#3285 - Risk Allocation Crib Sheet - Mergers and Acquisitions (Private Acquisitions)

Risk Allocation: Warranties, Indemnities & Representations

1. What does buyer want and why?

   1. Reassurances about the nature & state of the company/business it is acquiring and some possibility of recompense if the acquisition turns out to be other than expected

   2. Protections are not implied into a contract and therefore the general law affords very limited protection to a buyer

      1. Share Purchase

         1. Principle of caveat emptor applies (Buyer Beware)

         2. Buyer will be inheriting indirectly all the liabilities of the target company, whether it knows about them or not

         3. In the absence of express provisions, an aggrieved buyer has very little comeback on the seller unless a misrepresentation can be established

      2. Asset Purchase

         1. Buyer may get the benefit of some limited warranties under SOGA 1979

         2. Buyer cherry picks the liabilities he inherits

         3. Still will want additional express safeguards in the SPA

2. Warranties

   1. Contractual statements about what is to be acquired

   2. Helps elicit information about the business from the seller

   3. Imposes a legal liability upon the sellers and provides the purchaser with a remedy if statements prove to be incorrect and the value of the company is reduced

   4. Damages

      1. Put the buyer in the position it would have been in had the contract been properly performed (contractual damages), subject to the duty to mitigate

         1. Buyer’s loss will be the difference in value of the shares if the warranty had been true & their actual value

      2. Hadley v Baxendale loss will be recoverable if it is not too remote

         1. Loss which flows naturally from the breach

         2. Loss which was fairly & reasonably in the contemplation of both parties, at the time they entered into the contract, as the probable result of the breach

   5. Tax

      1. If liability crystallises, an adjustment will be made to the price of the target for capital gains purposes

         1. Consideration the seller received on completion will be reduced by the amount paid under the warranty claim

   6. Who may be unwilling to give warranties

      1. Minor shareholders

         1. May not want to be exposed to risk of joint & several liability

      2. Trustees

         1. Will not want to be exposed to personal liability

         2. Often limit trustees’ liability to net value for the time being of the trust capital

         3. On completion, when the capital is distributed to the beneficiaries, have the beneficiaries give the warranties

      3. Large shareholders with no management in target company

         1. Cannot be expected to give promises in relation to matters about which they know nothing

3. Representations

   1. Replies to a range of questions affecting the target & its business

   2. Misrepresentation is a false statement of fact made by one party to the contract to the other, which induces the other party to enter into the contract

   3. Remedies

      1. Rescission

         1. Aims at putting the parties back into the pre-contract position

         2. Equitable remedy so not always available

      2. Damages

         1. Court has discretion to award

         2. Can be awarded in lieu of rescission, but the right to rescind must not have been lost

         3. Negligent & fraudulent misrepresentation are assessed on a tortious basis aiming to put the innocent party in the position they would have been in had the tort not been committed

            1. If the buyer had not entered into the agreement

4. Indemnities

   1. Promise from the seller to reimburse the buyer in respect of a designated type of liability which may arise in the future

      1. Court will assess whether the specified event occurred and how much should be paid to fix the problem, by reference to the terms of the indemnity clause

      2. An indemnity paid will be a gain for CGT purposes (right to claim a chose in action) so the buyer should include a grossing-up clause such that the indemnity will be paid by the seller with the tax on top

5. Limitations to Seller’s Liability

   1. Entire Agreement Clause

      1. An attempt to exclude liability for misrepresentation of anything that led the parties to enter into the agreement, stating that the contract sets out the entire agreement between the parties

         1. Thomas Witter v TBP Industries the clause in itself with not exclude liability for misrepresentation, rather an express clause must be included BskyB

   2. Non-Reliance clause

      1. Acknowledgement that buyer has not relied on any representations made outside the agreement

      2. Clause must be reasonable

         1. Never reasonable to exclude liability for fraudulent misrepresentation

      3. In order to rely on the clause as evidential estoppel the seller must show (Watford Electronics)

         1. Provision acknowledging non-reliance is clear and unequivocal

         2. Buyer intended seller to act...