Representations and Warranties in M&A Agreements: Structure, Risks, and Liability Limitations

30In mergers and acquisitions (M&A) transactions, the accurate identification of legal risks and asymmetries of information between the buyer and the seller is critical to ensuring the validity, transparency, and fairness of the deal. One of the key legal instruments used to achieve this objective is the set of “Representations and Warranties” (R&W) in the M&A agreement. These are not mere formalistic statements but serve as a foundation for risk allocation, information disclosure obligations, and legal grounds for indemnification in the event of a breach. This article analyzes the structure, purpose, potential legal risks, and liability limitations surrounding R&W provisions and offers practical recommendations for parties to M&A transactions.

1. Concept and Role of Representations and Warranties in M&A

Under international legal practice, a “representation” refers to a statement concerning past or present facts, while a “warranty” is a contractual assurance as to the truth and completeness of such statements. In M&A practice, the two concepts are typically merged into a comprehensive framework known as the Representations and Warranties clause.

These provisions are designed to:

• Establish the legal, financial, tax, labor, intellectual property, and asset status, etc. of the target company;

• Serve as legal grounds for the buyer to claim damages in case of breach;

• Create pressure on the seller to provide transparent disclosures;

• Support post-closing obligations, including risk remediation commitments.

2. Typical Structure of Representations and Warranties

A standard R&W framework usually comprises the following groups of provisions:

(i) Representation on legal status and right of disposition

• Legal establishment and existence of the target entity;

• Legal capacity of the seller to execute and perform the agreement;

• No violation of laws or third-party obligations.

(ii) Representations on Financial and Accounting Matters
• Financial statements prepared in accordance with accounting standards;

• Absence of undisclosed liabilities or loans;

• No material changes since the date of the latest financial statements.

(iii) Representations on Ownership and Assets

• Full ownership of shares or equity interests by the seller;

• Fixed assets and land use rights are not mortgaged or under dispute;

• Status of intellectual property rights: trademarks, software, patents, etc.

(iv) Representations on Labor and Employment

• Employee list, labor contracts, and existing labor disputes;

• Obligations relating to social insurance and personal income tax;

• Bonus policy, employee stock ownership plan (ESOP), and key personnel agreements.

(v) Representations on Litigation, Disputes, and Legal Compliance

• The target company is not subject to any ongoing lawsuits or administrative sanctions;

• No violations of laws governing environment, investment, competition, or securities.

3. Common Legal Risks Related to R&W Provisions

If R&W clauses are poorly drafted or improperly implemented, parties may face the following risks:

(i) Misrepresentation Risk

This arises when the seller provides false or misleading information. In such cases, the buyer may:

• Request for a declaration of contract invalidity pursuant to regulations on civil transactions entered into under deception;

• Initiate legal action for damages.

(ii) Unclear Duration of Representations and Warranties

Disputes may arise where the agreement fails to define the validity period of R&W (e.g., 12–24 months post-closing), leading to uncertainty regarding the applicability of indemnification mechanisms.

(iii) Ambiguity in the Burden of Proof

In some cases, the seller may argue that the loss was not directly caused by a breach of R&W, thereby obstructing the buyer’s ability to pursue indemnification. The agreement should clearly allocate the burden of proof between the parties.

4. Liability Limitations for Representations and Warranties

In practice, sellers often seek to include certain contractual limitations to mitigate post-closing liability risks:

• Minimum threshold (de minimis): Only claims exceeding this threshold are indemnifiable;

• Cap on liability: Typically set at a percentage (e.g., 10–30%) of the total transaction value;

• Claim period (survival period): After a certain period (e.g., 18 months), the seller is released from liability;

• Holdback or escrow mechanism: A portion of the purchase price is withheld to cover potential R&W claims.

5. Recommendations for Enterprises and Investors

To manage risks associated with R&W provisions, the parties should:

• Ensure comprehensive and transparent disclosure during legal and financial due diligence;

• Consider escrow or holdback arrangements, particularly when the seller is an individual or sole proprietorship;

• Engage legal counsel throughout the transaction. Legal experts can assist in drafting precise clauses, adjusting the scope and duration of warranties, setting liability limitations, and aligning R&W terms with applicable law and international best practices. They can also provide guidance on causation and damage proofing in case of disputes.

This article, titled “Representations and Warranties in M&A Agreements: Structure, Risks, and Liability Limitations” is presented by TNTP. Should you require further discussion on this topic, please feel free to contact TNTP for timely assistance.

Sincerely,