Article about representations and warranties 1

1               What are Representations and Warranties Clauses?

Representations and Warranties is where a party in a contract promises the other party that the facts or legal related matters of the object of the contract are true and accurate, at the time or prior to entering into the contract.
There are two main provisions, which are provisions relating to the parties and provisions relating to the Target Company. Provisions relating to the parties include, for example, authority to enter into a binding contract, validity of the contract, and non-existence of relationship with anti-social forces and organized crime organisations. Provisions relating to the Target Company include non-existence of insolvency proceedings, accuracy of financial statements, non-existence of contingent debts and so forth. Many of these provisions are widely applicable to the scope of Due Diligence (“DD”).

2               Examples

Below is an example of a Representations and Warranties Clause by a Seller towards the Buyer in a Share Purchase Agreement. Clause 8.1.1 is a Representation of the Seller/Shareholder of the Target Company. Clauses 8.1.2 and 8.1.3 are Representations regarding the Target Company.  

Clause 8(Representations and Warranties)
8.1The Seller represents and warrants that the following clauses are true and accurate in all material aspects as of the date of this Agreement.
8.1.1Seller’s power and capacity
(i)  The Seller has been incorporated in accordance with and under the laws of Japan, and is a company limited by shares, which is validly existing in good standing.
(ii)The Seller has full power and authority to enter into this Agreement, and such act is within the Seller’s objects clause of the Seller. The execution, delivery and performance by the Seller of this Agreement have been duly and validly approved by the Seller’s Board of Directors and by all shareholders of Seller entitled to vote thereon, and no other actions or proceedings on the part of the Seller are necessary to authorize this Agreement. 
(iii) The Shares in the Target Company have been duly authorized, validly issued, and fully paid up, and are owned, legally and beneficially, by the Seller, which has the full authority to transfer the Shares. The Seller will transfer such Shares, free and clear of any and all Encumbrances, to the Buyer.

8.1.2Target Company
The Target Company is a company duly organized and validly existing in good standing under the laws of its jurisdiction of incorporation.

8.1.3Target Company’s Financial Statements
(i)The Financial Statements of the Target Company which have been submitted to the Buyer is valid, complete, and up-to-date authentic copy.
(ii) the Financial Statements present fairly in all material respects the financial position, assets and liabilities of the Target Company as of the dates thereof and the revenues, expenses, results of operations and cash flows for the periods covered thereby, in each case in conformity with the accounting standards which are widely adopted in Japan. The Financial Statements has not been materially affected by any special, exceptional or non-reproducible circumstance that may affect the financial position of the Target Company.

3               Purpose of Representations and Warranties Clause

In an M&A transaction, the buyer will conduct DD on the target company to gauge the value of the assets as accurate as possible. However, there is a limit to DD because there exists an information asymmetry on the Target business between the seller and the buyer which cannot be overcome. Hence, from the buyers’ perspective, the buyer can avoid risks on certain aspects if the seller were to warrant for such provisions which could not be covered in DD. On the other hand, it would also be advantageous to the seller if they were to make Representations and Warranties as this would make the buyer feel more at ease, therefore avoiding unnecessary negotiations on price reduction. Therefore, there are advantages for both parties in using Representations and Warranties clause.

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