Representations and Warranties - An Overview
Representations and Warranties - Meaning
Representations and Warranties are key clauses in all kinds of contracts. ‘Representation’ and ‘Warranty’ are not defined in the Indian Contract Act, 1872 (“ICA”). Representations and Warranties are used interchangeably in clauses and are often drafted as a part of the same clause; however, the two terms are separate, have a different meaning and essence, which is determined on a case to case basis. The consequences in the event of breach of either Representations or Warranties are also different.
Representations are statements of fact, true on the date when such statement is made, which is made for inducing the other party to enter into the contract. These are confirmations regarding a past or present fact or circumstance being true which results in the other party agreeing to transact. The Hon’ble Supreme Court of India, in Century Spinning and Manufacturing Company Ltd. & Anr. v. The Ulhasnagar Municipal Council and Anr., while analysing Representations as statements which are true, stated that “there is undoubtedly a clear distinction between a representation of an existing fact and a representation that something will be done in future. The former may, if it amounts to a representation as to some fact alleged at the time to be actually in existence, raise an estoppel, if another person alters his position relying upon that representation. A representation that something will be done in the future may result in a contract, if another person to whom is it addressed acts upon it. A representation that something will be done in the future is not a representation that is true when made…”
Few statements that would be Representations with regard to a contract for goods executed between a buyer and a seller company would be (a) the statement made by a seller company assuring that the seller company has the right, power and authority to enter into the current contract; (b) the statement made by the seller assuring the title of the goods; (c) the statement made by the seller assuring that it has complied with all applicable laws, including regulatory compliances for the purposes of selling the said goods; (d) the statement made by the seller that there is no conflict, obligation or restriction that will affect the performance of the agreement by the seller.
Warranties are statements or promise of a condition to be true. Warranties give the assurance that the representations given by a party are true or will remain true. Warranties are supported by an implied promise of indemnity if the condition or assertion is false. “Warranty” for the purposes of sale of goods has been defined under the Sale of Goods Act, 1930 (“SOGA”). Section 12 of SOGA defines Warranty as a stipulation collateral to the main purpose of the contract, the breach of which gives rise to a claim for damages but not to a right to reject the goods and treat the contract as repudiated. Warranties may be express or implied. Express Warranties are those which are expressly incorporated into the contract executed between the parties, whereas, implied Warranties are those that are assumed to be implied under law even though, the same may not be expressly mentioned in the contract executed between the parties.
Few instances of Warranties with regard to a contract for goods executed between a buyer and a seller company would be (a) the seller warrants that the goods will be free from material defects during the warranty period and will conform to the specifications required by the buyer; (b) the seller warrants that the sale of goods does not infringe any third party’s Intellectual Property rights.
While explaining the difference of Representations and Warranties, the Hon’ble Madras High Court in All India General Insurance Co v. S P Maheswari held that “Warranties are representations which are made the basis of the contract whereas a representation is not strictly speaking a part of the contract or of the essence of it, but rather something preliminary and in the nature of an inducement to it.”
General and Specific Representations and Warranties
Practically, for the purposes of several contracts, Representations and Warranties are used interchangeably and used together. A clause maybe drafted in a consolidated manner as a representation as well as a warranty, however, it will have to be interpreted on a case to case basis to determine the nature, breach and consequences.
Representations and Warranties are general and specific. The general Representations and Warranties are neutral and standard, and specific Representations and Warranties vary on a case to case basis depending on the nature of contracts as explained later in this article. For a better understanding, some of the general Representations and Warranties incorporated in agreements are given below -
Parties represent and warrant to each other that -
a. it is duly organized and validly existing under the laws of its jurisdiction;
b. it has the full power and authority to execute, deliver and perform its obligations under this Agreement;
c. it has taken all necessary actions under applicable laws to authorize the execution, delivery and performance of this Agreement;
d. this Agreement constitutes its legal, valid and binding obligation enforceable against it in accordance with the terms hereof;
e. it shall perform its obligations in accordance with the terms of this Agreement and ensure compliance with all applicable laws and regulations in the performance thereof;
f. the execution and performance of this Agreement shall not conflict with or constitute a breach of the terms of any law, agreement, policy, instrument, order, judgment, or decree to which it is a party or is otherwise bound.
Specific Representations and Warranties depend on the nature of contracts. To elaborate on how the specific Representations and Warranties vary on the basis of the nature of the contract and is specific to each transaction, some types of warranties are given below -
a. In agreements for sale of immovable property, some of the specific Representations and Warranties are - (i) the promoter represents and warrants that the promoter has absolute, clear and marketable title with respect to Property, development rights for the property; (ii) promoter has absolute, actual, physical and legal possession of the property and the same is without any encumbrances; (iii) promoter has all requisite approvals and compliances as per applicable law; (iv) there are no litigations pending before any court of law with respect to the said property.
b. In assignment agreements, the specific Representations and Warranties may include (i) assignor exclusively, absolutely and unconditionally owns all right, title, and interest in and to the work; (ii) assignor has not granted and will not grant any licenses or other rights including ownership to the work to any other third party; (iii) the work is free of any liens, encumbrances, security interests, and restrictions on transfer; (iv) the intellectual property that is assigned as part of the work does not infringe intellectual work rights of any third party; (v) there are no legal actions, investigations, claims, or proceedings pending or threatened relating to the work.
c. In shareholders’ agreements, Representations and Warranties are incorporated with regard to several specific factors including but not limited to the corporate status of the company, authority, shares, constitutional documents, business, financial statements, contracts, labour compliances, IPR, litigation, taxation etc. Some of the Representations and Warranties, inter alia, are,
the shares, i.e., (i) all shares are duly authorized and validly issued to the persons as mentioned; (ii) there are no encumbrances on the shares of the company, and the shares of the company are not listed on any stock exchange or regulated market; (iii) the issued and fully paid-up share capital of the company comprises the whole of the allotted and issued shares in the capital of the company.
financial condition of the company, i.e., (i) the business of the company has been carried on in the ordinary course so as to maintain the business as a going concern; (ii) there has not been any damage, destruction or loss materially affecting the business or assets of the company.
taxes, i.e., (i) all tax returns and reports required under law to be filed have been duly filed and all obligations, fees and charges have been paid or withheld as per applicable law.
Breach of Representations
In the event of a false statement that has been made in the form of a Representation, the act is known as ‘misrepresentation’ or ‘fraud’ basis certain factors and the rights of the aggrieved party are provided under the provisions of ICA. An understanding of misrepresentation and fraud is essential to determine the breach of Representation and the remedies available against such breach.
Section 18 of the ICA defines ‘misrepresentation’ as –
a. the positive assertion, in a manner not warranted by the information of the person making it, though he believes it to be true;
b. any breach of duty without an intent to deceive which results in the breaching party gaining an advantage of the person committing it, or any one claiming under him, by misleading another to his prejudice, or to the prejudice of any one claiming under him;
c. innocently causing the other party to an agreement to make a mistake as to the substance of the thing which is the subject of the agreement.
For an act to constitute misrepresentation, the positive assertion, breach of duty should have been made without an intent to deceive. In the event, the breaching party made the positive assertion, breach of duty with an intent to deceive knowing the same not to be true, then, the act would constitute ‘fraud’.
‘Fraud’ is defined under Section 17 of the ICA. An act of ‘fraud’ includes any of the following acts committed by a party to a contract with an intent to deceive the other party or to induce the other party to enter into the contract –
a. the suggestion, as a fact, of that which is not true, by one who does not believe it to be true;
b. the active concealment of a fact by one having knowledge or belief of the fact;
c. a promise made without any intention of performing it;
d. any other act fitted to deceive;
e. any such act or omission as the law specially declares to be fraudulent.
The Hon’ble Supreme Court, in the matter of Electrical Rengali Hydro Electric Project v. Giridhari Sahu, has discussed the difference between fraud and misrepresentation –
“A perusal of the definition of the word “fraud”, as defined in Section 17 of the Contract Act, would reveal that the concept of fraud is very wide. It includes any suggestion, as a fact, of that which is not true, by a person who does or does not believe it to be true. It may be contrasted with Section 18 (1) of the Contract Act which, inter alia, defines “misrepresentation”. It provides that it is misrepresentation if a positive assertion is made by a person of that which is not true in a manner which is not warranted by the information which he has. This is despite the fact that he may believe it to be true. In other words, in fraud, the person who makes an untruthful suggestion, does not himself believe it to be true. He knows it not to be true. But the law declares it to be misrepresentation on the basis of information which he had and what he believed to be true was not true. Therefore, the representation made by him becomes a misrepresentation as it is a statement which is found to be untrue. Fraud is committed if a person actively conceals a fact. The concealment must be active. It is here that mere silence has been explained in the exception which would affect the decision of a person who enters into a contract to be not fraud unless the circumstances are such that it becomes his duty to speak. His silence may itself amount to speech. A person may make a promise without having any intention to perform it. It is fraud.”
Consequences of breach of Representations
Breach of Representation provides the non-breaching party with contractual remedies. Section 19 of the ICA provides for the remedy available to a non-breaching party in the event of inter alia misrepresentation or fraud, and states that –
a. A contract where consent is caused by misrepresentation or fraud is voidable at the option of the non-breaching party. The non-breaching party can rescind the contract on account of the contract being void. The non-breaching party can further claim damages. Rescission of a contract is not possible in all cases and the remedy of rescinding a contract is not unfettered and such remedy available depends on a case to case basis. Exceptions provided against such remedy are –
The contract is not voidable if consent to the contract was caused by innocent misrepresentation or by silence, when the same is fraudulent under Section 17, and the non-breaching consenting party had the means of discovering the truth with ordinary diligence.
The contract is not voidable if the fraud or misrepresentation did not directly result in the making of the said contract, i.e., if the non-breaching party was not induced into entering the contract by such fraud or misrepresentation.
In order to exercise the remedy of declaring the contract void on account of fraud or misrepresentation, the non-breaching party will have to prove that it did not know that the Representations made were false, and such Representations induced the non-breaching party to enter into the contract. Further, ordinary diligence would not have led the non-breaching party to discover the truth.
The Hon’ble High Court of Delhi in the matter of Sikka Promoters Pvt. Ltd. v. National Agricultural Cooperative Marketing Federation of India Ltd., while analysing the consequences of innocent misrepresentation held that “The only inference possible is that either the parties were not ad idem as to the property subject matter of sale and in which case there cannot be said to be in existence any contract between the parties or that the contract if held to have come into existence was caused by innocent misrepresentation of the defendant within the meaning of Section 18(3) of the Contract Act as to the property being auction and is thus voidable at the instance of the plaintiff and which right the plaintiff exercised.”
The Hon’ble Supreme Court in Reliance Salt Ltd. v. Cosmos Enterprises, analysed the instances where fraud would lead to vitiating the contract; “Breach of contract by reason of supply of inferior quality of tea or salt or delay in supply or a short supply may render a party responsible for damages for commission of breach of contract, but, breach of contract alone does not lead to the conclusion that a fraud had been committed thereby. It is contended that commission of fraud would include any act to deceive but then such act must be confined to acts committed by a party to a contract with intention to deceive another party or his agent or to induce him to enter into a contract. Fraud, which vitiates the contract, must have a nexus with the acts of the parties prior to entering into contract. Subsequent breach of contract on the part of a party would not vitiate the contract itself”
b. The non-breaching party, at its instance, can call upon the breaching party to perform the contract and for the non-breaching party to be put in the position in which it would have been if the Representations made were true. The relief seeking specific performance of the contract is governed by the Specific Relief Act, 1963.
Breach of Warranties
The breach of Warranties is the violation of the assurances as may be given by one party to the other as Warranties under a contract and such breach may result in loss or damage to the non-defaulting party. Breach of Warranties does not impact the underlying promises on the basis of which the contract was executed and does not result in vitiation of the contract. The consequences of breach of Warranties differ from those in the case of breach of Representations. The remedy available to a non-breaching party, in case of a breach of Warranties, differs on a contract to contract basis. The non-breaching party is entitled to damages in addition to any specific remedies that the parties may have contractually agreed upon. However, breach of Warranties does not render the contract voidable. The damages claimed by the non-defaulting party shall be basis the loss that has been caused to the non-defaulting party on account of the breach of the Warranties and the manner in which it has altered the position of such non-defaulting party under the contract, and for other losses as may be contemplated/provided for under the contract and proved by the non-defaulting party.
The Hon’ble Supreme Court in the matter of Indochem Electronic and Anr. v. Additional Collector of Customs, while adjudicating the breach of Warranties and referring to SOGA, stated that
“Although in terms of sub-section (3) of Section 12 no right accrues to a purchaser to reject the goods on breach of stipulation of warranty, the same would not mean that the extent of damages cannot be equivalent to the price of the goods inasmuch as such a power has specifically been conferred upon the Commission. It is true, where a stipulation in a contract of sale is a warranty, its breach may give rise to a claim for damages but not to a right to reject the goods and treat the contract as repudiated, but, where a stipulation in a contract of sale is a condition, its breach may give rise not only to a claim for damages but also generally to a right to treat the contract as repudiated.”
The right of a non-breaching party under the contract to recover damages is subject to indemnities provided in the said contract. Representations and Warranties in a contract are backed by indemnities. Section 124 of ICA provides that a contract 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, is called a contract of indemnity. The scope of indemnity being given by one party can be absolute or restricted and limited on a case to case basis. The indemnified party is protected against any claims, losses and damages caused to the indemnified party due to the breach of Warranties by the defaulting party. Specific indemnities are incorporated in a contract basis the specific Warranties to protect the indemnified party against any breach.
In contractual transactions, i.e., sale purchase agreements, real estate agreements, service agreements, share purchase agreements and M&A transactions, the investor/purchaser usually conducts a due diligence which follows the principle of ‘let the buyer know’. due diligence is a process by which a party can identify the risks involved and accordingly seek Representations and Warranties in the contract. If it is possible that the investor/purchaser had knowledge regarding a particular assertion being true or false, then it may be difficult to seek remedy for misrepresentation. However, the non-breaching party has the option to protect such risk through specific indemnities.
Importance of Representations and Warranties in transactions
For every transaction, the negotiation of Representations and Warranties is an integral part and are important for all the parties in the transaction. Representations and Warranties benefit the purchaser of goods and services as well as the sellers and providers of goods and services. Representation and Warranties enable the purchaser to obtain information about the seller and the goods/services, obtain assurances regarding the material and essential aspects and gives the purchaser an opportunity to enhance and increase the protection to it and, thereby, mitigating its risk. Representations and Warranties benefit the seller/provider as it gives the seller/provider to assess its liabilities under a contract and be aware of the rights of the purchaser, use specific qualifications to mitigate its risk and accordingly take informed decisions while negotiating a contract.
Importance of Representations and Warranties in M&A Transactions
Representations and Warranties form part of the core of M&A transactions and negotiations. Any investor/purchaser, prior to investing in a target company, holds negotiations with the sellers/promoters of the target company. In order to ascertain whether the affairs of such company have been in compliance with applicable laws along with ascertaining certain specific concerns, the investor/purchaser requires the sellers/promoters of the target company to represent and warrant to the investor/purchaser regarding inter alia the compliance with laws, financial condition of the company, business being carried out in a fully compliant and lawful manner. In addition to the same, specific concerns are addressed, for instance, Representations and Warranties are obtained for protection regarding shares, capital structure, tax liabilities, intellectual property rights, litigation etc. Indemnity clauses are drafted in order to protect the investor/purchaser against any breach of Representations and Warranties and such clauses govern the rights of the investor/purchaser arising due to breach of Representations and Warranties. Hence, the Representations and Warranties form the basis for protection of the investor/purchaser.
Further, it is necessary for the sellers/promoters of the target company to ensure that there is true and complete disclosure of all aspects. To mitigate the risks, it is essential that the sellers/promoters of the target company carefully negotiate the Representations and Warranties. Additionally, the sellers/promoters need to provide adequate disclosures/qualifications wherever necessary with regard to specific liabilities and issues, which should not be considered as a breach at a later stage. In order to further restrict the liabilities, the sellers/promoters of the target company can specify the material Representations which would signify the Representations on the basis of which the investor/purchaser has been induced into the contract. The sellers/promoters of the target company can further better negotiate on knowledge qualifiers in order to mitigate the exposure to liabilities. These are some of the instances in which the sellers/promoters of the target company can restrict their liabilities through Representations and Warranties.
Based on the nature of transaction, on a case to case basis, the relevant Representations and Warranties need to be identified and negotiated to ensure protection of rights and mitigation of risks involved. Representations and Warranties are essential in the event a dispute arises between parties or there is a breach of the Representations and Warranties by a party. The rights of the parties would flow from the manner in which the clause is drafted and, therefore, it is important to ensure all relevant aspects are covered in the clauses.
Kindly treat this as an information update and the same shall not constitute as an advisory by the firm.
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