Representations and warranties of counterparty: Overview, definition, and example
What are representations and warranties of counterparty?
Representations and warranties of a counterparty are statements made by one party (the counterparty) in a contract that affirm certain facts or conditions are true as of the time of the agreement. These representations (assertions of fact) and warranties (promises about future performance) are designed to provide assurance to the other party that specific conditions or aspects of the agreement are accurate, legitimate, or will be met in the future. If the representations or warranties are found to be false or unfulfilled, the party making them may be liable for breach of contract.
In simpler terms, representations and warranties are guarantees from the other party that certain things are true or will happen, and if they are wrong, the party making them could be held responsible.
Why are representations and warranties of counterparty important?
These clauses are important because they provide a level of assurance and protection in business agreements. By requiring a counterparty to make representations and warranties, the other party can reduce the risk of entering into an agreement based on false or misleading information. They ensure that key facts or conditions about the deal, such as the ownership of assets, compliance with laws, or the financial health of a business, are accurate. If these statements prove to be false, the party making them may have to compensate for damages or allow the agreement to be terminated.
For SMB owners, ensuring that the counterparty’s representations and warranties are clear and accurate helps mitigate risks in contracts, investments, and transactions.
Understanding representations and warranties of counterparty through an example
Business Acquisition: You are purchasing a small business, and the seller makes several representations and warranties, including:
- The business is in full compliance with all applicable laws and regulations.
- There are no ongoing lawsuits or legal disputes involving the business.
- The business owns all the assets listed in the agreement free from encumbrances.
These representations and warranties give you confidence that the seller is being truthful about the business's legal standing, financial condition, and ownership of assets. If it turns out that the business was involved in an undisclosed lawsuit or does not own some of the listed assets, you could hold the seller accountable for breaching the agreement.
Loan Agreement: You, as a lender, enter into a loan agreement with a company. The company (the counterparty) makes the following representations and warranties:
- The company has the authority to enter into the loan agreement and fulfill the repayment terms.
- The company’s financial statements are accurate and have been prepared according to generally accepted accounting principles (GAAP).
- The company is not in default on any other loans.
These representations and warranties provide you with the necessary assurances that the company has the legal capacity to take on the loan and that its financial situation is accurately presented. If the company is later found to have misstated its financial condition or is already in default on another loan, you may have grounds to take legal action for breach of the agreement.
Example of representations and warranties clause
Here’s how a representations and warranties clause might look in an agreement:
“The Counterparty represents and warrants to the Buyer as follows: (i) The Counterparty is duly organized, validly existing, and in good standing under the laws of [jurisdiction]; (ii) The Counterparty has the legal right and authority to enter into and perform this Agreement; (iii) The Counterparty has not been involved in any material litigation or legal proceedings, nor are there any claims pending that would adversely affect the Counterparty’s ability to fulfill its obligations under this Agreement.”
Conclusion
Representations and warranties of counterparty are essential elements of any business agreement, providing assurance that the facts or conditions critical to the deal are truthful or will be met. For SMB owners, understanding the importance of these provisions helps ensure that they are not exposed to unforeseen risks or liabilities in contracts or transactions.
By ensuring that the counterparty’s representations and warranties are clearly defined and accurate, businesses can safeguard their interests, mitigate risks, and hold the other party accountable if any of the agreed-upon terms are violated.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.