What Is a Reps and Warranties Claim After a Business Sale?

A reps and warranties claim is a buyer's demand, after closing, to be compensated because a statement of fact the seller made in the purchase agreement turned out to be untrue. Examples include statements about financial statements, taxes, customer contracts, litigation or compliance. In a typical private-company deal the claim runs through the agreement's indemnification article, and that article decides what the buyer can recover:

• how long the representations survive;
• the basket or deductible losses must exceed;
• the cap on what the seller pays;
• the escrow or holdback that funds payment;
• any representations and warranties (R&W) insurance; and
• the written notice the buyer must give before the survival period ends.

Miss the notice deadline and, under Delaware law, the claim can be lost entirely.

At a glance

What "reps and warranties" are

In a purchase agreement, the seller makes representations and warranties: detailed statements about the business as of signing and, usually, closing. Common examples cover:

• that the financial statements are accurate;
• that taxes have been paid;
• that there is no undisclosed litigation; and
• that key contracts are valid.

Exceptions go in a disclosure schedule. A rep is "breached" if it was untrue when made. The buyer doesn't have to prove the seller lied, only that the statement was wrong and caused a loss covered by the contract.

Some agreements also contain a materiality scrape, which ignores "material" or "in all material respects" qualifiers when calculating losses. The agreement in *ABRY Partners*, for example, let the buyer seek damages "without reference to materiality qualifications" in the closing condition.

How indemnification works after closing

Acquisition agreements commonly make the indemnification article the buyer's sole and exclusive remedy for breaches, with listed exceptions. Fraud is the most important exception. The article sets who indemnifies whom, for which losses, subject to which limits, and through what process. Delaware courts generally enforce those terms between sophisticated parties. In *ABRY Partners* (Del. Ch. 2006), the Court of Chancery held that parties may limit the remedy for misstatements that weren't intentional. But "when a seller intentionally misrepresents a fact embodied in a contract — that is, when a seller lies — public policy will not permit a contractual provision to limit the remedy of the buyer to a capped damage claim." (In that deal the indemnity fund was $20 million, 4% of a $500 million price.)

Survival periods: the clock that matters most

A survival clause says how long after closing each rep can support a claim. Agreements often set different periods for different reps. For example, the 2023 asset purchase agreement Ascent Industries filed with the SEC (one example, not a market standard) provides:

• 12 months for general reps;
• 5 years for "fundamental" reps; and
• the full tax statute of limitations plus 60 days for tax reps.

Delaware treats a survival period that ends the rep and its remedy as a deadline to sue, not just a deadline for the breach to occur. In *GRT, Inc. v. Marathon GTF Technology* (Del. Ch. 2011), the court held that a one-year survival clause "unambiguously establishes a one-year limitations period for filing claims." The buyer's suit, filed after that year, was dismissed even though it had raised problems with the seller during the year. Delaware's default deadline for contract claims is three years. By statute, parties to a written contract involving at least $100,000 can choose a different period of up to 20 years (10 Del. C. §8106(c)). Other states' rules can differ.

Baskets, deductibles and caps

• Basket or deductible. Losses must exceed a threshold before the seller pays. In a true deductible, the seller pays only the excess. In the Ascent agreement, the seller pays "only such Losses … in excess of the Deductible up to the Cap" (the amount is redacted in the public filing). Other agreements use a basket that, once crossed, lets the buyer recover from the first dollar; the contract wording controls.
• Cap. The maximum the seller owes for general rep breaches. In the Ascent agreement, the cap for general reps equals the escrow amount. Fundamental-rep and other claims are subject to separate limits, and fraud or intentional misconduct is carved out.

Escrow and holdbacks

An indemnity escrow (or a holdback the buyer keeps) is a slice of the price set aside so the buyer has money to collect from. The escrow agreement says when it's released. In the Ascent deal, the remainder is released 12 months after closing, minus the amount of claims properly asserted and still pending.

R&W insurance

A buyer may also purchase a buy-side R&W insurance policy, which pays covered losses from breaches so the buyer looks to the insurer rather than (or before) the seller. In the Ascent agreement, recovery under the policy sits outside the exclusive-remedy clause, the buyer must keep the policy in force, and the insurer can't pursue the seller by subrogation except for fraud or intentional misconduct. Policies have their own terms, including retentions, exclusions and claim-notice requirements. Read the policy alongside the purchase agreement, and give notice under both if both apply.

The notice of claim: how to keep a claim alive

Indemnification articles generally require written notice describing the claim in reasonable detail, often with supporting evidence and an estimated loss. Notice given before the survival date usually preserves the claim. In the Ascent agreement, a claim "asserted in good faith and in writing" before the deadline "shall survive until resolved or judicially determined." The seller had 30 days to respond to a direct claim. Third-party claims (for example, a lawsuit or tax audit) usually have their own notice and defense-control rules.

Practical points:

• Calendar every survival date at closing.
• Send notice as soon as a problem appears, in the form and to the address the agreement requires.
• Notify the R&W insurer too, if there's a policy.
• Check whether the agreement requires a lawsuit or arbitration to be filed, not just notice, before the deadline (*GRT*).

Sandbagging and knowledge

Some agreements say whether a buyer can claim for a breach it knew about before closing. A "pro-sandbagging" clause allows it, and an "anti-sandbagging" clause bars it. If the agreement is silent, the governing law decides. Ask deal counsel how your contract and state treat it.

What buyers and sellers should do

Buyers: know which reps survive and for how long, track the escrow release date, keep evidence of losses, give detailed written notice early, and read the R&W policy.
Sellers: make disclosure schedules complete, negotiate survival periods, the basket and cap, and respond to claim notices within the contract's deadline. Don't rely on a cap if the claim alleges intentional misrepresentation.

Featured attorneys: Haute Lawyer Network members who handle corporate transactions include Natasha Belon, managing attorney of Lotus Law PLLC in Denver, whose firm's business practice includes mergers and acquisitions and partner buyouts, and Glenn L. Udell, a partner at Brown, Udell, Pomerantz & Delrahim in Chicago, whose practice spans corporate transactions and complex commercial litigation. Browse Corporate Law attorneys, Business Law attorneys or Find a Lawyer. *Listed attorneys are paid members of the Haute Lawyer Network. Editorial selection, not a ranking.*

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