Representations and Warranties: Everything You Need to Know
Representations and warranties in business contracts provide facts (representations) and security against loss (warranties) if the statements made are not true.7 min read
2. Why are Representations and Warranties Important?
3. Reasons to Consider Not Using Representations and Warranties
4. Reasons to Consider Using Representations and Warranties
5. What Could Happen When You Use Representations and Warranties?
6. What Could Happen When You Don't Use Representations and Warranties?
7. Frequently Asked Questions
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 Beyond that period, the warranty is no longer in effect.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:
- Material contracts
- Compliance with laws
- Intellectual property
- Financial statements
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.
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.
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.
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.
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.
Frequently Asked Questions
- I signed a contract with representations of facts that I have found to be false. What can I do?
The warranties spelled out in the contract offer protection for false representations. Read your contract carefully to determine what your options are in the event that the representation is false. Most buyers can end the contract without penalty and sue for damages to recover any time and money spent on the transaction.
- My company has an expiring contract with a big customer. Should this be included as part of the representations and warranties in a contract with another customer?
Yes, because the contract with the other customer could impact the valuation of your company. It's important to be upfront about any changes to the company or value that could occur during the terms of any contract, in order to avoid legal action based on false representations.
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