the same regulations per state laws and the parties involved.

Representations and warranties are commonly used in acquisition, joint venture, publishing, employment, and loan contracts. In a loan contract, the borrower involved in a financial transaction will provide representations and warranties to the lender as a way to convince the lender to issue a loan. But if the borrower's representation is no longer true, the lender can enforce the penalties spelled out in the contract.

In an acquisition or merger agreement, the company buying or acquiring the other company will likely want the other company to agree to a number of representations and warranties in the deal. These issues could include:

  • ERISA
  • Material contracts
  • Authority
  • Taxes
  • Compliance with laws
  • Intellectual property
  • Employment
  • Financial statements
  • Capitalization

In an agreement of this nature, the company acquiring the other party will typically limit the contract to a few specific issues to have it "narrowly drawn."  

The three main purposes of representations and warranties are:

  • To allow the buyer to gather information, learn as much as possible about the seller (or other company involved in the transaction), and make an informed decision
  • To support both involved parties by spelling out the framework for the penalties and course of action if the contract issuer's representations are found to be false
  • To protect the buyer and give him/her options to cancel or re-negotiate the contract terms before or after signing

Representations and warranties are especially important during the due diligence period, since this is the time that allows the signers to further investigate claims made before entering into the agreement. This section of a contract will also include an indemnification, or detail the protections and options given to the buyer in the terms.

Different laws might have different definitions of representations and warranties. But in loans and other contracts, representations refer to facts made by one party and warranties refer to the security for the involved party if the representations are not actually true.

The purpose of representations and warranties is to disclose information between the two parties. Those given by the seller in a business contract tend to be more extensive because they could include information about stocks, liabilities, assets, and any target companies involved in the transaction.

There are implied warranties and expressed warranties. Implied warranties fall within the restrictions of the Uniform Commercial Code, which means that all goods sold should be "fit for a specific purpose." Expressed warranties are included in written contracts and signed by both parties. If a buyer is trying to take legal action against a seller, it is easier to prove that the seller violated the terms of an expressed warranty than an implied warranty.

Key Differences Between Representations and Warranties

While both representations and warranties involve the presentation of facts in contracts, their key differences lie in their nature and legal consequences. A representation is a statement made about past or present facts, typically inducing the other party to enter into the agreement. For instance, a seller might represent that a product is free from defects. A warranty, however, is a promise that a certain fact is true, and it extends beyond just a statement of fact—it is a guarantee that the facts will remain true throughout the contract's life. A breach of warranty often leads to damages but not contract termination, unless the warranty is a condition.

Key Differences:

  • Representations: Statements of fact about the past or present.
  • Warranties: Guarantees about the truth of facts and often cover future performance or conditions.
  • Consequences of Breach: A false representation can lead to a claim for misrepresentation and contract rescission, while breaching a warranty typically results in damages.

Why are Representations and Warranties Important?

In a contract or business agreement, the representations and warranties act as assurances given by one party to the other. While the actual contract and terms of the agreement may differ, the ideas of representation of facts and warranty to protect the involved parties are the same across all contracts. A buyer should rely on these representations as fact unless proven otherwise. Representations and warranties used together serve as the best form of protection for a buyer.

Both buyers and sellers should note that exaggerating the good points of a product or service does not constitute a false representation. Salespeople are expected to "puff" their products or services to a certain extent to help make them more appealing. But if any of the information presented as fact is found to be an outright lie, it would constitute a false representation.

Understanding Legal Implications and Risk Allocation

The legal implications of misrepresentations or warranty breaches vary significantly, making it crucial for both parties to understand the distinctions. Representations that prove false may allow the affected party to rescind the contract and potentially seek damages, depending on whether the misrepresentation was fraudulent, negligent, or innocent. On the other hand, breaching a warranty typically results in a claim for damages, though it does not necessarily justify terminating the contract unless the warranty is considered a condition of the agreement.

Risk Allocation:

  • Representations and warranties allocate risk between parties. For example, if a seller makes false claims about a product (representation), the buyer may be entitled to rescind the contract and claim damages.
  • If a warranty is breached, the buyer may be entitled to damages but not contract termination unless specific conditions are met.

Reasons to Consider Not Using Representations and Warranties

Some companies choose to never include representations in contracts or agreements because using representations puts the company at risk of being sued for fraud. You may also find that contract drafters leave the words "representations and warranties" off  the contract to keep it concise and eliminate redundancy. Simply referring to the information as representations can also reduce wordiness of a contract while accomplishing the same goal, which is to protect the buyer and seller.

Reasons to Consider Using Representations and Warranties

Including representations and warranties in a contract helps to allocate risk between both signers. Representations and warranties also become the foundation for security and protection to terminate or amend the contract. If one of the representations made is inaccurate, the warranty included outlines the action that the one signer can take against the other. In most cases when a representation is false, the warranty allows the other person involved in the contract to terminate or decline the transaction.

When a lawyer or legal representative drafts a contract, he or she has a legal obligation to protect the client against risks while securing advantages that will come from entering into the agreement. With representations and warranties included in the contract, the lawyer can feel confident that the contract fulfills both of these responsibilities.

If one party involved in a contract intentionally makes a false representation, the other party can make a common law claim of deceit, also referred to as a tort. In order to qualify as a common law of deceit, the party must prove:

  • Conscious ignorance or knowledge of what makes the representation false
  • Intent to make the contract signer rely on the other
  • Justifiable reliance

Without proof of these elements, the claim will fail. If the contract issuer can prove that the other party knew about the falsity of the claim prior to signing, this will also cause the common law claim of deceit to fail in court.

How Representations and Warranties Mitigate Risk

By including representations and warranties in a contract, both parties ensure that key facts are verified and agreed upon. This acts as a form of risk mitigation, as false representations allow for rescission or damages, while warranties provide a clear path to recover damages for breaches. This can protect buyers from fraudulent or negligent misstatements and help sellers manage their liabilities. Additionally, warranties can cover future events, offering further security to the buyer.

What Could Happen When You Use Representations and Warranties? 

If your contract includes representations and warranties, they will help to protect you in case any of the claims made by the seller turn out to be false. The affected party can typically rescind or void the terms of the contract, then go on to obtain funds for recovery of the time and money spent as part of the transaction.

In some states, courts will use out-of-pocket measures to determine the damages when representations are false. The first way to measure damages limits the amount returned to the buyer. The measurement takes the amount the buyer paid for the item, then deducts what the item was worth. The resulting amount is what would be owed to the buyer in damages.

The second out-of-pocket measure to calculate damages looks at the benefit of the bargain. This method is more commonly used in violations of representations and warranties written into contracts. The formula for this method takes the value of the item as represented by the seller, then deducts the actual worth of the item.

Potential Remedies for Breach of Representations or Warranties

When representations and warranties are included in contracts, they provide specific remedies if breached:

  • Misrepresentation: If a representation is false, the party affected may seek damages or rescind the contract.
  • Warranty Breach: Breaching a warranty typically results in a claim for damages but does not automatically terminate the contract unless the breach is substantial enough to trigger a contract condition.

What Could Happen When You Don't Use Representations and Warranties? 

One of the problems that many people face in relation to representations and warranties is implied warranties and how well those are protected. In the event that your contract or agreement doesn't include a spelled-out warranty, it's hard to claim that the representations made don't come with some type of common law warranty. If a seller is making claims about a product or service, the buyer should have protection even if the warranty isn't clearly stated.

In one example of this struggle, CBS Inc. took legal action against Ziff-Davis Publishing Co. in 1990. CBS claimed that Ziff-Davis falsely represented and warranted the financial condition of a division that it would be selling to CBS. During the due diligence period, CBS had its accountants review all financial statements of that division. The accountants reported that the financial statements did not match up with what was represented and warranted in the contract, but CBS representatives signed anyway.

In this example, which went to the highest court In New York, the issue was whether or not CBS could state a breach of the warranted claims, as those involved in the transaction had evidence that they were not true. But in this case, CBS won the fight and could end the contract without penalty.

Not using representations and warranties at all in a contract could put you at risk for signing an agreement with invalid terms. However, there is still some implied protection, which is how CBS won its case against Ziff-Davis. 

Risks of Not Using Representations and Warranties in Contracts

Failing to include representations and warranties can expose parties to significant risks. Without clear representations, one party may later claim that the other party misrepresented critical facts. This can lead to legal disputes, particularly in the absence of a remedy. Implied warranties or common law protections may still apply, but they may not offer the same level of assurance as explicitly stated warranties. For example, if the product's condition or performance is not guaranteed, the buyer may have limited options for recourse in case of defects or failure.

Frequently Asked Questions

  1. What is a representation in a contract?
    A representation is a statement of fact made to induce the other party into entering the contract. If found false, it may lead to a misrepresentation claim.
  2. What is a warranty in a contract?
    A warranty is a promise that certain facts in the contract are true, with remedies available if the warranty is breached.
  3. How do representations differ from warranties?
    Representations are statements of fact made pre-contract, while warranties are promises within the contract itself, often guaranteeing future performance.
  4. What are the legal implications of a false representation?
    A false representation can lead to a misrepresentation claim, which may result in rescission or damages.
  5. Can a false representation lead to contract termination?
    Yes, a false representation can allow the affected party to rescind the contract, effectively terminating the agreement.

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