Compliance with Laws Representation - Flat versus Qualified
A representation is a statement of fact made by one party to induce the other party to enter into the transaction. In a sale of business transaction (whether an asset or entity sale), the seller makes a litany of representations about the business it’s selling (and about its ability to enter into the transaction) to induce the purchaser to buy the business.
In today’s column, I’m going to focus on the “Compliance with Laws” representation that a seller of a business makes in a sale of business transaction. The typical buyer isn’t going to want to take over (or pay full price for) a business that it thinks may be breaking the law. The seller makes the “Compliance with Laws” representation to assure the buyer that the Company isn’t in violation of any law or regulation.
The parties typically spend quite a bit of time negotiating the wording of this representation.
The buyer would like the seller to make the representation “flat”, that is, without qualification.
Here is a variation of a standard “flat” Compliance with Laws representation (asset purchase version).
“The Seller is not in breach or violation of any….. law, regulation or other rule of any government authority or ruling or other determination of any court or other tribunal to which the Seller, or with respect to which any of its assets or business, is subject.”
In this case, any violation of the law, no matter how trivial, would subject the seller to a possible claim by the purchaser for misrepresentation, even if the violation has no material adverse impact on the business being sold. (For a rough analogy, imagine that you are applying for a home loan and the bank refuses to approve your application because you have an unpaid jaywalking ticket. Assuming that the ticket is for a small amount, it has no bearing on your creditworthiness.)
Most sellers, on the other hand, want to qualify this representation with wording that minimizes this risk.
The Seller can qualify the representation several ways.
List the Exceptions –
“Except as set forth in attached Exhibit A, the Seller is not in breach or violation of any….. law, regulation or other rule of any government authority or ruling or other determination of any court or other tribunal to which the Seller, or with respect to which any of its assets or business, is subject.”
In the revised representation, the seller would list all the violations in an exhibit to be attached to the asset purchase agreement. Note that this method is only as accurate as the memory of the seller. If the seller forgets to list a violation, then it’s a misrepresentation. For the seller, although better than a flat representation, it’s still not so forgiving.
Knowledge Qualifier
“To the best of it’s knowledge, the Seller is not in any breach or violation of any….. law, regulation or other rule of any government authority or ruling or other determination of any court or other tribunal to which the Seller, or with respect to which any of its assets or business, is subject.”
In the revised representation, the seller makes a misrepresentation only if it was aware of the violation (or should have been aware of the violation after making at least a reasonable inquiry).
Materiality Qualifier –
“The Seller is not in any [material] breach or violation of any….. [material] law, regulation or other rule of any government authority or ruling or other determination of any court or other tribunal to which the Seller, or with respect to which any of its assets or business, is subject.”
In my next post, I’ll explain how the placement of the word "[material]" in the representation can have a dramatic impact on the meaning of the representation, and discuss commonly negotiated compromise language for this representation.
