Reps & warranties…what the heck?!?

When reviewing, commenting and negotiating international commercial and financing agreements, the use of terminology can differ (extensively) from what we are used to in the Netherlands. During my studies, but even more so in working life thereafter, legal English terms have become a standard part of my vocabulary. When advising the key stakeholders in contracting within the companies I act for as in-house counsel, it sometimes becomes abundantly clear that the use and consequences of certain English legal terms is a bridge too far to fully comprehend.

For instance: warranties, representations and covenants. All similar in that they are forms of assurances provided by one party to another with respect to a transaction entered into between the parties. However, they do vary in the extent of the obligations that are imposed on the party making the assurance as well as in the remedies available to the party to whom the assurance is made, for breach of the assurance. This week, I was asked to look into a major (English law based) contract for one of my clients. The contract was entered into after a review with “Dutch law glasses on” and contained a serious number of reps and warranties. Some of them “easy to comply with”, others “impossible to comply to”, leaving the company with extensive risks and new challenges to ensure proper adherence to the contract terms.

Let’s take a closer look…

REPRESENTATION

A statement of fact which is relied on by the receiving party and that induces them to enter into the contract. It is normally before the contract but may be repeated in the contract as well.  A party may claim misrepresentation where a false representation has been made. They may be entitled to rescind the contract, meaning the contract would be set aside. In addition, the receiving party may also be entitled to damages, putting them back into the position they would have been had the contract never been entered into.

In the context of a finance transaction, a representation will often become a contractual term. Representations (and for the like warranties) in finance documents are statements which an obligor makes, in express terms, about itself and the circumstances of the debt or security. From the financier’s point of view, they set out the factual matrix on which it has agreed to make available the loan or accept security.

Although a breach of representation may entitle the person receiving the representation to a remedy for misrepresentation (for example, rescission) or breach of contract, in finance documents, such a breach also constitutes an event of default.

WARRANTIES

A warranty is a statement of a present fact, made in such a way that the giver of the warranty may be liable to the receiver if the statement is incorrect. In good English: you cannot “warrant” that you will do something (a future obligation) or that something will be the case in the future (a statement of future fact). That you should “undertake”. Nevertheless, warranties are often given in commercial agreements as statements of a future fact, e.g. a quality assurance that goods will comply with their description for a period of time after delivery.

The use of “warrants” in this sense has become commonplace and has the advantage over “undertakes” that terms as to quality etc can be easily placed in a single warranty clause and identified as such.

Warranties may be expressly set out in the contract (a warranty may be made that services will be provided to a particular standard). They may also come from statute or, alternatively, be implied by common law.

Generally, if the statement (warranty) made it is not true the receiving party has a claim for breach of contract.  If it is a fundamental breach the receiving party may have the right to terminate the contact in addition to a claim for damages.  However, unlike a claim for misrepresentation, the contract is not undone.

UNDERTAKING OR COVENANT

An undertaking is an agreement to do (or not do) something in the future. A contract might provide that you “undertake to” do something, or it might just say that you “shall” do it or that you “agree to” do it. These expressions in the end all mean the same thing: you are supposed to act according to what you have promised!

It’s a contractual statement that a party will do, or will not do, something during a period of time (often the term of the agreement).  An example of a positive contractual covenant is “Party A shall issue a press release announcing the relationship within 30 calendar days of the Effective Date”; a very common negative covenant is a non-solicitation provision under which a party agrees not to solicit employees of the other party for a period of time. The action or inaction will occur in the future, not at the time the covenant is made.  It is often related to, but not key to, a party’s performance under an agreement. Like a warranty, there are certain implied covenants read into every contract, such as the implied covenant of good faith and fair dealing.  Unlike a warranty, some of these implied covenants cannot be waived by the parties.

Like a warranty, a covenant is a part of the contract and not made to induce a party to enter into the contract. In the event of a breach of a covenant, in addition to compensatory damages for breach of contract, if the covenant is material enough it could excuse the future performance of the non-breaching party (e.g., the breach of covenant frustrates the purpose of the agreement such that continued performance no longer matters), and may give rise to a right of rescission similar to a breach of representation.  Further, unlike the breach of a representation or warranty, the breach of a covenant may give rise to injunctive relief or specific performance.

Finally, remember:  in many contracts, one class of indemnified claims is breach of representations, warranties and/or covenants which can result in broad indemnification of the other party. So always check your indemnification provisions to align usage of these terms in the entire agreement. In addition, make sure that the terms align with the third party claims for which you want to provide indemnification coverage to the other party!

(*Sources: – Thomson Reuters Practical Law, – Forbes: A Guide To M&A Representations And Warranties Insurance In Mergers And Acquisitions, 23 Jan 2019, – William Blackstone: Commentaries on the Laws of England (Book III of Private Wrongs, Oxford University Press 2016)

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