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This article is sponsored by Parsons Behle & Latimer.

One of the most important events in the life of a business owner is the decision to sell their business. The key legal document to accomplish such a sale will typically be an asset purchase agreement or equity purchase agreement. The largest section of any purchase agreement is almost always a list of representations and warranties made by the parties. Though both buyers and sellers will be required to make representations and warranties, the list of seller representations is often much more extensive.

Representations and warranties are contractually binding statements of fact made by one party to the other. For sellers, these statements typically concern the state of operations of their business and are meant to give buyers comfort that the business they are buying is consistent with what they believe it to be. For example, a seller might be required to represent that it is in compliance with all laws, that its financial statements are accurate, that it has paid all taxes due and that it is not involved in any litigation.

The initial draft purchase agreement prepared by a buyer or their counsel will typically include many representations and warranties that are styled as blanket statements, and it is up to the seller to determine whether it can make the representations as written or if it needs to negotiate any qualifiers or exceptions. In many instances, these exceptions will be disclosed in a schedule attached to the purchase agreement. For example, if a seller is not able to make a representation regarding compliance with law without exception, it might negotiate the representation to read as follows:

‘Except as set forth in Schedule 1.1, Seller has complied, and is now complying, with all laws applicable to the conduct of its business.’

Any instances of noncompliance with law would then be disclosed in detail on the schedule. If an exception or qualifier to a representation or warranty is disclosed in the purchase agreement or a schedule attached to it, a buyer will be deemed to have notice of it. Issues that are only orally communicated to a buyer but not listed on a schedule will typically not protect a seller from liability if the buyer later suffers loss as a result of the seller’s nondisclosure.

Full disclosure is critically important for sellers, as sellers will generally be required to reimburse a buyer for any losses the buyer incurs related to the breach of any representation or warranty. This obligation is referred to as ‘indemnification’. For certain key representations, a seller’s obligation to indemnify may extend indefinitely, and for other less fundamental representations, the obligation may only survive for a few months after the closing of the transaction. Because of these risks, sellers should carefully review each of the representations and warranties in a purchase agreement, negotiate any modified language that is necessary and err on the side of over-disclosure with regard to any exceptions that need to be listed in schedules.

Understanding the representations and warranties in a purchase agreement can be difficult, but taking the time to negotiate them and properly disclose any exceptions is key for a seller to successfully exit their business. This article is only meant to provide a high-level summary of some of the key issues involved in negotiating representations and warranties and consulting with an attorney is always advisable when negotiating the legal documents associated with a business sale.