Representations and Warranties

What Are Representations and Warranties?

Representations and warranties (often called "reps and warranties") are formal statements included in the definitive purchase agreement of a business sale. Representations are assertions of fact — "the company has no pending litigation." Warranties are promises that those facts are true — and that the seller will stand behind them.

Together, they form the legal foundation of trust in the transaction. If a representation turns out to be false, the buyer has grounds for a claim against the seller.

Why They Matter

Reps and warranties serve three purposes:

1. Disclosure mechanism. They force the seller to disclose material facts about the business — everything from outstanding lawsuits to tax liabilities to the status of key contracts.
2. Risk allocation. They define who bears the risk if something undisclosed emerges after closing. If the seller represented that all taxes were current but a liability surfaces, the seller is responsible.
3. Indemnification trigger. Most purchase agreements include an indemnification section that requires the seller to compensate the buyer for losses arising from breached representations.

Common Representations Made by Sellers

A typical purchase agreement includes representations covering:

• Organization and authority. The seller has the legal right to sell the business.
• Financial statements. The financials provided are accurate and prepared consistently.
• Taxes. All tax returns have been filed and all taxes paid.
• Contracts. All material contracts are disclosed, valid, and in good standing.
• Litigation. No pending or threatened lawsuits exist (or all are disclosed).
• Employees. Employee-related obligations (benefits, compensation, disputes) are accurately described.
• Intellectual property. The business owns or has rights to all IP used in operations.
• Compliance. The business complies with all applicable laws and regulations.
• Environmental. No environmental liabilities exist (relevant for manufacturing or real estate).
• Customer and supplier relationships. No material customer or supplier has indicated an intent to terminate their relationship.

Survival Periods and Indemnification

Reps and warranties do not last forever. They have survival periods — typically 12 to 24 months after closing — during which the buyer can bring a claim. Certain representations, such as tax and environmental reps, often have longer survival periods of three to six years.

The purchase agreement also sets indemnification caps (usually 10% to 20% of the purchase price) and baskets (a threshold the buyer's losses must exceed before a claim can be made).

Representations and Warranties Insurance

In larger transactions, buyers may purchase representations and warranties insurance (RWI). This policy covers losses from breached reps, reducing the seller's exposure and allowing more of the purchase price to be paid at closing rather than held in escrow. RWI has become increasingly common in deals above $10M.

Practical Advice for Sellers

• Be thorough and honest. Deliberately omitting a known issue is far worse than disclosing it. Undisclosed problems give the buyer indemnification claims.
• Use disclosure schedules. Exceptions to representations are listed in disclosure schedules attached to the agreement. If you know about a pending lawsuit, disclose it in the schedule.
• Negotiate scope carefully. Push for knowledge qualifiers ("to the seller's knowledge") where appropriate, and resist overly broad representations that go beyond what you can reasonably verify.
• Understand your post-closing exposure. Know the survival periods, indemnification caps, and escrow holdback amounts before you sign.