When a business sells substantially all of its assets, the Asset Purchase Agreement will contain a section containing representations (“rep” for short) and warranties. These are generally styled as statements of fact concerning various important aspects of the assets and the transaction. Generally, the seller provides the majority of reps and warranties (although the buyer will often “sign off” on a few).

The reps and warranties are intended to be relied upon by the party “receiving” the reps and warranties. Indeed, the Asset Purchase Agreement will specifically state that the reps and warranties are being relied upon. For example, something like the following statement will be included: “Seller warrants and represents to Buyer the following, intending to induce Buyer’s reliance and understanding that the Buyer will rely thereon: …”

Reps and warranties offer a level of confidence because, if the reps and warranties turn out to be false, then there are legal remedies. These legal remedies include bringing suit for fraud, which might involve nullifying the entire transaction and putting the parties back in their “original positions.” The legal remedies also include filing claims for breach of warranty. The reps and warranties are also often relied upon by others, including those entities or third parties that are financing the purchase, providing insurance coverage, or engaged in other services related to the transaction.

Reps and warranties also assist in the due diligence process leading up to the consummation of the transaction. Many reps and warranties are common and expected. As one example, most Asset Purchase Agreements will contain some rep/warranty about litigation or administrative actions. The representation might be phrased as follows:

“There is no suit or action, legal, administrative, arbitration or other proceeding or governmental investigation affecting the Assets pending, or threatened against Seller that materially or adversely affects the Assets.”

If the Seller refuses to agree to this representation, that is a “red flag” that suggests a lot of due diligence is needed to determine if there are pending lawsuits or other proceedings. The Seller may also want to modify the representation by adding the phrase “to the best knowledge and belief of Seller.” That is less concerning but still suggests that more due diligence is needed on this potential issue.

There are a number of commonly included reps and warranties in Asset Purchase Agreements. These might even be called “boilerplate.” These include reps and warranties about:

• Corporate authority
• Ownership of the assets and good title
• Assets being free from liens and encumbrances
• Non-infringement — if the assets involve intellectual property
• Quality and quantity of assets
• No material change in assets from the signing of the Asset Purchase Agreement to closing
• Brokers and fees
• Insurance — coverage, past and current claims related to the assets
• Compliance with laws
• Payment of taxes
• Litigation and other similar proceedings with respect to the assets

Contact the Business Attorneys at Revision Legal For more information, contact the experienced Business Lawyers at Revision Legal. You can contact us through the form on this page or call (855) 473-8474.

Survival Periods and Indemnification: Post-Closing Enforcement

Representations and warranties would be meaningless without a mechanism for enforcing them after closing. That mechanism is the indemnification provision — the most heavily negotiated section of virtually every Asset Purchase Agreement. It specifies: (1) the survival period during which claims can be brought; (2) the minimum damage threshold before a claim can be brought (the “basket” or “deductible”); (3) the maximum aggregate exposure (the “cap”); and (4) the procedure for asserting and resolving claims.

Survival periods vary by type. “Fundamental” representations — authority, ownership of assets, capitalization — typically survive for the full statute of limitations period, often six years. General representations survive for 18 to 36 months after closing. Tax and environmental representations often have longer survival periods tied to the applicable regulatory limitations period.

The basket can be structured as a “true deductible” (the seller is only liable for damages above the threshold) or a “tipping basket” (once damages exceed the threshold, the seller is liable from the first dollar). Sellers prefer the true deductible; buyers prefer the tipping basket. Caps on general representations are typically 10 to 20 percent of the purchase price, while fundamental representations and fraud are usually uncapped.

Specific Representations Commonly Negotiated in Asset Purchases

• Intellectual property representations. The seller represents that it owns or has the right to use all IP embedded in the assets, that the IP does not infringe third-party rights, that all registrations are current and valid, and that no third party has asserted an infringement claim.
• Material contracts. Sellers represent that all material contracts are valid, binding, and not in default, and that the sale does not trigger any change-of-control or anti-assignment provisions — critical when the value of the assets includes customer contracts with assignment restrictions.
• Employee and labor matters. Sellers represent the absence of pending claims under the FLSA, ERISA, or state wage statutes, and compliance with immigration requirements for the workforce.
• Environmental representations. For asset purchases involving real property or manufacturing operations, these address compliance with CERCLA, RCRA, and applicable state environmental laws, and the absence of known hazardous substance releases.
• Financial statements. Sellers represent that financial statements have been prepared consistently with GAAP (or past practice), accurately reflect the financial condition of the assets, and that no material adverse change has occurred since the most recent balance sheet date.

Representations and Warranties Insurance

Representations and warranties insurance (RWI) has become increasingly common in middle-market M&A transactions. RWI allows the buyer to purchase an insurance policy covering losses from breaches of representations and warranties, shifting risk from the seller’s indemnification obligation to the insurer. This is attractive to sellers who want a clean exit and full release of post-closing liability.

A buy-side RWI policy typically requires a retention of approximately 1 percent of deal value and covers up to 10 percent of the purchase price in losses. Coverage is subject to underwriting exclusions — typically for known breaches, environmental matters, and certain tax matters. Premium rates generally range from 2 to 4 percent of the policy limit. When RWI is used, the parties often agree to a significantly reduced seller indemnification obligation, which changes negotiating dynamics around the basket, cap, and survival period substantially.

Revision Legal’s business attorneys guide buyers and sellers through all aspects of asset purchase agreement negotiation, including representations, warranties, indemnification, and escrow arrangements. If you are buying or selling a business or its assets, contact us at (855) 473-8474.