SMB M&A SERIES: Limiting Liability - Representations and Warranties in Purchase Agreements

Jul 17, 2024

By: Daniel J. Fetter, Esq.


The SMB M&A series provides insights into buying and selling a small business.

In all business transactions, the Seller will be asked to make a series of representations and warranties ("R&W") regarding the business. These R&W, which can range from 1 - 20 pages depending on the size of the transaction, cover the Seller's finances, taxes, condition/title of assets, liabilities, legal compliance, litigation, employment matters, contracts, customers, etc. The purpose of the R&W is to give the Buyer a comprehensive understanding of what he or she is purchasing (the good and the bad).


This portion of the Purchase Agreement is heavily negotiated as its effect shifts liability between the Seller and Buyer from issues that may arise post-closing. If the Buyer suffers a financial loss, the Buyer will review the R&W and make a claim for indemnification if it can be argued that such loss stems from a breach of those representations. For this reason, the Buyer will want the representations to be as broad as possible while the Seller will try to limit their scope and mitigate its post-closing liability.  


There are several ways a Seller can try to reduce their liability exposure. This article will focus on some of the basic strategies used.   


Use Qualifying Language:


Limit the representation to what the Seller actually knows (or should know after a reasonable investigation).  For example, consider these two statements:


1. "The products sold by Seller do not infringe on the proprietary rights of others."


2. "To Seller's actual knowledge, the products sold by Seller do not infringe on the proprietary rights of others." 


Example "1" is a statement of fact and shifts liability to the Seller in the event any infringement claim arises, regardless of the Seller's knowledge on the issue. Example "2" shifts liability to the Seller only if Seller actually knew of the infringement at the time of closing.

 

Sellers may also try and limit the scope of the representation by including a "materiality" qualifier.  Consider the following examples:  


1. "Seller is and has been in compliance with all applicable laws."


2.  "Seller is and has been in compliance, in all material respects, with all applicable laws." 


No Seller can truly make the representation under example "1", and including such a statement may subject the Seller to being liable for any costs, no matter how small, due to potential immaterial claims by the Buyer.  Under example "2", Seller is acknowledging that the business is not in absolute compliance, but such violations do not rise to the level of having a material effect on the business.  Buyers do not like this limitation because unless the Purchase Agreement defines "material" (not all do), it raises the question of what is material?  Buyers may try to address this issue by including a "materiality scrape", which is a topic for a separate article. 

    

Survival Period:  


The Purchase Agreement will state how long the R&W survive closing. The survival period will typically last between 12-24 months following closing with some representations surviving longer in accordance with the applicable statute of limitations (these are referred to as "Fundamental Representations"). This limits the time a party has to make an indemnity claim for a breach of a R&W.  Buyers prefer to have representations extend as long as possible while Sellers try to shorten the survival period.  As long as Buyer notifies Seller of a claim before the representation has expired, the Buyer's claim will be valid.  


Accuracy:


Last but not least, take the time to carefully review each representation and investigate when necessary to ensure the statement is accurate.   


These are only some of the strategies found in Seller's tool-kit to reduce exposure. Sellers may also consider the deal structure (stock vs. asset), baskets, caps and anti-sandbagging clauses (which will be covered in additional articles). 


The Scolaro Law Firm handles small business M&A transactions throughout New York State, Vermont, Pennsylvania and Florida. If you are interested in buying/selling a business, please contact Daniel Fetter or the attorney at our firm with whom you work.


This article is intended to be for informational and discussion purposes only and is not to be construed as legal advice or as a legal opinion on which certain actions should or should not be taken.

Important Notice for New York State LLCs: Addressing the 30-Year Limit Expiration

08 Aug, 2024
By: Nicholas J. Graham, Esq. Limited Liability Companies ("LLC") have been authorized in New York since 1994. When the law was first enacted, an LLC could not have perpetual existence like corporations. This limitation was removed in 1997. If your LLC was established under the old New York State law that imposed a 30-year lifespan, it's crucial to be aware of the approaching expiration of your company's duration. Originally, LLCs in New York were required to specify a limited duration, commonly set at 30 years. Many of these companies are now reaching the end of this period and must take action to continue operating. Special attention should be given to LLC's formed between 1994 and 1997, as they were likely established with a 30-year lifespan. What Has Changed? The law in New York has evolved, and LLCs are no longer bound by the 30-year limit. Pursuant to NY LLC law §701(1), businesses now have the option to exist perpetually, providing greater flexibility and stability for long-term planning. However, this change is not automatic for existing LLCs that were originally set up with a 30-year term. What You Need to Do To ensure your LLC can continue its operations beyond the original 30-year term, you need to file an amended Articles of Organization with the New York Department of State. This amendment should update the duration of your LLC to perpetual, or to another term if desired. Steps to Amend Your Articles of Organization: Prepare the Amendment: Draft an amendment to your LLC's Articles of Organization. This document should clearly state the new duration of the LLC, typically set to "perpetual." File the Amendment: Submit the amended Articles of Organization to the New York Department of State. This can usually be done online or by mail. Ensure that you include the necessary filing fee. Update Internal Documents: Reflect the change in your LLC's operating agreement and any other internal documents to ensure consistency and compliance. Notify Members and Stakeholders: Inform all members and relevant stakeholders of the change to ensure everyone is aware of the updated status of the LLC. Why It Matters Failing to update your LLC’s duration could result in the automatic dissolution of the company once the original 30-year term expires. This could lead to significant disruptions in business operations and potential legal complications. By taking proactive steps to amend your Articles of Organization, you can ensure the continuity of your LLC and take advantage of the flexibility offered by the current laws. Need Assistance? The Scolaro Law Firm specializes in helping businesses navigate changes in regulatory requirements. If you need assistance with amending your Articles of Organization or have any questions regarding your LLC's status, please contact us. Our experienced team is here to provide the guidance and support you need to keep your business running smoothly. This article is intended to be for informational and discussion purposes only and is not to be construed as legal advice or as a legal opinion on which certain actions should or should not be taken.

SMB M&A SERIES: Limiting Liability - Representations and Warranties in Purchase Agreements

17 Jul, 2024
By: Daniel J. Fetter, Esq. The SMB M&A series provides insights into buying and selling a small business. In all business transactions, the Seller will be asked to make a series of representations and warranties (" R&W ") regarding the business. These R&W, which can range from 1 - 20 pages depending on the size of the transaction, cover the Seller's finances, taxes, condition/title of assets, liabilities, legal compliance, litigation, employment matters, contracts, customers, etc. The purpose of the R&W is to give the Buyer a comprehensive understanding of what he or she is purchasing (the good and the bad). This portion of the Purchase Agreement is heavily negotiated as its effect shifts liability between the Seller and Buyer from issues that may arise post-closing. If the Buyer suffers a financial loss, the Buyer will review the R&W and make a claim for indemnification if it can be argued that such loss stems from a breach of those representations. For this reason, the Buyer will want the representations to be as broad as possible while the Seller will try to limit their scope and mitigate its post-closing liability. There are several ways a Seller can try to reduce their liability exposure. This article will focus on some of the basic strategies used. Use Qualifying Language: Limit the representation to what the Seller actually knows (or should know after a reasonable investigation). For example, consider these two statements: 1. "The products sold by Seller do not infringe on the proprietary rights of others." 2. " To Seller's actual knowledge , the products sold by Seller do not infringe on the proprietary rights of others." Example "1" is a statement of fact and shifts liability to the Seller in the event any infringement claim arises, regardless of the Seller's knowledge on the issue. Example "2" shifts liability to the Seller only if Seller actually knew of the infringement at the time of closing. Sellers may also try and limit the scope of the representation by including a "materiality" qualifier. Consider the following examples: 1. "Seller is and has been in compliance with all applicable laws." 2. "Seller is and has been in compliance, in all material respects , with all applicable laws." No Seller can truly make the representation under example "1", and including such a statement may subject the Seller to being liable for any costs, no matter how small, due to potential immaterial claims by the Buyer. Under example "2", Seller is acknowledging that the business is not in absolute compliance, but such violations do not rise to the level of having a material effect on the business. Buyers do not like this limitation because unless the Purchase Agreement defines "material" (not all do), it raises the question of what is material? Buyers may try to address this issue by including a "materiality scrape", which is a topic for a separate article. Survival Period: The Purchase Agreement will state how long the R&W survive closing. The survival period will typically last between 12-24 months following closing with some representations surviving longer in accordance with the applicable statute of limitations (these are referred to as " Fundamental Representations "). This limits the time a party has to make an indemnity claim for a breach of a R&W. Buyers prefer to have representations extend as long as possible while Sellers try to shorten the survival period. As long as Buyer notifies Seller of a claim before the representation has expired, the Buyer's claim will be valid. Accuracy: Last but not least, take the time to carefully review each representation and investigate when necessary to ensure the statement is accurate. These are only some of the strategies found in Seller's tool-kit to reduce exposure. Sellers may also consider the deal structure (stock vs. asset), baskets, caps and anti-sandbagging clauses (which will be covered in additional articles).  The Scolaro Law Firm handles small business M&A transactions throughout New York State, Vermont, Pennsylvania and Florida. If you are interested in buying/selling a business, please contact Daniel Fetter or the attorney at our firm with whom you work. This article is intended to be for informational and discussion purposes only and is not to be construed as legal advice or as a legal opinion on which certain actions should or should not be taken.
Share by: