Private M&A purchase and sale agreements in Canada follow a very familiar pattern and typically include what can be described as the ‘usual representations and warranties’. In sophisticated purchase agreements the usual representations and warranties are comprehensive and cover everything from corporate, employment and environmental matters to financial, tax and intellectual property matters. While the usual representations and warranties cast a wide net, they are by no means a one-size-fits all solution for addressing risk. Each transaction is unique and requires that clients, their financial advisors and their legal advisors turn their mind to drafting representations and warranties that address the specific risks of the transaction.
In many cases the customized repsentations and warranties that are required will be apparent based on the business of the target company. For example, a technology target will typically require a variety of additional representations and warranties to minimize the unique risks and liability exposure associated with the particular technology business. A transaction that involves real estate will require additional real estate and environmental representations and warranties. And so on based on the business of the target. These are obvious risks which are easy to identify. It is the less obvious risks that buyers need to think about carefully and discuss with their financial and legal advisors.
Take for example a business with a backlog of work that will be peformed by the target following closing. While the buyer may view the backlog as an attractive feature and it may have even influenced pricing, the business has a lot of moving parts and the buyer may not be focused on the details of the backlog. While the usual representations and warranties regarding financial statements and contracts cover some of the risk associated with a backlog, they do not squarely cover off risks around the quality of the backlog. A vendor wanting to improve the profile of a business prior to sale may be tempted to bid low for work in order to create a healthy looking backlog. Following closing the buyer may discover that the backlog is in fact a liability because it is comprised of a number of loss-making contracts. If the purchase agreement did not include specific representations and warranties regarding the quality of the backlog, the buyer may not have a remedy for the losses arising from the backlog.
While it is impossible to predict or forsee every possible risk, buyers and their financial and legal advisors should take the time to come up with a list of risks specific to the transaction. If the usual representations and warranties do not cover off each risk or only partly cover the risk, then it is time to start drafting and negotiating specific reprentations and warranties that do cover the risk.