Representations, warranties, indemnities and post-closing covenants
Scope of representations, warranties and indemnities
Does a seller typically give representations, warranties and indemnities to a buyer? If so, what is the usual scope of those representations, warranties and indemnities? Are there legal distinctions between representations, warranties and indemnities?
In general, Norwegian acquisition agreements are far less detailed than they are in most Anglo-Saxon jurisdictions. However, seller representations and warranties are now commonly included in most acquisition agreements in Norway. There may also be substantial differences between the representations and warranties in acquisition agreements where the buyer and seller are both Norwegian, and where the buyer is foreign. A seller will normally give both representations and warranties and, subject to the negotiating position of the parties, specific indemnities may also be given due to specific issues arising from the due diligence.
Warranties given by a seller typically address:
- power and authority;
- no conflicts;
- ownership of shares or assets and no encumbrances;
- ownership of subsidiaries;
- financial statements, management accounts (and locked-box accounts);
- finance and guarantees;
- no leakage;
- books and records;
- accounts receivable;
- intellectual property rights;
- conduct of business;
- customers and suppliers;
- no material changes;
- pensions and employee plans;
- labour disputes and compliance with labour laws;
- no change of control;
- ownership of real property;
- compliance with laws;
- insurance coverage;
- no insolvency or dissolution;
- no corruption or bribery;
- agreements with sellers or sellers’ related parties; and
- disclosed information.
If a company is sold in a structured sales process, the warranties offered by the sellers will normally have a narrow scope. Warranties offered by private equity funds in a structured sales process of their Norwegian portfolio companies could also be influenced by market practices in such fund’s home jurisdiction. A UK sponsor could, for example, attempt to limit its warranties to fundamental warranties (ownership of shares, valid execution of documentation, etc), at the same time requesting the buyer to rely on its own due diligence and, if possible, on business warranties provided by the target’s management team in a separate warranty deed. If, however, the seller is a Norwegian or Nordic private equity fund, such an approach has been less common.
A seller will normally attempt to agree that the sole remedy in cases of breach of warranties is damages, and that the buyer has to prove that it, subject to its duty to mitigate its damages, has suffered loss (that is, the value of the shares or the business acquired has been reduced) caused by the breach of the warranties. Sometimes, but less frequently, the parties may agree that a buyer is entitled to a reduction in the purchase price. Under the Sale of Goods Act, further remedies are available for breach of warranties, including a right to rescind the SPA in the case of a material breach. Normally, the parties will agree to contractually exclude the Sales of Goods Act, including any rights to rescind the SPA.
Subject to the parties’ bargaining position, specific risks revealed during the due diligence or disclosure may be subject to indemnities, since the buyer normally will be precluded from bringing a warranty claim in relation to a matter it is aware of at signing. Risks that a buyer may want to cover by indemnities could include costs of environmental damages, or the outcome of an ongoing or expected tax inspection or an ongoing litigation. It is not customary in Norway for a buyer to require the seller (or for a seller to accept) to give warranties on ‘an indemnity basis’ like in the US.
Claims for misrepresentation can result in damages on a tortious basis under the Norwegian Contract Act 1918, and a seller may attempt to exclude representations from the SPA.
Limitations on liability
What are the customary limitations on a seller’s liability under a sale and purchase agreement?
A seller will normally attempt to limit its aggregate liability under an SPA at a percentage of the agreed purchase price. Business warranty claims are typically subject to additional limitations, such as:
- a requirement of notice of a breach of warranty;
- time limits for bringing claims (which expires 12 to 24 months after completion);
- the exclusion of small claims (de minimis) and the prevention of claims until a specified threshold has been met (basket) for all claims exceeding the de minimis threshold; and
- a maximum cap on the seller’s financial liability, often between 15 to 50 per cent of the purchase price.
Fundamental warranties and tax warranties are often carved out of parts of the limitation regime.
In addition, a seller will normally also want to include more general limitations on its liability, such as:
- qualifying warranties by disclosure of all information contained in a data room;
- knowledge qualifications in warranties and materiality qualifications in warranties and covenants;
- recovery from third parties;
- rules on the conduct of claims from third parties; and
- prevention of double recovery: for example, the buyer cannot claim against the seller if the buyer can claim against an insurance company and get full recovery.
Is transaction insurance in respect of representation, warranty and indemnity claims common in your jurisdiction? If so, does a buyer or a seller customarily put the insurance in place and what are the customary terms?
The Norwegian M&A market has witnessed a substantial increase in the use of W&I insurance as a way to agree on liability under an SPA. This type of insurance policy is now very popular among sellers seeking a clean exit, and it has become common for sellers in structured sales processes to arrange ‘stapled’ buy-side W&I insurance to be made available to selected bidders. A seller may also want to propose the use of such insurance as a way to achieve a competitive advantage in a bidding process. This type of policy will not provide the policyholder with protection relating to specific indemnities that the parties agree as a result of any due diligence findings or disclosure by the seller. An insurance provider may, however, be willing to underwrite policies covering known and specific contingent risks relating to, for example, tax and environmental liabilities, but at a higher insurance premium.
W&I insurance policies will contain a set of general and specific exclusions depending on the target and its industry. Examples of general exclusions comprise liability and claims relating to:
- issues known to the policyholder;
- fines and penalties uninsurable by law;
- pension underfunding;
- transfer pricing; and
- fraud by the seller.
In addition, deal-specific exclusions are often included, and can comprise a wide variety of issues, for example, liabilities arising from the use of asbestos. Insurance brokers will state that it may take four to five business days to put such insurance in place; however, the parties should calculate between five to 10 business days as more realistic timing. It is common that the buyer wants to take out insurance coverage of only approximately 10 per cent to 20 per cent of the enterprise value of the company or business being acquired. The insurance community offers these insurance policies subject to a deductible in an amount equal to 0.5 to 1 per cent of the target’s enterprise value. The premium to arrange a policy has been decreasing in the past couple of years owing to fierce competition between the insurance companies offering such policies. The premium to arrange a policy will typically be between 1 and 2 per cent of the insured amount, but can in today’s market may also be lower than 1 per cent.
Do parties typically agree to post-closing covenants? If so, what is the usual scope of such covenants?
It is quite common that sellers must covenant not to compete with the company or the business to be sold. To be enforceable, any non-competition covenant must apply to a reasonable geographic area for a reasonable time period. Guidance states that a non-compete restriction can be justified for a period of up to three years where both goodwill and know how are transferred, but only two years where it is solely goodwill. Each transaction, and the protections sought, must be considered on a case-by-case basis.