Meaning
Contractual statements of fact and assurance made by one party to another at the time of executing an agreement establish the baseline conditions and allocation of risk for the transaction. Incorporating representations and warranties encourages the disclosing party to be transparent about its financial or legal status. The statements define the legal remedies available if any of the asserted facts prove to be false.
Risk Allocation
Contracting parties use these assertions to transfer the financial risk of unknown liabilities to the party best positioned to know the truth. Drafting detailed representations and warranties protects the buyer by forcing the seller to disclose material information, such as pending lawsuits, tax debts or intellectual property disputes. This allocation of risk is reflected in the final purchase price or contract terms.
Legal Remediation
Finding that a statement was inaccurate after the transaction has closed can lead to substantial financial losses and operational disruption. The breach of representations and warranties gives the non-breaching party the right to sue for damages or terminate the contract. This legal recourse ensures that the injured party is compensated for the difference in value.
Transaction Closure
Mergers, acquisitions and major supply agreements rely on the accuracy of these statements to proceed to completion. The verification of representations and warranties often requires the seller to produce disclosure schedules that list exceptions to the general statements, such as active contracts or minor disputes. This thorough process ensures that the buyer has a complete and accurate understanding of the assets or services being acquired, reducing the likelihood of post-transaction disputes.
