Mitigating Contractual Risks: Representation And Warranties
Representations and Warranties are legal devices to minimize the inherent risks involved in any business relationship
Entrepreneurs are often excited to partner with someone else to launch a new product or services, as long as the new business relationship does not bring new risks and issues. To this effect, at Cea Legal, we are always asked to do everything possible to reduce new unforeseen risks. Our answer relies on drafting comprehensive and clear “representation and warranties” clauses. In simple words, “representation and warranties” are statements regarding past and future performances, targets, and situations. For instance, our client might inform us that they are purchasing a company on the assumption that the business will give our client access to a specific geographic area. We will make sure that the Seller represents that the company has clients from the desired location. If this turns out to be untrue, our client will have a contractual tool to ask for damages.
A thorough business due diligence is necessary before signing a binding agreement. This process helps the business attorney ascertain current business conditions, thus drafting accurate and balanced assurances for the future. Provided that each transaction is different, common due diligence items that we at Cea Legal suggest our client to conduct on the other party are the financial status, the existence of liabilities, compliance with legal requirements to provide services or to sell goods, the extension or potential violations of third parties of intellectual property rights.
One of the most critical aspects to draft effective “representations and warranties” clauses is to avoid “boiler-plate” language. To achieve this and therefore to customize the contractual clauses, it is imperative to fully understand our clients’ business operations and goals. This is why we demand that our clients outline business details of the transaction: the most important key-terms, the biggest obstacles envisioned, the targets intended to achieve, and the importance of closing this specific deal. Based on these “inputs”, we decide to be more or less aggressive in our requests to the other party.
Representations and warranties clauses can vary considerably depending on several factors, such as the nature of the transaction and the negotiation power of each party. Some of the most common representations and warranties provided for in commercial agreements are the authority of each party to enter the transaction, the accuracy of the financial statements disclosed, the existence of any pending or threatened litigation, compliance with applicable laws, and the possession of any license to conduct business, the ownership of intellectual property and/or trade secrets, details regarding material contracts and existing customers.
Surprisingly, many seasoned entrepreneurs neglect requesting strong representations and warranties from the other party. However, the excitement for closing a deal quickly and the understandable desire to limit legal fees before starting the new business relationship could and does cause significant subsequent damages and waste of resources. With our flexible and practical approach, at Cea Legal, we are able to offer strong contractual protections to our clients, without getting stuck in long negotiations.
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