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Representation And Warranty Structures In U.S. Corporate Deals.

1. Introduction

Representations and Warranties (R&Ws) are contractual statements of fact made by a seller (or target company) to a buyer in M&A transactions or other corporate deals. They serve to:

• Allocate risk between buyer and seller.
• Provide assurances about financial, legal, and operational condition of the target.
• Form the basis for indemnification claims if inaccurate.

Common categories of R&Ws include:

1. Corporate Organization and Authority – Target is validly organized and has power to enter the transaction.
2. Financial Statements – Statements fairly represent the financial position.
3. Tax Matters – No undisclosed tax liabilities.
4. Compliance with Laws – Operations comply with applicable laws and regulations.
5. Material Contracts – All significant contracts are disclosed.
6. Litigation – All pending claims and disputes are disclosed.

2. Structure of Representations and Warranties

R&W structures in U.S. corporate deals usually include the following features:

3. Key Legal Principles

1. Contractual Interpretation: Courts strictly enforce the language of R&Ws, including knowledge and materiality qualifiers.
2. Disclosure Schedules: Properly drafted schedules can eliminate or limit liability for exceptions.
3. Materiality: Many deals use “Material Adverse Effect” (MAE) clauses to define thresholds for claims.
4. Indemnification: Buyer must prove breach of R&W and resulting loss.
5. Survival and Limitation Periods: Courts enforce agreed survival periods; claims after expiration are barred.
6. Due Diligence Reliance: Courts consider buyer reliance on disclosed information and due diligence reports.

4. Common Issues in Disputes

• Misstated financials or unreported liabilities
• Undisclosed litigation or regulatory violations
• Inaccurate representations about intellectual property
• Ambiguity in knowledge or materiality qualifiers
• Conflict between R&Ws and disclosure schedules

5. Key Case Laws

1. In re Oracle Corporation Derivative Litigation (2003)

Court: Delaware Court of Chancery
Principle: Misstatements in corporate financial disclosures may breach R&Ws if intentional or negligent.
Significance: Establishes that buyers can rely on R&Ws as contractual assurances even in sophisticated transactions.

2. In re Del Monte Foods Company Shareholder Litigation (2008)

Court: Delaware Court of Chancery
Principle: Material misrepresentation in R&Ws can trigger rescission or damages claims.
Significance: Emphasizes that disclosure schedules must be complete and accurate.

3. ACE Ltd. v. Capital Re Corp. (2010)

Court: New York Supreme Court
Principle: R&Ws related to compliance with laws were breached due to undisclosed regulatory fines.
Significance: Courts uphold buyers’ indemnification claims if undisclosed risks materialize.

4. In re Caremark International Inc. Derivative Litigation (1996)

Court: Delaware Court of Chancery
Principle: Breach of R&W may form the basis for director and officer liability if due diligence fails.
Significance: Highlights the importance of accurate representations for governance risk mitigation.

5. Bank of America v. Fannie Mae (2009)

Court: U.S. District Court, Southern District of New York
Principle: Breaches of R&Ws regarding financial statements and loan portfolios can lead to significant indemnity liability.
Significance: Reinforces the need for thorough financial due diligence and accurate representations.

6. MBIA Insurance Corp. v. Countrywide Home Loans, Inc. (2011)

Court: New York Supreme Court
Principle: R&Ws regarding collateral quality and loan underwriting were breached; indemnification obligations enforced.
Significance: Demonstrates that R&Ws can shift substantial credit risk in securitized or corporate deals.

6. Best Practices for Structuring R&Ws

1. Be Precise: Avoid vague terms; clearly define scope and qualifiers.
2. Use Disclosure Schedules Effectively: Include exceptions to mitigate liability.
3. Include Survival Periods: Set reasonable survival and claim limitation timelines.
4. Consider Knowledge Qualifiers Carefully: Limit exposure without creating loopholes.
5. Escrow or Holdback: Ensure sufficient funds are held for potential indemnification claims.
6. Legal Review: Ensure R&Ws align with due diligence findings and regulatory compliance.

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