Section: Representations and Warranties of Seller
Negotiation Time: Minimal to Moderate
Transaction Costs: Insignificant or Expensive
Major Impact: Deal Value and Risk Management
What is This? The Representations and Warranties of Seller portion of the Agreement is used to save the Buyer time and money. Rather than require the Buyer to go through third parties to find certain information, the Seller provides the information and must reimburse the Buyer for any Losses it suffers if the information is false or misleading. Here, the Seller provides information regarding the real property used by the Business.
The Middle Ground: In the Real Property representation and the corresponding Disclosure Schedules, the Seller discloses the Owned Real Property and Leased Real Property used by the Business and represents that: (1) it has not received notice of any building code violations, zoning ordinance violations, or violations of any other laws or governmental restrictions; (2) there are no existing, pending, or threatened condemnation proceedings affecting Real Property used by the Business; (3) the disclosed Real Property is sufficient to conduct the Business as conducted prior to the Closing; and, (4) no other real property is necessary to conduct the Business as conducted prior to the Closing.
With respect to the Owned Real Property, the Seller represents that it has marketable fee simple title free of any Encumbrances other than those listed in the Disclosure Schedules and the Permitted Encumbrances, that it has not leased the property or given anyone permission to use it (other than as disclosed in the Disclosure Schedules), and that no one holds any option rights on the property (e.g. rights of first refusal or rights of first offer).
With respect to the Leased Real Property and each individual lease, the Seller represents that the lease is valid and possession of the property is undisturbed, all rent due has been paid and nothing has occurred that would result in breach or default, there has been no notice given regarding termination of the lease, and the Seller has not created an Encumbrance on its interest in the property.
Purpose: For some businesses, real property such as office space is merely a necessary but fungible tool. With a little planning, the business could easily move down the street or to another part of town without breaking stride. For other companies, the real property they own or lease is itself the business, and the company would not be nearly as valuable if that specific property was not included in the transaction. The result is that some acquisition negotiations will focus heavily on real property and will require the input of real property experts, while others will deal with real property issues quickly and move on.
Buyer Preference: If the Real Property held by the Business is an important aspect of the deal, the Buyer will want to consult a real property attorney regarding the content of the Seller’s representations, the mechanics of transfer, and necessary due diligence procedures. Generally, as the importance of property to the Business increases, the Seller’s representations and Buyer’s property-focused due diligence will increase as well.
Seller Preference: The Seller wants to limit its representations as much as possible. For example, the representation regarding notice of building code or zoning ordinance violations is arguably covered by the more general “Compliance with Laws” representation, so the Seller may try to exclude the more specific representation contained in this section. The Seller can also constrain its representations by adding materiality or knowledge qualifiers, and by limiting its title representation to “valid” or “insurable” title rather than “marketable” title.
Differences in a Stock Sale Transaction Structure: Because a transfer of property is not necessary in a stock sale, representations regarding Owned and Leased Real Property are included with the Title to Purchased Assets representation (i.e. the property is treated, for the most part, as just another asset). There are a few representations that pertain only to the Seller’s Owned Real Property, but they are more focused on providing the administrative information necessary to operate the Business rather than focusing on the transferability of the property.
We want The Middle Ground to be an ongoing dialogue for and resource to the lower middle market M&A community. The outline above is generally applicable, but there is always specific case law and nuance around certain industries that can be useful in helping buyers and sellers come together. If you are a lawyer or deal professional, we encourage you to add your perspective below.