Breach of Representations and Warranties in M&A: A Buyer’s Guide

following guest post is contributed by
Goda A. Raghavan
and Kirthi Srinivas
, who are advocates with HSB
Partners, Chennai and can be contacted at and
respectively. Views are personal and do not represent the views of the firm.]
price in a mergers and acquisitions (M&A) transaction is normally fixed
after factoring the risks and liabilities that are being incurred by the buyer.
Such risks and liabilities are arrived at after a thorough financial and legal
due diligence. Nevertheless, as Ronald Reagan famously said “Trust, but
verify”, the buyer demands numerous representations and warranties as a means
of assurance relating to several facets of the seller or target company in the
definitive documents. Definitive documents in such transactions are usually an
investment agreement, a share purchase agreement or a business transfer
Indian Contract Act, 1882 (“Act”) provides for consequences in case of
misrepresentation and breach of warranties. Section 19 of the Act states that
in the event an agreement has been entered into by coercion, fraud or
misrepresentation, the aggrieved party has the following remedies:
contract shall be voidable at the option of the aggrieved party.
aggrieved party may require specific performance.
shall be a restitution for unjust enrichment by the parties.[1]
It must
be noted that the power to avoid a contract is not an unfettered right and section
19 of the Act provides for an exception to the general rule, i.e., that if
misrepresentation or fraudulent silence[2] is capable of being
discovered by ordinary diligence by the aggrieved party, then the contract
cannot be avoided by the aggrieved party.
term “ordinary diligence” is not defined under the Act. However, in the case of
Erie Bank vs. Smith,[3]
the phrase “ordinary diligence” has been interpreted to mean “that degree of care which men of common
prudence generally exercise in their affairs, in the country and the age in
which they live. These last words are quite material quite important, in this
case i.e. “in the country and the age in which they live” thus, what might be
ordinary diligence in one country, be negligence, even gross negligence in
another country, be negligence, even gross negligence
on this interpretation, a due diligence may diminish the ability of the buyer
to claim for any remedy under law or the definitive documents upon discovery of
breach after the transaction has been concluded. The same would apply in the
case of a disclosure letter provided by the seller. Two judgments of the
English Courts worth mentioning in this regard are New Hearts Limited vs. Cosmopolitan Investment Limited[4]
and Infiniteland Limited vs. Artisan Contracting Limited.[5]
In the New Hearts case, warranties were given
in a share purchase agreement as being subject to “matters fairly
disclosed (with sufficient details to identify the nature and scope of the
matter disclosed) in the disclosure letter
”. The Court laid down a qualitative test, which was
broad in its scope and required the seller to disclose the matter fairly and in
sufficient detail. However, the Court of Appeal, in the Infiniteland case, rejected the qualitative tests and observed that
adequacy of disclosure must be measured against the requirements of the share
purchase agreement executed between the parties and not against the requirement
of any general common law concept of “fair” disclosure. It also observed that
whether a buyer’s knowledge prejudices its ability to bring a warranty claim
depends on how this is expressed in the share purchase agreement.
The practical implication of the
aforementioned judgments are that the buyer seeks fair and sufficient
disclosure to identify the nature and scope of the matter disclosed or seek a
specific disclosure against specific warranties. Another qualifier in the
definitive document is “what would constitute buyer’s knowledge, considering
that due diligence is generally outsourced to a law firm or to chartered
accountants. Therefore, “knowledge of consultants and advisers” are excluded
from the “buyers knowledge”.
Be that
as it may, to protect the interest of the buyer, an indemnity clause is
inserted in definitive documents as protection from any losses that may be
incurred despite knowledge of certain facts. This post lists out certain mechanisms adopted by
a buyer in case of breach of any of the representations and warranties, in
addition to any remedy available under law:
1.     Indemnity
contracts as defined under section 124 of the Act are contracts by which one party promises to save the
other from loss caused to him by the conduct of the promisor himself, or by the
conduct of any other person. It
is the most common form of protection
sought by the buyer.
may be uncapped in monetary limit and without any time period restriction.
Parties may negotiate a time period restriction or a monetary limit for claim.
(a)        To the advantage of the seller, monetary
limits in terms of the indemnity amount i.e. de-minimis threshold (being the minimum amount of accrued claims
above which the indemnity may be enforceable) and/or claims limitation (being
the maximum amount of claims that may be entertained by the seller) are often
negotiated.  However, with respect to the
tax warranties, buyer seeks to be indemnified to the entire amount of tax
(b)       Non-Tax representations and warranties:
In relation to time period restrictions, sellers often negotiate for a maximum
of 1-2 years as the validity for discovery of a breach or misrepresentation or
for a statutorily prescribed limitation period prescribed.
(c)        Tax representations and warranties: In
light of the ambiguities surrounding tax implications associated with cross
border mergers and acquisitions in India, the buyers seek for specific tax
indemnities to survive for the period of limitation (normally being a period of
7 years).
representations and warranties, which are fundamental to the transaction
itself, are often carved out from the aforementioned limitations, including
those relating to ownership, incorporation and authority to enter into the
definitive documents.
It is
often seen during negotiations that sellers vehemently resist the idea of
giving uncapped indemnities to the buyer and this generally leads to protracted
discussion between the parties rationalizing the “why” and the “why not”, until
better commercial sense prevails and parties decide to move on.
2.         Escrow
/ Holdback
safety net sought is a hold back of the purchase price in an escrow account. An
escrow or a hold back is a mechanism by which a certain part of the purchase
price is placed in an escrow account. The account is controlled and operated by
a neutral escrow agent, for a period of time with instructions from both
sellers and buyers under an escrow agreement, to secure payment on
indemnification. Often, a process of tiered release of the escrowed funds over
a period of 18-24 months is used. It effectively preempts settlement of
disputes between the parties in a sale transaction, which could otherwise
become a deal breaker.
India, there are no regulatory restrictions on the creation of escrow accounts
relating to transactions between two Indian parties and the consideration being
in Indian rupees. In the event of any transaction involving a non-resident, the
Reserve Bank of India (RBI) vide Circular RBI/2010-11 /498 A. P. (DIR Series)
Circular No. 58 dated May 02, 2011 has permitted authorized banks (Category 1)
to open and maintain escrow accounts keeping in mind the time lag between
payment of purchase consideration and the receipt of the shares under the
automatic route. However, certain conditions attached to such approval inter alia are (i) a maximum period of
six months for maintaining the escrow and (ii) the amount kept under escrow
must be interest free. The RBI however, requires parties to obtain its prior
permission for creation of indemnity escrows, which commence from closing of
the transaction and may extend for a period of 3-5 years thereafter.
3.         Bank
sanction to a guarantee is provided under section 126 of the Act which defines
a contract of guarantee as a contract to perform the promise, or discharge the
liability, of a third person in case of his defaul
definitive documents, bank guarantees are sometimes sought as a protection
measure for the buyer in case of breach or misrepresentation of certain
representation and warranties by the seller which affect the very basis of the
assets or properties of the business being acquired. Bank guarantees may be
sought by the buyer in lieu or in addition of an escrow or purchase price
often than not, buyers seek an unconditional bank guarantee since the courts in
India, through a catena of judgments [See Svenska
Handelsbanken v. Indian Charge Chrome and Ors
.;[6] National Highway Authority of India v. Ganga Developers and Anr.[7]]
have resisted the idea of granting an injunction against invocation of an
unconditional bank guarantee except in case of proven fraud, special equities
or irretrievable injury (See Itek
Corporation case
A caveat may be placed that while obtaining of a bank guarantee in the case of
a breach of a representation and warranty is rare, it is not unheard of.
4.         Representations
and Warranties Insurance (RWI)
A useful but relatively
untapped option protecting the interests of the buyer is the option of purchasing
a RWI. It is still at a very nascent stage in the Indian market.
concept of an RWI is like any other insurance providing coverage over
contingent liabilities, arising out of breach or misrepresentations of
representations and warranties. The major advantage is the safety net that the
insurance provides for investments by the buyer in uncharted waters by reducing
the dependence on indemnity clauses, escrows, the uncertain tax regime in India
and also proceeding against multiple sellers with disproportionate indemnity
liability, especially in a jurisdiction like India. RWI is also preferred in
the event that the seller is an investment fund and the life of a fund is
nearing an end.
India, there are a few insurance brokers, for e.g. Optima Insurance Brokers and
Marsh who procure underwriters to provide such RWI. Anecdotally, we understand that
premiums for such RWI are in the range of Rs. 30-50 lakhs and consequently such
RWIs would make commercial sense if the transaction value were in excess of Rs.
25 crores. While the brokerage charges are dependent on the premium that is
charged, some companies charge in the range of 4-8% of the premium.
5.     Put
option is a remedy available at the hands of such option holder to sell certain
specified number of shares or percentage of shares and requiring the obliging
party to buy such shares at a predetermined price or based on some agreed
formula provided for in the definitive document. This is applicable only in a
stock purchase transaction. It must be understood that a put option is a severe
consequence as it has the potential of reversing the entire transaction.
specifically relating to a transaction involving a non-resident, put option
must be structured having regard to the pricing guidelines issued by the RBI
(A.P. (DIR Series) Circular No. 4 dated July 15, 2014) to ensure that when
shares are transferred from:
(i)        a
non-resident (seller) to Indian resident (buyer), the share price shall be not
more than the fair market value worked out as per any internationally accepted
pricing methodology for valuation.
(ii)       a
resident (seller) to non-resident (buyer), the share price shall be less than
the fair market value worked out as per any internationally accepted pricing
methodology for valuation.
these are a non-exhaustive list of commonly used industry practices adopted by
a well advised buyer, the bargaining power and the resolve of the buyer across
the negotiating table are the ultimate determinants of the clauses that finally
see the light of day in the definitive documents. However, it is in the
interest of the buyer that these clauses be agreed upon, at a macro level, at
the stage of the term sheet, so as to avoid a sabotage of the deal at the very
end, after time, effort and money have been expended by all parties. While an
absolutely risk insulated position is the utopia for the buyer, the buyer must
leverage business prudence vis-à-vis negotiating in hope for a comfortable
position, in the interest of sealing the deal.
Goda A. Raghavan & Kirthi Srinivas G

[1] Section 65 of the Act states that “When an agreement is discovered to be void,
or when a contract becomes void, any person who has received any advantage
under such agreement or contract is bound to restore it, or make compensation
for it, to the person from whom he received it”.
[2] As defined under Section 17 of the Act.
[3] (Pa.) 3 Brewst 9
[4] (1997) 2 BCLC 249
[5] (2005) EWCA Civ 758
[6] AIR 1994 SC 626
[7] AIR 2003 SC 3823
[8] 566 Federal Suppl. 1210

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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