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What You Need to Know About Representations and Warranties in Mergers and Acquisitions

Posted By Administration, Monday, September 21, 2020

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By Robert J. Fisher, JD, ByrdAdatto

To many buyers and sellers, the stack of papers involved in a mergers and acquisitions (M&A) transaction can seem like a burden. Parties often zero in on the purchase price while disregarding long, dense parts of the agreement. In doing so, some of the most critical terms of the agreement can go overlooked, which can compromise the liability of either party, as well as decrease the value of the deal. Whether buyer or seller, particular attention should be paid to the following three sections of a purchase or sale document:

  1. Representations and warranties;
  2. Disclosures; and
  3. Indemnification.

These key sections work together, each influencing the other, to outline the promises being made and the protections in place if those promises are broken.

Representations and Warranties

Critical

to the agreement, the representations and warranties section details the assertions and promises made by both buyer and seller regarding the transaction. Claims to the valid existence of the company, the title to everything being sold, the authority to enter the transaction, and the existence or denial of any pending litigation or employee issues are all covered under this section. Ideally, sellers want this section to be as skinny as possible, meaning their assertions are kept to the minimum. The less the seller promises, the less the buyer can claim as an issue after the fact. On the other hand, buyers want it thick, offering a clear, exact picture of what is being purchased. A comprehensive set of representations and warranties prevent the seller from hiding negative facts that could damage the buyer after closing.

Disclosures

Disclosures serve as the exceptions to the assertions made under the representations and warranties. Generally, representations and warranties contain language that allow for certain disclosed items to be carved out. For example, one may state, “There is no pending litigation against the seller, except otherwise disclosed.” For a seller, the disclosures section is where they need to be up-front and honest. In fact, it is far better to over-disclose than to hide any issues. The more forthcoming the seller is on the front end, the less risk there is of a buyer claiming misrepresentation after closing. For a buyer, this is the time to take out the fine-toothed comb. Review disclosures carefully to determine any risks, issues or liabilities that may be inherited on purchase. Red flags found in disclosures may also indicate the need to adjust the purchase price or ensure better protection in the next section—indemnification.

Indemnification

Think of this section as the insurance policy between the parties for the transaction. Typically, the indemnification stipulates that one party must reimburse the other if any fact was not disclosed, therefore making a representation and warranty untrue. For example, if the seller makes claim to no pending litigation and fails to disclose a lawsuit against them, then they would need to reimburse the buyer for the cost of the lawsuit. It is in the best interest of the seller to ensure a limited indemnification section, thus barring any future compensation for items addressed in the previous two sections. On the flip side, a buyer wants a broad indemnification policy to protect against any issue not disclosed or promise misrepresented. Additionally, the buyer should ensure recompense for documented disclosures, such as prior standing litigation or employee disputes.

When involved with any kind of M&A transaction, it is critical to take time with the purchase and sale documents that structure the deal. It is the details of these agreements that preserve interests and provide critical protection from liability. Each of the above three sections play a crucial role in ensuring each party knows exactly what they are getting in the transaction, with no expensive hidden costs.

AmSpa members receive a complimentary 20-minute Introductory Compliance Assessment with a ByrdAdatto attorney. Click here to learn how to join AmSpa today!

Robert J. Fisher’s passion for health care traces back to his high school days of shadowing doctors. His passion evolved in college to study as a pre-med major. The last major evolution of Robert’s interest in health care was the transition to an interest in health care law. With this education, a business attorney for a father, and a renowned orthopedic surgeon for a father-in-law, Robert has the pedigree for success as a business and health care attorney at ByrdAdatto.

Tags:  Business and Financials  ByrdAdatto  Med Spa Ownership 

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