The representations and warranties provisions in corporate agreements originate from U.S. law and arise from the duty to disclose, whereby the parties to a deal, in particular the seller, must clearly inform their counterparty on the conditions of the asset or business subject to the transaction.
In Brazilian law this same duty to inform is a consequence of the principle of objective good faith between contracting parties, which is intended to guide contractual relations.
The representations and warranties clauses express the circumstances and the context formed by the factual and legal reality in which the transaction is inserted. Through the representations and warranties, facts, information and/or documents relevant to the deal at hand are revealed. The veracity of the content is also attested to.
These clauses enable the parties to the contract to balance the asymmetry of information between them, allowing a better assessment of the risks and pricing of the asset in a given transaction.
Regarding the origin of the institute of representations and warranties, there is also a difference between the specific concepts of "representations" and "warranties" within the common-law legal system.
Representations are statements that refer to the circumstances that occurred in the past or at the time of the instrumentalization of the respective contract, functioning as guiding premises for the formation of the business.
On the other hand, warranties serve as assertions provided from one party to the other on the existence of facts in relation to which there is no discussion with respect to their subjectivity. Warranties have the purpose, therefore, to remove from the receiving party the burden of determining the veracity of the fact for itself, being the equivalent to a promise to indemnify the other party in case the guaranteed fact proves itself false.
In Brazil, when incorporating the concepts of representations and warranties, no rigorous differentiation was made. In practice, when drafting corporate transaction agreements, it is common for there to be no distinction between what is a representation and what is a warranty, including for the purposes of the obligation to indemnify resulting from any violations to the provisions of these clauses.
An important aspect to consider when drafting representation and warranty clauses is the inclusion of qualifiers. These are criteria added to the text of the representations and warranties that allow for the limitation of liability in relation to a given statement. Among these criteria, the following qualifiers may be highlighted:
- knowledge, to remove responsibility for facts that are not known to the declaring party; and
- materiality, the purpose of which is to limit the content of the information provided to issues that may materially affect the business or represent a material deviation from what has been represented by the party.
Considering that these concepts are naturally subjective, it is interesting to remove as much as possible the subjectivity from the qualifiers through the creation of objective parameters aimed at defining the criteria of materiality and knowledge within the scope of the contract.
It is also important to note how the representations and warranties clauses relate to the other clauses contained in agreements for corporate deals, among which the conditions precedent and indemnification clauses stand out.
The conditions precedent clause establishes the acts and elements that shall be satisfied from the contract’s signature date so that a certain party is obliged to complete the transaction.
It is common to find among the conditions precedent the maintenance of the validity of the representations and warranties presented on the agreement’s execution date, at the time when the closing of the deal occurs. It is also usual that materiality criteria are adopted in this ratification provision of the representations and warranties in order to enable the acceptance of such provision by the selling party.
With regard to the indemnification clause, if after the closing of the transaction the facts and information represented by the parties are not verified in practice or if there is inaccuracy with respect to the data provided, the party responsible for the breach of its representations and warranties shall indemnify the counterparty for any losses suffered due to these breaches.
The option for the indemnification model has a direct impact on the care that the parties should take when drafting the representations and warranties clauses.
Indemnification mechanics that provide for indemnification only for non-compliance with contractual obligations and breach of representations and warranties will require greater attention from the buyer in respect to the amplitude and detail of the representations and warranties.
On the other hand, indemnification mechanics based on the "my watch, your watch" model allow the buyer a lesser degree of concern regarding the seller’s representations and warranties, considering such mechanics provide the buyer with protection in relation to the entire past of the asset in question.
Despite originating in foreign law, the representations and warranties clauses play a vital role in the process of drafting contracts for corporate transactions in Brazil and find support in the Brazilian legal system.
It is therefore critical to identify, in each transaction, the relevant representations and warranties to be provided by the counterparty, making adaptations as appropriate, to provide additional protection against any contingencies that may arise following the completion of the deal.
