Representations and Warranties Sellers Give in a Business Sale

A purchase agreement is more than a price and a closing date. A large part of it is a list of statements the seller makes about the business: that the books are accurate, that the business owns what it says it owns, that no one is suing it, and much more. If one of those statements turns out to be wrong, the buyer may be able to claim money from you, sometimes long after the sale closed.

This article explains what these promises are in plain terms, how time limits fit in, and the usual ways sellers try to keep their exposure in check. Specific terms such as caps and holdbacks are negotiated and vary by deal, so use this as preparation for a discussion with your lawyer.

What representations and warranties are

A representation is a statement of fact about the business at a point in time. A warranty is a promise that a statement is true, backed by the seller's agreement to compensate the buyer if it is not. In most purchase agreements the two are bundled together and the terms are used almost interchangeably.

The buyer relies on them because it cannot see everything about the business before closing. They shift the risk of the unknown back to the seller. Typical subjects include financial statements, ownership of assets, contracts, taxes, employees, litigation, permits and compliance with laws.

How the deal structure changes your exposure

In a share sale, the buyer takes over the corporation with its history. In an asset sale, the corporation sells selected assets, and the corporation realizes the gains while the shareholder is taxed again when proceeds are paid out. The seller's promises, and who gives them, differ accordingly.

If you are an individual selling shares, you may be personally giving the promises, and your own money is at stake. If your corporation sells assets, the corporation gives them, but the buyer may want you to back them personally or to hold back part of the price. Look closely at who is named as the seller and whether you are signing in a personal capacity.

Other legal steps can also be part of a sale. A sale of all or substantially all of a corporation's property outside the ordinary course of business needs shareholder approval by special resolution, and the notice must include the agreement or a summary and a statement of dissent rights. A voting shareholder who dissents and follows the statutory procedure is entitled to be paid the fair value of their shares. A seller should confirm approvals are in order, because a warranty that the sale was properly authorized could otherwise be untrue.

How long can a claim come after closing?

Ontario's basic limitation period is two years from discovery. The Act says that period applies despite any agreement to vary it, but a business agreement made on or after October 19, 2006 may vary or exclude a limitation period other than the 15-year ultimate period. That is why purchase agreements often set contractual survival periods for warranty claims.

For you, the practical point is to look at how long each promise lasts. The agreement should say which promises last longer and which last a shorter time. How long each promise lasts is a negotiated term, so it is worth confirming the details with a lawyer.

Ways sellers try to limit liability

None of the following is automatic. Each one has to be negotiated and written into the agreement, and what a buyer will accept depends on the deal.

If part of the price is held back and paid later, you may be able to claim a capital gains reserve for proceeds not yet due, with the gain generally brought into income over no more than five years. Your accountant can say how a holdback affects your tax reporting.

What to do next

• Read the representations section line by line and mark every statement you cannot be sure is true.
• Gather records so you can check the statements: financials, contracts, leases, permits and employee files.
• Prepare the disclosure schedule early and be complete rather than brief.
• Ask what the survival period is for each group of promises.
• Confirm who gives the promises, you or your corporation, and whether you are personally liable.
• If employees will move to the buyer in an asset sale, note that service with you counts as service with the buyer if the buyer hires them.
• Confirm with your lawyer whether any competition notification applies, since most small-business sales fall below the thresholds.

Treat the representations as a risk allocation exercise, not boilerplate. A review before you sign is much easier than a dispute after closing.

Frequently asked questions