Most New York lawyers could probably sketch out the table of contents for an acquisition agreement for a business without much difficulty or disagreement. Somewhere in the front of the document there would be an article called “Representations and Warranties of Seller.” In a typical New York law-governed acquisition agreement, this article would contain detailed and heavily negotiated representations and warranties regarding the business to be acquired. It would be customary in the representations and warranties for the seller to make detailed statements regarding all matters of the target’s business and legal status, including that the company has been properly incorporated and is in good standing and concerning litigation, employees, taxes, real estate and environmental matters. The representations and warranties are included to assist the buyer in its due diligence process and help ensure that any pertinent facts regarding the business to be acquired are disclosed to the buyer before it commits to purchase the business. The representations and warranties also provide the buyer with a post-closing remedy against the seller should the representations and warranties prove to be inaccurate.
While the precise terms and conditions of the representations and warranties of the seller would be subject to negotiation and could vary significantly from deal to deal, there generally would be little or no negotiation between the buyer and seller regarding the inclusion of these provisions in the acquisition agreement. In an acquisition agreement governed by New York law, it is common market practice for a seller to make both representations and warranties. In contrast, in an acquisition agreement governed by English law, counsel for sellers and buyers would generally agree that it is standard market practice to provide solely warranties and to not make any representation with respect to the business to be sold. English counsel for a seller is vigilant in ensuring that none of the factual statements regarding the business to be sold are in any way described as a representation. What accounts for this difference? Are English and New York law so very different in what constitutes a representation or warranty or in how they treat representations and warranties? This Article takes a closer look at why New York and English law take very different approaches to including representations in acquisition agreements.
Representations and Warranties
The couplet “representations and warranties” has been repeated and read so many times by New York and U.S. lawyers in general that it is perhaps instinctively used without any thought as to its meaning. Many practitioners might assume that the words “representation” and “warranty” are synonymous, broadly meant to mark or indicate an assertion of fact. While this is generally true, the words do have distinct meanings.
Black’s Law Dictionary defines a representation as “a presentation of fact … made to induce someone to act, especially to enter into a contract” and § 159 of Restatement of the Law (Second) Contracts defines a misrepresentation as “an assertion that is not in accord with the facts.” Not all such assertions, however, can provide the basis for a claim for misrepresentation. Comment C to § 159 of Restatement of the Law (Second) Contracts provides that in order to be actionable as a misrepresentation an assertion must relate to something that is a fact at the time the assertion is made. Such facts include past events and present circumstances but exclude future events (Comment C to § 159 of Restatement of the Law (Second) Contracts).
Black’s Law Dictionary defines a warranty as “an express or implied promise that something in furtherance of the contract is guaranteed by one of the contracting parties.” According to Black’s, the four principal differences between a representation and a warranty are that (1) a warranty is an essential part of a contract while a representation is usually only a collateral inducement, (2) an express warranty is usually written on the face of the contract while a representation may be written or oral, (3) a warranty is conclusively presumed to be material while the burden is on the party claiming breach to show that representation is material and (4) a warranty must be strictly complied with while substantial truth is the only requirement for representation. In addition, because a warranty is a promise, unlike a representation, a warranty may extend to a future event.
If you listen carefully to a solicitor, you will begin to understand that it is not these or any other substantive differences between representations and warranties that he or she takes exception to. Rather, it is the difference in the remedies available to a plaintiff for a breach of a representation compared to the remedies available for a breach of a warranty that is the basis for the solicitor’s position that an acquisition agreement should include solely warranties and not representations. Specifically, the solicitor is concerned that by including both representations and warranties, a plaintiff would be permitted to rescind the transaction, whereas such a remedy would not be available if the agreement included solely warranties.
I think most U.S. lawyers would be sensitive to such a concern and would agree that under most circumstances it would not be appropriate for the buyer to have a rescission right in the event of a breach by the seller of a representation and warranty. In most instances, U.S. lawyers would likely agree that while the buyer should be permitted to sue for damages, the buyer should not be permitted to unwind a closed transaction.
What most U.S. lawyers might not appreciate, however, is that the distinction in remedies that forms the basis for the solicitor’s objection to include both representations and warranties in an acquisition agreement, is also present under the laws of most U.S. states. Yet, U.S. lawyers routinely include both representations and warranties in an acquisition agreement.
Claims for Misrepresentation and Breach of Warranty
A contractual claim for fraudulent misrepresentation has its origins in the common law tort of deceit, and in most U.S. jurisdictions a successful claim for fraudulent misrepresentation would provide a plaintiff with the right to rescind the contract. In order for a misrepresentation to be actionable as fraudulent, it must not only be consciously false but also be intended to mislead another (§ 162(1) of Restatement of the Law (Second) Contracts). In order to make a contract voidable, a fraudulent misrepresentation must have induced the recipient to enter into the contract. Finally, there needs to be a reasonable connection between the misstatement and the action taken in reliance on the statement — i.e., the recipient must have been justified in relying on the misrepresentation.
An assertion, however, does not need to be fraudulent to be a misrepresentation. In order for a misrepresentation that is not fraudulent to be actionable it must be a material misrepresentation. A misrepresentation is material if it would be likely to induce a reasonable person to manifest his assent, or if the maker knows that it would be likely to induce the recipient to do so (§ 162(2) of Restatement of the Law (Second) Contracts). If a party enters into a contract based on a material misrepresentation, and the party is justified in relying on such material misrepresentation, then the contract is voidable.
Breach of Warranty
In contrast to a claim for misrepresentation, a successful claim for breach of warranty, which is in essence a contract claim and not founded on tort, would provide a plaintiff with a cause of action for money damages but would not allow the plaintiff to rescind the contract.
So if English and New York law are both the same in permitting rescission for a misrepresentation but not for a breach of warranty, why do New York law acquisition agreements routinely include both representations and warranties but English law acquisition agreements include solely warranties?
Some commentators have noted that this English hypersensitivity to the word “representation” may be misplaced. They note that whether or not a party has a valid claim for a misrepresentation (under English or New York law) should have nothing to do with whether the statement in question was identified by the parties as a representation, warranty or anything else. Rather, the availability of the remedy of rescission should be available if the plaintiff is able to prove the prima facie elements of a misrepresentation claim, regardless of whether the statement was identified as a representation or warranty. For example, assume a seller of a business stated in an acquisition agreement that the business to be sold had all the permits necessary to carry out its business as currently conducted, but this statement was identified neither as a representation nor a warranty. Absent another provision of the agreement that specifically excluded the right to rescind the contract, if this statement later turns out to be false, the purchaser should be able to rescind the contract so long as the purchaser is able to prove each of the elements of a claim for misrepresentation. Should the result be any different if the acquisition agreement labeled the statement as a “warranty” and not a “representation and warranty”? So long as the acquisition agreement did not specifically exclude the remedy of rescission, then a good argument can be made that the result should not be any different. Accordingly, the important fact is not whether or not the assertion was labeled a “representation,” “warranty” or “representation and warranty” but rather whether or not the acquisition agreement contains additional language that operates to exclude the remedy of rescission.
Most New York law-governed acquisition agreements generally include a provision intended to exclude certain rights and remedies. Just as it is common in a New York law acquisition agreement to have an article dealing with the representations and warranties of the seller, it is just as common to have an article dealing with indemnification. In addition to agreeing to indemnify the buyer for liabilities arising out of certain specified events or risks, the indemnification article also generally provides that the seller will indemnify the buyer for losses arising out of a breach of the seller’s representations and warranties. The indemnification article will also generally contain a provision pursuant to which each of the seller and buyer agrees that its sole and exclusive remedy with respect to any claims arising out of the acquisition agreement will be pursuant to the indemnification provisions contained in the indemnification article. This provision usually goes on to include a specific waiver by the parties of any and all other rights, claims and causes of action that they might have against the other party, except pursuant to the indemnification provisions set forth in the indemnification article. Accordingly, in most New York law acquisition agreements it can be argued that the parties agree that the remedy of rescission will not be available.
Whether or not, or under what circumstances, the remedy of rescission would be available would to a certain extent depend on the exact wording of the waiver language. For example, in many instances a purchaser would insist that the waiver not apply to, and request the waiver to specifically exclude, claims with respect to fraud. Accordingly, in such an instance, if the waiver did not extend to claims with respect to fraud the remedy of rescission might be available for a claim based on a fraudulent misrepresentation but not be available for a claim based on material misrepresentation. Even in certain jurisdictions, where the waiver does not exclude claims with respect to fraud, however, courts have held that public policy prevents a seller from contractually insulating itself in an acquisition agreement from claims by a buyer for rescission due to intentional misrepresentations concerning the business or assets being sold and included in the acquisition agreement (See e.g., ABRY Partners V, L.P. et al. v. F&W Acquisition LLC et al., 891 A.2d 1032 (2006)).
If the waiver language typically included in the indemnification article of a New York law-governed acquisition agreement effectively excludes the right to rescission, then in reality, a typical English law-governed acquisition agreement (which includes only representations) and a typical New York law-governed acquisition agreement (which includes both representations and warranties and a specific waiver of any rights or remedies other than those pursuant to the indemnification provisions contained in the acquisition agreement) would lead to the same result — the unavailability of the remedy of rescission. Of course, this might not always be the case and the extent to which rescission would be available would depend on the waiver language ultimately agreed to between the parties and whether the relevant jurisdiction permits a waiver for intentional or fraudulent misrepresentation. The fact, however, that most New York law-governed acquisition agreements include this type of waiver language helps to explain the different treatment of representations and warranties in acquisition agreements governed by New York and English law.