Negotiated Acquisitions of Companies Subsidiaries and Divisions CH 11 + 12

Negotiated Acquisitions of Companies Subsidiaries and Divisions § 11.
01
Negotiated Acquisitions of Companies, Subsidiaries and Divisions (LJP) > CHAPTER 11: Seller
Representations and Warranties
§ 11.01 General Considerations
To many attorneys, the portion of the acquisition agreement relating to the Seller's representations and
warranties is the cornerstone of the agreement and the entire acquisition process.
Because so much hinges on the representations, and, perhaps, because of the uniquely "legal" nature of
representations, attorneys spend an inordinate amount of time negotiating them. The representations article is
often the first part of the agreement to be negotiated by the attorneys. This approach is quite logical since many
of the key sections in the other portions of the agreement, such as the "bringdown" provision in the conditions
section and the indemnification provisions, are based on the representations and warranties. There are also other
reasons for handling the representations first. Beyond any explicit interdependence, the representations and
warranties article, and, indeed, the actual process of negotiating the various representations themselves, often
sets the "tone" or, phrased somewhat more formally, the philosophical framework and approach of the
acquisition agreement. Is the agreement pro-Buyer or pro-Seller? Bare bones or long form? Symmetrical as
between the parties' representations, agreements and conditions or weighted in favor of the Buyer? 1 While the
answers to these questions, and the more general issue of the basic approach of the agreement, will not
eliminate the need for negotiation over the remainder of the document, they will certainly be very relevant to
the process. 2 Finally, since it is also often the case that the representations and warranties article comes first in
the agreement, attorneys will tend to go in that order unless there is a good reason not to. 3
[1]-Purpose of Representations
1For an example of what the drafters (at least) viewed as a "Buyer's reasonable first draft," see "Model Stock Purchase Agreement with
Commentary," American Bar Association, Committee on Negotiated Acquisitions, Business Law Section (1995) (the "ABA Model
Agreement").
2 The effect of negotiating the representations and warranties article first on the remainder of the agreement might be somewhat unexpected.
Consider the Seller who has successfully negotiated a very limited representation as to whether governmental approvals were required in
connection with the transaction. When the parties get to the article on conditions, the Seller might find that the deficiencies in the
representation cause the Buyer to insist on a separate, broadly worded condition on the topic. The Seller, for its part, might feel that it already
had the argument about "comfort" on governmental approvals and that the Buyer is re-opening the issue. Of course, the approach of handling
this "comfort" issue in the covenants rather than the representations may make sense if the parties agree that the Buyer may use the time
between signing and closing to investigate which approvals are necessary or to seek to obtain them if it is also agreed that the Buyer's remedy
for breach of a covenant is merely the ability not to close the transaction.
3 Indeed, the gamesmanship and arguments that the due organization and good standing representation occasionally generates is truly
amazing, and many times completely out of proportion to what is appropriate. The reason is simple: it is traditionally the first representation
set forth in the agreement and the attorneys (or their clients) are anxious to establish early on who has the upper hand in the discussions or
who is the tougher negotiator or, in a more constructive vein, what the appropriate level of detail is for the picture of the Company that the
Seller will be painting in the representations.
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Negotiated Acquisitions of Companies Subsidiaries and Divisions § 11.01
In a typical acquisition agreement, the Seller's representations perform two roles. First, they "paint a picture," as
of the moment that the parties become contractually bound, 4 of the business being acquired. It is the target
company as so described that the Buyer believes it is paying for, and much of the remainder of the acquisition
agreement deals with the consequences of this picture either proving in retrospect to have been inaccurate or
changing prior to the closing. The representations may describe the business being sold in terms that are both
affirmative: "Schedule 2 sets forth a list of all of the Company's material agreements," and negative: "the
Company is not in violation of any agreement to which it is party." 5
The second general function that the representations serve, and in this respect they work together with the
covenants contained in the acquisition agreement, 6 is to set forth a road map of many of the events that must
occur between signing and closing. For example, a representation by the Seller as to which governmental
approvals are required in connection with the execution, delivery and performance of the acquisition agreement
will, in fact, guide the Buyer in determining exactly what has to be done, what filings have to be made, what
approvals are necessary, and how long all such matters will take in order to consummate the transaction. 7
The time involved between signing and closing may be of critical importance to both the Buyer and Seller for
any number of reasons. First, of course, this is because time translates into money. A fixed purchase price
payable in nine months is worth considerably less to a Seller (and, for that matter, is considerably cheaper for a
Buyer) than the same amount payable in two months. A similar analysis applies in a stock transaction, at least
where the stock to be issued by the Buyer pays a dividend during the period between signing and closing at a
higher rate than the Company's stock. (Indeed, acquisition agreements often prohibit the paying of any
dividends by the Company during the period between signing and closing.) 8 While a variable purchase price,
one that includes interest or a closing balance sheet adjustment in a cash transaction, might be useful in solving
this problem, other concerns are not so easily dealt with. For example, the risk of non-consummation might be
significantly greater if the closing takes longer. Both the Buyer and the Seller can be damaged in this
circumstance: the Buyer can be hurt by losing its perceived opportunity and the Seller may be disadvantaged
because the Company may now be viewed as "damaged goods" due to the possibility that disclosure of the
pending transaction may well have adversely affected the Company's operations. Similarly, the risk of third
4 While many representations speak as of the date of the agreement, others describe some feature of the Company as of an earlier date.
Generally, this latter type of representation deals with financial or similar matters, such as representations concerning the Company's
financial statements or tax returns which would typically trigger off the last quarter financial statement or filed tax return. It is important for
the Buyer in these cases to separately cover the period from such earlier date to the date of signing the agreement, at a minimum with a
representation as to the absence of any material adverse change since the date of the most recent financial statements. See § 11.04[9] infra.
Changes thereafter (i.e., post-signing) are handled through the operation of the bring-down condition. See § 14.02 infra.
5 One very important development over the past ten years has been the divergence in the treatment of representations and warranties in
acquisition agreements for public companies and privately owned companies (including subsidiaries and divisions). For example, agreements,
where the target is publicly owned have few, if any, representations of the "affirmative" type and significantly fewer representations in
general, as compared to agreements for the acquisition of privately owned businesses. See § 16.03 infra. This is in part related to the fact that
post-closing indemnification for breach of representations is rare in public company transactions. The Authors believe that in certain
circumstances the Sellers may be able to successfully argue that such "listing" representations should not be covered by indemnification; even
without such an exception it may be difficult for a Buyer to show any "loss" from such a breach.
6 See Chapter 13 infra.
7 While most of the statements made in this Chapter 11 concerning the Seller's representations are also true with respect to the Buyer's
representations, this is particularly true of this point. Facts about the Buyer, such as its need for shareholder, lender or governmental approval
can significantly affect the likelihood of, and the time required before, closing.
8 A market price formula in a stock transaction, that is, where the exact number of shares to be received in respect of each share of Company
stock is not a fixed ratio but, rather, depends on the trading price of stock of the Company or Buyer or both over some specified period of
time prior to closing, is an important protection but will not solve this "time value of money" problem (although an individual stockholder
may employ "self help" by selling his stock during the pendency of the transaction and reinvesting the proceeds). See § 16.05 infra.
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party competition increases with the time it takes to close. A Buyer who has no confidence in a Seller's ability
to run its business profitably is often anxious to close and take control as quickly as possible. Conversely, a
Buyer might want to wait and observe the Company's business or operating results over a longer period of time
before closing. Perhaps the Company is about to introduce a new product on the market and the Buyer is only
interested in acquiring the Company if it turns out to be a success; or perhaps the Buyer is awaiting the outcome
of a pending litigation against the Company: there are a virtually unlimited number of considerations that might
make either party want to speed up or slow down the process. 9
As previously discussed, from the Buyer's point of view, a key role of the Seller's representations is to paint a
picture of the business. This is a valuable purpose in and of itself. A Buyer may learn facts about the business it
is acquiring of which it had been unaware. As a result, the Buyer might change its view as to the appropriate
purchase price or even the desirability of doing the acquisition at all. 10 More likely, the Buyer may learn things
about the Company which will cause it to want to renegotiate certain, less central, aspects of the transaction.
For example, the Buyer of a division from a large and diversified corporate Seller might insist that the Seller
remain responsible for a particular litigation or liability of which the Buyer previously had been unaware, or
that the Seller agree to continue to perform certain services for the acquired business post-closing. Had there
not been representations flushing out the existence of the litigation or the fact that certain necessary functions
(for example, data services) were provided by the Seller's corporate headquarters to the division the Buyer is
buying, the Buyer might have unwittingly assumed the risk of the litigation and the cost of obtaining such
services.
At least as important as the foregoing, however, are the rights that accrue to the Buyer if the picture shown by
the representations is wrong, either at signing or at closing. These will depend in large part on the conditions 11
and indemnification 12 articles of the agreement, and how the representations and warranties interact with these
other provisions. For example, most acquisition agreements provide that if the Seller's representations made at
signing are no longer true at closing, 13 the Buyer is not required to go forward and consummate the
acquisition. 14 If the representations and warranties were also not true at signing, the Buyer could generally
refuse to close and, in addition, sue the Seller for damages. 15 In the event the Buyer consummates the
9 Note, however, that the Buyer will need to have negotiated the agreement so that it has the right not to close if such events occur or fail to
occur. The "normal" agreement would include a material adverse change condition but it is not at all clear that such condition would be found
to have occurred by virtue of the failure of a product not introduced at the time of signing. See § 14.02 infra.
10 For example, a significant off-balance sheet liability previously unknown to the Buyer might be discovered. Alternatively, the Buyer might
learn that the Seller has an operation that is subject to governmental regulation (see § 5.05 supra) and that, as a result, the acquisition will
take too long to close. Sometimes the Buyer can gain such knowledge merely by asking for such a representation.
13 See § 14.02 infra. In a two-step public acquisition where the Buyer first acquires the bulk of the Seller's stock in a tender offer which is
then followed by a merger (wherein Buyer acquires the remainder of the Seller's stock), the "closing" for this purpose might be the purchase
of stock under the tender offer, not the consummation of the merger. See § 16.02[3] N.37 infra. As a result, the conditions applicable to the
second step are quite limited and would not include a bringdown of the representations to the second closing.
14 This is the so-called "bringdown" condition. The condition is sometimes worded so as to require accuracy of the representations at signing
as well as at closing. See § 14.01 infra. See also, § 11.01[3] infra for a discussion of the importance of the specific wording of the various
representations for purposes of the bringdown condition.
15 The Buyer's right to terminate the agreement and sue for damages by reason of a misrepresentation exists under common law. See
generally, Farnsworth, Contracts 246-247 (1990). However, the parties may, by contract, change this. See: §§ 15.01 et seq. infra. See also, §
11.01[3] infra. While the agreement may be silent on the point, as a practical matter there is a "materiality" qualifier to this: if a Seller wants
to press it, it's unlikely that a court would consider it appropriate for a Buyer to be able to refuse to close on account of a minor
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transaction, its claim for damages is dealt with in the indemnificationarticle 16 of the agreement. 17 Thus, there
are three distinct reasons for a Buyer to want a Seller to make representations and warranties in general and any
specific one in particular:
(1) to assist the Buyer in understanding the business it is acquiring and in doing its due diligence;
(2) to allow the Buyer to refuse to close the transaction if the representations are not true at closing; and
(3) to enable the Buyer to recover damages if a representation turns out to have been false when made,
whether or not the transaction closes. 18
To these three motivations we might add a fourth aim, discussed above and closely related to the due diligence
function: to assist the Buyer in managing and completing the acquisition process. 19 Of course, as discussed
below, not all of these motivations are present in any particular case.
The Seller's views about its representations are in large part the inverse of the Buyer's. The Seller does not want
to have to spend long hours creating a detailed disclosure schedule to help educate the Buyer about the Seller's
business, thus increasing the likelihood that the Buyer may renegotiate the purchase price.20 The Seller also
misrepresentation; further, if a Buyer were to do so and the transaction did not close, a court might not impose (and a Buyer might not
pursue) damages unless there had been significant costs incurred or some element of wrongdoing.The situation becomes more complicated if
the Seller's representations were not true at signing but are true, at least in all material respects, at the scheduled closing date, or at the time
that the Buyer is considering terminating the agreement. The Buyer, if it does not wish to close (in all likelihood for a totally unrelated
reason), will point to the literal language of the closing condition that requires accuracy at signing as well as closing in order to justify its
refusal to close. The Seller will argue that the Buyer should be required to proceed with the transactions on the grounds that it is irrelevant
whether the representations were true when made at signing so long as they are correct at closing, the time that Buyer obtains ownership of
the business being sold. In effect, any problem that may have previously existed has been cured.
16 Absent a contractual provision expressly on point, difficult questions can arise as to whether this right exists if the representations were
true when made but not at closing. See § 15.02[1][a],[f] infra. See § 15.02[2] Ns. 24.1-24.8 infra and accompanying text.
17 Acquisition agreements for public companies do not usually provide for indemnification. See § 16.04 infra.
18 It is unusual (although not unheard of) for Buyers in the acquisition agreement to waive the liability of Sellers for material
misrepresentations if the transaction fails to close, particularly where the misrepresentation is the reason for it. While this result may seem
equitable at first, it ignores all of the expenses and the "opportunity cost" of a Buyer who has proceeded to work on a transaction on the basis
of misrepresentation. A fraud claim, which requires a showing of a knowing misstatement, provides a very poor substitute for contractual
protection.In the event the transaction does close, the parties might agree in the contract that there is no post-closing remedy for
misrepresentations; that is, the representations and warranties in the acquisition agreement do not "survive" the closing. There may, however,
still be some remedies available for the aggrieved Buyer, so long as certain requirements are satisfied. While the elements of these causes of
action vary, they are generally poor substitutes for contractual indemnification. For example, both common law fraud and securities law
claims require some sort of malicious intent, at the very least, knowledge, on the part of the Seller which is often not required to obtain
indemnification under an acquisition agreement. See § 11.02 infra. In any event, the availability of each of these noncontractual remedies is
significantly enhanced (indeed, in the case of common law fraud, only available) if the Buyer is able to point to an explicit representation
which was in fact breached. The one non-contractual remedy of some real potential use is under Section 11 of the Securities Act of 1933, 15
U.S.C. § 77k, with respect to material misstatements and omissions in the registration statement. See: §§ 5.02, 5.03[2] supra. The remedy
may be enhanced if the Seller provided Buyer with a "no material misrepresentations" representation, even if such provision did not survive
the closing. See § 11.04[9] infra.However, this remedy will often apply following the execution of the acquisition agreement and full
disclosure at such time will avoid liability while perhaps not affording the other party an "out" if no representation has been breached. (Of
course, such disclosure might, for example, result in shareholders of the other party not approving the transaction, thereby obtaining an "out"
in that manner.)
19 This last purpose is somewhat different from the others in that it does not relate only to the condition of the Seller's business but, rather, to
the interaction of the transaction with the Seller's business and the process which needs to be followed to consummate the transaction.
Accordingly, it is not relevant to analyzing a number of the "pure business" representations. This is particularly important in public company
acquisitions. See: §§ 5.10[2][b], [c] and 8.04[3] infra for a discussion of the need to plan and integrate disclosure controls and procedures and
internal controls over financial reporting.
20 As a strategic matter, the Seller may be wise to disclose as much as possible about the business. If the Buyer's indemnification rights are
limited to matters as to which it is unaware, detailed disclosure schedules may limit significantly the Seller's potential post-closing liability.
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wishes to limit the Buyer's rights to refuse to close the transaction and does not want to have to return any part
of the purchase price post closing because of a misrepresentation.21
[2]-Scope of the Representations
The universe of representations that a Seller can be asked to make is limited only by the ingenuity (or, from the
viewpoint of the Seller, the unreasonableness) of the Buyer and its counsel. 22 It is also important to remember
that the Seller's concerns about the scope of the representations are the flip side of the Buyer's reasons for
wanting them. Thus, since an acquisition agreement negotiation is rarely a wholly one-sided process, it is useful
for a Buyer to analyze representations which it is considering requesting (or insisting upon) in light of the
concerns of both parties. Often times, a Buyer might determine that it does not really need the benefits
provided. In other instances, however, a Buyer may take the position that obtaining additional representations
which would provide some additional, albeit minimal (and perhaps, theoretical) protection to the Buyer is in
and of itself sufficient justification for insisting upon such representations. 23 There is, of course, no answer as
to whether this position is right or wrong; in fact, it is rarely a question of right or wrong. The most that usually
can be said is that there will be cases where such an approach is consistent with other aspects of the transaction
and other instances where it is not. For example, contrast the case of a Buyer who is paying a high price for a
business for which there is not likely to be any competition from other potential buyers, where time is not of the
essence and where the Buyer wants the business being acquired to be in pristine shape (and is paying for it to be
so), with the situation where a Seller that is the target of a hostile takeover bid is conducting an auction of either
itself or a major subsidiary, where there are several bidders, all offering approximately the same price and
where the time pressure of external factors requires that the transaction be documented and closed quickly. A
Buyer can insist on obtaining as many and as extensive representations in the second case as in the first, but it
would probably be a mistake to do so if the Buyer is seriously interested in signing and closing the deal.
A Buyer might be willing to forego a particular representation for either of two reasons. First, its subject matter
might not be particularly important to the Buyer in light of the business being acquired, so that none of the
benefits which flow from representations generally are relevant to the Buyer in the context of the specific
representation at issue. Indeed, the representation might not even make sense in light of the business involved.
One example would be a representation as to the status of pension plans under foreign law when, in fact, the
Seller has never had any foreign operations. Another might be a lengthy representation as to the absence of
See § 10.02 supra. Sellers should remember the interrelationship between this and the Buyer's and its representatives' rights of access and
inspection between signing and closing. See § 13.02[1] infra. Further, a Buyer's ability to close and sue based on a representation which it
knew at closing had been breached may be limited if it arguably did not proceed in reliance on such representation (especially if the breach
was acknowledged at closing). See Galli v. Metz, 973 F.2d 145 ( 2d Cir. 1992), applying New York law. The question is somewhat unsettled,
with a different result in New York in a case where there was an express reservation of rights at the closing. See CBS, Inc. v. Ziff-Davis
Publishing Co., 75 N.Y.2d 496, 554 N.Y.S.2d 997553 N.E.2d 997 ( 1990). Some courts have held a Buyer's personal knowledge of a breach as
barring recovery. See Hendricks v. Callahen, 972 F.2d 190 ( 8th Cir. 1992), applying Minnesota law. See generally, § 15.02[2] infra. The
Authors suggest that the parties deal directly with the question of the effect of the Buyer's knowledge. See, e.g.:First Circuit:Mowbray v.
Waste Management Holdings, Inc., 45 F. Supp.2d 132 ( D. Mass. 1999).Second Circuit:Promuto v. Waste Management, Inc., 44 F. Supp.2d
628 ( S.D.N.Y. 1999).Third Circuit: Giuffrida v. American Family Brands, Inc., 1998 U.S. Dist. LEXIS 5588 (E.D. Pa. April 22,
1998).Eleventh Circuit:Southern Broadcast Group, LLC v. GEM Broadcasting, Inc., 145 F. Supp.2d 1316 ( M.D. Fla. 2001).
21Related to this last concern, of course, is the Seller's concern about its liability for a misrepresentation in the event the Buyer does not close
by reason of a breach.
22 This is, not to imply that Sellers are necessarily willingly led to the slaughter; "asking" does not imply obtaining.
23 There is some authority to the effect that the typical financial statement representation may be given less by a court as to items not
otherwise covered by specific representations when the acquisition agreement contains specific representations about other financial
statement line items. See, e.g., Delta Holdings, Inc. v. National Distillers & Chemical Corp., 945 F.2d 1226 ( 2d Cir. 1991), cert. denied503
U.S. 985 ( 1992). The Authors nonetheless believe that counsel should include specific representations as to matters that are important to the
client.
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environmental liabilities when the business being acquired is an advertising agency located in two floors of an
office building in downtown New York. A Seller might argue that the chances of environmental liabilities
being a serious problem are probably too remote to justify a lengthy negotiation over whether to include the
representation. 24 A less extreme situation might involve a representation as to the Seller's equipment (consisting
of office furniture) being in good repair. Unlike the other two examples, the Seller could, in fact, have
equipment which is not in good repair, and will have to be replaced by the Buyer. However the amount
involved might be sufficiently small that the Buyer does not believe (or knows that the Seller will never agree)
that a breach of this representation should provide an excuse for the Buyer not to close or to obtain post-closing
damages; 25 alternatively, the Buyer might be comfortable simply based on its on-site inspection of the
equipment. In either case, there is little risk to the Buyer.
Secondly, the purpose to be served by including the particular representation, while important, may be
achievable in another way. For example, suppose that the Buyer is acquiring a publicly held Seller in a
leveraged acquisition, 26 the acquisition agreement does not provide for indemnification (in other words, the
representations and warranties do not "survive" the closing), and the agreement contains a "financing condition"
that neither the Buyer nor the Seller is obligated to close the transaction unless the Buyer has been able to
obtain financing. 27 In this situation, representations are not needed for one, and in large part, for a second, of
the three roles discussed above, that is, providing an excuse not to close or as the basis for recovery of post-
closing damages. Indemnification will not be available 28 and, if anything turns out to be seriously wrong with
the business, the Buyer will in all likelihood be unable to obtain financing, thereby causing the financing
condition not to be satisfied. This leaves just the due diligence function, which in and of itself would most
likely not justify an extended negotiation over a long list of representations. The outcome in this situation has
traditionally been a stripped down agreement with certain basic representations: due organization, 29
authorization, 30 no violation, 31 capitalization, 32 financial statements, 33 no material adverse change, 34 accuracy
of SEC filings 35 and possibly some others. 36
24 At the risk of our appearing biased in favor of Buyers, the response to a Seller, for which we have never heard a truly convincing
counterargument, is that the more outlandish the Buyer's concern, the easier it is for the Seller to make the representation without any
attendant risk.
25 Of course, this issue can be addressed by fixing the appropriate size "basket" in the indemnification section. See § 15.03[1] infra.
26 See Chapter 20 infra for a discussion of leveraged buy-outs.
27 See: §§ 12.04, 13.02[3], 14.11[4], 20.04 infra for a discussion of financing conditions and the Buyer's representations and covenants
concerning financing.
28 However, absent agreement to the contrary there is still the ability of the Buyer to sue for damages in the event of a misrepresentation if
the transaction does not close. See also: Ns.13, 16 supra.
29 See § 11.04[2] infra.
30 See § 11.04[6] infra.
31 See § 11.04[7] infra.
32 See § 11.04[4] infra.
33 See § 11.04[8] infra.
34 See § 11.04[9] infra.
35 See § 11.04[16][e] infra.

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There are some counterarguments that the Buyer might make, however, in support of more extensive
representations being included in the acquisition agreement, even in the public company leveraged buyout
context. First, purely as a business matter, the Buyer might not want to rely on the financing condition to justify
a refusal to close the acquisition 37 but would prefer to base its right to abandon the transaction on a particular
representation not being true at the closing. Secondly, a Buyer might not be willing to commit its time, money
and reputation to try to effect a transaction unless the Seller is willing to make various representations. 38 The
Buyer's concern in this instance is not so much a fear of not being able to obtain the financing and thus not
being in a position to close because something about the business has changed; rather, the Buyer might be
concerned that there is a preexisting problem, one that would be flushed out by the Seller making additional
representations. The problem is all the more acute since the leveraged Buyer will probably need to make "full-
blown" representations to its lenders. The Buyer is not willing to proceed further along the acquisition process,
making the necessary commitments of time and money, unless the Seller is willing to "step up to the plate" and
make the additional representations. 39 Finally, the opposite is also true. Just as the Buyer derives real comfort
from a Seller who is willing to step up and make representations, both it and its lenders might become very
nervous when faced with a Seller who refuses to make what they believe to be standard representations, using
as an excuse that the Buyer does not need them because of the financing condition. The absence of the
representations in the acquisition agreement might well make the financing more difficult to obtain. 40
If the parties reach an impasse on any given representation, it is useful to see whether there is a way to address
both their concerns. For example, if the Seller is concerned about being sued post-closing on a
misrepresentation, but the Buyer is primarily interested in being given full information up front and in having
broad rights to refuse to close the transaction in the event of a misrepresentation, a compromise can be reached.
The representation would be left "flat" (that is, unqualified), but a limitation on the Buyer's rights would be
included in the indemnification provisions. 41 Indeed, through judicious use of knowledge and materiality
qualifications, many compromises can be effected,42 at least where the concerns of the Buyer and the Seller are
36 Even some of the listed representations might not find their way into the agreement if management, without the aid of a third party equity
source, is buying the company. See § 20.04 infra. This issue is directly linked to whether or not the Seller's indemnification is to be extensive
or, because of the management involvement, nonexistent. While equity might suggest that the Seller's indemnification be quite limited in
such circumstances, practice is often the contrary, particularly when a third party equity funding source is involved. For a discussion of
representations and warranties in the case of public company acquisitions, see § 16.03 infra.
37 The Buyer's reliance on the financing condition to avoid closing might result, depending upon the specific terms of the acquisition
agreement, in the obligation to pay a "bust-up" fee to the Seller or the Seller's obligation to pay such a fee or expense reimbursement to it
being negated, whereas such fee and expenses might be recoverable if the Buyer failed to close as a result of the inaccuracy of one of the
Seller's representations. Invoking a financing condition might also create a perception in the marketplace that it was the Buyer's fault that the
deal failed since obtaining the financing is the Buyer's job. See § 20.04 infra.
38 Not only do Buyers, particularly financial Buyers such as LBO firms, believe that there is an "opportunity cost" involved in spending a
significant amount of time on an unsuccessful transaction, they are also concerned about the stigma of not completing an acquisition (even if
through no fault of their own) and the possible negative impact such failure may have upon them in competing for other acquisition
transactions in the future. See § 20.02 infra.
39 It is the Buyer's ability to sue the Seller for a misrepresentation by using a simple beach of contract action that enables the Buyer to derive
comfort from the Seller's willingness to make the representations. Indeed, in a very theoretical sense, the moment the Seller is willing to make
the additional representations is arguably the same moment that the Buyer no longer needs the comfort which getting the representations
provides.
40The problem is exacerbated because of the necessity that the Buyer make representations concerning the business to its lenders in the credit
agreement.
41 Alternatively, the representation can be limited through use of a knowledge qualification. See § 11.02 infra.
42 See: §§ 11.02, 11.03 infra.

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not diametrically opposed. It is an unhappy fact, however, that there will be many cases where the interests of
the parties cannot be reconciled and someone will have to concede if a deal is to be made.
Having said all of this, we return again to the critical point made earlier about an acquisition agreement: 43it is a
negotiated document that in large part reflects the parties' relative bargaining power and the other attendant
circumstances (including time pressure). This is, in turn, a function of the basic economics of the transaction:
the attractiveness of the purchase price, the prospect of competing purchasers and the availability on the market
of substitutes for the business being acquired. Nowhere is this concept truer than in the case of the Seller's
representations and warranties, in terms of both their number and their scope, and the related indemnification
provisions. All other things being equal, the Buyer that is willing to pay substantially more than any other party
to acquire a particular business will be much more likely to obtain extensive representations and warranties and
full protection with respect to both closing conditions and indemnification. Conversely, the Seller may be
willing to accept a lower purchase price in return for increased certainty of closing and limited or no
indemnification risk.
There is a potential trap for the unwary that arises from a basic principle of contractual construction, although
we suspect that most practitioners probably would not have anticipated its application to acquisition
agreements. In most acquisition agreements, a problem with the target's business could be covered by several
different representations. For example, a violation of environmental law could be covered by the sections on
environmental matters, 43.1 violations of law, 43.2 absence of undisclosed liabilities, 43.3 accuracy of SEC
disclosure, 43.4 and financial statement compliance.43.5 Some of these representations will have qualifications or
limitations that others do not-a knowledge limitation would be a good example-or that are phrased somewhat
differently. Is the Buyer protected so long as it could find one representation that is breached? Conversely, can
a Seller argue that limitations in one representation should, in effect, be read into other representations when
their scope overlaps? Alternatively, could the Seller argue that the presence of one representation covering the
matter precludes the applicability of the others? It would seem that the Buyer would have the better of the
argument. However, at least one leading court has ruled in favor of the Seller in this situation on the basis of the
rule of contractual construction that a specific provision governs over a more general one where their
application would lead to different results. 43.6 A noteworthy aspect of the court's decision was that the contract
contained specific statements in certain of the Seller's representations and warranties that they were the
exclusive representation that covered the subject matter of such representation; however, the specific
representation in question that the court held to apply to the exclusion of the more general representation did
not contain such a statement. 43.7 In light of the foregoing, Buyers should consider whether it may be appropriate
to include somewhere in the contract-most likely either at the beginning or end of the article on representations
and warranties, or in a miscellaneous section near the end of the contract-an express statement that the various
43 See the discussion in the text (first paragraph of § 11.01[2]) supra.
43.1 See § 11.04[11] infra.
43.2 Id.
43.3 See § 11.04[8] infra.
43.4 See § 11.04[16][e] infra.
43.5 See § 11.04[8] infra.

43.6See DCV Holdings, Inc. v. Conagra, Inc., Civ. Act. No. 98C-06-301, 13-15 (Del. 2005) (a representation as to the absence of known
violations of law held to preclude applicability of a representation as to the absence of undisclosed liabilities, which was not qualified by
knowledge).
43.7 The court did not discuss this fact, which under basic rules of contractual interpretation would have pointed to a different outcome.
Page 733 of 901
representations and warranties are independent of each other and that neither the provisions of one nor any
limitations contained therein should be read to limit any other.
[3]-Timing Considerations and Representations: Effect of the Bringdown

Representations generally speak as of the date of the agreement and, for purposes of the closing conditions, as
of the closing, oftentimes by not specifying a different date. However this is not always the case, and it is
worthwhile examining the consequences of what might appear at first to be relatively minor differences in
drafting. Consider the three slightly different versions of the same Seller representation set forth below:
(1) The Company is in compliance with all laws applicable to it.
(2) As of the date of this Agreement, the Company is in compliance with all laws applicable to it.
(3) The Company, as of the date of this Agreement, is and, as of the Closing Date, will be in compliance
with all laws applicable to it.
These three formulations have very different consequences to the parties.44 Consider the situation where the
Company is in compliance with applicable law on January 1, when the acquisition agreement is executed, but
not on March 1, when the parties are otherwise ready to close. Assume also that the Buyer's obligation to close,
be it to purchase stock or assets or to effect a merger, is conditioned on the Seller's representations and
warranties being "true and correct as of the Closing Date." 45
The first question is whether the condition is satisfied and, consequently, whether the Buyer is obligated to
close. We would argue that in the case of versions (1) and (3) the condition is in fact not satisfied. The third
version is the easier of the two: the representation is not true as of March 1. Specifically, the statement "As of
the date of this Agreement the Company was, and as of the Closing Date the Company is, in compliance with
all laws applicable to it" is not true because on the intended Closing Date (March 1 in our example) the
Company is not in compliance with applicable law. A similar analysis applies to version (1) because the
statement "The Company is in compliance with all laws applicable to it" does not have any time frame
specified. Consequently, it always refers to compliance on the date on which the statement is made, or deemed
made, which the Buyer would (correctly) argue is March 1 for purposes of the bringdown condition.
The outcome is different, however, with version (2). The representation itself contains a limiting reference to a
date. It only speaks, by its terms, as of the date of the Agreement. Hence, when the representation is for
purposes of the closing condition deemed to have been made again as of March 1, the Closing Date, the
statement that is deemed to be repeated is still a statement as to the state of affairs on January 1. The fact that
the Company is not in compliance on March 1 is irrelevant, and, accordingly, the Buyer will not be excused
from closing. 46
44 A fourth version-one which is quite common-would be: "As of the date hereof, the Company is in compliance with all laws applicable to
it." We would generally view this formulation as having the same legal effect as version (1), although in any given agreement the Seller
might be able to argue that it is the equivalent of version (2) (which is much less favorable to the Buyer).
45 The so-called "bringdown condition." See § 14.02 infra.

46 Thus, the benefit to the Buyer of the bringdown condition is lost. If all of the representations referred to the "date of this Agreement" and
the bringdown condition required accuracy at both signing and closing, the Buyer would argue that the analysis in the text would render
unnecessary the requirement in the bringdown condition to accuracy at the time of closing in addition to the time of signing as a way of
regaining such benefit. The Buyer should be more likely to obtain a more favorable interpretation from a court if the bringdown condition
required that the Seller's representations and warranties be "true and correct as of the Closing Date as if made as of such time instead of as of
the date of this Agreement (because there would be an ambiguity as between these provisions)." Conversely, the Buyer would have a more
difficult time if the bringdown required that the Seller's representations and warranties must be "true and correct as of the Closing Date as if
made as of such time (except in the case of representations and warranties made as of a specific date, which shall be true as of such date)". In
any event, Buyers should, as a normal rule, draft and negotiate acquisition agreements so as to avoid these types of disputes.
Page 734 of 901
There is a difference between versions (1) and (3) which we should point out. Both formulations, as discussed
above, will allow the Buyer not to close. In case (3), however, the representation in the form actually made,
subsequently proved to be false. This allows the Buyer to claim a breach and sue for damages. In effect, on
January 1, the Seller guaranteed to the Buyer that the Company would be in compliance with applicable law on
March 1. The breach is of the representation when made on January 1. The fact that it took until March 1 to be
able to test the accuracy of the representation made on January 1 does not change this. By contrast, in version
(1), the representation, when made, spoke only as of January 1. For purposes of the closing condition the
representation was not true as of March 1, but the Seller had never warranted that it would be. In such instance
the bringdown condition does not repeat the representations as of the Closing Date for purposes of liability for
breach 47 but, rather, only for purposes of whether the Buyer is obligated to close.
Great care needs to be taken in drafting these provisions in order to avoid-as much as is possible-undesirable
outcomes. Of course, in most transactions, these disputes occur not in the context of a court but in the middle of
a transaction that, generally speaking, the Seller and the Buyer still want to consummate. That being said, these
varying contractual interpretations will then serve as one party's leverage and may result, for example, in a
negotiated purchase price reduction or the strengthening of the Buyer's post-closing indemnification rights.
Negotiated Acquisitions of Companies, Subsidiaries and Divisions (LJP)

Copyright © 2020 ALM Media Properties, LLC. All Rights Reserved.
Further duplication without permission is prohibited.
End of Document
47 However, the situation is more complicated if the Buyer closes, both in the case where the Seller delivers an officer's certificate at closing
stating that the representation is still accurate or where the Seller takes an exception from its closing certificate for the particular
representation, especially if the Buyer's due diligence investigation had made it aware of the misrepresentation. See § 15.02[2] N. 23 infra.
§ 11.02 Knowledge Qualifications
Sellers often refuse to make various representations on the grounds that they simply do not know whether they are
true or not. One common example of this is the representation that "there is no litigation pending or threatened
against the Company." Sellers, quite rightly, point out that they have no way of knowing whether any person is
"threatening" litigation. As a result, the representation is often modified to read: "There is no litigation pending or,
to the best of Seller's knowledge, threatened against the Company."
Several issues arise in connection with knowledge qualifications made to representations. The first, and most
important, is whether a knowledge qualification is appropriate with respect to any particular representation. A
second question has to do with whose knowledge is relevant if such a qualification is agreed to by the parties.
Finally, the exact formulation of the limitation may be significant.
The key fact to realize when discussing knowledge qualifications is that their use or absence allocates risk between
the Buyer and the Seller. 1 For example, in the representation set forth above as to the absence of threatened
litigation, the Buyer might respond to the Seller's argument by saying, in effect, that it is not a question of whether
it is fair to expect the Seller to be aware of threatened litigation, but that, as between the Buyer and the Seller, the
risk should be on the Seller. The reason for this risk allocation might be that, as between the two of them, the Seller
is more likely to be in a position to know whether there exists a basis for a lawsuit than the Buyer and, thus, should
bear the risk of the threatened lawsuit that no one knows about yet. Alternatively, the Buyer (or the Seller, for that
matter) might simply take the position that, regardless of which party is in a better position to know of a threatened
litigation or the basis therefor, the pricing of the transaction did not take into account the objecting party assuming
such risk. 2
The problem with this latter approach, of course, is that the parties never actually thought about the specific
question of who should bear the risk of threatened litigation when they priced the deal. Consequently, it is difficult
to come to an objective resolution of when a particular knowledge qualification is appropriate, based on the pricing
of the transaction. 3 Over time, what has developed in practice is that a few representations have traditionally been
qualified by a knowledge limitation, and others have not (while a third category of representations can commonly
be found either so limited or "flat"). The purchase price argument is best used when this traditional structure is to be
1 This is also true with respect to materiality limitations and baskets, thresholds and caps. See: §§ 11.03 and 15.03 infra.
2 Another way of stating the Buyer's position, a formulation which avoids the problem noted in the text below, is: "This is a great price. If
you want it, forget about this knowledge garbage." The Seller has a corresponding argument.
3 There will be cases where this is not true and, for example, a particular risk is identified by the parties at an early stage and explicitly
allocated to one party or the other. One example might be where neither the Buyer nor the Seller has conducted any environmental audit of
the Company's business and does not know of any problem, but the parties have agreed that, and have priced the transaction on the basis that,
the risk of any environmental problem should be borne by the Seller.
Page 736 of 901
upset. In other words, a party may be successful in arguing that its pricing of the transaction took into account
"normal" representations, with a "standard" use of a knowledge qualification. For example, it would be very
unusual for a representation as to the absence of pending litigation against the Company to be qualified by the
words "to the best of Seller's knowledge." 4 In this case, the Buyer might very well insist on some sort of purchase
price adjustment as a quid pro quo for the qualification because of the added risk.
It is useful to consider the effect of the use of a knowledge qualification on the three roles 5 played by
representations generally in the acquisition process. Insofar as the due diligence function is concerned, it would
appear that the Buyer will not learn less about the Seller's business in the course of negotiating a particular
representation if it agrees to a knowledge qualification. However, the absence of a knowledge qualification and the
resulting liability risk for the Seller may cause the Seller to more thoroughly investigate its business, thereby
indirectly improving the due diligence investigation of the Buyer. With respect to the second role assigned to the
Seller's representations and warranties, allowing the buyer to refuse to consummate the acquisition by reason of the
operation of the bringdown condition, the use of knowledge qualification limiting a Seller's representation should
not have a significant impact. If a particular representation is not limited by a knowledge qualification and the
Seller is not, and does not prior to closing become, aware that the underlying substance of the representation is not
true, then the parties will believe that the bringdown condition is satisfied and the transaction will close. The result
would be no different if the representation contained the qualification. Conversely, if the Seller is aware at closing
that the representation is not true, the parties will realize that the bringdown condition has not been satisfied,
regardless of whether the representation contained a knowledge qualification. In either circumstance, then, the
presence of a knowledge qualification should not limit or broaden the Buyer's right to refuse to close.
One thing that Buyers have to be careful about is a representation with a knowledge qualification that talks in terms
of " Seller's knowledge as of the date of this Agreement." This type of timing formulation, as with non-knowledge
qualified representations, effectively defeats the whole purpose of the bringdown. 5.1 The point is that allowing the
qualifier to creep into the knowledge qualifier may be as dangerous as qualifying the entire representation.
It is with respect to the Buyer's ability to sue for damages, either in conjunction with terminating the agreement or
pursuant to an indemnification right following the closing, that the use of a knowledge limitation makes the biggest
difference. If the representation at issue is qualified by a knowledge limitation, the Buyer, in order to recover
damages, not only has to show that the underlying representation was false, but that the Seller was aware of it. This
is essentially a question of fact and might necessitate a full trial before being resolved. Moreover, to state the
obvious, if the judge or jury is not convinced that the Seller actually knew of the misrepresentation, the Buyer will
not recover any damages, regardless of how serious the misrepresentation was or the cost (including expenses in the
event the transaction does not close or damages or liability to a third party, depending on the particular
representation, if the transaction does close) to the Buyer. 6 The important lesson is that knowledge qualifications
4 The utility of this limitation may turn on the identity of the persons covered by the qualifier as defined in the acquisition agreement. See
text below.
5 See § 11.01[1] supra.
5.1 See § 11.01[3] supra.
6 Buyer's knowledge as to a breach of a warranty learned though its own investigation may affect its ability to collect through the Seller's
indemnification even in the absence of a knowledge qualification in the representation. See § 11.01 N.20 supra. See, e.g.:First
Circuit:Mowbray v. Waste Management Holdings, Inc., 45 F. Supp.2d 132 (D. Mass. 1999); Pegasus Management Co. v. Lyssa, Inc., 995 F.
Supp. 29 (D. Mass. 1998).Second Circuit:Rogath v. E.R. Siebenmann, 129 F.3d 261 (2d Cir. 1997); Promuto v. Waste Management, Inc., 44
F. Supp.2d 628 (S.D.N.Y. 1999).Third Circuit:Giuffrida v. American Family Brands, Inc., 1998 U.S. Dist. LEXIS 5588 (E.D. Pa. April 22,
1998).Seventh Circuit:Middleby Corp. v. Hussman Corp., 1992 WL 220922 (N.D. Ill. Aug. 27, 1992).Eleventh Circuit:Southern Broadcast
Group, LLC v. GEM Broadcasting, Inc., 145 F. Supp.2d 1316 (M.D. Fla. 2001).State Courts:California:Kazerouni v. De Satnick, 228 Cal.
App.3d 871, 279 Cal. Rptr. 74 (1991).Indiana:Shambaugh v. Lindsay, 445 N.E.2d 124 (Ind. App. 1983).
Page 737 of 901
are less important, to both parties, in situations where there are no indemnification rights, and where the likelihood
of a significant lawsuit for a simple misrepresentation in the context of a terminated transaction is small, such as the
typical acquisition of a public company.
A second major concern which arises in those cases where a knowledge qualification is used is the issue of whose
knowledge is relevant for the purposes of the limitation. There are a number of different possibilities, depending on
the particular transaction. If a parent company is selling a division or subsidiary, the knowledge can be that of the
parent, some or all of its officers or the subsidiary/division or some or all of its officers. If an entire company,
private or public, is being sold, the obvious choices would be the company itself or some or all of its officers. In
addition there is no reason in any given case why any single employee or group of employees could not be
included, and the appropriate entity or group of persons will vary from transaction to transaction. The Buyer wants
the group whose knowledge is referred to in the qualification to the representations tobe as large as possible, and to
make sure that it includes the people who would be the most likely to in fact have knowledge about the accuracy of
the representations in question. 7 Sellers generally do not want the knowledge of an entire corporate entity and all of
its employees to be the relevant body. While it might be possible to argue that knowledge of a "company" would
not include that of low-level employees, and that only the knowledge of officers should be attributed to the
corporate entity, this is by no means clear absent express language to this effect.8
Buyers and Sellers of subsidiaries or divisions face an interesting question as to the inclusion of management of the
business being sold in the group whose knowledge is relevant, particularly if they are going to remain with the
Buyer. On the one hand, they are the logical people to actually have the knowledge about the business in general,
and any given representation in particular, and so it would make sense for the Buyer to want to include them in the
group. On the other hand, will these people be willing to admit to the Buyer afterwards that they knew of the
misrepresentation that had been made, in a sense by them, to their new employer? Sellers, for their part, will worry
that the Buyer will pressure the persons who are now its employees to determine with hindsight that in fact, they did
know of the misrepresentation. For this reason Sellers of subsidiaries often try to have the qualification linked to the
knowledge of officers (or a few specified officers) of the parent entity. Buyers generally insist, however, on the
inclusion of the important management people of the business being sold. 9 In any event, in a sale of stock
transaction, a representation being subject to the knowledge of the selling stockholders, rather than management or
the Company, will generally render it useless.
The third question that comes up with respect to a knowledge qualification is the scope of the investigation that has
to be performed, if any. Again, there is a whole spectrum of possibilities ranging from a statement that "knowledge"
means "actual knowledge without any inquiry" to a standard of "knowledge after reasonable investigation." The
Buyer's and the Seller's respective preferences on this issue are obvious.
Often, no reference to any investigation or inquiry is made, and the qualification will be simply a reference to "the
knowledge of" the persons specified. The issue is whether, in this situation, a court would hold that the Seller (or
any party whose knowledge is referred to in the agreement) had a duty to conduct some sort of inquiry or
investigation. The question is essentially one of contractual interpretation and presumably will vary greatly in
interpretation from jurisdiction to jurisdiction. For example, if there is such a specific duty spelled out elsewhere in
the acquisition agreement, a court might be less likely to infer such a duty where the agreement is silent.
7 On occasion the Buyer will request that the Seller make a representation as to the group specified being the appropriate one.
8This highlights the difficult question as to whether a Buyer is better served by negotiating the identity of a specific "knowledge group" or
merely being silent.
9 See § 20.04 Ns. 5-8 infra, and accompanying text, for a discussion of some of the intricacies that can arise with respect to indemnification
provisions and knowledge of misrepresentations by management members of an LBO acquiror group.
Page 738 of 901

End of Document
§ 11.03 Materiality Limitations
[1]-In General
Perhaps the most important way in which a Seller can limit the scope of its representations is by imposing a
materiality standard on many of its representations. For example, instead of having to list "all agreements to
which the Company is a party" on Schedule X, the Seller could agree to list only "all material agreements to
which the Company is a party" on the Schedule. Similarly, instead of representing that "the Company is in good
standing in every jurisdiction where it is required to be qualified to conduct business," the Seller will represent
that "the Company is in good standing in every jurisdiction where it is required to be qualified to conduct
business, except where the failure to be in good standing will not have a material adverse effect on the
Company."
There are a number of preliminary points to be made about such materiality limitations. The first, and one of the
most important, is that the level of item or problem which is material will vary significantly from transaction to
transaction. Second, materiality is by nature a very imprecise concept and will depend upon the context, even
when dealing with the same company. For example, the dollar level necessary to achieve a "material" hit to
earnings may be significantly different from the size of an adverse claim to title of some Company property
which would be considered "material." 1 The determination of materiality is to be made at the time the
representation is made-either at signing or, for purposes of the bringdown condition 2 and possibly for
indemnification, at closing. 3
As a result, one approach might be to try to quantify the dollar level of an item or problem necessary to result in
a representation being false, rather than using a standard such as "material." Counsel should keep in mind that
the dollar level will vary from representation to representation. While this may appear straightforward. Buyers
and Sellers often find that they have such a difficult time agreeing on a dollar standard for each representation
that they resort to use of the word "material" in many cases.4 This is particularly true in the case of agreements
providing for the acquisition of public companies.
1 For securities law purposes, a fact is material if there is a substantial likelihood that the disclosure of the omitted fact would have been
viewed by the reasonable investor as having significantly altered the "total mix" of information made available. See TSC Industries, Inc., v.
Northway, Inc., 426 U.S. 438, 97 S.Ct. 48, 50 L.Ed.2d 70, motion denied 429 U.S. 810 (1976). There has recently been increased focus on
what level of problem would be "material" to or, more frequently, would be deemed to constitute a "material adverse effect" on a company in
the merger and acquisition context. See: Ns. 98.1, 98.7-98.31 infra and accompanying text.
2 See § 14.02 infra.
3 See Frontier Oil Corp. v. Holly Oil Corp., 2005 WL 1039027 at *38 (Del. Ch. April 29, 2005).
4 Of course, the parties will also have to decide, once the dollar amount is agreed upon, exactly what it relates to. Damages for breach of
contracts? Loss of business under a breached contract? Annual payments under a contract? Something else? The one notable exception to this
Page 740 of 901
More so than with a knowledge qualification, the exact placement of the materiality limitation and what it
modifies is important. Consider, for example, the representation: "The Company's operations are conducted in
compliance with applicable law." Two possible uses of a materiality qualification to limit the representation are:
(1) The Company's material operations are conducted in compliance with applicable law.
(2) The Company's operations are conducted in material compliance with applicable law.
The two versions are quite different. If, for example, the Company has a small, immaterial business which is
being operated in a manner which violates an "important" law with severe penalties attached to its violation
(such as many environmental or antitrust statutes), the first formulation of the representation would arguably
still be true, whereas the second would not.
In many instances, in fact, there may be several ways in which the materiality limitation can be used, each with
different consequences. Suppose the Buyer has agreed to some sort of materiality qualification to the standard
representation: "The merger will not violate any agreement to which the Company is a party." Some of the
possibilities are:
(1) The merger will not violate any material agreement to which the Company is a party.
(2) The merger will not violate in any material respect any agreement to which the Company is a party.
(3) The merger will not violate in any material respect any material agreement to which the Company is a
party.
(4) The merger will not violate any agreement to which the Company is a party where such violation would
be material to the Company. 5
(5) The merger will not violate any agreement to which the Company is a part except for such violations
which in the aggregate will not be material to the Company.
(6) The merger will not violate any agreement to which the Company is a party except for such violations
of immaterial agreements which in the aggregate will not be material to the Company.
It is not obvious what the order of preference would be among these choices for a "typical" Buyer or Seller. As
among the first three choices, the Seller would prefer the third, while this would be the Buyer's last choice. It is
unclear how the parties would rank the first two alternatives: one focuses on the materiality of the agreement,
the other on the materiality of the breach. Which is more important? We would guess that a Buyer might prefer
(2) to (1), with the Seller 6 being the reverse. From the Buyer's perspective (1) fails to deal with "aggregating"
problems across several immaterial agreements, even if the agreements when taken together are material. The
same can be said of (3) and (4) for that matter: they do not "aggregate" breaches of different agreements with
each other in determining the severity of the problem. Moreover, from the Seller's perspective, each of the first
three misses the mark by not looking at the bottom line: how serious is the breach and its consequences to the
is in the area of representations concerning litigation, where the relief sought (if monetary) can be easily compared to a dollar amount
specified in the representation. See § 11.04[7] infra.
5 The language "material to the Company" in (4), (5) and (6) is often found in a more expanded form. For example, the standard might
instead be "material to the business, assets, condition (financial or otherwise) or results of operations [or prospects] of the Company and its
subsidiaries taken as a whole," and is often the basis for the definition of "material adverse effect." See also, § 11.04[9] infra.
6 Presumably a breach that would result in a termination of a contract or the payment of significant damages would be a material violation. It
is probably more important to a buyer to know about all of these than to know about unimportant, de minimus penalties or consequences
under agreements that are material to the Company only.
Page 741 of 901
Company itself. Thus, most Sellers would prefer (4) 7 to (1), (2), (3) or (5); Buyers would most likely prefer (2),
with (5) being significantly preferable to (4). 8
As previously noted, (4) and (5) are often drafted in a more expansive way with the standard being "material to"
or "having a material adverse effect on" the business, assets, condition (financial or otherwise) or results of
operations of the Company and its subsidiaries taken as a whole. Indeed, in public company transactions and, to
a lesser degree, in large transactions involving private companies or subsidiaries and divisions, our judgment is
that (5), as so modified, is the most common of the alternatives. 9 One reason for this is the absence of
indemnification and the infrequency of suits for breach of representation when the transaction fails to close; 10
another is the burdensome nature of preparing disclosure schedule exceptions, if any, if the first three choices
(in particularly (1) and (2)) were used. In our experience, still a third reason might be that the parties'
bargaining power is more likely to be equal when the Seller is larger.
In the Authors' experience, the exception relating to "material adverse effect" on the business is sometimes
accompanied by a limiting clause, either built into the definition of "material adverse effect" or appearing
separately, stating that the excepted matter will not "materially delay or impair the ability of [Target] to perform
its obligations under the Agreement or consummate the transaction." Given the underlying case law interpreting
"material adverse effect" which generally focuses on the clause relating to impact on the business as opposed to
the ability to perform obligations or consummate the transaction, the addition of this limiting clause may
substantially limit the scope of the qualifier. Such limitation arises from the observation that, while courts
across jurisdictions have been loath to articulate events that would have a "material adverse effect" on the
business, it seems obvious that a more substantial universe of matters could be said to "materially delay or
impair" the ability of the Target to perform its obligations under the Agreement. In light of this dichotomy,
practitioners representing Sellers would do well to be careful about the inclusion of this limiting clause in the
definition of "material adverse effect," particularly absent carve-outs, and in individual representations. If it is
to be included, the more optimal path for the Seller is likely to include in the definition of "material adverse
effect" where the clause may more easily be made subject to the customary carve-outs.
The language in the preceding paragraph is often heavily negotiated with respect to such matters as whether
"prospects" are included, whether the representation will refer to a material adverse effect as "having occurred,"
"might occur," "would occur" or "is reasonably likely to occur," and whether events caused by such things as
"changes in general economic conditions" should be excluded. The language generally parallels that of the
representation that there has not been a "Material Adverse Change" (as defined in the agreement) since a certain
date. Accordingly, the various disputes over the exact language is resolved in a similar way for both the
qualifier to the general representations and the specific representation as to the absence of a material adverse
effect. 11
7 Even better, in the Seller's view, would be (4), but having it limited to material agreements; similarly Buyers would tend to like (6). Both of
these formulations, however, are unusual.
8 As discussed in § 11.04[10] infra, material adverse change or effect qualifiers recently are being treated by the courts as imposing a high
standard, making choice (5) more attractive to sellers, and less to buyers, than had previously been the case.
9 The parties should be aware, however, that this is a fairly high standard. See § 11.04[10] infra for a discussion of the "no material adverse
effect" representation, which is similar.
10
This is generally the case in the public company acquisition context.
11 See § 11.04[9] infra. The one qualification to this is that a number of the limitations often found in the definition of "material adverse
change," such as those relating to general economic or industry conditions, terrorist attacks, announcement of the transaction, etc., may not be
appropriate exceptions to a material adverse effect or material adverse change qualification to a representation dealing with, for example,
compliance with law. See § 11.04[9] Ns. 98.4-98.7 infra. For example, a qualifier to material adverse effect for matters arising out of the
execution, delivery and performance of the acquisition agreement (see § 11.04[9] at N. 98.4 infra) would completely eviscerate the no
violations representation. See § 11.04[7] infra.
Page 742 of 901
[2]-Appropriate Use of Materiality Qualifications

There is no right answer as to when a materiality qualification is appropriate. The use of such limitations (as is
the case with respect to virtually all aspects of the agreement) is in the final analysis a function of the basic
bargaining power of the parties as well as the economics and other circumstances of the transaction.
This being noted, there are several additional observations to be made. First, in a large transaction the choice in
many instances may be between use of materiality exceptions and long disclosure schedules containing endless
lists of exceptions to the representations. In the situation where speed and secrecy are essential,12 the use of
materiality qualifiers becomes critical. Second, the addition of a materiality standard to a representation is not
necessarily fatal to any of the three functions generally served by the representations and warranties portion of
the agreement. The due diligence role is still performed, albeit to a lesser extent; the Buyer won't learn about
the business and its problems with the level of detail that would be the case absent the qualification, but it
should still find out about the serious problems. Similarly, the Buyer will have the ability to walk from the
transaction as well as enjoy the benefit of any indemnification provisions. The only difference, which may be of
some economical significance, is that none of these rights will be triggered unless there is a "material" problem.
The proper analysis for the Buyer in deciding whether it will agree to a materiality limitation is for it to review
the purposes of the representations discussed above and ask itself, as to each purpose, "does materiality matter
with respect to this representation?"
Sellers generally request the materiality qualification for same reasons as are set forth above. It is unacceptable
to most Sellers for a Buyer to have the right to walk from the transaction as a result of an immaterial problem;
they do not want the Buyer to be able to claim indemnification for a minor misstatement; nor do they want to
prepare two hundred pages of disclosure schedules. None of these positions is by any means unreasonable, at
least insofar as a number of the representations are concerned. This is not to say, however, that a Buyer would
or should necessarily agree to any or all of them.
There are often different ways of providing the Seller with the protection it is looking for, but without
necessarily qualifying the representation with a materiality limitation. One way problems can be addressed is by
inserting a materiality limitation into the bringdown condition itself; another by using "baskets" or
"thresholds" 13 in the indemnification area. For example, suppose a Buyer wants to know about every problem,
no matter how immaterial, with the Seller's business and also insists on a broad right to refuse to close under the
bringdown condition, but is willing not to be indemnified until problems aggregate $5 million. The easiest
solution would be not to modify the representations in question by materiality but, rather, to include a "basket"
or "threshold" 14 in the indemnification section to the effect that the Buyer cannot recover damages from the
Seller until the aggregate amount of damages suffered by reason of the Seller's misrepresentations aggregate $5
million. This, of course, might not be a high enough dollar threshold to convince the Seller that it should be
willing to forego materiality qualifiers.
Certain representations are virtually never qualified by materiality limitations directly.15 These include
representations as to due organization, capitalization, authority to do the transaction and, in many instances,
financial statements. Generally, these representations are of one of three types. First, the representation may
have a special type of materiality built in already, such as "generally accepted accounting principles" in the case
12 As is the case with many public company deals.
13 See § 15.03 infra.
Other issues are presented with respect to the operation of such "baskets;" most notably, when damages exceed the basket amount,
14 Ibid.
does the Buyer begin to collect over such amount or is it reimbursed for all its prior damages?
15As discussed in § 11.03[3] infra, the bringdown condition often contains a materiality qualification which may operate as an indirect
qualification in such situations.
Page 743 of 901
of the financial statement representation. 16 The second situation is where materiality does not make sense as a
concept in the context of the particular representation. For example, the Seller either authorized the transaction
or did not; there is no such thing as having materially authorized it. The third type of representation where a
materiality qualification is rarely found is one where the subject matter is such that most Buyers will care about
even immaterial inaccuracies. This would certainly be the case with a representation as to the capitalization of
the target where the Buyer is acquiring stock. Unless the Buyer is told the exact number of shares, it may not
know how much it is required to pay or, depending upon the form of the transaction, whether it actually will be
acquiring all of the outstanding shares.
[3]-Double Materiality
In the course of negotiating agreements one will often hear the Buyer's counsel objecting to a particular
provision on the grounds of "double materiality." This can have several different meanings but in each case the
Buyer believes that the Seller is somehow obtaining twice the protection it needs or deserves.
One common circumstance is where the Seller wishes to qualify the same representation with materiality
limitations in two places. One such example would be a representation to the effect that "the merger will not
violate in any material respect any material agreement of the Company." Is this a terrible thing to do to the
Buyer? The answer is "no." This is not to say that the Buyer would in turn be unreasonable if it insisted on
removing one or both of the limitations. The critical point, of course, is for the Buyer and the Seller to be aware
of the implications of the qualifications. In this example, if there is an immaterial agreement which is breached
"in a big way" or a material agreement with an immaterial breach as a result of the transaction, the Buyer is not
protected. It is possible that the Buyer is not concerned about taking this kind of risk. Indeed, this is often where
negotiations come out.
A second common example of double materiality is where not only is a representation qualified by materiality,
but also the bringdown condition. For example, consider an acquisition agreement which contains the
representation discussed in the prior paragraph and a bringdown condition which requires the accuracy of the
representations at closing in "all material respects." A Buyer might argue that the "in all material respects"
language should be deleted from the bringdown. After all, the representation already is limited to material
breaches of material agreements. Why, the Buyer might ask, should it not be able to refuse to close if the
representation was false in any respect? The Seller would most likely argue that the qualification in the
bringdown is there for dealing with other representations which do not themselves have materiality
limitations. 17 This use of double materiality appears quite often, especially in public company deals, and most
Buyers appear to accept it.
A third aspect of double materiality is, again, quite common, but more significant. This is where the
representation is qualified by materiality and, in addition, there is a basket or threshold that must be exceeded
before the Buyer is entitled to be indemnified for losses. There are two aspects to this. Again, using version (3),
for example, of the representation as to no violations of agreements discussed in subsection [1] above, even if
there were a material breach of a material agreement, the Buyer will not be able to recover any damages from
the Seller unless the aggregate of damages from the breach of this and other representations exceed the basket
or threshold amount. The second, less obvious point is that damages incurred from immaterial breaches of
material agreements or material breaches of immaterial agreements are not covered by the indemnification
provision, even if the basket or threshold amount has already been met, since they do not constitute a
16 See § 11.04[8] infra. Since January 1, 1989 accountants' reports state that a company's financial statements "present fairly, in all material
respects," the financial position of such company as of the dates and for the periods indicated, in conformity with generally accepted
accounting principles. See "Reports on Audited Financial Statements," Statement on Auditing Standards No. 58 (April 1988). As a result, it is
becoming more common for the financial statement representation to also contain such materiality limitations.
17 Indeed, it is a little difficult to understand how a representation could fail to be true in "an immaterial respect."
Page 744 of 901
misrepresentation. There is, again, no correct answer to this issue. Whether these outcomes are appropriate
depends on the parties, their expectations, their bargaining power and how much they are concerned about these
risks.

End of Document
§ 11.04 Specific Representations of the Seller
[1]-In General
In this section we will discuss certain of the more common representations and warranties requested of Sellers
in acquisition agreements. It is important to realize that there are many ways to draft any particular
representation; the exact language used will be a function of numerous considerations and, in many cases,
differences in language will not make any substantive difference. Conversely, a minor variation can make the
difference between a representation being true or false (which in turn may allow the other party to fail to close,
to sue for damages or to obtain indemnification). Looked at somewhat differently, phraseology might make the
difference between a Buyer uncovering and obtaining protection against a particular problem previously
unknown to it or having to live with the problem while going forward with the agreement and the acquisition.
The factors that might cause an attorney to draft a representation in one way rather than another include prior
practice, a desire to specifically cover an item so as to avoid any possible ambiguity, a desire to avoid covering
an item so as to preserve ambiguity in order to avoid what may be, at best, a difficult negotiation or, at worst, an
exception on a disclosure schedule, 1 preventing the agreement from being too drawn out, or insuring that
everything the attorney could think of is covered, regardless of the resulting length of the agreement. In short,
there is no such thing as a "model" form of representation covering a particular topic.
One general consideration applicable to specific representations and warranties is the identity of the party
making them in that, depending on the type of transaction, it may be appropriate for more than one entity to do
so. The issue is most clear in a transaction which involves both the sale of subsidiaries of the Seller and assets
of certain other of its subsidiaries. In such a case it would appear that the "owners" of the property being sold
(the Seller in the case of the subsidiaries and such other subsidiaries in the case of the asset sales) should be
making the representations. This becomes more important to the extent knowledge qualifications 1.1 are a part of
such representation; the creditworthiness of such parties will also be a consideration.
[2]-Corporate Organization and Existence

Sellers are almost invariably asked to represent that the Company is a "corporation, duly organized, validly
existing and in good standing under the laws of its jurisdiction of incorporation." 2 The purpose behind the first
portion of the representation is clear, at least in those circumstances where the Company itself is being
1 See § 10.02 supra.
1.1 See § 11.02 supra.

2 A similar representation would still be given if the Company is another type of entity, for example, a limited partnership.
Page 746 of 901
acquired, either through a stock purchase or merger. 3 The Buyer is surely entitled to know that the entity it is
purchasing is what it purports to be. Indeed, the potential consequences if the Company in fact were not a
validly existing corporation may be extremely far reaching and difficult to predict. For example, the purchase of
"stock" of such an entity might not transfer the Company's operations to the Buyer; if the Company is not a
validly existing corporation, the transfer of its stock might very well not vest the Buyer with ownership of
anything. Similarly, it may not be clear how the transaction in such a case is to be authorized on behalf of the
Company, in the case of a sale of assets or a merger, or the Seller, in the case of a stock sale.
The critical point to a Buyer-one which, absent special circumstances, the Authors agree with-is that it should
not have to even think about these issues. It is one thing if there is a specific, unavoidable problem in any
particular transaction, such as a reason why the Company might not be a validly existing corporation; it is quite
another for a Buyer to assume the consequences of the Company (or Seller) not being validly organized and
existing or in good standing 4 as a general matter. It is in large part because of this, and also because the
representation is in fact usually not a problem, that there is rarely much disagreement or negotiation over it. 5
It is useful to cover some of the nuances of language appearing in the representation, particularly since
attorneys are often called upon to render an opinion on these matters as a closing condition. 6
The Company being "duly organized" means that the incorporation of the Company complied with the relevant
state corporate law applicable at the time. The representation would not technically be true, for example, if state
law at the time required some sort of formality, such as having the charter notarized before filing, if the
Company failed to so comply. A number of attorneys would also interpret the language as covering the initial
corporate formalities beyond the mere act of incorporation, such as the election of the initial board of directors
and officers and the adoption of by-laws. 7 As a practical matter, however, it is our experience that Sellers and
their attorneys rarely worry about these nuances insofar as the representation, although not the opinion, is
concerned. Insofar as allocation of risk is the issue, it is clearly appropriate that the risk of adverse
consequences from a defective incorporation should be on the Seller, not the Buyer. 8 The situation might (but
need not) be different if the parties were aware of a specific problem at the outset of the transaction. In such
3 An aggressive Seller might argue that the Buyer has no need of the representation in a purchase of the Company's assets. However, when
representing a Buyer the Authors would ordinarily insist upon getting the representation, if, for no other reason, because of concerns as to
what consequences might have arisen over time if the requested representation were not true, including whether any liabilities were thereby
created which the Buyer might be assuming (expressly or by operation of law). Similarly, if the representation were not true, due
authorization of the asset sale would presumably require approval of the Seller's board of directors, rather than that of the Company.
Consequently, a mistaken belief that the Company was validly existing as a corporation is likely to result in the due authorization
representation being false. In addition, a normal due diligence investigation as to due authorization focuses on board resolutions, compliance
with various requirements (quorum, notice) of the board meeting authorizing the transaction and, in some cases, the election of the
authorizing board. It would not generally inquire as to the valid existence of the Company as a corporation. Therefore, when looked at from a
due diligence point of view, the representation as to the Company validly existing is important because of its impact on other representations.
4 See § 11.04[3] infra.
5 This representation is virtually never qualified by materiality or knowledge, except to the extent it is coupled with a statement concerning
the Company's good standing in all the jurisdiction in which it conducts business. See § 11.04[3] infra.

7 See, e.g., Special Committee on Legal Opinions in Commercial Transactions, N.Y. County Lawyer's Ass'n., "Legal Opinions to Third
Parties: An Easier Path," 34 Bus. Law. 1891 (1979).
8 The corporate statutes of many states today provide that technical defects in the organization of corporations can be cured after the fact.
See, e.g., 8 Del. Code Ann. § 103(f).
Page 747 of 901
case they might well agree to allocate the specific risk in a particular manner, as for example, to the Buyer in
return for a purchase price adjustment or, alternatively, to the Seller, but subject to a "basket" or "threshold." 8.1
The reference to the Company "validly existing" means that it still exists as a corporation: it has not been
merged or liquidated or dissolved out of existence. The representation also protects the Buyer in the somewhat
unusual situation where the duration of the Company's existence is limited in its charter. 9 In this case, the
representation in effect states that the termination date has not yet occurred.
Although the phrase "good standing" is not commonly used in state corporate statutes (at least with respect to a
domestic corporation), the language that the Company is in "good standing" in its state of incorporation is
generally assumed to mean that it has performed whatever acts are required by such state to be performed so as
to avoid the state being able to suspend or terminate (or, arguably being able to request a court to do so) the
corporate charter. 10 The particular requirements will vary from state to state, but will often include having filed
various annual corporate or state tax reports, having the name and address of a registered agent for service of
process on file and having paid the requisite fees and taxes (including franchise taxes).11
It is not unusual for this representation to include a statement as to true and complete copies of the Company's
certificate of incorporation, by-laws and other organizational documents having been made available to the
Buyer and, perhaps, as to the validity and effectiveness of such documents.
The Company is also often asked to represent that it has "full corporate power and authority to conduct its
business in the manner in which it is conducted and to own and lease its properties." The representation, as
drafted, relates to corporate authority and power; it does not purport to pick up regulatory or similar authority
(for example, Federal Communications Commission licenses in the case of a company operating radio stations)
necessary to conduct the Company's operations. These matters are often dealt with elsewhere in the acquisition
8.1 See § 15.03[1] infra.

9 See, e.g.:
Delaware:8 Del. Code Ann. §§ 102(b)(5), 122(1).
New York:N.Y. Bus. Corp. L. § 402(a)(9).

10 See, e.g.:
California:Cal. Corp. Code § 1801.
Delaware:8 Del. Code Ann. §§ 136(c), 284, 502(e).
Maryland:Md. Corps. & Ass'ns Code Ann. § 3.503.
Ohio:Ohio Rev. Code Ann. § 5733.20.
11 Interestingly enough, many states, including Delaware, do not use the term "good standing" in their corporate statutes, at least with
reference to domestic corporations; as such the term is somewhat imprecise. However, its use in acquisition agreements is virtually universal.
Indeed, even though the term may not be defined in a particular state corporate statute, the Secretary of State of such state is likely to have its
own view as to the requirements which must be satisfied before it will issue a "good standing" certificate. The Delaware Secretary of State
will issue a certificate stating whether the corporation is in "good standing" or a certificate stating whether the corporation: (1) is in good
standing, (2) has filed all required annual reports and (3) has paid all franchise taxes due. The Delaware Secretary of State now takes the
position that a domestic corporation being in good standing means that it is still validly existing and has paid all franchise taxes that are due
and that it is not two or more years delinquent in the filing of its annual reports.
The important point, however, is that whatever it takes to be in good standing, and whatever the phrase actually means, the consequence of
being in good standing is that the corporation will not be subject to the risks described in N. 10 supra and the accompanying text.
Page 748 of 901
agreement. 12 The representation as to corporate authority and power primarily goes to the Company's purposes
and powers as set forth in its certificate of incorporation and by-laws. Under most modern corporate statutes,
unless the charter or by-laws expressly limit the purposes of, or business to be conducted by, the corporation,
the company can engage in any lawful activity.13 Similarly, corporations by statute are generally granted broad
powers 14 including the power to make contracts. This has not always been the case, and an extensive body of
case law has developed over the years concerning the consequences of corporations engaging in ultra vires
acts. 15
[3]-Good Standing as a Foreign Corporation

Companies are usually asked to represent that they are duly qualified and in good standing to conduct business
in each jurisdiction where the nature of their business or their ownership or leasing of assets makes such
qualification necessary. This representation, unlike that dealing with good standing in a company's jurisdiction
of incorporation, often touches off a fair amount of discussion.
The laws of each state require foreign corporations "doing business" in that state to "qualify," usually by
making a filing with, and obtaining a certificate from, the applicable secretary of state. It is often unclear,
however, whether qualification as a foreign corporation is actually required in any particular state in light of a
corporation's activities there. For example, many state statutes set forth specific acts which are in and of
themselves insufficient to require qualification as a foreign corporation, such as maintaining bank accounts,
effecting sales through independent contractors, borrowing money, holding board or shareholder meetings. 16
12 See § 11.04[11] infra. As a matter of style, however, some attorneys include here as well the representation as to noncorporate (for
example, regulatory) power and authority. Such a representation might read as follows: "The Company and its subsidiaries have full power
and authority and possess all material governmental licenses, permits, franchises and approvals necessary to conduct their business and own
and operate their assets."
13 See, e.g., 8 Del. Code Ann. § 102(a)(3), which states in relevant part:
"It shall be sufficient to state, either alone or with other businesses or purposes, that the purpose of the corporation is to engage in any
lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware, and by such statement
all lawful acts and activities shall be within the purposes of the corporation, except for express limitations, if any. . . ."
See also, N.Y. Bus. Corp. L. § 201 (allowing general statement so long as charter states that it is not formed to engage in any activity that
requires state regulatory approval without such approval being obtained first).
The only commonly encountered exceptions to this involve certain highly regulated industries such as banking (see, e.g., 8 Del. Code Ann. §
126). While the critical state is the one where the Company is incorporated, other jurisdictions where the Company conducts significant
operations or has substantial assets should also be considered.
14 See:
Delaware:8 Del. Code Ann. § 122.
New York:N.Y. Bus. Corp. L. § 202.
15 See generally, Henn and Alexander, Laws of Corporations (1983). Most jurisdictions now limit those parties who can bring proceedings to
enjoin ultra vires acts. In Delaware and New York, for example, such actions may be brought by a shareholder or the attorney general (8 Del.
Code Ann. § 124); N.Y. Bus. Corp. L. § 203, but not by a party who has entered into a contract with the corporation and who wishes to
challenge the corporation's act as ultra vires.
16 The list varies from state to state. See:
Connecticut:Conn. Gen. Stat. Ann. § 33-397.
Delaware:8 Del. Code Ann. § 373.

Page 749 of 901
Some states attempt to define affirmatively what constitutes "doing business." 17 Nonetheless, in many cases it
will be unclear whether qualification in any given state is required, and companies often determine whether or
not to qualify as a foreign corporation based upon a businessman's balancing of a number of nonlegal (or quasi-
legal) considerations. These considerations may involve such factors as the expense and inconvenience
involved, the effect of qualification on the company's liability for taxes or ability to be sued in the state in
question, whether there are any other negative consequences of qualification, what the consequences of failing
to qualify are if it were determined that qualification was required and the likelihood of being caught if the
company failed to qualify and qualification were required.
The Buyer has legitimate concerns relating to the failure of the Company to be duly qualified as a foreign
corporation where required to be so. Post-closing, the Company (which will then be owned by the Buyer) may
suffer adverse consequences from its failure to qualify where qualification is required. While the effects of such
a failure vary from state to state, two are worth noting. 18 Since most states require foreign corporations doing
business in the state to pay an annual tax, a company that failed to be duly qualified will have a liability for
such past unpaid taxes, plus, in some cases, penalties. 19 In addition, some state statutes may deny foreign
corporations access to their courts for the purpose of enforcing contracts when they have failed to qualify to do
business in the state. 20 This can be particularly problematic if that state is the only one where jurisdiction or
venue can be obtained. Indeed, in a few jurisdictions, 21 subsequent qualification will not solve the problem: if
the Company were required to be qualified when it entered into the contract, the bar will be permanent.
Qualification requirements ignored by the Seller in the past may also have a significant impact on the future. At
a minimum, any economic cost such as taxes associated with qualification would not be reflected in financial
projections which are, in all likelihood, based on historical types of expenses. While the additional going-
forward expense will often not be large enough to change the basic economics of the transaction, there will be
instances where this will not be the case. Indeed, the going-forward cost may be much higher than the historical
Georgia:Ga. Code Ann. § 14-2-1501.
New York:N.Y. Bus. Corp. L. § 1301(b).

17 See, e.g.:
Kansas:Kan. Stat. Ann. § 17-7303.
Massachusetts:Mass. Gen. L. Ann., Ch. 181, § 3.
18 Other consequences include the imposition of monetary fines on the corporation, as well as penalties on the individuals acting on behalf of
the corporations.
19 See, e.g., N.Y. Tax L. §§ 209, 217. This may not be of concern to a Buyer in an asset purchase if it is not assuming (or is not otherwise
responsible as a matter of law under a successor in interest theory) the liability insofar as the past is concerned. The future is another matter,
however, if the Buyer has not counted on these additional costs.
20 See, e.g.:
Delaware:8 Del. Code Ann. § 383(a).
New York:N.Y. Bus. Corp. L. § 1312(a).
But see, each allowing non-qualified foreign companies to defend actions:
Delaware:8 Del. Code Ann. § 383(b).
New York:N.Y. Bus. Corp. L. § 1312(b).

21 See, e.g.: Ala. Code § 10-2A-247.
Page 750 of 901
expense would have been as a result of the Buyer's future business plans (for example, a significant expansion
of sales into a particular state). 22
Buyers often ask Sellers to list on a schedule the jurisdictions where the Company is duly qualified. This is
essentially a due diligence type of representation, helping the Buyer to determine just how aggressive a position
the Seller is taking when it makes the representation that the "Company is in good standing in all jurisdictions
where it is required to be so." 22.1
Thus far, we have analyzed the Buyer's risks. However, the Seller also has some legitimate concerns with
respect to this representation. It is running a business and making business decisions, often involving questions
that are not "black or white." Indeed, it might expect any rational Buyer to continue to take the same calculated
risks it does. By the same token, the Seller doesn't want to act as an insurer of the Buyer against such risks.
The compromise often reached is to have the Seller represent that the Company is duly qualified and in good
standing as a foreign corporation in all jurisdictions where qualification is required except for those
jurisdictions where the failure to be so qualified will not have a material adverse effect.23 A less common
variation consists of replacing this materiality qualification with an exception for those jurisdictions "where the
Company can become so qualified without any material adverse effect."
Buyers who are particularly concerned about this area will sometimes ask the Seller to represent that no one
from the office of the secretary of state (or similar official) of any jurisdiction where the Company is not
qualified has notified the Company that it should be qualified in such jurisdiction. Unfortunately, such a
representation often leads to more problems than it is worth. For example, who at the Company must have been
notified? How senior must the official have been who did the notifying? Must the notification have been in
writing? How recent must it have been? What must the state official have actually said? Absent
indemnification, 24 the additional protection afforded to the Buyer by this separate representation is marginal in
most cases.
22 Of course, the Buyer would have had this problem even if the Company had always been qualified to do business in such state. The
difference is that the Buyer would have known to factor the cost of qualification into its financial models. This might have resulted in a lower
purchase price being offered.
An interesting situation can arise as to the calculation of damages if the Seller had represented that the Company was in good standing in
every jurisdiction where required. Even if the Seller were generally liable for consequential damages, e.g., additional expense as a result of
the expanded business or because of the way in which the Buyer intended to operate the business post-closing (see § 15.02[3] N. 31 infra and
accompanying text), in this situation a materiality qualification with respect to the representation as to good standing would make the
representation accurate with respect to the Company pre-closing, but not post-closing. The Seller may very well win this one in court. The
lesson is simple: it is critical that the Buyer's attorney be aware of the Buyer's plans post-closing.
22.1Due diligence is unlikely to be of much help to the Buyer except in the most obvious of cases since Buyer's counsel will not be in a
position of sufficient knowledge with respect to the Company's state-by-state activities.
23 This compromise is affected by all of the usual concerns about materiality qualifications, including particularly the definition of "material"
for such purpose. See § 11.03[2] supra. Occasionally the Buyer will also ask the Seller to represent that any failure to be so qualified can be
cured without material expense and will not render any material contract unenforceable.
24 Sellers are reluctant to make representations like this if they will serve as the basis of indemnification. The Seller will argue that the key
question is whether qualification is required in a particular jurisdiction. If so, then the representation as to good standing should serve as the
basis of indemnification; it will contain, unlike the additional statement as to governmental notification, whatever materiality and similar
qualifications have been negotiated. If the Company is in fact not required to be qualified in the state in question, or if there is a materiality
qualification in the representation (and the failure is immaterial), the Seller will take the position that it is irrelevant whether a governmental
official raised the issue or, indeed, has a contrary view. Buyers will point out that such a representation goes to the likelihood of a dispute
arising or, phrased somewhat differently, of the Company being "caught," and that, if they cannot receive assurances that this risk is small,
they will require some additional protection, such as elimination of a materiality qualification or, in a very extreme instance, a purchase price
adjustment.
Page 751 of 901
[4]-Capitalization and Title to Stock

Buyers in stock purchase and merger transactions will invariably insist on representations concerning the
Company's outstanding equity capitalization, including the title and amount of any outstanding rights to acquire
any class of equity securities, such as employee stock options, warrants and convertible debt.
The representation will usually begin by covering the numbers of authorized and outstanding shares of each
class of stock. There are several reasons why a Buyer desires this information, the most important of which is to
be able to verify at closing that it has acquired all the outstanding shares of stock. In addition, if the transaction
is one where the amount paid is calculated or stated on a per share basis, the exact number of shares outstanding
will determine the aggregate cost to the Buyer. Finally, if the Company is closely held, rather than publicly
traded, the Buyer will want to know who it is dealing with, the percentage of outstanding shares that such
persons own and, in particular, whether it is dealing with the holders of all the Company's shares. Even if the
Company is publicly held, the number of shares outstanding will be relevant to determining the number of
shares which must be tendered to the Buyer in order to confer control or voted in favor of the transaction to
approve the deal. 25 The existence, and voting rights, of any series of outstanding preferred stock 26 is
particularly relevant to a Buyer trying to determine what the obstacles are to closing. Generally, if the approval
of the Company's shareholders is required, this applies equally to a sale of substantially all the Company's
assets. 26.1
Sellers will often be unable to give a representation as of the date of the acquisition agreement as to its
outstanding stock, but will be able to give it as of the end of the prior month or quarter. This should be
acceptable to a Buyer so long as the Seller is able to represent:
(1) that the only stock issuances since such date were of certain limited types, such as issuances upon the
exercise of options or warrants or the conversion of convertible debt securities which, in each case, were
outstanding on such date;
(2) as to the amount of such options, warrants, convertible securities and rights that were outstanding on
such date; and
(3) that no options, warrants, convertible securities or similar rights to acquire stock were issued since such
date.
While there are other possible solutions, from the Buyer's point of view it is critical that the Seller's
representation, when all of its separate pieces are taken together, gives comfort as to the maximum amount of
outstanding shares and rights to acquire shares at signing. 27
25 This will be especially relevant to a Buyer which is seeking a "lock-up" in the form of a stock option agreement from the Company or a
stock purchase or voting agreement with a large shareholder. See: §§ 16.01, 16.02 infra.
26 Depending upon the treatment of shares of preferred stock in the transaction, as well as the applicable corporate statute and the rights of
the preferred stock set forth in its certificate of designation, the holders of such shares of preferred stock may be entitled to a "class vote" in
respect of the acquisition. In such case, the failure to obtain the favorable vote of the preferred stockholders of the corporation, voting
separately as a single class, may cause the transaction not to be approved or consummated, notwithstanding approval by the common
stockholders and the fact that the preferred stockholders might represent a tiny economic interest relative to the common stockholders. See §
4.12 supra.
See, e.g.:
Delaware: 8 Del. Code Ann. § 242(b)(2) (in the case of merger agreements which also amend charters).
New York: N.Y. Bus. Corp. L. § 903(a)(2) and the discussion at § 4.12 supra.
26.1 See: §§ 2.03, 2.04 supra.
27 The situation from signing to closing will be covered in the covenant section of the acquisition agreement. See § 13.03 infra.
Page 752 of 901
The Buyer must do more than merely obtain a representation as to the amount and type of outstanding
convertible securities, warrants and options. It is imperative that the Buyer's attorneys also read the documents
governing such instruments to determine the effect of the acquisition upon them. 28 Two potential problems
illustrate the importance of this. First, in some cases, a purchase of stock 29 of the Company will not affect
outstanding convertible options. While this may appear to be good news for a Buyer, it is in fact just the
opposite: if the Company's convertible securities, warrants or options remain convertible into the Company's
stock following the closing, the Buyer runs the risk of waking up some day after the closing and discovering
that it no longer owns all of the stock of the Company!
The second problem is more subtle, but also more common. As we have seen, 30 there is no substantive business
difference 31 between the Buyer acquiring ownership of the Company by (1) a wholly owned shell subsidiary of
the Buyer merging into the Company, with the Company surviving as a wholly owned subsidiary of the Buyer
(a "reverse triangular" merger), or (2) the Company merging into the Buyer's wholly owned shell subsidiary
with such subsidiary (which now owns all of the assets and liabilities which therefore belonged to the
Company) surviving the merger, again as a wholly owned subsidiary of the Buyer (a "forward triangular
merger"). Virtually all indentures and most option plans have complicated adjustment formulas which deal with
the effect of a merger of the issuer of such securities and options on the conversion or exercise rights of the
holders of such debentures or options. Usually, at least in the case of debentures and institutionally held
warrants, the holder will receive, upon a post-merger conversion or exercise, the same securities, cash or
property that would have been obtained by first converting or exercising such securities or warrants prior to the
merger, obtaining (in most cases) common stock of the Company, and then receiving whatever common
stockholders would get in the merger. While there are a host of fascinating issues that these provisions raise, 32
unfortunately many are drafted (through carelessness) to apply only in the event of a merger of the Company
"into" another corporation. A reverse subsidiary merger is often not covered and, as a result, the conversion
adjustment section is inapplicable. Arguably, just as was the case in the prior problem discussed, the
convertible securities, warrants or options remain convertible into, or exercisable for, Company stock. 33
The capitalization representation also usually includes assurances that the outstanding shares of Company stock
"were duly authorized, validly issued, fully paid and non-assessable, and not issued in violation of any
preemptive rights." This is one of those representations which, with the possible exception of the last part,
rarely causes much discussion. 34 Since the Buyer will be stepping into the shoes of the shareholders whose
28 Generally, that will not be the case in a sale of less than substantially all of the Company's assets. Nonetheless, it is prudent for the Buyer
to take a "quick look" even in this situation.
29Since all public acquisitions involve a merger of the target company as the final step, see: § 2.08[6] N. 41 supra and accompanying text, §
16.02 infra, this problem does not arise where the Company is publicly held. But see the second problem discussed in the text above.

31 There are of course important consequences of adopting one method rather than the other, including tax considerations.
32What happens in a cash-out merger? See, e.g., Broad v. Rockwell International Corp., 642 F.2d 929 ( 5th Cir.), cert. denied454 U.S. 965 (
1981). What happens in a cash-election merger? See § 22.03 infra for a discussion of election mergers.
33 Kirschner Brothers Oil, Inc. v. Natomas Co., 185 Cal. App.3d 784, 787, 229 Cal. Rptr. 899, 901 ( 1986). These problems are not
necessarily insurmountable. For example, the direction of the merger could be changed. See § 1.02[7] infra. However, if the Buyer is going to
have any reasonable chance at solving these problems, it must become aware of them as early as possible and certainly before closing.
34 A similar representation is also made in merger agreements providing for a reverse subsidiary merger as to the new stock to be issued by
the Company (by virtue of the conversion into Company stock of the stock of the disappearing shell subsidiary) to the Buyer.
Page 753 of 901
stock it is acquiring, it certainly has a legitimate interest in knowing that everything about the issuance of such
stock was proper. 35
The portion of the representation concerning preemptive rights 35.1 is the only aspect that ever causes much
discussion. Unfortunately, the cause is simple: in a large number of cases, companies have previously issued
stock in violation of preemptive rights. The reasons are not all that surprising. Many times the violations
occurred when the issuers were small private companies, often with inexperienced counsel. Such corporations
may have operated with something less than full regard for corporate formalities. (They may well be very lucky
if minor technical, preemptive rights issues are the worst of their problems.) 36 In addition, many state statutes
provided that shareholders were entitled to preemptive rights unless such rights were specifically negated in the
charter. Indeed, this was the law in Delaware until July 1967, when the presumption was reversed. 37 From the
Buyer's point of view, however, violations of preemptive rights may represent a real money issue. In all
likelihood, the current value of stock of the Company, and the price that the Buyer is paying, is in excess of the
cost a holder of preemptive rights would have had to pay to exercise such rights. Making matters worse is the
fact that the sale of the Company is the very type of event most likely to "wake up" sleeping claimants who
might have forgotten that they ever owned stock in the Company (or had preemptive rights).
The Buyer is clearly entitled to know all the facts. If stock had been issued by the Company in violation of
preemptive rights, then the next step is to quantify the problem. Once this has been done, the parties can turn to
the questions of whether there are any defenses available, the likelihood of a claim being asserted and who
should bear the risk of liability.
Sellers (or the Company) are commonly asked to represent as to the absence of any agreements with third
parties with respect to the voting of any stock of the Company. Sellers of privately owned companies (including
subsidiaries), and large or insider shareholders of publicly held companies who enter into "lock-up"
agreements, are also invariably asked to make a representation about title to stock of the Company, free and
clear of any adverse claims, or voting or other rights, of third parties.
The most common issue with respect to Sellers and their title to stock is whether they can avoid making the
representation as to themselves, but, rather, state that at closing, the Buyer, assuming that it is acting in good
faith and without notice of any adverse claim within the meaning of the applicable Uniform Commercial
Code, 38 will obtain title "free of any adverse claim." 39 Indeed, the Seller might argue that any exceptions to the
title representation taken by them on a disclosure schedule or in the agreement as to third party claims will
constitute "notice" to the Buyer and that the Buyer will be better off, and will in fact succeed to greater rights
enabling it to cut off the third party's interest, if the Seller did not represent as to its title, thereby having to list
all third party rights.
35 This is certainly true in a merger or stock acquisition. In addition, the Buyer might want to know this in an asset acquisition as well. For
example, the validity of any shareholder approval might be tainted by any of the Company's outstanding shares not being duly authorized or
validly issued.
35.1Many of the same issues are presented in circumstances in which a party who may or may not be a stockholder) had a right of first refusal
or other superior right with respect to stock issuances.
36 Some major problems include: defective incorporations, revocation of charters, failures to properly elect Subchapter S status, other tax
problems and piercing the corporate veil risks.
37 8 Del. Code Ann. § 102(b)(3). As a result, any Delaware corporation which was incorporated prior to July 1967 the charter of which was
silent on the issue had to comply with preemptive rights until such year. A subsequent charter amendment expressly negating preemptive
rights, as well as the above-mentioned statutory amendment negating such rights, did not eliminate violations of preemptive rights that arose
prior to such time.
38 See U.C.C. § 8-302(1), (2).
39 See U.C.C. § 8-302(3).

Page 754 of 901
While the Seller's argument is not necessarily incorrect, there are several potential concerns of the Buyer that
may or may not be addressed by it. First the Buyer will be held to have had notice of what it would have known
had it exercised due diligence. 40 Second, the Uniform Commercial Code gives no protection against claims that
are not adverse (for example, principal-agent or customer-broker). 41 It is also not by any means clear that all
rights, for example, previously granted proxies, of third parties would be cut-off. 42 Finally, if there is a current
lien on the Seller's title, it may present a significant obstacle to closing, and the Buyer would want to know
about it at as early a stage as possible.
[5]-Subsidiaries
Companies will also commonly be asked to make representations concerning their subsidiaries if such entities
are being directly or indirectly sold in the transaction or, sometimes, if they are sellers of their assets. 43 Such
representations will generally cover corporate organization and power, good standing, capitalization of the
subsidiary and the parent Company's title to stock of its subsidiaries. Buyers will want to know, not only that
the parent Company owns the subsidiary's stock free and clear of any liens, but that it owns all of the
subsidiary's stock (or, if not, who the other owners are) 43.1 and that no other persons may acquire subsidiary
stock through the exercise of options, warrants or preemptive rights. Frequently, a list of subsidiaries and their
jurisdictions of incorporation is also required. Finally, Buyers sometimes inquire whether companies own
equity securities of any entities other than subsidiaries; companies often take exceptions from such
representation for portfolio securities with an aggregate cost (or value) not exceeding a specified dollar amount.
In addition, the Buyer may want the Seller to make representations about the business of the Company as to its
subsidiaries as well. 43.2
[6]-Due Authorization
Another representation almost universally found in all types of acquisition agreements governs the corporate
authorization of the transaction on behalf of the Company or, in a sale of stock transaction, the Seller.
The representation traditionally has several parts. First, the Company (or the Sellers in a stock purchase
transaction) state that it has corporate power and authority to execute and deliver the acquisition agreement and
40 See U.C.C. § 1-201(27).
41 See U.C.C. § 8-302, Cmt. 4.
42 But see, N.Y. Bus. Corp. L. § 609(h) (purchaser may revoke an "irrevocable proxy" unless the proxy is noted on stock certificate).
See also:
California:Cal. Corp. Code § 705(f).
Texas: Tex. Bus. Corp. Act Ann., Art. 2.29C.
Delaware is silent on the issue. 8 Del. Code Ann. § 212(e).

43A critical issue will be the definition of "subsidiary." Is it limited to corporations, a majority of the voting stock of which is owned by the
Company, or will it encompass entities over which the Company exerts vaguer concepts of "control"?
43.1Companies often need exceptions for directors' qualifying shares which may exist since some jurisdictions require that some portion of a
corporation's stock be held by local residents.
43.2 These could include virtually all of the representations made by the Company, including about its financial statements, status of its
litigation, title to assets, etc. See § 11.04[8], [10] and [12] infra.
Page 755 of 901
to consummate the transactions contemplated thereby. 44 There are many variations in the manner of phrasing
the last part of this. For example, the language used might be "to perform its obligations under this Agreement"
or "to perform the transactions provided for herein." Whether such nuances in language have any meaningful
substantive effect will vary from case to case.45 These nuances are likely to be more meaningful in the other
portions of the due authorization representation relating to board of director approval and enforceability. 46
Next, the representation is made that all corporate action necessary to approve the execution, delivery and
performance of the acquisition agreement has been obtained. The representation might be drafted to indicate the
nature of the action. For example, "The Board of Directors of the Company has duly authorized the execution,
delivery and performance of this Agreement and no other corporate action is required on the part of the
Company in order to authorize the execution, delivery and performance of this Agreement."
It is worth discussing what happens if this is not actually the case. One instance where this might occur is fairly
straightforward. If the approval of the shareholders of the Company is required,47 and if the Company is
publicly held, such approval will have to be solicited by means of a proxy statement, prepared in accordance
with the SEC's proxy rules and reviewed by the SEC. 48 In this situation, the acquisition agreement will be
executed following approval of the Company's board of directors, but not all corporate action required to
approve the transaction will have been taken by such time. Consequently, the Company will normally take an
exception from this portion of the representation for shareholder approval. The Buyer should require the
Company to specify the shareholder vote requirement 49 and, in particular, if the Company has any shares of
preferred stock outstanding, whether such shares are entitled to a class vote in respect of the transaction.50
44 This portion of the representation is sometimes combined with that discussed previously concerning the Company's corporate power and
authority to operate its business. See § 11.04[2] supra.
45 In part, this will depend on whether there are ancillary documents of importance, such as a bill of sale or a separate non-compete
agreement since the performance of those agreements might be "transactions contemplated hereby" but not necessarily "obligations under this
Agreement."
46 Consider, for example, the problem of board approval of financing agreements in a leveraged buyout, where, as is often the case, the
acquisition agreement is executed before the financing agreements are finalized (or, on occasion, before negotiations have even commenced).
47 This will be the case in most mergers to which the Company is a party. However, this does not apply in certain jurisdictions in situations
the corporation survives and issues only a minimal number of shares in the transaction. See, e.g., 8 Del. Code Ann. § 251(f). This approval is
not required in "short-form" mergers. See, e.g., 8 Del. Code Ann. § 253. Such approval is also required in the sale of all or substantially all of
the Company's assets. See, e.g.:
Delaware:8 Del. Code Ann. §§ 251(c), 271(a).
New York:N.Y. Bus. Corp. L. §§ 903, 909.
For a fuller discussion of these issues, see: §§ 2.03, 2.04, 2.05 supra.
48 See § 5.03[2] supra.

49 In many jurisdictions, the required vote is a majority of the outstanding shares of common stock. See, e.g.:
California:Cal. Corp. Code § 1201.
Delaware:8 Del. Code Ann. § 251(c).
Florida:Fla. Stat. Ann. § 607.1103.
In some states, however, a two-thirds vote is required. See:
New York:N.Y. Bus. Corp. L. § 903.

Page 756 of 901
Buyers should not, however, allow Companies to execute acquisition agreements subject to board approval-that
is, without obtaining board approval prior to the execution of the agreement or requiring, as a contractual
matter, a second board approval after signing and before closing. 51 This essentially provides the Company with
an option to go forward or not. 52 Indeed, in a closely held company, and certainly in the purchase of a
subsidiary where a corporate parent is the only shareholder, Buyers will typically try to get the shareholder vote
locked up at the time the acquisition agreement is executed. It does the Buyer little good to avoid a second
board approval in these cases if the same people as are on the board are able to get a "second look" and
terminate the transaction simply by exchanging their director "hats" for shareholder ones.
The final portion of the representation deals with the acquisition agreement being a binding obligation of the
Company, enforceable against it in accordance with its terms.53 Companies, whether or not publicly held,
sometimes request to make this portion of the representation "subject to shareholder approval," if shareholder
approval is, in fact, necessary to consummate the transaction.54 Buyers, recognizing that there are critical
Texas: Tex. Bus. Corp. Act Ann., Art. 5.03E. See generally: §§ 2.03, 2.04 supra.
In addition, many states have enacted takeover legislation which requires a higher vote for business combinations with an "interested
stockholder." An "interested stockholder" is one owning more than a specified percentage of the outstanding stock of the Company prior to
the approval of the transaction or the execution of the merger agreement. See, e.g., 8 Del. Code Ann. § 203. Takeover statutes are discussed in
§ 2.03[2] Ns. 14-19 supra and accompanying text.
In certain cases Buyers obtain voting or "lock-up" agreements from major shareholders. See § 16.02 infra. Query the need for the shareholder
vote exception if the Company's shareholders are able to act by majority written consent (See, e.g., 8 Del. Code Ann. § 228) and if the Buyer
has obtained a voting agreement from the required number of holders concurrently with the execution of the acquisition agreement. (Unless
the actual vote is taken by such shareholders by written consent following the Board meeting, the Authors would recommend that the
Company still take such an exception in its representation.)
51 Indiana used to require mergers of an Indiana corporation to be approved by its board, then by its shareholders and, thirty days following
such shareholder approval, by its board again. See Ind. Code § 23-1-5(f) (repealed 1987). Thus, notwithstanding initial approval by the board
and shareholder approval, the board could look at the transaction one last time just before closing and, if it no longer thought the deal made
economic sense, could call off the merger. Predictably, this drove buyers crazy. One solution which we have used in this situation was to
require payment of a penalty if the board of the Company actually failed to re-approve the transaction following shareholder approval. This
would not be an acceptable solution if Board approval was not obtained prior to signing at all (i.e., would the fee be enforceable against the
Buyer if the Board had not approved it) and, in any case, was not a perfect solution for a buyer whose primary desire was to close the deal
and was subject to the Seller board's determination that the amount of such penalty was reasonable under the prevailing circumstances.
Happily, the Indiana statute has since been revised to eliminate this requirement of a second board approval. See: Ind. Code Ann. §§ 23-1-40-
1et seq.
52 Interestingly enough, as a result of the "fiduciary-out" provisions that commonly find their way into acquisition agreements (see § 13.05[1]
infra) the Company tends to end up in a position that approximates this in any event. However, there is an important difference-at a
minimum, as a practical matter and, particularly, insofar as the board's "mind set" is concerned-between the two situations. The Authors
believe that, absent a specific, intervening event, most boards are less likely to use a fiduciary out provision to get out of an acquisition
agreement than a contractually negotiated "second look provision."
53 Some (but not all) leading investment banking firms have, absent unusual circumstances (such as involving foreign or highly regulated
issuers), stopped requiring representations in underwriting agreements as to the enforceability of such agreements, although they still insist on
representations as to the corporate authorization of the execution, delivery and performance of such agreements. Presumably, this resulted
from a number of factors, not the least of which is that underwriters have become comfortable with respect to the enforceability of such
agreements based on having been involved in thousands of underwritings, covering issuers in all jurisdictions, that underwriting agreements
are not executed until one week before closing and that they receive legal opinions as to enforceability at closing. This has not been the
approach taken in acquisition agreements. Representations as to enforceability are almost always included.
54 See § 2.03 supra. This will normally not be the case in a stock or asset sale, unless the stock or assets being sold constitute all or
substantially all of some corporate entity's assets. See: §§ 2.03[3], 2.05 supra.
Page 757 of 901
aspects 55 of the agreement which are enforceable regardless of whether or not the approval of the Company's
shareholders is obtained, strongly resist this qualification (and rightfully so). 56
The other qualification that Companies often attempt to include here (and are often successful) is that
enforceability is limited by "bankruptcy, insolvency, reorganization, moratorium or similar laws now or
hereafter in effect affecting creditors' rights generally." From a risk allocation point of view the Buyer has the
better argument on this issue as well. Such language is appropriate for a legal opinion, since, as a matter of law,
an acquisition agreement is not specifically enforceable against a Company that has filed for bankruptcy
protection. 57 However, this is not to say that the Buyer should not have a damage claim assertable against the
Company for breach and, while the Authors believe that a Buyer should have good arguments as to why
allowing a "bankruptcy" exception to an enforceability representation should not create a defense 58 for the
Company as debtor-in possession, 59 or for a trustee, against such a claim, this is not a risk that a Buyer should
have to take.
[7]-No Violations; Approvals

A particularly important representation deals with whether the execution, delivery and performance of the
acquisition agreement will violate:
(1) the Company's certificate of incorporation or bylaws (or in the case of noncorporate entities, such as
limited partnerships, similar governing documents);
(2) any agreement to which the Company or any subsidiary is a party; or
(3) any applicable law, rule, regulation or court order. 60
A second part of the representation gives comfort as to the absence (except as specified) of governmental
approvals or filings required in connection with the execution, delivery and performance of the acquisition
agreement.
Clauses (2) and (3) of the first part of the representation, as well as the second part covering governmental
approvals and filings, are sometimes qualified by materiality in one form or another. 61 The portion dealing with
55 These include virtually everything in the agreement (for example, the representations, covenants and expense and termination fee
provisions) other than the sections dealing with the merger (or sale of assets) itself and that which depends upon it, such as adjustments of
options and dissenters' appraisal rights.
56 The Company does not need the qualification. The conditions article of the agreement will state that the Company's obligation to merge or
sell assets is subject to numerous conditions, one of which will be obtaining shareholder approval. See § 14.05[1] infra.
57 See Bankruptcy Code § 362(a), 11 U.S.C. § 362(a).
58 The language setting forth the obligations of the Company in the agreement, particularly the covenants, will not be qualified by the
"bankruptcy exception." An agreement (absent issues of the authority of the Company or the Sellers to have executed it in the first place-an
issue which is rarely relevant in sizeable transactions) is what it is: it either is or is not enforceable, regardless of whether there is a
representation covering enforceability or whether it is qualified.
59 See Bankruptcy Code § 1107, 11 U.S.C. § 1107.
60 For some reason, the language variations that appear with all parts of this representation are greater than most. For example, the shorthand
reference in the text to "violations" of agreements can be drafted to expressly include: "violations, conflicts, breaches, creations of events of
defaults or security interests, changes in rights of parties, termination rights, acceleration rights, penalty rights, and the effect of giving notice
or lapse of time or both, whether or not given." Similarly, the reference to "laws, rules, regulations or court orders" can be replaced with a
much longer list. See § 11.04[1] supra.
61 This is commonly done in the case of large or publicly held companies; in smaller transactions Buyers might very well resist such a
qualification. After all, the postclosing entity is likely to suffer damages or risk liability, even as a result of breaches of immaterial contracts.
See § 11.03[1], [3] supra.
Page 758 of 901
the noncontravention of the Company's charter and by-laws is almost never limited by materiality. It is also
unusual for any part of the representation to be limited to "the Company's knowledge."
This representation is critical to a Buyer for a number of different reasons. First, it informs the Buyer as to those
instances following the closing (or possibly even the signing of the agreement) where the Company will be in
breach, thereby risking not only liability, but a loss of the anticipated benefits of the agreement or method of
operation. This could conceivably cause the transaction to no longer make sense, economically or strategically,
to the Buyer. 62 Second, it is possible that the Buyer could itself be exposed to liability for causing the breach by
the Company of an agreement 63 or a violation of law, whether or not the Buyer's acquisition of the Company
closes. Finally, the representation allows a Buyer to figure out what it has to do and what problems it has to
solve in order to close the transaction. Indeed, the portion of the representation dealing with governmental
approvals and consents is particularly critical in this regard.
In any event, a Buyer should not rely on the representation to permit it to refuse to close since, by having taken
the necessary exceptions in the disclosure schedule, the Seller's representation will be true at signing and
closing. Thus, the Buyer, in order to obtain the ability not to close the transaction if the consents were not
obtained, should either require a covenant on the part of the Company to obtain the required consents 64 or
condition the Buyer's obligation to close on such consents having been obtained or both. The representation
arguably has even more significance in an asset transaction. There, the performance of the asset purchase
agreement presumably includes the assignment of agreements relevant to the business being acquired. 65 If the
performance of the acquisitions agreement would result in a breach of such agreements, such agreements
generally may not even be transferred to the Buyer.
A difficult issue may arise in those instances where the question of the transaction violating applicable law is a
close one, but both parties, with full knowledge, have decided to proceed. One such case may be where the
government might allege an antitrust violation; another might be where the Buyer is in a regulated industry and
may or may not be allowed to consummate the transaction. In these cases, it is unfair for either party, by
62 The Buyer would presumably include a closing condition requiring that any such breach be waived, or that any such third party (or
governmental) consent be obtained. See § 14.03 infra. This will not, of course, work in all instances and might, in any case, cost money
(including where governmental approval is required, see, for example, New Jersey Environmental Cleanup Responsibility Act ("ECRA"),
N.J. Stat. Ann. §§ 13:1K-6et seq.
63 $10.5 billion in the case of Texaco for its alleged tortious interference with Getty Oil's contract with Pennzoil. Pennzoil Co. v. Texaco Inc.,
No. 84-05905 (151st Dist. Harris County, Tex. Dec. 10, 1985), aff'dTexaco, Inc. v. Pennzoil Co., 729 S.W.2d 768 ( Tex. App. 1987). See: §§
6.03[3], 6.04 supra. There are also potential issues concerning the enforceability of the acquisition agreement if its execution, delivery or
performance violates another agreement. In this case, however, the Buyer may be worse off if it is aware of the breach. See Restatement
(Second) of Contracts, § 194 (1981).
64 It is difficult for the Company to agree to the covenant approach. This would put it in breach if it were unable to obtain the requisite
consents, something which may very well be out of the Company's control. Thus, the covenant is often qualified with a "best efforts"
limitation; the result is a need for a separate condition. See § 13.06 infra. Even if the covenant is "flat" (no materiality and no best efforts
qualifications), materiality can creep in through the bringdown condition. See § 14.02[7] infra. Another approach is for the parties to agree to
enter into alternative arrangements designed to put the Buyer to the extent practicable in a position whereby postclosing it will enjoy the
benefits and burdens of the contract as to which consent was not obtained. Again, this has an element of "best efforts" and the Buyer may feel
it needs a specific condition with respect to the receipt of consents to assignment as to some or all of the contracts to be conveyed.
65 Buyers: beware of an agreement with an inadvertent hole in it as a result of:
(1) an assignment section that excludes contracts which do not permit assignment; and
(2) a representation section that does not cover the assignability of contracts except by reference to "performance of the acquisition
agreement."
The Buyer would not be protected by indemnification (absent an additional representation somewhere) in this situation even if no agreements
of the Company were assignable.
Page 759 of 901
making a "no violations" representation, to bear this risk (unless that is the actual business deal). The problem is
how to take the exception without creating a road map for a lawsuit by the government or a third party. 66
[8]-Financial Statements; Undisclosed Liabilities

Probably one of the two 67 most important representations a Company is asked to make about its business
concerns its financial statements. More than any other single item, the financial statements provide significant
and complete information about the business being acquired. Not only do the financial statements provide
comfort concerning the revenues, earning power and cash flow of the Company, they also set forth (on an
historical cost basis) the Company's assets and liabilities.
In most transactions, the language of the representation is fairly standard. Usually, it recounts that the Company
has delivered its last (or last two or three) annual statements of income, cash flow and balance sheets, for and as
of the years then ended, accompanied by the report of the Company's independent public accountants thereon, if
any. If any quarterly financial period of the Company for which financials are available has elapsed since the
most recent year-end, the representation will state that they have also been delivered, as well as for the
comparable period of the prior year. Thus far, there is usually little disagreement between Buyers and Sellers:
the representation merely states what has been delivered. 68
The important part of the representation follows. The Company warrants that the foregoing financial statements
(including the accompanying notes) are "prepared from and in accordance with the books and records of the
Company in accordance with generally accepted accounting principles consistently applied (except as indicated
in the notes thereto) and fairly present the financial condition, and results of operations of the Company as of
and for the periods indicated."
Several points are worth noting. First, the representation does not state that the financial statements are
complete, accurate, not misleading or true and correct. Nor does it state that the financial statements do not
contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or
necessary to make the statements made therein in light of the circumstances in which they were made, not
misleading. 69 None of these are the standards followed by accountants in preparing or reviewing financial
66 One solution is to simply take the exception on the disclosure schedule. This may be quite dangerous, depending on the potential problem,
since disclosure schedules tend to get around, although not as much as the acquisition agreement. In an area where the necessity for such
consents is well known, such as in a transaction that is going to be reviewed by the antitrust authorities under the Hart-Scott-Rodino Antitrust
Improvements Act, this might be workable. Another, imperfect solution if the problem is applicable to both parties, would be for each party
to make the same representation to the other and to have such representations not survive the closing (that is, not be a basis for post-closing
indemnification).
67 The other is the representation as to the absence of any material adverse change since the date of the last financial statement or, in many
agreements, audited financial statements delivered to the Buyer. See § 11.04[9] infra. Together, these two representations cover all of the key
financial aspects of the Company up to signing and, when considered in conjunction with the bringdown condition, to closing.
68 Generally, the only argument is over the number of past years of audited financials which are to be the subject of the representation. A
factor clearly relevant to the number of years covered would be what the Buyer used to value the Company. In addition, there may be
circumstances where the financial statements have not been audited, often if only part of the business is being sold. See N. 77 infra and
accompanying text.
69 Indeed, an accountants' report that financial statements fairly presented the financial position of a company in accordance with generally
accepted accounting principles has been held to be materially misleading for purposes of the federal securities laws, even though the financial
statements complied with GAAP. See Herzfeld v. Laventhol, Krekstein, Horwath & Horwath, 378 F. Supp. 112, 121-126 ( S.D.N.Y. 1974),
aff'd in part, rev'd in part540 F.2d 27 ( 2d Cir. 1976).
Because of this, a careful Seller might wish, so as to avoid any ambiguity or misunderstanding, to exclude from a representation concerning
compliance with the securities laws which covers its Report on Form 10-K the financial statements included therein. See § 11.04[16][e] infra.
Page 760 of 901
statements. The standard used is "fairly present in accordance with 'GAAP'-generally accepted accounting
principles-consistently applied (except as otherwise noted.)"
Since this standard asserts that the financial statements fairly present the financial position of a company in
accordance with generally accepted accounting principles, it is somewhat elusive to attorneys and most persons
other than accountants why it does not guarantee that the financials are true, correct and complete.
One of the best discussions of the meaning of these terms can still be found in a 1992 Statement on Auditing
Standards of the American Institute of Certified Public Accountants. 70 It is worth quoting in part:
"2. The phrase "generally accepted accounting principles" is a technical accounting term which
encompasses the conventions, rules and procedures necessary to define accepted accounting practice at a
particular time. It includes not only broad guidelines of general application but also detailed practices and
procedures. . . .
"3. The independent auditor's judgment concerning the fairness of the overall presentation of financial
statements should be applied within the framework of generally accepted accounting principles. Without
that framework the auditor would have no uniform standard for judging the presentation of financial
position, results of operations, and changes in financial position in financial statements.
"4. The auditor's opinion that financial statements present fairly an entity's financial position, results of
operations, and changes in financial position in conformity with generally accepted accounting principles
should be based on his or her judgment as to whether (a) the accounting principles selected and applied
have general acceptance; (b) the accounting principles are appropriate in the circumstances; (c) the
financial statements, including the related notes, are informative of matters that may affect their use,
understanding and interpretation . . . (d) the information presented in the financial statements is classified
and summarized in a reasonable manner, that is, neither too detailed nor too condensed . . . and (e) the
financial statements reflect the underlying events and transactions in a manner that presents the financial
position, results of operations, and cash flows stated within a range of acceptable limits, that is, limits that
are reasonable and practicable to attain in financial statements. (footnote omitted)." 71
Compliance with generally accepted accounting principles will not, however, render financial statements
immune to attack. As noted above, this standard does not insure compliance with the federal securities laws. 71.1
More importantly, however, is the implication that for financial statements to "present fairly" requires more
than mere compliance with generally accepted accounting principles. Indeed clause (c) of paragraph 4 above
seems to indicate this, as does at least one decision (indicta.) 71.2 Perhaps because of these inherent limitations,
the "in accordance with generally accepted accounting principles" qualifier has been omitted from the
representation providing that the financial statements "fairly present" the financial position of the Target on an
In light of the existence of a specific representation covering the financial statements, the parties generally do not bother to take such an
exception in such representation.
70 See "'The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles' in the Independent Auditor's Report,"
Statement on Auditing Standards No. 69 American Institute of Certified Public Accountants 1992 (SAS No. 69 revised SAS No. 5 (1975)).
71 Id. at ¶¶ 2, 3 and 4.
71.1 See N. 69 supra.
71.2See Herzfeld v. Laventhol, Krekstein, Horwath & Horwath, 378 F. Supp. 112 ( S.D.N.Y. 1974), aff'd in part, rev'd in part 540 F.2d (2d
Cir 1976):
"Our inquiry is properly focused not on whether Laventhol's report satisfies esoteric accounting norms, comprehensible only to the
initiate, but whether the report fairly presents the true financial position of Firestone, as of November 30, 1969, to the untutored eye of
an ordinary investor."
See generally, Freeman, "Post-Closing Purchase Price Disputes," New York Law Journal, p. 5, col. 1 (Sept. 12, 1991).
Page 761 of 901
increasingly frequent basis. 71.3 The Authors would suggest that a potential downside of this approach is that the
representation that the financial statement "fairly present" without a GAAP qualification is arguably even more
opaque than the qualified version, as the resulting representation cannot be tested against any commonly
accepted objective standard.
Secondly, in part as a result of the foregoing, and this is obviously a point with far greater significance than the
negotiation of one representation in the acquisition agreement, the Company's financial statements, including
the notes thereto, must be closely analyzed by someone with an accounting background. At a minimum,
"generally accepted accounting principles" permit in numerous areas different methods of reflecting events and
transactions. 72 The same numbers may paint two very different pictures of a business, depending upon which of
different permissible methods of accounting for an event are used. Indeed, the due diligence procedures of the
Buyer might very likely go beyond the financials and accompanying notes.
Third, the representation might not be accurate insofar as it relates to the Company's unaudited quarterly
financial statements. For example, such statements are normally subject to year-end audit adjustments, and
Sellers often wish a qualification to this effect. Buyers, for their part, would like assurances that these
adjustments will be of a "normal and recurring" type. 73 In addition, quarterly financial statements included in
Reports on Form 10-Q filed pursuant to the Securities Exchange Act of 1934 typically do not contain the full
set of notes required by generally accepted accounting principles.74 In this case, the representation can be
modified to add at the end "except that the above-mentioned quarterly financial statements were prepared in
accordance with the accounting rules applicable to Reports on Form 10-Q under the Securities Exchange Act of
1934 and, accordingly, do not contain all the footnotes required by generally accepted accounting principles."
Buyers should not object to this.
Finally, it is important that the Buyer examine the accountants' report that accompanies the Company's financial
statements. Obviously, it will be of interest to the Buyer if the report is qualified in any manner. The Buyer
must also ask its accountants if the existence of the qualification or limitation in the Company's accountants'
report will, following the closing when the Company is a consolidated subsidiary of the Buyer, cause the
Buyer's accountants to include a similar qualification or limitation with respect to the Buyer's financial
statements. It is one thing for the Buyer, in its capacity as an acquiror, to make a decision to proceed with the
acquisition of the Company, notwithstanding an accountants' report which is not "clean." It is quite another for
the Buyer, particularly if publicly held, to have to continue with the same qualifications or limitation in its
audited financial statements because it now owns the Company. The Buyer will (or should) have made a full
investigation as to the reason for qualification or limitation and concluded that, notwithstanding this problem,
the acquisition makes sense, economically or strategically. This, in turn, will quite simply be because the Buyer
71.3 For example, "The 2019 ABA Private Target Mergers and Acquisitions Deal Points Study" indicated that only 15% of the studied
transactions included financial statement representations that were fully GAAP-qualified.
72 Indeed, it has been noted that in a typical income statement, given the different choices permitted by generally accepted accounting
principles, there were a million possible combinations of results. See Fifles, Kripke and Foster, Accounting for Business Lawyers 97 (1984)
citing Chambers, Accounting Finance and Management, 187-188 (1969). See also, Codification of Accounting Standards and Procedures,
Statement on Auditing Standards No. 1, ¶ 110.02 (American Institute of Certified Public Accountants 1973).
73 Before the parties get into a major disagreement over this type of qualification and what limitations (such as those discussed in the text or
as to such adjustments being immaterial) should be applicable, it is often useful for them to consider, at least where there are no post-closing
indemnification obligations, whether there is any reasonable chance that the transaction will close after the Company's year end. It is one
thing for a Seller with a calendar fiscal year to worry about year-end adjustments if the deal is signed up in December; it is quite another if it
is signed in April. Having said this, a qualification for any year-end audit adjustments arguably would render the representation always true,
regardless of whether the quarterly financials were even close, since, presumably, any problems will be corrected in the audit.
74 17 C.F.R. § 210.10-01.
Page 762 of 901
has concluded that there is no real underlying problem 75 or that, in any event, the acquisition still makes sense,
because the purchase price reflects the appropriate level of risk as to whatever event or risk caused the report to
be qualified. However, the Buyer's accountants may not reach, or even be permitted to reach the same
conclusion. As a result, the Buyer, particularly if the acquired business is a material part of the combined
companies, may find, much to its unhappiness, that the accountants' report on its financial statements will for
several years following the closing contain the same qualification or limitation.76
An issue that has arisen during the last few years is whether the representation should be qualified by
materiality; in other words, should it state that the financial statements "fairly present" or "fairly present in all
material respects" the financial condition and results of operation of the Company as of and for the periods
indicated? 76.1 Prior to January 1, 1989, the form of accountants' reports did not contain the words "in all
material respects"; however, in April 1988, the form of report was changed to include the materiality
reference. 76.2 It is our understanding that the change was made for the sole purpose of drawing attention to what
was already implicit in the concept of financial statements being "fairly presented in accordance with generally
accepted accounting principles"-that is, that a materiality standard already applied-and not to effect a
substantive change. Accordingly, one could sympathize with a Buyer who does not wish to add a second layer
of materiality; however, one could also understand the reluctance of a Seller to go further in the language of the
representation than the accountants did in their report.
The only times that the substantive content of the financial statements representation is much different from
what has been described above is when a part of a business is being acquired and the applicable financial
statements for that part of the business leave "something to be desired." In most large transactions, and in most
transactions of any size where the business being sold has been operated as a separate division, this will
generally not be the case. 77 When it does occur, however, rather than referencing generally accepted accounting
principles, consistently applied, the representation dealing with the financial statements delivered by the
Company to the Buyer might merely warrant that such financial statements "were prepared in accordance with
the accounting principles, policies and procedures set forth on Schedule X to this Agreement" or "reflect the
best reasonable efforts of the Sellers to prepare financial statements reflecting [the business being sold] on a
stand-alone basis." Clearly, the first version is far preferable to the second from the viewpoint of the Buyer.
Similar to the risk discussed above, the Buyer in this situation should be concerned as to what the acquisition
will do to its postclosing consolidated financials. Specifically, will the transaction produce impossible hurdles
for the Buyer in preparing its historical or future financial statements following the closing?
In all of the cases where the financial statement representation falls short of the GAAP norm, the due diligence
investigation takes on additional importance. Particularly where reference cannot be made to a well understood,
75 Accountants and attorneys responding to audit inquiries are much more constrained in their ability to conclude that something is not a
problem than businessmen are. See "American Bar Association Statement of Policy Regarding Lawyers' Responses to Auditors' Requests for
Information," 31 Bus. Law. 1709 (1976).
76 A similar problem exists under Regulation S-X, 17 C.F.R. §§ 210.1et seq., the SEC's accounting rules. Regulation S-X imposes various
requirements which in many instances go beyond generally accepted accounting principles. If the Buyer has publicly traded securities, debt or
equity, its financial statements will have to comply with Regulation S-X. This will continue to be true following the transaction. If the
Company did not itself have publicly traded securities, its financial statements will not necessarily have been prepared in compliance with
Regulation S-X and, accordingly, additional time and expense will be incurred to prepare post-closing consolidated financial statements.
Moreover, the additional requirements of Regulation S-X as applied to the Company, or, indeed, the mere review by the SEC of the
Company's financial statements, could result in a change to the numbers. Thus, the accounting impact of the transaction could be quite
different from a public reporting perspective to the Buyer than what it had expected. The importance of this cannot be overemphasized.
76.1 See § 11.03[2] supra.

76.2 See "Reports on Audited Financial Statements," Statement on Auditing Standards No. 58 (April 1988).
77 In many divisional or subsidiary purchases the representation as to financial statements is exactly as set forth in the text above.
Page 763 of 901
uniform set of accounting rules, procedures and conventions, the Buyer has to fully understand the assumptions
and methodology used to create the Company's financial statements. 78 The Buyer who is particularly uneasy
about the Company's financial statements could, of course, insist upon a full-blown audit. 79 Requiring the
completion of the audit prior to execution of the acquisition agreement often will result in an unwanted delay.
Accordingly, the solution is often to require the audit prior to closing. The critical issue, then is what the
Buyer's "walk rights" will be in the event of any deviation between the audited numbers and the unaudited
financials delivered prior to signing. 80 There is no easy answer to this; it is a central part of the negotiation.
There was a period of time in the late 1970s when everyone, including buyers of businesses, was concerned
about violations of the Foreign Corrupt Practices Act (the "FCPA"). 81 In part, this was because of all the
adverse publicity to which violators were subjected. As a consequence, many acquisition agreements contained
specific representations as to the absence of any violation of the FCPA. There were generally two parts to the
FCPA's prohibitions. One dealt with payments to foreign governmental officials; 82 the other concerned the
integrity of the Company's accounting controls. 83 Representations regarding this second part have remained in
many acquisition agreements, especially with respect to acquisitions involving public acquirors and public or
private targets. 83.1
Closely related to the financial statement representation is the representation concerning undisclosed liabilities.
Unlike the financial statement representation, one does not always find this representation in acquisition
agreements. The representation generally takes one of two forms. The first is to state that, as of the date of the
Company's most recent balance sheet, the Company did not have any liabilities, whether absolute, contingent,
known or unknown, that were not reflected in such balance sheet. Sellers often object to this formulation by
pointing out that generally accepted accounting principles do not require that all such types of liabilities be
reflected in the balance sheet.84 Thus, the second common form: that there were no liabilities as of such date of
78 As pointed out in N. 72 supra, however, because of the wide leeway and range of choice permitted by generally accepted accounting
principles, this level of understanding is always important.
79 If the Buyer is going to obtain financing for the acquisition based on the financial performance of the Company, this may be required. If
the financing is to be provided by the public markets, not only does the SEC have rules which require audited financial statements be
prepared in accordance with Regulation S-X as of a relatively recent date, the marketplace often requires additional comfort in the form of
audits for fiscal periods since the prior year-end. These financial statements as well as pro forma financial statements may also be required in
connection with the filing of a Form 8-K. See § 5.03[1] supra.
80 There are numerous issues lurking here. Must the variance be material? Should the Buyer be permitted to terminate the agreement only if
there are different numbers in certain categories as for example sales or "EBIDT" (earnings before interest, depreciation and taxes)? Is a
purchase price adjustment a more appropriate remedy? Such variance may also have an effect on the calculation of a post-closing working
capital adjustment. See § 17.02 infra.
81 Pub. L. No. 95-213, Title I, 91 Stat. 1494 (1977), 15 U.S.C. §§ 78, 78dd-1, 78dd-2, 78m, 78ff.
82 Section 30A of the Securities Exchange Act of 1934, 15 U.S.C. § 78dd-1. While many acquisition agreements no longer specifically cover
this part of the Federal Rules of Civil Procedure, it is worthwhile noting that a compliance with law representation, see § 11.04[11] infra, that
is qualified by materiality might not be breached by an illegal payment. See § 11.03 supra.
83 The FCPA amended Section 13(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78m(b). This amendment essentially requires
publicly held companies to "make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of [their] assets" and to "devise and maintain a system of internal accounting controls sufficient to provide
reasonable assurances" that transactions are executed in compliance with management's authorization and recorded in accordance with
generally accepted accounting principles and that access to and accountability for assets are adequately controlled.
83.1 See: § 5.10[2][b], [c] supra, § 16.03[1] infra.
84See, e.g., "Accounting for Contingencies," Statement of Financial Accounting Standards No. 5 (Financial Accounting Standards Board
1982).
Page 764 of 901
a type required by generally accepted accounting principles to be reflected in a balance sheet that were not so
reflected in the company's balance sheet as of such date.
There is no "correct" answer as to which form of the representation is appropriate. It is merely a question of
who should bear the risk of the unknown (i.e., the cost of unknown liabilities) and who would bear the burden
(and risk) of additional work. This work generally consists of preparing a disclosure schedule listing non-
GAAP liabilities as exceptions to the representation (for the Seller) or conducting a more extensive due
diligence investigation (on the part of the Buyer).
From the Buyer's point of view, it is not clear that the second form of the representation adds any protection to
that afforded by the general financial statements representation. Each essentially states that the balance sheet
was prepared in accordance with generally accepted accounting principles. However, from the Seller's
perspective there are, at a minimum, numerous contingent or even absolute future liabilities that would be
required to be disclosed under the first form of the representation but which are neither required by generally
accepted accounting principles to be disclosed nor present any actual surprises to the Buyer. For example,
ordinary contracts and leases constitute liabilities of a type that would be required to be disclosed by the more
extensive form of representation; however, the Seller should not be at risk because of a failure to disclose these
matters. Litigation provides another example. It would not make sense for the Seller to be required to list all
litigation on a disclosure schedule 85 as an exception to a general representation concerning nondisclosed
liabilities when the litigation representation itself 86 contains negotiated qualifications and limitations. One
solution which we have found to be of some practical use is to use the first form of the representation, but to
allow the Seller to take an exception for anything disclosed on the disclosure schedule in response to any other
representation or for any item of a type that is the subject of any other representation. This does not, however,
solve a more important problem, particularly if the acquisition agreement provides for indemnification: the first
form of the representation covers (and therefore puts the risk on Sellers for) unknown liabilities.
There are a few observations worth making as to this representation. First, it is our experience that in public
company acquisitions, where the Buyer is not entitled to indemnification post-closing, the broader
representation is more likely to be used than in purchases of private companies, subsidiaries or divisions,
although the broader version of the representation, which is not limited to GAAP liabilities, has been appearing
more frequently even in private company transactions. 86.1 Second, in an asset transaction where the Buyer is
only assuming those liabilities which it expressly agrees to, 87 rather than a stock purchase or merger transaction
where the Buyer indirectly succeeds, as the owner of the stock of the Company, to the economic risk of all of
the Company's liabilities, the primary focus of the debate will often shift to the undertaking or other assumption
document, rather than the representation. 88 Finally, and this gets back to the first point above, there are other
ways to deal with some of the Seller's concerns with a broad representation. One solution may be through the
85 Clearly, additional problems arise as to "unknown liabilities."
86 See § 11.04[10] infra.

86.1See "The 2019 ABA Private Target Mergers and Acquisitions Deal Points Study" which found that, of the private company acquisitions
which were surveyed and included a no undisclosed liabilities representation, 38% contained the GAAP-qualified version of the
representation.
87 In addition to those liabilities for which the Buyer, by operation of law, is liable as a "successor." See § 18.07 infra.
88 However, this merely changes the context in which the debate as to who should be liable for non-GAAP liabilities takes place, it does not
change the issue involved. Moreover, the undertaking is often drafted by referencing the undisclosed liability section in the acquisition
agreement. Finally, the Seller should be careful that a broadly drafted representation, through the operation of the indemnification section,
does not undermine the Buyer's obligations in the undertaking. Similarly, a narrowly drawn undertaking will protect the Buyer in an assets
purchase even if the representation is limited, or not included, in the agreement.
Page 765 of 901
use of "baskets" or "thresholds." 89 In addition to quantitative "baskets," the representation may be qualified, at
least outside of the indemnification provisions, so as to refer only to "material" liabilities or, as is common in
the public company context, contain an exception for liabilities "which would not reasonably be expected to
have a material adverse effect." A less common, and in the Authors view, less logically coherent approach to
limiting the representation would provide for the Seller to make the representation only to its "knowledge."
Perhaps, because this qualifier is so antithetical to the basic concept of the no undisclosed liabilities
representation, Sellers rarely obtain its inclusion in practice. 89.1Another solution is to exclude certain limited
types of liabilities from the representation, for example, environmental liabilities. 90
If an undisclosed liability representation is included, it usually will also cover the period since the last balance
sheet date. Clearly, the Company will have incurred liabilities since such date, including of a type that under
generally accepted accounting principles would be required to be disclosed on a balance sheet. Similarly the
Company will continue to incur such liabilities from the date of execution of the agreement until closing.91 As a
result, the Company will generally take an exception for liabilities incurred in the ordinary course of business.92
[9]-No Material Adverse Change

Another critical representation 93 which is almost always found in acquisition agreements concerns the absence
of any material adverse change in the Company's business 94 since the date of the most recent balance sheet, or
audited balance sheet, of the Company delivered to the Buyer. 94.1 Sometimes the representation will also
include a warranty that the Company's business has been conducted in the ordinary course since such date.
There are several aspects of the representation that often result in discussion. One important issue relates to the
date from which the representation runs. Is the balance sheet date that of the most recent audited balance sheet
or the more recent (in all likelihood) unaudited balance sheet? The Buyer would generally prefer the longer
period; moreover, it is more comfortable with the accuracy of the description of the company as of the date for
89 See § 15.03[1] infra.

89.1See "The 2019 ABA Private Target Mergers and Acquisitions Deal Points Study" which found that, of the private company acquisitions
which were surveyed and included a no undisclosed liabilities representation, only 1% contained the knowledge-qualified version of the
representation.
90 See discussion in the text at the end of the preceding paragraph.
91 Keep in mind the effect of the bringdown condition on this representation.
92 The possible liabilities since the date of the most recent balance sheet can be classified into four types:
(1) immaterial, ordinary course;
(2) material, ordinary course;
(3) immaterial, out of the ordinary course; and
(4) material, out of the ordinary course.
It is rare for the first type of liability to be picked up by the representation or for the fourth type not to be. The dispute between the Buyer and
the Seller generally involves whether the representation should cover the second and third types. The resolution, and, indeed, the need for the
second part of the representation at all, will depend in part on the "no material adverse change" representation. See § 11.04[9] infra.
93 This is the other representation referred to in the text accompanying N. 67 supra.

94 The actual formulation will refer to a list such as the "business, assets, operations or financial condition of the Company and its
subsidiaries taken as a whole."
94.1Depending upon how it is drafted, the bringdown of this condition to closing may serve as a substitute for a material adverse change
closing condition. See § 14.11[5] infra.
Page 766 of 901
which there are audited financials, rather than the date of the more recent unaudited financial statements.95 If
the audited balance sheet date is used, the Seller will often ask for exceptions, either in the agreement itself or
the disclosure schedule, for matters disclosed in their most recent quarterly financial statements.
Buyers should be careful that the representation speaks only in terms such as "since [the date of the relevant
balance sheet], there has not been . . .," rather than "from [the date of the relevant balance sheet] to the date of
this Agreement, there has not been. . . ." When the former version is tested at closing through the bringdown, it
will also cover the period from signing to closing; the latter formulation will not pick up this period. Thus, if the
second version is used, to protect the Buyer against post-signing material adverse changes, there should be a
separate condition dealing specifically with the period from signing to closing. 96
Usually the representation will also state that various events have not occurred since the balance sheet date.
While these events will not all be of a type that constitute a material adverse change, they will generally reflect
whether the prior financial statements are based on facts that are inapplicable going forward; if there has been
an occurrence of an out-of-the-ordinary course of business transaction; the status of corporate assets such as a
diminution because of a dividend issuance; or the incidence of a self-dealing or insider transaction. Among the
items which a Buyer might ask the Company to represent have not occurred are: dividends; stock acquisitions;
incurrence of liens on the Company's assets or of additional debt by the Company; payment or prepayment of
debt; compensation increases or benefit plan amendments; inventory or receivables write-offs; changes in
accounting policies or practices; or settlements of litigation or material disputes. As a rule of thumb, the longer
the period of time that has elapsed since the date of the relevant balance sheet, the more extensive the list the
Buyer will request, and the larger the Company and the more confident the Buyer is as to the manner in which
it has been operated, the shorter the list. Similarly, the list tends to be shorter in public company acquisitions. 97
An important aspect of the representation relates to the litany of items in which a change is tested to determine
whether it is materially adverse. In addition to "prospects," 98 the list can include any or many 99 of "business,"
"financial condition," "condition (financial or other)," "assets," "liabilities," "operations," "results of
operations," "properties" or "capitalization." Probably the most important item of the list is "business," but it is
often used in conjunction with other items.100
95 Consider the case, however, where the period from the date of the audited balance sheet to the date of the unaudited financials was a
particularly good one for the Company's business. In this case, drafting the representation to run from the earlier date could cause a
subsequent problem period to, in effect, be shielded by the earlier, profitable period.
96 Normally, this condition would track the representation. However, it would not normally include the list of specific events and actions that
the representation might go on to state have not occurred since the date of the balance sheet. See the following paragraph of the text. In light
of the covenant restricting the operation of the Company's business from signing to closing, see § 13.03 infra, this should not be a significant
problem. It is true, however, that the second approach (use of the separate condition) would not afford the Buyer the same indemnification
rights as the more expansive form of the representation, at least if the acquisition agreement provided that indemnification was based on the
accuracy of the representations at closing. See Chapter 15 infra. See § 14.11[5] infra.
97 It is often, although not always the case, that the covenant dealing with the operation of the Company's business from signing to closing
will cover these same matters. See § 13.03 infra.
98 See: Ns. 102-105 infra and accompanying text.

99 Use of all of these would clearly be redundant.
100 The list of items has been referred to as the "field of change." See Adams, "A Legal Usage Analysis of 'Material Adverse Change'
Provisions," 10 Fordham J. Corp. & Fin. L. 9, 29-35 (2004). As discussed therein, "business" is the most important item on the list but
should probably not be used by itself, discussing Pine State Creamery Co. v. Land-O-Son Dairies, Inc1999 U.S. App. LEXIS 31529 at *10
n.1 (4th Cir. Dec. 2, 1999), rev'g 1997 U.S. Dist. LEXIS 22035 at *9 (E.D.N.C. Dec. 22, 1997) (reversing court holding that "business" did
not include operating profit). See Adams supra, 10 Fordham J. Corp. & Fin. L. at 32. See also, N. 116 infra.
Page 767 of 901
Sellers sometimes try to limit the effect of this representation by excepting from it certain specific matters that
it believes will, or are likely to, occur during the anticipated pendency of the agreement, 101 as well as events
that have occurred since the date of the last (or last audited) balance sheet. Examples could include the loss or
anticipated loss of a significant customer, specific operational problems, change in governmental regulation, a
favorable contract that won't survive the closing, write-down of assets or adverse business trends. Some of these
exceptions may be hard for a Buyer to resist from a "common sense" point of view although they clearly affect
(probably in a negative way) the ability to prove the occurrence of such an event if litigation were to ensure.
It also bears noting that there are significant variations as to how forward looking the representation is. For
example, some include "prospects" in the list of things that there has been no material adverse change in. Others
don't talk about prospects, but still refer to events which "are reasonably likely" to have a material adverse
effect on the business, etc.; still others refer only to events which "have had" such an effect.102 It is also worth
noting what might be forward looking at the time of signing may no longer be forward looking, but, rather, a
statement about the past when made in the bringdown at closing. 103 This is particularly true when the
acquisition is made in a regulated industry when the period pending closing can be quite lengthy. From the
Seller's perspective, one of the potentially problematic aspects of the forward looking formulations is that they
can, after the fact, result in triggering indemnification obligations of the Seller for events it neither knew about
nor had reason to know about. 104
A number of other drafting issues can arise. Most important are the exceptions discussed below. For example, is
the standard materiality measured against the target and its subsidiaries, taken together-i.e., "as a whole"-or
should materiality be measured with the focus on the parent company or one or more of its subsidiaries
101 Even if the language of the representation is not forward looking, see: Ns. 104-105 infra and accompanying text, it will be generally
repeated at the closing either by reason of a bringdown or a separate closing condition. See: §§ 14.02, 14.11[5] infra.
102 Clearly the issue here is that a materially adverse event can have occurred without the effect on the target's business being felt yet. For
example, a major customer or supplier could have notified the target that, effective as of a date following the closing (e.g., year-end), it will
be terminating their relationship. The Buyer might argue that this has an immediate effect on what constitutes the "business," although the
financial consequences would not occur until sometime next year. Such an argument may or may not convince a court. The court in Goodman
Management Co. L.P. v. Raytheon Co. was not convinced by the argument that "prospects" should be viewed as being inherently part of the
terms "business," "assets" or "financial condition." Goodman Management Co. L.P. v. Raytheon Co., 1999 WL 681382 at *14 (S.D.N.Y.
1999). See Pacheco v. Cambridge Technology Partners, Inc., 85 F. Supp.2d 69, 73, 77 ( D. Mass. 2001) (material adverse change in
"business, financial condition or results of operations" did not pick up "prospects;" although "Business Condition" had separately included
"prospects" it had specifically limited this usage to be only one of the two parties, not the other, and, even as to that party, was limited to
"events, conditions, facts or developments known" to it). See also, Pittsburgh Coke & Chemical Co. v. Bollo421 F. Supp. 908, 930 ( E.D.N.Y.
1976), aff'd560 F.2d 1089 ( 2d Cir. 1977) (to conclude that adverse changes in aviation industry, with which the company had extensive
dealings, in and of itself constituted material adverse changes in the company's existing business or financial condition was "patently
absurd"). See also, Cendant Corp. v. Commonwealth General Corp., 2002 Del. Super. LEXIS 251 (Del. Ch. Aug. 28, 2002) ("could
reasonably be expected to have a material adverse effect" held to raise a question of fact as to whether it covered prospects), and cases
discussed therein. Whether the representation is forward looking can be of importance when dealing with litigation. See, e.g., S.C. Johnson &
Son, Inc. v. DowBrands, Inc., 167 F. Supp.2d 657 ( D. Del. 2001) (court, applying Delaware law, held patent infringement claim against
company not to be a material adverse change "unless and until a court adjudicates claim in favor of the third party and decides that the asset
can no longer be used in the business"); 167 F. Supp.2d at 670. See also, Frontier Oil Corp. v. Holly Corp., 2005 WL 1039027 (Del. Ch.
April 29, 2005), discussed at N. 144 infra. But see, the Delaware Chancery Court's opinion in Akorn, Inc. v. Fresenius Kabi AG, C.A. No.
2018-0300-JTL (Del. Ch. 0ct. 1, 2018), holding that the appropriate method for evaluating an effect on a target's business is to compare the
performance of the target during each financial period between signing and Closing with the target's performance during the same financial
period of the preceding year to determine if the adverse effect is material and then consider whether such effect will be expected to continue
to affect the target's future performance in a durationally significant manner.
103 This could also affect indemnity claims. See § 15.02[2] infra.
104This could be the case if the event had not yet actually had, as of the signing or closing, any effect on the Seller's business. Of course,
Buyers would argue that this was irrelevant, that the issue is not knowledge or fault, but rather who should bear the risk of an "inappropriately
high" purchase price.
Page 768 of 901
separately. The former standard, which is clearly preferable from the Seller's perspective, is much more
common; on occasion, however, a Buyer will argue that a particular subsidiary is critical to its motivation in
doing the transaction and that a material adverse effect on the subsidiary's business might not be picked up by a
test that looks to the company and all of its subsidiaries taken as a whole, either because the subsidiary is not, as
of today, so material to the consolidated company or, even if it is, the effect is diluted. 105
Sellers often seek to negotiate certain generic exceptions to the no material adverse change representation, in
addition to any specific issues they might be aware of. These include events or changes caused by general
economic conditions, industry conditions, 106 the announcement of the transaction, or the execution, delivery
and performance of the acquisition agreement, 107 changes in GAAP, 108 and changes in governmental
regulation. Sometimes, terrorist acts are specifically excluded from (or included in) the representation. 109
105 For example, a 15% decline in operating profits of a subsidiary that contributes 40% of the total operating profits of the overall group
(with four other subsidiaries each contributing 15%) translates to only a 6% drop in overall operating profits.
106 The cases are not uniform on whether changes "external" to a company, such as those that affect the entire industry would be picked up
absent an exclusion such as this. Compare:Pittsburgh Coke & Chemical Co. v. Bollo, 421 F. Supp. 908 ( E.D.N.Y. 1976) (discussed at N. 102
supra) andBorders v. KRLB, Inc., 727 S.W.2d 357 ( Tex. App. 1987) (discussed at N. 115 infra), with IBP, Inc. v. Tyson Foods, Inc., 2001
Del. Ch. LEXIS 81 (Del. Ch. June 15, 2001) (discussed at Ns. 125-137 infra and accompanying text, especially N. 128 infra). Often there is
an exception to the exception, requiring that the impact not be disproportionate to the company relative to other participants in the industry or
to other participants in the industry in the geographical areas where the company operates. This can easily lead to a whole set of other
negotiations: Which industries? Which areas? Disproportionate to everyone in the industry or just disproportionate to the industry generally?
Which geographic areas? etc.
107It would be expected that this qualification, in any event, would be inapplicable to a "no violations" representation. See § 11.04[7] infra.
See also, § 11.03[1] N. 4.3 supra.
108 These might be modified to exclude those having a material impact on the ability of Buyer to obtain financing. Sellers often resist this
limitation on the exclusion, however. Given the relatively limited period of time before most termination dates, and given the tortoise-like
speed of changes in GAAP, it will be possible in many instances for Buyers to feel comfortable that no changes in GAAP not already
publicly known will occur prior to closing.
109 Other exceptions, found more often in transactions involving the technology sector, include changes in stock price, loss of customers or
suppliers, failure to meet projections or estimates of earnings by securities analysts or company projections, loss of employees, effect of
change of control provisions and effects resulting from compliance with the acquisition agreement. Buyers sometimes provide a qualification
to such exclusions as drops in stock prices or failure to meet projections that the exclusion does not cover any underlying cause or event. An
interesting case which highlights the importance of the exception relating to the failure to meet forecasts or projections is Osram Sylvania,
Inc. v. Townsend Ventures, LLC, C.A., No. 8123-VCP (Nov. 19, 2013). Osram, as plaintiff in the case, alleged that the Sellers had learned
soon after signing that the target business would under-perform pre-signing forecasts by 50% for the first quarter ending after signing and
before Closing. Osram further alleged that, despite the Sellers' covenant to inform Osram of any event that would cause a "material adverse
effect," Sellers neglected to tell Osram that the target business would not meet its sales forecasts. It should be noted that the definition of
"material adverse effect" in the underlying Stock Purchase Agreement did not include an applicable exception for the failure to meet forecast.
In declining to dismiss Osram's post-Closing indemnification claims regarding breach of its covenants, the court held that the failure to meet
forecasts in question "could reasonably be interpreted as reflecting a change in circumstances that was 'materially adverse to the Business' . .
." Thus, at least at the motion-to-dismiss phase, the court countenanced a claim based on the theory that the failure to meet forecasted
performance constituted a "material adverse effect." In light of this result and the potential that other courts could reason similarly, the
authors strongly counsel that practitioners argue strenuously for the exception relating to the failure to meet forecasts and projections when
representing sellers.
Exceptions for actions "required" or "permitted" by the agreement may be risky. For example, do they cover everything done in the ordinary
course? Everything that is not specifically prohibited? In either case, whatever consequences follow from such actions? For general
discussion of material adverse effect clauses, particularly from a drafting perspective in high-tech transactions, see: Adams, "A Legal Usage
Analysis of "Material Adverse Change' Provisions," 10 Fordham J. Corp. & Fin. L. 9 (2004); Howard, "Deal Risk, Announcement Risk and
Interim Changes-Allocating Risks in Recent Technology M&A Agreements," in Risdon, Drafting Corporate Agreements 2000-2001 Series
B-1219 (PLI 2000).
Page 769 of 901
Buyers often resist these generic exclusions, although most agreements probably contain an exception for
general economic condtions 110 and, although not quite as common, industry conditions. 111
In the Authors' view, one area that Sellers sometimes overlook in negotiating exceptions is the overall structure
of the "material adverse effect" definition. Specifically, as discussed above, the "material adverse effect"
definition sometimes includes both a component addressing impacts on the Target business and its operations
and a separate component addressing effects which materially delay or impair the Target's ability to comply
with its obligations under the Agreement and consummate the transaction. Putting aside that there exists far less
case law focusing on the second component of the definition, in certain instances the exceptions are expressly
drafted so as to apply to the clause relating to impacts on the business but are not repeated with respect to the
clause relating to compliance with obligations or consummation of the transaction. As evidenced by Vice
Chancellor Glasscock's opinion in Cooper Tire & Rubber Company v. Apollo (Mauritius) Holdings, this
approach poses a risk to Seller that matters which are understood as not being the basis for a "material adverse
effect" under one clause of the definition may be taken into account under another. 111.1 In light of this
110 In our experience, Buyers are starting to argue about this qualification more, particularly in cash transactions.
111This exception is much more common if the parties are already in the same industry. Even there, however, the exception is often qualified
by a requirement that the adverse change in industry conditions not have a disproportionately greater impact on the target than on the Buyer.
An interesting case in this regard is Allegheny Energy, Inc. v. DQE, Inc., 74 F. Supp.2d 482 ( W.D. Pa. 1999), aff'd216 F.3d 1075 ( 3d Cir.
2000). The merger agreement between two electric utility holding companies contained a provision effectively permitting termination if a
representation as to the absence of a material adverse effect was false. At issue between the two parties (each an electric utility holding
company) was a provision in a material adverse effect clause stating that the effect of certain regulatory legislation which impacted both
parties shall be taken into account only to the extent the effect on one party exceeds the effect on other. 74 F. Supp.2d at 490, 491. (Emphasis
added.)
The court rejected the interpretation that one measured the difference in write-offs between the two companies and compared that difference
to the financial results of the company that had the greater write-off. 74 F. Supp.2d at 514-517. Instead, the court held that the effect of the
legislation on each separately had to be considered and then the two impacts compared. If the effect on one was greater than the effect on the
other and "such greater effect was materially adverse then there was a material adverse effect." 74 F. Supp.2d at 516. In other words, rather
than comparing the write-offs against income for each company, subtracting one from the other, and then comparing the impact of such
difference on operations of the company with the layered write-off, the court compared the effect on each company of its write-off, and then
determined which company had suffered more and whether such greater "suffering" was a material adverse effect). 74 F. Supp.2d at 516. The
court found a material adverse effect had occurred: one party lost 105% of its net income (compared to 42% for the other) and its write-off
was more than triple the size of the other's (although its book value had only been 37% higher). 74 F. Supp.2d at 518.
The Allegheny Energy, Inc. v. DQE, Inc. case indicates how important the exact language is. There are at least four possible approaches to
take in determining whether the effect of an industry-wide event is disproportionate as between two companies. One actual dollar impact
could be subtracted from the other and the difference compared to the financial profile of the company that suffered the greater impact to see
if it is materially adverse. (This is the least likely alternative.) The second approach is to determine separately the effects of the event on each
company to see which company suffered the greater adverse effect, and then the situation would be evaluated to decide if adverse effect was a
material adverse effect on such company. Third, the adverse effects on each company could be determined separately, compared, and then it
could be decided if the increment (i.e., the difference between the two relative effects) is materially adverse to the company that suffered the
greater effect. Finally, proceeding as in the third method above, the separate adverse effects on each company could be compared, then it
would be determined if one adverse effect is sufficiently greater in terms of its impact than the other so as to be "substantially
disproportionate." If so, it would next be determined whether the greater relative adverse effect is materially adverse to the company. (We are
not sure whether the court in Allegheny followed the second or fourth methodology, although we suspect it to be the second one. In any event,
it appears that the court interpreted "to the extent that" (which would imply that the incremental effect as in the first and third approaches
should be focused upon) as meaning "if." Of course, in the real world nothing is as mathematically exact as this discussion would imply;
similarly the determination of whether a material adverse effect has occurred is not solely a quantitative one.
Specifically, in Cooper Tire & Rubber Co. v. Apollo (Mauritius) Holdings, C.A. No. 8980-VCG (Del. Ch. Oct. 31, 2014), the Delaware
111.1
Chancery Court considered the proper treatment of a significant labor dispute in the context of a "material adverse effect" definition
comprising two principal components: (i) a clause addressing impacts on the Target business, subject to, among other things, a specific
Page 770 of 901
possibility, practitioners representing Sellers would do well to ensure that excepted matters expressly apply to
both components of the definition.
The questions remain: How does one determine whether there has been a material adverse change? Is it
triggered at a certain percent of earnings or sales or equity? If so, then of which period's sales, earnings or
equity? And compared to what? One thing seems clear. The standard of what constitutes a "material adverse
effect" is quite high, 112 much higher than most clients believe: for example, that fact that the impact of an event
would have been sufficient to cause the Buyer to have lowered the price it was willing to pay in the acquisition
does not mean that there has been a "material adverse effect."
There is little consistency in the decisions, many of which involve fairly small transactions. Some of the
outcomes are quite surprising, even when allowing for the vagaries of the exact language of the representation
(or condition). 113 For example, material adverse effects have been found not to have occurred114 where a radio
exception regarding the impact of the announcement of the transaction on labor unions and (ii) a clause relating to delay or impairment of
performance of the Target's obligations or consummation of the transaction, which was not subject to the exception. In construing the
definition, Vice Chancellor Glasscock rejected Cooper's argument premised on the parties' intent to exclude the impact of strikes for all
purposes of the "material adverse effect" definition, regardless of the specific language. Instead, Glasscock held that each clause of the
definition needed to be construed separately, noting "it is axiomatic that contractual provisions must be read to make sense of the whole."
Glasscock went on to find that the two components of the definition combined to impose the risk of strikes on the Buyer under the first
clause, but then to limit that imposition of risk under the second clause if the strike would "reasonably be expected to prevent or materially
delay or impair the ability of [Cooper] to perform its obligations . . ." While the Authors would argue that this outcome is somewhat
counterintuitive, particularly given that the obligation whose performance was impaired was the ordinary course covenant and did not relate
to the execution of an element of the transaction itself, and very likely was not specifically contemplated by the parties, nonetheless
practitioners should take the decision into account in drafting definitions going forward. In our view, in most situations, Sellers will likely
find it more conceptually sound to draft the definition of "material adverse effect" to either exclude the second component relating to delay or
impairment of performance altogether or to expressly apply the exceptions to this clause as well. Buyers, on the other hand, will likely argue
to retain the clause and, perhaps, negotiate which particular exceptions are relevant for the clause.
See, e.g., Aquila and DiNoto, "Opening Pandora's Box? Johnson & Johnson Learns the Hard Way that Playing the MAE Card is a Risky
112
Gamble," 10 M&A Lawyer 1 (Feb. 2006).

113 The issue of whether a material adverse change has occurred is generally one of fact. See, e.g.:
Second Circuit: Georgia-Pacific Corp. v. GAF Roofing Manufacturing, Corp., 1997 WL 217586 (S.D.N.Y. May 1, 1997).
Third Circuit:Allegheny Energy, Inc. v. DQE, Inc., 74 F. Supp.2d 482, 508, 518 ( W.D. Pa. 1999) (necessary to consider the size and nature
of the transaction and the nature of the parties' businesses; court also indicated that alarming public statements made by a party concerning
the effect of a restructuring order provided "further confirmation" of the order's material adverse effect).
Tenth Circuit:Land v. Roper Corp. 531 F.2d 445, 449 ( 10th Cir. 1976).
State Courts:
Illinois:Israel v. National Canada Corp, 276 Ill. App.3d 454, 658 N.E.2d 1184, 1191, 213 Ill. Dec. 163 ( 1995).
It has been suggested that the relevant perspective as to what constitutes a material adverse change is that of the reasonable expectations of
the acquiror in light of its general circumstances and that, for example, there may be an argument for a lower standard for "material adverse
effect" in the case of a highly leveraged financial buyer than a well-heeled strategic acquiror. See Reisner, Pagano and Rose, "Material
Adverse Clauses: Practice in an Uncertain World," 10 M&A Lawyer 10 (Nov. 4, 2006). Similarly, however, large fluctuations in profits and
losses may be an inherent and recurring feature of the target's business. See Bear Stearns Co. v. Jardine Strategic Holdings, Ltd., 1988 N.Y.
Misc. LEXIS 892 (N.Y. Sup. June 28, 1988).
114 See also, Gordon v. Dolin 105 Ill. App.3d 319, 434 N.E.2d 341, 348, 61 Ill. Dec. 188 ( 1982) (court found that the specific provision
relating to absence of actual notice of determination by customers rendered inapplicable the general language of a material adverse change
clause).
Page 771 of 901
station listening audience (as measured by its arbitron rating) dropped by more than 50%, 115 in a purchase of
interests in oil and gas where the price per barrel of oil dropped from $28.85 to $20.35, 116 in a purchase of a
business for $3 million where losses of $700,000 occurred during a period that the seller had represented the
business would "break even", 117 where the 1987 market crash caused a $100 million loss in a brokerage's firm
arbitrage department and a drop in its stock price from $19 to $13, 118 or where the target suffered a $21,000
loss over a three-month period, as compared to annual losses of $15,000, $39,822 and $33,000 over the prior
three years. 119
Although most cases that have considered decreases in profits in the 40% or higher range found a material
adverse effect to have occurred,120 the leading case in the area found a 64% drop in quarterly earning not to
constitute a material adverse effect. 121 At lower levels of decrease in profits or net worth, the outcome is less
certain. 122 Moreover, an event can be material from a federal securities law 123 or accounting 124 perspective, but
not constitute a material adverse effect.
115 The clause was held to only reach deliberate adverse action by management, not events over which management had little or no control.
See John Borders v. KLRB, Inc., 727 S.W.2d 357 ( Tex. App. 1987). But see, Great Lakes Chemical Corp. v. Pharmacia Corp., 788 A.2d 544,
557 ( Del. Ch. 2001) (entrant of new competitors in industry, price cutting in industry, patent infringement by a competitor and diminished
sales and loss of major customer due to market forces, although "external" factors, should be taken into account in determining whether a
material adverse effect had occurred).
116The court reasoned that while there may have been a material adverse change in the value of the interests to be purchased there was not
one in the interests themselves. See Esplanade Oil & Gas, Inc. v. Templeton Energy Income Corp., 889 F.2d 621 ( 5th Cir. 1989).
117 See Pine State Creamery v. Land-O-Sun Dairies, Inc., 1997 U.S. Dist. LEXIS 22035 (E.D.N.C. 1997) (question was one for the jury where
there were severe losses for two-month period, but business was seasonal and downturns were expected as part of business), rev'd 1999 U.S.
App. LEXIS 31529 (4th Cir. Dec. 2, 1999).
118 The court held that it could not conclude as a matter of law (i.e., that there was a question of fact) that the acquiror had become aware of a
fact with respect to the brokerage firm that in the reasonable judgment of the acquiror had material adverse significance with respect to the
value of the brokerage's firm shares to the acquiror. (The transaction was a tender offer for 20% of the brokerage firm's shares.) See Bear
Stearns v. Jardine Strategic Holdings, 161 A.D.2d 297, 556 N.Y.S.2d 473 ( 1990).
119 See Auble v. Sprosty, 1977 Ohio App. LEXIS 9304 (Ohio App. July 14, 1977).
120 Arkansas:KLRA, Inc. v. Long, 6 Ark. App. 125, 639 S.W.2d 60, 63-64 ( 1982) (48% decline in profits for year, as compared to the prior
year).
Delaware: Raskin v. Birmingham Steel Corp., 1990 Del. Ch. LEXIS 194 (Del. Ch. Dec. 4, 1990) (50% decline in profits over two consecutive
quarters).
New York:Katy v. NVF Co., 100 A.D.2d 470, 473 N.Y.S.2d 786, 788 ( 1984) (400% decline in earnings over a year (from a profit of $2
million to a loss of $6 million).
Ohio: Truck World Inc. v. Fifth Third Bank, 1995 WL 577521 (Ohio App. Sept. 29, 1995), appeal dismissed75 Ohio. St.3d 1404, 661 N.E.2d
754 ( 1996) (in context of a loan agreement default provision, $1 million loss over two months compared to a projected loss of $348,000 for
one month and a projected profit of $85,000 for the other).
Texas:Sale v. Contran Corp., 486 S.W.2d 161 ( Tex. App. 1972) ($500,000 loss reflected on audited financial statements compared to a
$500,000 profit shown on previously delivered interim financial statements).
121 IBP,Inc. v. Tyson Foods, Inc., 789 A.2d 14 ( Del. Ch. 2001), discussed at Ns. 125-137 infra and accompanying text (64% drop in earnings
for quarter compared to corresponding quarter of proceeding year held not to constitute a material adverse effect).
122 The following cases held that a material adverse change existed:
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The question does arise as to why the parties do not more often try to quantify what constitutes a material
adverse effect? The problem is that it is very difficult in most cases for the parties to reach agreement on a
particular percentage or dollar decrease in sales, earnings or net worth. Even if they could, however, the reason
for the change might be much more important to the business or financial condition than whether, for example,
Second Circuit:Pan Am Corp. v. Delta Airlines, Inc., 175 B.R. 438 ( Bankr. S.D.N.Y. 1994) (a 17% decline in one month's revenues and a
20% decline in advanced bookings from that predicted in the company's business plan was a material adverse change in a company's
prospects); Polycast v. UniRoyal, 1988 U.S. Dist. LEXIS 9648 (S.D.N.Y. Aug. 25, 1988) (actual profits of $5.25 million as compared with
projected profits of $13.3 million for such year constituted a material adverse change in prospects).
State Courts:
Illinois:Peoria Savings & Loan Ass'n. v. American Savings Ass'n., 109 Ill. App.3d 1043, 441 N.E.2d 853, 859, 65 Ill. Dec. 538 ( 1982)
(acquiror suffered a material adverse effect by reason of its acquisitions of two unstable banks which had incurred a monthly loss of $700,000
and its loss of 9% net worth during the relevant period).
The following cases held that a material adverse change did not exist:
First Circuit:Glassman v. Computervision Corp., 90 F.3d 617, 633 ( 1st Cir. 1996) (3% differences in percentages of the ratio of backlog to
revenue measured at the end of consecutive quarters was not material; court noted that it believed that a 9% difference would also not be;
note that the standard was not "material adverse effect").
Second Circuit: In re Domestic Fuel Corp., 79 B.R. 184 (Bankr. S.D.N.Y. 1987 (write off of a loan representing 3% of the purchase price did
not constitute a material adverse effect); Berkowitz v. Baron428 F. Supp. 1190, 1192 ( S.D.N.Y. 1977) (a 6.6% decline in net worth from
$450,000 to $420,000 was not a material adverse change).
Ninth Circuit:Hawaii Corp. v. Crossley, 567 F. Supp. 609, 626-627 ( D. Haw. 1983) (8% difference in estimated losses during eight-month
period was not a material adverse change in reported assets).
State Courts:
New York:Rudman v. Cowles Communications, Inc., 35 A.D.2d 213, 315 N.Y.S.2d 409, 413 ( 1970) (15% increase in tax liability during a
three-month period did not constitute a material adverse change in current liabilities).
123See TSC Industries v. Northway, 426 U.S. 438, 449, 96 S.Ct. 2126, 48 L.Ed.2d 757 ( 1976) ("an omitted fact is material if there is a
substantial likelihood that a reasonable investor would consider it important"). See generally, § 7.01[1] Ns. 6-9 supra and accompanying text.
What is important to a reasonable investor in the market is not the same as what is important to an acquiror. (Interestingly enough, it might be
argued that more things are significant to an acquiror than an investor; however, it seems clear that the standard for material adverse effect is
harder to satisfy than mere materiality. See, e.g., N. 122 supra.)
124 The accounting definition of materiality has been described as "the magnitude of an omission or misstatement of accounting information
that, in light of surrounding circumstance, makes it probable that the judgment of a reasonable person would have been changed or influenced
by the omission or misstatement." See Statement of Financial Accounting Concepts No. 2: Qualitative Characteristics of Accounting
Information at Glossary of Terms, ¶ 132 (Financial Accounting Standards Board 1980). This often occurs in the 5-10% range, but there are
no generalized standards since the materiality decision is a qualitative one based on a wide range of factors, including the nature of the item
under consideration, whether it arises from a routine or abnormal transaction, the size of the company and its financial condition and trends in
profitability. Id. at ¶¶ 123-131, 167, 170 (quoted in SEC v. Price Waterhouse, 797 F. Supp. 1217, 1237 ( S.D.N.Y. 1992)). See also, SEC Staff
Accounting Bulletin No. 99-Materiality (Aug. 12, 1999). In fairness, one gets the impression that all of the discussion (particularly in SAB
No. 99) about 5%-10% not being a hard and fast rule is much more about treating changes below that level as material than it is about
reaching the opposite conclusion with respect to changes above it.
The accounting determination is generally concerned with the issue of whether misstatements or omissions in financial statements were
material for purposes of deciding whether the financial statements painted an accurate financial picture of the company as of the date and for
the historical periods covered (usually thirty to ninety days before the date of the financials). By contrast, a material adverse effect clause in
an acquisition agreement is designed to deal with changes since a specified date in a company's business, financial condition, etc. One might
expect less tolerance for deficiencies in the accuracy of historical financial statement than in changes since a benchmark date-changes which,
by reason of the bringdown, extend into the future (relative to the signing of the agreement).
Page 773 of 901
the decrease is 1% above or below the negotiated level. Similarly, since not every event may be immediately so
easily reflected in revenues, earnings or net worth (or for that matter in any other quantifiable benchmark),
Buyers will want any quantified levels of decreases in particular items, such as earnings, not to be exclusive
determinants of whether a material adverse effect has occurred; once these measures become nonexclusive,
however, a Seller might wonder whether it has really gained anything from the quantification. All of these
problems are exacerbated in the public company context.
Unfortunately, very few of the decisions contain anything other than conclusory statements as to whether or not
some change or development constituted a material adverse effect. Until 2018, the only truly notable exception
was IBP, Inc. v. Tyson Foods, Inc., 125 a Delaware Chancery Court decision by then Vice Chancellor Strine
applying New York law. 126 The case arose out of an acquisition agreement between IBP and Tyson, the winner
in a bidding contest with another party for IBP. 127 The merger agreement contained a material adverse change
representation which stated that since the balance sheet date of December 25, 1999, there has not been any
event, occurrence or development of a state of circumstances or facts that has had or reasonably could be
expected to have a material adverse effect on the "condition (financial or otherwise), business, assets, liabilities
or results of operations" of IBP and its subsidiaries taken as a whole (an "MAE"). 128 Tyson claimed that two
events, taken separately, but, in any event, when taken together, constituted an MAE. 129 The first was the
decline in IBP's operations during the last quarter of 2000 and the first quarter of 2001. The second item
involved a one-time (noncash) charge resulting from the impairment of goodwill at a small subsidiary.130 Most
of the court's analysis focused on the first item. On a normalized basis, the first quarter of 2001 was 64% below
the first quarter of 2000. 131 The court, finding the question to be a close one, put the burden of proof on
Tyson 132 and found in favor of IBP. 133 With respect to the first quarter, however, the court concluded that
125 IBP, Inc. v. Tyson Foods, Inc., 789 A.2d 14 ( Del. Ch. 2001).
126It appears that Tyson Foods is also viewed as the law in Delaware. See Frontier Oil Corp. v. Holly Corp. 2005 WL 1039027 at *34 (Del.
Ch. April 29, 2005).
127IBP had originally agreed to be acquired in a leveraged buyout. After that transaction was announced, Smithfield Foods, followed by
Tyson, each made unsolicited bids, an auction developed between them and, eventually, Tyson won.
128 See IBP, Inc. v. Tyson Foods, Inc., N. 125 supra, 789 A.2d at 65. There was, it should be noted, no carve out or exception for
developments effecting IBP's industry generally. According to the court, if IBP had wanted to exclude industry wide factors it "should have
bargained for it." Id. at 66.
129 Tyson also claimed various other bases for breach and/or having the right to terminate the agreement. Most significant was the failure of
the financial statement representation to be true by reason of an SEC required restatement resulting from accounting irregularities at an IBP
subsidiary. The undisclosed liability representation, however, contained (through the disclosure schedule) an exception for liabilities
associated with improper accounting practices at the subsidiary. The court felt that it was elevating substance over form for Tyson to be able
to refuse to close because the SEC had required the restatement of historical financial statements (thus invoking the financial statement
representation, which did not have the disclosure schedule exception), but would have no such ground had the same charge been taken in the
following quarter. Essentially, the court seems to be implying that if the Buyer knows about the problem before signing-or if it is disclosed as
an exception to one representation-it cannot be used to create a breach of another. Id., 789 A.2d at 55-65. Query, however, the agreement that
a restatement was more likely to provoke shareholder litigation against IBP than a subsequent hit to earnings.
130While the impairment charge ($60 million) was worth as much as $.50-$.60 per IBP share, the subsidiary with respect to which the charge
had been incurred was a disaster (it was the one with improper accounting practices), its shut down would have little effect on IBP going
forward, and, on an asset basis, the charge was insignificant to IBP. Id., 789 A.2d at 69-71.
131 Id., 789 A.2d at 69.
132 This was one of several interesting, possibly, critical, procedural rulings the court made. First, New York law, that chosen by the parties in
the agreement with respect to substantive matters was also held to be applicable with respect to what the burden of proof was, not Delaware
law. (New York law, which is the minority rule, provides a mere preponderance of evidence was sufficient to support specific performance,
rather than clear and convincing evidence, the rule in Delaware and a majority of jurisdictions). Id., 789 A.2d at 53 & n.92. Second, and most
Page 774 of 901
Tyson had been adequately warned about the downturn before it entered into the merger agreement. With
respect to the second quarter, a short-term view was inappropriate; rather an event needed to be considered
from the long-term perspective of a reasonable acquiror. Even when a material adverse effect is as broadly
written as the one in the IBP-Tyson agreement, the court felt that the provision is best read as a backstop
protecting the acquiror from the occurrence of unknown events that substantially threaten the overall earnings
potential of the target in a durationally significant manner: 134
"The important thing is whether the company has suffered a material adverse effect in its business or
results of operations that is consequential to the company's earnings power over a commercially reasonable
period, which one would think would be measured in years rather than months." 135
In light of the cyclical nature of IBP's business, and the fact that analysts were predicting earnings over the next
two years for IBP which were in line with the historical troughs in the beef cycle,136 the application of its long-
term view led the court to conclude that no material adverse effect had occurred.137
The three most important conclusions coming out of the IBP decision were, first, that whether a material
adverse change has occurred depends in large part on the long-term impact of the event in question (a
somewhat speculative analysis), and, second, that an acquiror's pre-signing knowledge about trends and
possible events, including what is learned in due diligence and disclosed on the schedules to the agreement,
could diminish its ability to successfully claim that a material adverse effect has occurred. Finally, it is much
tougher to prove the existence of a material adverse effect than clients realize.138
critically, the court concluded that Tyson, who was seeking to terminate the agreement (and was asserting the existence of a material adverse
effect as the basis for this and as a defense against IBP's claim for specific performance), bore the burden of proof as to whether there had
been a material adverse change, notwithstanding that IBP was seeking specific performance of the agreement. (The party seeking to avoid
performance because of the other party's breach bears the burden of proof under both New York and Delaware law). Id. at 53 & n.94. Indeed,
Vice Chancellor Strine indicated that if he were wrong and that IBP had the burden of proof (i.e., to show the absence of an MAE so as to
obtain specific performance of the agreement), and if the standard it would have to meet were that of clear and convincing evidence (the
Delaware standard for specific performance) rather than the tougher New York standard, IBP would not prevail. Id. at 72 & n.172.
In addition, Tyson also had the worst of it with respect to the burden of proof on certain additional rescission claims based in fraudulent
inducement, and deficiencies in the due diligence process: New York law imposed a higher burden (clear and convincing evidence) than
Delaware (a preponderance of the evidence). Id. at 53-54.
133 This was also the classic case of bad facts influencing a decision that will likely be cited for the simple proposition that a 64% drop in
earnings is not sufficient. One gets the distinct impression that the Vice Chancellor Strine thought that Tyson itself did not believe that there
had been a material adverse effect, but, was, instead, suffering "buyer's remorse." Among the facts that supported this result were that Tyson's
bankers still thought the deal was fair to it with "tremendous strategic sense" and represented "great long term value." Id., 789 A.2d at 50, 69-
70. In addition, Tyson did not even raise the material adverse effect claims in its correspondence with IBP, its announced reasons for
terminating the merger agreement or, indeed, until the litigation started. Id. at 51, 65. Finally, Tyson did not offer any evidence that the drop
in second quarter earnings resulted in a decrease in IBP's value or earnings potential Id. at69-70.
134 Id., 789 A.2d at 68.
135 Id., 789 A.2d at 67. (Emphasis added.)
789 A.2d at 70-72. The court did indicate some skepticism about analysts' predictions, however. Moreover, in an earlier statement, the
136 Id.,
court noted that, had the full year 2001 been projected on a straight-line basis calculated using the first quarter's results, then that "sort of
annual performance would be consequential to a reasonable acquiror. . . ." Id. At 69. Presumably the court was indicating that repeated
annual performance at this level would be an MAE.
137 Id., 789 A.2d at 71-72.
138 See also, Frontier Oil Corp. v. Holly Corp., 2005 WL 1039027 (Del. Ch. April 29, 2005), discussed at N. 144 infra.
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Largely informed by the conceptual framework set forth in IBP, Inc. v. Tyson Foods, Inc., Vice Chancellor
Laster's 2018 opinion for the Delaware Chancery Court in Akorn, Inc. v. Fresenius Kabi AG138.1 seeks to
provide a detailed, fact-based analysis for its holding that Akorn had in fact suffered a material adverse effect as
defined under its merger agreement with Fresenius. Significantly, Akorn is the first post-trial opinion of the
Delaware Chancery Court finding the existence of a material adverse effect giving rise to the right of a Buyer to
terminate a public company merger agreement.
By way of summary, in Akorn the Delaware Chancery Court found that (i) Akorn, a generic pharmaceutical
company, had suffered a "sudden and sustained drop" in its business performance following execution of its
merger agreement with Fresenius, due to, among other things, increased pricing competition, and that such drop
constituted a "General MAE" resulting in a failure to satisfy a stand-alone absence of MAE condition in the
merger agreement, and (ii) there existed "overwhelming evidence of widespread regulatory violations and
pervasive compliance problems at Akorn" which were qualitatively and quantitatively material and gave rise to
a breach of Akorn's regulatory compliance representations of sufficient magnitude that it would reasonably be
expected to result in a material adverse effect, this causing the bringdown condition not to be satisfied (a
"Regulatory MAE").
In analyzing the General MAE, Vice Chancellor Laster conducted a fact-based analysis of Akorn's performance
during the four quarters following the signing, noting the drop in revenue, operating income and earnings per
share in comparison to the comparable quarter of the preceding fiscal year. The reduction in performance on a
quarterly basis ranged from 25% to 34% in terms of revenue, from 84% to 134% in terms of operating income,
and from 96% to 300% in terms of EPS. While Vice Chancellor Laster declined to adopt a bright line test for
the magnitude necessary to support an MAE finding, he comcluded that magnitude of the business drop off at
Akorn was sufficient under the circumstances. Moreover, the Vice Chancellor found that the four-quarter
period observed as well as the fact that the decline showed "no sign of abating" supported that the declines were
"durationally significant" over a period of years in accord with the discussion in IBP, Inc. v. Tyson Foods, Inc.
Similarly, in analyzing the Regulatory MAE, Vice Chancellor Laster analyzed the quantitative magnitude of the
remediation costs associated with remedying Akorn's compliance issues and noted that the overall projected
cost of $900 million, or 21% of equity value, while not free from doubt, "would reasonably be expected to
result in an MAE." Thus while not providing an all-purpose numerical threshold for determining the existence
of an MAE, the Akorn opinion provides a clear methodology for evaluating the magnitude of a given effect and
an approach for assessing its durational significance.
Although Akorn did adopt much of the reasoning in IBP, Inc. v. Tyson Foods, Inc., Vice Chancellor Lasster did
specifically reject the concept that an MAE provision should be interpreted as a back-stop for unknown events,
concluding that if the parties had desired to exclude items known or forseeable to the Buyer they could have
expressly provided for such an exception in the merger agreement. While only time will tell whether the
holding in Akorn will be followed by other courts, the Authors would suggest that practitioners representing
Sellers counsel their clients that there can be no assurance that known or forseeable events will not be taken into
account in MAE determinations unless such treatment is expressly provided for in the MAE definition.
[10]-Litigation
The representation governing the absence of litigation can be drafted as either an informational or a judgmental
type of representation. Occasionally both kinds of representations will be included in the same agreement. The
determination of which is appropriate will depend on the amount and complexity of the litigation, the business
deal as to risk allocation and the extent of and time allotted for the Buyer's due diligence investigation.
138.1 See Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL (Del. Ch. 0ct. 1, 2018).
Page 776 of 901
The "informational" approach would be to have the Company state that, except as disclosed on the disclosure
schedule, "there is no litigation pending against it." In effect, the Company warrants that it has delivered a list
of all litigation to the Buyer, but makes no representations as to how any of the disclosed lawsuits will come
out, or the effect on the Company of losing one or more of them. 139 The onus is on the Buyer to get comfortable
with the risks inherent in these suits. This can be a fairly attractive approach for the Seller if it can be assured
that nothing will be omitted from the disclosure schedule. 140 For the Buyer to even consider accepting this type
of representation without more, it has to be very comfortable about its due diligence investigation (or not have
the leverage to negotiate a better position). If there are any specific lawsuits where the Buyer is concerned about
the outcome, either from a closing condition or an ultimate liability perspective, they will have to be dealt with
specifically.
The other type of litigation representation that one often sees is to the effect that, except as set forth on the
disclosure schedule, "there is no pending litigation against the Company that (is reasonably likely to/in the
Company's reasonable judgment is likely to/will) have a material adverse effect on the Company." This clearly
takes much, but not all, of the responsibility for getting comfortable with the outstanding lawsuits off the
Buyer's shoulders and puts it onto the Company's (or, in the context of indemnification, on the Seller's). If a
non-scheduled litigation proves to have a material adverse effect it will, subject to certain obvious caveats, 141
be the Seller's problem, not the buyer's. One variation of this approach, which in many ways is in between these
two types of representations, it to represent as to the absence of litigation "which in many ways is in between
these two types of representations, is to represent as to the absence of litigation "which if adversely decided"
would have a material adverse effect on the Company. Having said this, the determination of whether a
particular piece of litigation is "likely to have" or "reasonably likely to have" 142 is not necessarily one that is
particularly Buyer favorable, particularly if it has the burden of proof. 143 Any such analysis, at least if done for
purposes of determining whether a closing condition (i.e., the bringdown) has been satisfied, will involve a
significant amount of speculation as to what is likely to happen in the future. 144
139 Whether this version of the representation is brought down to closing, or whether it speaks only as of the date of the agreement, is an
important question for both the Buyer and the Seller. Bringing it down to closing creates a problem for the Seller: literally, even a completely
frivolous lawsuit brought during the post-signing, pre-closing period will give the Buyer the right to refuse to close. Conversely, limiting the
representation to the date of the agreement exposes the Buyer to the risk of a serious post-signing litigation (but presumably not imminent
enough in the timing or certainty of its outcome to trigger a "no material adverse change" representation or condition).
140 The Seller will be helped if the representation is limited (in the case of lawsuits seeking dollar damages and which will not otherwise
affect the Company or its business) to those where the damages requested is below a specified, negotiated dollar amount.
141 The Buyer must learn that the representation was untrue prior to closing or prior to its indemnification right lapsing. It will not do the
Buyer any good to have been able, through the use of the bringdown condition to walk from the deal if it does not become aware of this until
after the closing. Similarly, finding out the representation was untrue will not allow the Buyer to recover damages (absent fraud) if the
representations do not survive the closing and there is no indemnification provided for in the agreement.
In addition, the standard used will affect the Buyer's rights (although this is truer for purposes of post-closing indemnification than for closing
obligations). Whether the representation was actually untrue may depend as much on whether it spoke in terms of "will have" or "in the
Company's reasonable judgment is likely to have" as it does on the question of whether losing the litigation had a material adverse effect on
the Company.
142 Given the time period of most litigation, it will normally be highly unlikely that the litigation would be concluded before closing and,
therefore, formulations of "have had" a material adverse effect will be of little use.
143 See N. 132 supra and accompanying text. See also, Frontier Oil Corp. v. Holly Corp., 2005 WL 1039027 at *34 (Del. Ch. April 29, 2005).
144 See, e.g., Frontier Oil Corp. v. Holly Corp., 2005 WL 1039027 at *35-*36 (Del. Ch. April 29, 2005), where the court analyzed whether a
toxic tort lawsuit filed against one party to a merger rendered false a representation that in effect stated that the litigation would not have a
material adverse effect (as defined) and would not reasonably be expected to have a material adverse effect. The court, in reaching the
conclusion that the party for whose benefit the representation was made had failed to show that the representation was false (i.e., failed to
show that the litigation was reasonably likely to have a material adverse effect), appeared to require the party to show that it was reasonably
Page 777 of 901
A number of subsidiary issues come up in the negotiation of this representation, the relevance of which will
vary greatly from case to case, depending in large part upon which type of representation is involved: will the
Buyer's due diligence investigation result in the loss of the Company's attorney-client privilege in connection
with any particular litigation? Should threatened litigation or governmental investigations be included and, if
so, should there be a knowledge qualification with respect thereto? Should the representation cover whether
there is the basis for any litigation not yet asserted and, if so, is there any way to avoid creating a road map for a
future plaintiff? What is the effect of any insurance? 145 What is the effect of reserves having been taken in prior
financial periods? 146
[11]-Compliance with Law: Environmental Matters

Companies are often asked to represent that they have operated their businesses in compliance with law. In the
Authors' experience, the Buyer's interest in using this representation to elicit disclosure from the Seller, as
opposed to solely allocating risk, is greater than with some other representations and warranties, owing to the
simple fact that some instances of pre-Closing non-compliance may have ramifications for the ongoing business
which are not easily or adequately addressed by post-Closing indemnification. The representation also provides
comfort that the Company has all necessary permits to operate its business and that it is not in violation of any
injunctions or orders. The representation is frequently qualified by materiality; a knowledge qualification,
however, is more unusual. 146.1 The precise language is, as always, important, however. A representation that
the Company is conducting its business in compliance with applicable laws is not the same representation as
one that states that the Company is conducting, and has in the past always conducted, its business in accordance
with applicable law. 147 Companies sometimes seek to limit how "far back" the representation goes, for
example, how many years must the Company have been operated in accordance with applicable law? 148
Companies may also seek to limit the ambit of the representation so as not to cover evidence of potential non-
likely that the other party would lose (on the merits) the toxic tort case and that the damages would be such as to result in a material adverse
effect. While it can be understood how, given the language of the contract, the court reached this result, the practical consequence is to place
an almost impossible burden on the party alleging breach unless the litigation in question is likely to be concluded (at least at the trial or
appellate level where it was at that time) prior to the scheduled closing. Arguably, in Frontier the party seeking to assert the inaccuracy of the
representation would have to outline to the court what the toxic tort trial was reasonably likely to show and convince the court that the jury
award that was reasonably likely to occur would be high enough to constitute a material adverse effect. (Such a trial, including discovery,
could take years to conclude.) It remains to be seen whether courts going forward will apply such a high standard.
145 The Company's existing insurance with respect to pre-closing periods comes up in a variety of contexts. The first question will be whether
such insurance is an asset the Buyer will be acquiring; this issue can become greatly complicated if the Company is a subsidiary or division of
a larger company which extended its "umbrella" coverage to the Company. Another typical concern relates to the nature and extent of the
insurance, including an examination as to whether it is of the "claims made" or "occurrence" variety and whether any gaps in coverage will
therefore occur. In addition, in the indemnification context, will the amount the Seller needs to pay be decreased by any insurance benefit
received by the Buyer? See § 15.03[2] infra.
146 Note the interrelationship in this context of the litigation representation and the financial statement representation. See § 11.04[8] supra.
For example, :The 2019 ABA Private Target Mergers and Acquisitions Deal Points Study" indicated that "knowledge" qualified
146.1
compliance with law representations were exceedingly rare, having been included in only 2% of the studied transactions.
147 See Merrill Lynch & Co. v. Allegheny Energy, Inc., 2003 WL 22795650 (S.D.N.Y. Nov. 25, 2003), discussed in Annual Survey of
Judicial Developments Pertaining to Mergers and Acquisitions of the Negotiated Acquisitions Committee of the Section of Business Law of
the American Bar Ass'n, 59 Bus. Law. 1521, 1528-1529 (2004). Buyer's concern about the past is well placed. After all, the historical
financial statements reflect the past conduct of the business. It is no comfort to the Buyer to find out later that the Company stopped violating
laws the week before the acquisition agreement had been signed, but that the three prior years of net income would have been reduced by
75% if the Company had not been conducting its business in violation of law.
148 At least in those cases where there is a materiality limitation, some Buyers refuse to allow such a limitation. After all, they argue, even if
it is unlikely that an old violation of law would have a material adverse effect on the Company today or in the future, the Buyer wants to be
protected.
Page 778 of 901
compliance with law, such as notices of investigations or notices of violations, although in the Authors'
experience Companies often have only mixed success in so limiting the representation. 148.1 With one major
exception, the representation rarely causes much argument, absent a specific concern on the part of the
Buyer. 149
The one exception deals with environmental matters. The risks and costs of failing to comply with
environmental laws have become tremendous in recent years. Indeed, it is not uncommon for buyers to
determine not to proceed with transactions which they otherwise desire solely because of an unwillingness to
take such risks. Environmental representations and warranties are often of vital importance in acquisition
agreements, not only because they help define the characteristics and hence the value of property being
transferred as part of the transaction, but also because of the potentially open-ended nature of environmental
liabilities, many of which may not be manifest even on an inspection of the property. In addition, in a leveraged
acquisition, secured lenders to the Buyer have their own specific concerns. 150
From the perspective of the Buyer, environmental representations of the Company should ideally include the
following:
(1) The Company's business has all of the required environmental permits and authorizations.
(2) The business is in compliance with all applicable environmental laws, permits, and authorizations.
(3) There are no environmental claims pending or threatened against the business.
(4) There are no actions, conditions, or circumstances pertaining to the business that may give rise to any
future environmental claims.
(5) All locations on which the business may have conducted certain environmentally risky activities have
been identified.
(6) No consents or approvals for transfer of environmental permits or the business itself are required, or
such consents and approvals can be obtained expeditiously without material cost.151
More than in most areas, the issue of qualifications based on the Company's knowledge is critical; the inclusion
or deletion of such a limitation may have a very significant impact on the Buyer's indemnification rights. 152 The
Buyer should try, if there is to be a knowledge qualification, to include the appropriate plant personnel in the
group of people whose knowledge is relevant. 153 The Buyer may also want to reserve the right to conduct its
own on-site environmental review, retaining the right to not close if it discovers a breach of an environmental
148.1For example, "The 2019 ABA Private Target Mergers and Acquisitions Deal Points Study" indicated that, while the compliance with law
representations in 77% of the studied transactions covered notices of violations, only 19% of the studied transactions included compliance
with law representations that covered notices of investigations. This dichotomy may in part be explained by the fact that representations
regarding Litigation may be drafted broadly so as to pick up governmental investigations, thus partially obviating the need to cover the topic
in the compliance with law representation.
149 See, however, § 11.04[16][j] infra for a discussion of an increasingly troublesome issue in the area of federal labor law.
150See: the Comprehensive Environmental Response, Compensation and Liability Act of 1980, 42 U.S.C. §§ 9601-9657; § 20.04 N. 6 infra.
The lender's concern relates primarily to being held responsible for so-called "Superfund" liability as an "owner or operator" of the facility.
151 The above representations may be covered in part by other representations in the agreement. See, for example: § 11.04[7] supra
(transaction not in violation of any law), § 11.04[8] supra (undisclosed liabilities), § 11.04[10] supra (litigation) and the no violation of law
provision discussed in the text above. This duplication can be forgiven. The risks and consequences to the Buyer of missing something in the
environmental area is so great that the careful Buyer should be allowed both "belt" and "suspenders."
152 See § 11.02 supra.
153 Id.
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representation. 154 If a review is to be conducted prior to closing, the agreement should assure the purchaser
access to the plant site, records and personnel. 155
The Buyer will usually demand an absolute representation that the Company has all required environmental
permits and authorization, which should be identified in a separate disclosure schedule. There are also likely to
be important determinations of nonapplicability of certain environmental laws that are not permits in the
traditional sense. Two examples include determinations under state or federal laws requiring environmental
impact assessments of new projects, and determinations of nonjurisdiction under state and federal laws relating
to wetlands. The Buyer typically would want environmental representations to address such issues. 156
In addition, the Buyer will usually insist upon a representation that the Company's business is in compliance
with environmental laws. A careful Buyer may also wish to conduct its own investigation into the matter.
One issue that often arises with respect to this representation is the definition of "environmental laws." In order
to provide the broadest coverage, the Buyer tends to define this to include all federal, state and local, and even
foreign laws and regulations as in effect from time to time relating to pollution, the protection of human health
and safety or the environment, including laws which relate to or which impose liability in connection with any
conceivable handling, manufacturing, processing, distribution, use, treatment, storage, release, transport,
discharge, spillage, or migration of hazardous materials. "Hazardous materials" is often defined expansively as
well to include hazardous substances, toxic substances, wastes, contaminants, petroleum and petroleum
products. The term "hazardous materials" can even be expanded to include a generic term like "chemicals,"
since "chemicals" would be included in the representation only to the extent that they are subject to regulation
by "environmental laws." 157 The Buyer sometimes also insists that the company represent that there are no
circumstances that may prevent or interfere with full compliance, whether at the time of the agreement or in the
future. As a practical matter, such a representation, if given, will usually be knowledge-based.
Next, the Buyer will often ask the Company to state that there are no pending or, to the Company's knowledge,
threatened environmental claims. The term "environmental claim" is likely to be defined more broadly than
"case" or "proceeding." It will often include notice, by any person or entity, alleging potential liability of any
kind under environmental laws. This includes potential liability as a result of the presence or release into the
environment of hazardous materials at any location (whether or not owned by the business), as well as potential
liability relating to circumstances that could form the basis of an alleged violation of an environmental law. A
significant issue for the buyer is the potential liability of the Company relating to the business's predecessors
and subsidiaries, to properties it no longer owns, to divisions that have been spun off and to previous
agreements to indemnify or assume environmental liabilities. Consequently, the Company's representation is
154 Surprisingly, many businesses still do not give environmental matters priority consideration. Discussions with plant personnel may reveal
that there are unauthorized hazardous waste storage areas, wastewater outfalls without permits, and similar problem areas on-site.
A Buyer's desire to conduct this kind of investigation (often referred to as "Phase II" environmental due diligence which includes taking core
samples) is serious for a Seller and may make such Buyer's bid much less attractive than other bidders in an auction setting which do not
request such rights. The Seller will also become concerned about the effect of its knowledge of any problems which are discovered in the
event the transaction does not close.
155 The environmental use type of "access and review" goes significantly beyond the normal "access" provision since the Buyer may well
want the ability to conduct an environmental audit which may include the taking of core samples, etc. See § 8.04[1] supra. The issues
surrounding these audits are becoming increasingly complex and sometimes the negotiation of the agreement governing the actions of the
Buyer's environmental consultant can itself become an intense negotiation, particularly over the issue of responsibility for any damage which
results from the taking of core samples etc.
156 This will be particularly true in the situation where the acquisition involves land held for development, or where the environmental
representations are part of a lender's credit agreement to finance construction.
157On occasion, the Company will also be asked to represent that it has not received any communication alleging that the business is not in
compliance with environmental laws, permits and authorizations. But see, N. 24 supra and accompanying text.
Page 780 of 901
often requested in a form that includes any person or entity whose liability for any environmental claim the
Company has or may have retained (or assumed), either contractually or by operations of law. 158
Statutes like the federal Superfund law, 159 and similar state laws, which are primary sources of environmental
liability, do not require any "violation," they impose strict, retroactive liability. Hence, the careful Buyer might
request a representation that there are not past or present actions, activities, circumstances or conditions that
could form the basis of any environmental claim against the Company (or against any person or entity for
whose environmental liability the Company may be liable).
In addition, the acquisition agreement should schedule complete inventories of:
(1) all underground tanks on property owned, leased, or operated by the business;
(2) all structures owned or leased that contain asbestos;
(3) any polychlorinated biphenyls ("PCBs") used or stored on any owned or leased property; and
(4) all on-site and off-site locations where the business has stored, disposed of (including spilled and
abandoned), or arranged for the disposal of hazardous materials.
From the Company's point of view, materiality and knowledge qualifications are generally quite important in
the area of environmental representations. In addition, the Company will often try to limit liability to that
resulting from the Seller's active violations of the law, eliminating any responsibility based on actions of third
persons or on theories of strict liability. Other areas where the Company would try to limit the scope of
representation is in the definition of environmental laws and hazardous materials, limiting it to include only
specifically referenced federal and state laws that list hazardous materials. Limiting the definition of hazardous
materials to listed materials will help the Company avoid liability for releases of materials which may later be
determined to be hazardous (for example, electromagnetic radiation). A final issue of some importance is
whether the Company will be able to get the Buyer to agree to exclude personal injury claims from the
definition of "environmental claims."
[12]-Title to Assets
Acquisition agreements often contain representations that the Company has "good and marketable 160 title" to its
assets (or to the assets which it purports to own) free and clear of all liens, title defects and encumbrances. The
Buyer may also ask the Company to represent that title is "insurable." 161 Exceptions are almost invariably
needed to these representations. Such exceptions might include scheduled liens, liens which are disclosed in the
notes to the Company's balance sheet, and liens and title defects which do not materially detract from the value
158 A related issue, which is not often considered in connection with representations, relates to contractual releases. Has the Company
retained valuable rights of indemnification with respect to environmental matters from a third party under a previous agreement? Are these
rights assignable to the Buyer in an assets or forward merger transaction? Will they terminate upon a change of control of the Company? If
the Company has released a third party, what is the scope of the release?
159 42 U.S.C. §§ 9607et seq.

160 Marketable title is generally title which is free from encumbrances and any reasonable doubt as to its validity, and which is such title as a
reasonably intelligent person, who is well informed as to facts and their legal consequences and is ready and willing to perform his contract,
would be willing to accept in the exercise of ordinary business prudence. Technically, title may be unmarketable because of any encumbrance
on the property that an ordinarily prudent person who has knowledge of the facts and legal questions involved would not accept in the
ordinary course of business (even if favorable to the particular purchaser involved) regardless of how ancient the encumbrances may be. To
simplify the determination of whether title is marketable, many states have adopted marketable title statutes which limit the number of years
(for example, forty years) of title history which must be searched for a determination of marketability.
161 Insurable title is title to real property which can be insured against loss or damage resulting from defects or failure of title. "Insurable" title
is a much more lenient standard than "marketable" title because many encumbrances against real property do not affect the validity of title,
and title insurance companies will often insure a title which is not marketable. In transactions in which real estate is particularly important-for
example, the sale of a motel chain-it may make sense for the Buyer to actually obtain title reports from a title insurance company and even,
perhaps, title insurance. The cost of such items will of course be the subject of negotiation.
Page 781 of 901
of, or interfere with the use of, the property. Another common exception is liens for taxes not yet due (or which
are being contested in good faith, and in respect of which adequate reserves have been established). The Buyer
may also want lists of real property assets owned by the Company. If the transaction is a purchase of assets, the
representation will also generally cover the title that the Buyer will obtain to such assets.
This is a typical place for inclusion of other representations related to the status or condition of assets, even
though such matters do not technically involve title. Examples include representations that the assets being
conveyed are in good condition or good working order, ordinary wear and tear excepted, or that such assets
constitute all of the assets used or necessary in the conduct of the business being conveyed.
[13]-Taxes
As a threshold matter, it is important to understand that the tax representations will to a great extent be a
reflection of the overall "business deal" and the relative strengths of the parties in negotiating the transaction. In
part, they can be viewed as adjuncts to the financial statement representation that all liabilities required by
GAAP to be reflected on the balance sheet are so reflected and to the tax indemnities often found in acquisition
agreements (except those relating to public companies). Notwithstanding this, they are important from the
Buyer's perspective for ferreting out any tax skeletons in the Company's closet. Although, in a typical
acquisition, the Buyer will rely greatly on the due diligence examination taking place between execution of the
acquisition agreement and the closing, such examination is not likely to uncover all the various tax problems
that may be lurking within the Company. The tax representations therefore take on added importance. Prior to
drafting and negotiating the tax representation, the Buyer should determine at the outset:
(1) whether the tax representations made in the agreement will survive the closing (and, if so, for what
length of time); and
(2) the specific types of tax problems that might not be picked up in a due diligence examination but
which, if they were to surface after the closing, would be important enough to justify the Buyer's
questioning the wisdom of having consummated the deal (or perhaps, having done so without
indemnification of such problems).
As an initial matter, the Buyer will want to get a general representation of fairly broad application regarding the
tax history of the Company. For example, the Company might be asked to represent that all "tax returns" 162
required to be filed with respect to the Company and its affiliates, or any of their income, properties or
operations, are in all respects "true, complete and correct and have been duly filed in a timely manner." In
addition, it should state that all "taxes" attributable to the Company and its affiliates that are or were due and
payable (without regard to whether such taxes have been assessed) have been paid. The aggressive Buyer will
often ask for a representation that the Company has no material liability for taxes other than in respect of its
current taxable year, and that adequate provisions for such taxes are reflected on the Company's financial
statements, in conformity with generally accepted accounting principles.
The last representation is relatively favorable to the Buyer. An alternative representation proposed by the
Company might provide that "the Company (and its subsidiaries) have filed all material tax returns required to
filed and paid all taxes shown to be due on such returns." Whereas the first representation described above
states unambiguously that the Company has no unpaid tax liabilities to date, the alternative representation
merely represents that the Company has filed and paid whatever taxes are shown on the tax returns, and would
not be breached if the Buyer discovered that the returns were inaccurate and deficiencies were ultimately
assessed. Even this relatively weak alternative representation could be improved considerably, however, if it
contained an additional statement that the financial statements of the Company provide adequate accruals and
reserves for taxes.
162 The terms "taxes" and "tax returns" are typically defined quite broadly and generally include, respectively, any "taxes, charges, fees,
levies or other assessments of any kind whatsoever" (with examples extensively listed), and all "reports or returns" relating to such taxes.
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The first representation also arguably covers more than just the historic tax liabilities of the Company. Because
the representation includes separate statements that the tax returns were "complete" and "correct" when filed, it
may encompass such indirect matters as net operating and capital loss carryovers, adjusted tax basis of assets,
depreciation and amortization schedules and numerous other factual matters that do not necessarily result in the
imposition of deficiencies against the Company for prior taxable periods. Such matters could nevertheless be
relevant to a determination of the Company's substantive tax liability in periods ending after the closing, and
any increase in future tax liabilities occasioned by the inaccuracy of such matters could give rise to an
indemnification claim for damages against the Seller if such form of representation had been used. 163 If,
however, net operating losses, and other tax attributes constitute a material element of the value of the target,
the Buyer would be well advised to insist on a specific representation as to these issues.
Other provisions of the acquisition agreement 164 will be necessary to address the allocation of both substantive
tax liability and responsibility for filing returns in respect of pre-closing and post-closing periods.
Another important piece of information regarding the Company's "tax history" involves audits. The Company is
often asked to represent that, except as set forth in the disclosure schedule (which should set forth the type of
return being excepted, the date filed and the date of expiration of the statute of limitations), the statute of
limitations for the assessment of federal, state, local and foreign income taxes has expired for all consolidated
federal income tax returns of the consolidated groups which includes the Company, or that the consolidated
federal income tax returns of the consolidated group that includes the Company have been examined by the
Internal Revenue Services for all years through a specified date. This representation usually also states that
there is no claim or assessment pending 165 against the Company or any of its affiliates for any alleged
deficiency in taxes, that there is no audit or investigation currently being conducted that could cause the
Company or any of its affiliates to be liable for any taxes and that there are no agreements in effect to extend
the period of limitations for the assessment or collection of any tax for which the Company or any of its
affiliates may be liable. Although this representation may appear to be less significant, in light of the extensive
filing and payment representation described above, it is useful in eliciting information regarding disputes and
contests and highlights which taxable years are still open to audit. 166 Possibly of even greater importance,
however, is that the information elicited in response to this representation will alert the Buyer to tax issues that
may impact the future tax liabilities of the target against which no indemnification will generally exist.
A broad tax representation should include a provision on withholding in which it is represented that the
Company and its affiliates have complied with all tax withholding provisions of applicable federal, state, local
and foreign laws and have paid over to the proper governmental authorities all amounts required to be so
withheld and paid over. Notwithstanding the arguable overlap of this representation with the more general tax
representation set forth above, the withholding issue deserves special attention, since deposits for withholding
may be made after the closing for wages paid and other payments made on or before the closing date. The
responsibility for such compliance may ultimately reside with the Buyer, who will therefore have an interest in
identifying and qualifying, to the extent possible, such future liabilities.
163 It should be noted that the tax attributes of the Company become far less important to the Buyer if the transaction is structured as an
acquisition of assets rather than stock, or if a "deemed asset sale" joint election is made under Section 338(h)(10) of the Internal Revenue
Code of 1986, I.R.C. § 338(h)(10) (the "Code" or "I.R.C."). In such case, the Buyer would only be concerned about the Company's "tax
history" if it had reason to believe that it might be liable for the Company's tax problems under a transferee liability theory (for example, if
the Company, in selling its assets, failed to comply with the applicable state bulk transfer laws). See § 19.02 infra.
164 See § 19.02[4] infra.

165 The representation may also cover "to the best of the knowledge of the Company," threatened claims, assessments or investigations.
166 This information is also necessary to assess properly the exposure of the Company to claims for delinquent taxes, and should confirm the
findings of the due diligence examination with respect to representations that are to survive the closing.
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A representation is sometimes included regarding the filing obligations of the Company in various states, and a
statement regarding whether the Company computes its state income taxes on an apportionment of business
income under a unitary or combined method. This information is necessary in order to deal with the closing of
the tax year for state tax purposes, and to provide for the responsibility and cooperation required to prepare and
file state tax returns for tax years that "straddle" the closing date or involve some form of combined or unitary
reporting.
Finally, the Buyer should also consider the need to obtain representations regarding the following additional
items:
(1) tax elections in effect which would affect the Company; 167
(2) the Company's allocable share of overall foreign losses;
(3) the potential liability for "recapture" of ordinary losses; 168
(4) the extent to which the Company holds "tax-exempt use property" within the meaning of Section 168(h)
of the Internal Revenue Code; 169
(5) whether the Company is a partner in any partnerships; 170 and
(6) whether the Company is a party in any agreement that would require it to make any "excess parachute
payment." 171
[14]-Employee Benefits Plans

The Buyer will typically require a representation that all of the various types of employee benefit plans or
arrangements which the Seller of any "ERISA affiliate" of the Company172 is contributing to, or maintaining
for, its current or former employees are listed on a schedule to the purchase agreement. The purpose of this list
is to aid and enhance the due diligence process. Further, even if the Buyer were not assuming or accepting a
transfer of assets and liabilities from any plan, if it is employing the purchased units' employees after the
purchase, the Buyer will want to know the overall existing benefit scheme so it can determine its future benefit
scheme in view of the employees' current expectations. 173 The Company will ordinarily have no objections to
167 The Company should also agree not to revoke any such elections, or make any new elections, without the consent of the Buyer.
168 I.R.C. § 1231.
169 I.R.C. § 168(h).

170 Items of income and gain of the partnership generally are not reportable until the taxable year of the partner which includes the last day of
the partnership's taxable year. Thus, partnership income earned prior to the closing date may be includable in post-closing periods. Therefore,
the Buyer should require the Seller to pay its share of the tax liabilities attributable to such income, to the extent the Seller benefited from
such income either through distributions or favorable purchase price adjustments.
171 I.R.C. § 280G.
172 "ERISA affiliates" are usually defined by reference to Section 4001(b) of the Employee Retirement Income Security Act of 1974, as
amended, 29 U.S.C. §§ 1301(b)(1)et seq. ("ERISA"), which generally uses the concept of "single employer" for purposes of imposing ERISA
"Title IV liability" (also commonly referred to as an "ERISA controlled group"). The purpose of the inclusion of plans of ERISA affiliates is
to ensure an adequate identification of all plans that might give rise to ERISA Title IV liability. "Title IV liability" is the name commonly
given to liability imposed by the Pension Benefit Guaranty Corporation ("PBGC") on an ERISA controlled group for unfunded pension
liabilities. This liability is joint and several and generally may be imposed on any member of an ERISA controlled group.
173 If the acquisition is a stock purchase, the Buyer will generally by operation of law assume the plans maintained by the subsidiary being
sold, and the Buyer will want to ascertain the subsidiary's ability to cut back or eliminate any such plans. In an asset purchase, the Buyer will
generally be able to avoid liability by excluding any such plans from the liabilities being assumed, although cases have resulted in Title IV
liability for asset purchases which did not expressly assume such liability. See, e.g.:
Page 784 of 901
this representation, although it may prefer that the list be limited to material plans (the threshold for materiality
may be negotiated) or to plans of the Company (thereby eliminating the need to list all plans of all ERISA
affiliates; if the Buyer were to agree to this limitation, it would likely insist that representations regarding
"control group" liability described below extend to these nonlisted plans).
Next, the Buyer will typically require the Company to represent that pertinent documents relating to each of the
listed plans have been delivered to the Buyer in the course of the Buyer's due diligence. Documents so
requested include:
(1) a copy of the plan and all amendments;
(2) annual reports and actuarial reports most recently filed with respect to the plan (for example, for the
preceding two years)-these documents provide financial information and actuarial assumptions that permit
the Buyer to better ascertain the financial condition of the plan;
(3) summary plan descriptions and other communications to employees relating to the plans (such
communications could override inconsistent plan provisions); 174
(4) related trust or third-party funding vehicle documents, if applicable, and related financial statements
(also relevant to ascertain a plan's financial condition); and
(5) letters from the Internal Revenue Service, if applicable, confirming the tax-exempt status of the plan.
The Buyer 175 would still require the above listed information if, for example, it were accepting a transfer of
assets and liabilities into a plan of the Buyer (if there is an overfunding, all or a portion of it can be transferred
in this manner; the amount of overfunding and the tax qualified status of the Seller's plan would be relevant
information to the Buyer). The Seller might object to providing this information in respect of plans that are not
being assumed by the Buyer, claiming that such information would be irrelevant.
The Buyer will also commonly seek representations regarding Title IV liability. These would include
representations that:
(1) no unsatisfied Title IV liability has been incurred by the Company or any ERISA affiliate, and that
there is no material risk that any such liability will be incurred (other than for premiums due the PBGC,
though the Buyer will seek a representation that PBGC premiums have been paid when due);
(2) the PBGC has not instituted termination proceedings for any plan, and no material risk of such
proceedings being instituted exits; and
(3) the plans are adequately funded to meet accrued benefit obligations.
As noted above, the Company (or its subsidiaries) may be jointly and severally liable for obligations of an
ERISA affiliate that terminated an underfunded plan, and therefore this potential liability may be incurred by
the Buyer. These representations generally would not be necessary where assets are being purchased and no
liabilities relating to these plans are being assumed. 176 In regard to the funding representation, the Buyer will
need to ascertain the actuarial basis for the representation and to determine the appropriateness of the
assumptions underlying this basis (for example, if pension assets are assumed to return 10%, the plan's funded
status will be adversely affected if future returns are actually lower). The Company may want to limit these
Third Circuit: Central Pennsylvania Teamsters Pension Fund v. Bear Distributing Co., 2009 WL 812224 (E.D. Pa. March 26, 2009) (an asset
purchaser was liable for the seller's failure to pay withdrawal liability to a multiemployer pension plan).
Seventh Circuit:Upholsterers' International Union Pension Fund v. Artistic Furniture of Pontiac, 920 F.2d 1323 ( 7th Cir. 1990) (asset
purchaser held liable for past due contributions to a multiemployer pension plan).
See also, § 19.03 infra.
174 See, e.g., Heidgerd v. Olin Corp., 906 F.2d 903 ( 2d Cir. 1990).
175 See § 19.02 infra.
176 But note the case law to the contrary cited in N. 173 supra.
Page 785 of 901
representations with a materiality or knowledge qualification; the Buyer's response to such a limit will depend
on its aversion to risk and on the results of its due diligence review.
The Buyer will often also seek a representation to the effect that the Company, its ERISA affiliates, and the
plans subject to ERISA (including such plans' trustees, administrators and other fiduciaries) have not engaged
in a "prohibited transaction." This is the common term for a broad range of behavior proscribing self-dealing
activities involving benefit plans. 177 Liability for these transactions is joint and several (as with Title IV
liability) and therefore may attach to the Buyer in a stock acquisition or where plans are assumed by the Buyer.
If the Buyer is not assuming any benefit plan liabilities in an asset purchase, this representation may not be
appropriate. Again, the Seller may want to limit these representations with a materiality or knowledge
qualification.
Another representation which the Buyer will commonly seek is one to the effect that all payments required to
be made to benefit plans have been made, and that no "accumulated funding deficiency" 178 has been incurred.
The purpose of this representation is to ensure that there is no liability with respect to actual contributions to the
plans. The appropriateness of this representation depends, as before, on whether the Buyer is purchasing assets
or stock, and whether liability for the plans is being assumed.
Another representation which the Buyer will often require involves "multi-employer pension plans." 179 These
plans are maintained pursuant to collective bargaining agreements and involve contributions made by more than
one employer. The Buyer will want the Company to represent either that no such plans exist or that:
(1) no withdrawal events triggering liability have occurred (and no material risk of such events exists);
(2) no contingent liability in respect of an asset sale by the Company or one of its ERISA affiliates made in
the prior five years exists; 180
(3) there is no material risk that the plan will go into reorganization; and
(4) liability under the plan, if a withdrawal event occurred on the date of the agreement, would not exceed a
dollar amount (this dollar amount is subject to negotiation).
Again, these representations may not be appropriate where the plans are not assumed by the Buyer in an asset
purchase. The Company may desire to qualify this representation by limiting its scope to the Company's
knowledge, because the information is often best known to the plan and not to the Company. Withdrawal
liability is imposed on a joint and several basis for an ERISA controlled group, and consequently a stock
purchase or an assumption of the plan could give rise to this liability for the Buyer. A representation as to this
dollar amount will often trigger an indemnity if liability ultimately attaches and it is discovered that the dollar
amount was understated.
Next, the Buyer will often seek a representation to the effect that the Company's plans are operated and
administered in accordance with applicable law, including ERISA and the Internal Revenue Code, and that each
plan intended to be tax-qualified under the Code 181 is so qualified. The Company may want to limit this
177 See generally: ERISA § 406, 29 U.S.C. § 1106; I.R.C. § 4975.
178An "accumulated funding deficiency" is the common term for accrued liabilities resulting from a failure to adequately fund certain benefit
plans. See I.R.C. § 412.
179 See ERISA § 3(37), 29 U.S.C. § 1002(37).
180 ERISA imposes such liability, on a joint and several basis, for an ERISA controlled group member that sells assets resulting in a
withdrawal event for a plan in certain situations, unless, among other things, (1) the purchaser assumes an obligation to contribute to the plan,
(2) the purchaser provide a bond from an acceptable surety equal to the greater of (a) the Seller's average contributions over the last three
complete years or (b) the Seller's required contribution for the last full year prior to the sale, and (3) the Seller remain secondary liable if the
purchaser incurs a withdrawal liability during the succeeding five plan years.
181I.R.C. § 401(a) provides the statutory requirements for tax qualification of a retirement plan, which permits a deduction to the sponsor for
contributions made thereto.
Page 786 of 901
representation to material or best knowledge, or, if an IRS letter regarding tax qualification has been obtained,
may want to simply represent to that effect. The Buyer will typically concede to a representation limited to
compliance "in all material respects" for general ERISA and applicable law compliance because Sellers
generally will not want to risk the possible inaccuracy of a representation as to "strict compliance" with such a
large body of rules and regulations. The Buyer will not require this representation if liability for the plans is not
being assumed.
Additionally, the Buyer will seek a representation that the Company does not provide medical benefits to its
employees beyond retirement. Liability for these benefits typically grows much faster than inflation since such
liabilities historically have been expensed on a "pay as you go" basis, and thus the ultimate liability may be
significantly understated. 182 If the Company is unable to make this representation because it provides such
benefits, the Buyer may request all historical cost information and ascertain the ability of the Company to cut
back or eliminate these benefits.
The Buyer will typically require the Seller to represent that there are no pending or anticipated claims involving
plans, other than routine claims for benefits. The Buyer seeks such a representation to protect against
potentially large liabilities involving the Seller's plans-for example, a suit alleging breach of fiduciary
responsibility and seeking high damages. The Seller will typically ask that this representation be limited to
material claims.
The Buyer will also typically seek a representation that the consummation of the transaction (either alone or in
conjunction with a termination of employment) will not trigger severance payments or accelerate the vesting of
equity or other awards to employees of the Seller (or, if there is the possibility that such benefits will be
triggered, that the potential costs associated with such benefits be disclosed, including, if applicable, the
possible costs of Section 280G gross-up payments-see below). Such a representation assures the Buyer that the
transaction will not result in hidden costs due to such arrangements-for example, in the form of expensive
"golden parachutes" to executive officers-or, at a minimum, that the potential costs are disclosed. In a similar
vein, the Buyer may also seek a representation that no amounts payable under the Seller's plans in connection
with the transaction will be nondeductible under Section 280G of the Code or subject to an excise tax under
Section 4999 of the Code. These representations enable the Buyer to take into account the potential cost of lost
deductions for parachute or change in control payments that exceed the limits imposed by Section 280G. The
Section 4999 excise tax, assessed against certain employees receiving payments exceeding Section 280G limits,
would cause the Buyer to incur the cost of "grossing up" the employee for the excise tax if gross-ups are
provided for in a relevant agreement or plan. In the context of an asset sale or the sale of a subsidiary, these
Section representations may be less important since, unless the transaction represents the sale of a significant
portion of the Seller's consolidated operations, it will not likely constitute a transaction encompassed by Section
280G. 182.1
Finally, the Buyer commonly seeks a representation that there are no limitations (except as required by law) on
the Seller's (and eventually, the Buyer's) ability to amend or terminate the Seller's plans. Such a representation
provides assurance to the Buyer that it will have sufficient flexibility on a going-forward basis with respect to
the types of benefits it can provide, without being limited by contractual plan provisions.
[15]-No Misleading Statements; Nonreliance Clauses

Buyers often ask Companies to include a representation to the effect that the acquisition agreement does not
"contain any untrue statement of a material fact or omit to state any material fact necessary to make the
statements contained in the acquisition agreement not misleading." Many times the representation will be
182Beginning in 1993, FASB (Final Accounting Standards Board) rules require companies to reflect these long-term costs on their balance
sheets.
182.1 See § 22.07[2] infra for a further discussion of Section 280G.

Page 787 of 901
drafted to include not only the agreement itself but also all documents and writings delivered in connection
therewith. The Buyer also, on occasion, asks the Company to represent that it has disclosed all information
material to an investment in the business to the Buyer. This representation, often referred to as a "Full
Disclosure" representation, which should be viewed as highly Buyer-friendly (as discussed below), is relatively
rare in practice, particularly in the absence of the representations relating to untrue statements of material facts
and omissions. 182.2 The Authors would suggest that the correlation among the representations may be explained
by the comparative strength of the Buyer parties in the transactions in which the provisions appear.
Representing the Seller, the Authors generally try to resist all of these formulations. 183 The second to the last is
arguably too broad. 184 The last is, except in very unusual circumstances, much too broad. 185 The first does not
really make a lot of sense. The representations say what they say; what does it mean for a representation to
contain a material misstatement or omission? The problems with this first formulation become even more clear
when one takes the elements of the representation one at a time. First, the circularity of the "untrue statement of
material fact" element becomes clear when one considers whether there exists a plausible scenario in which the
statements of facts within the Agreement, i.e., the representations and warranties, contain an untrue statement of
material fact but have not been breached. Putting it a different way, the "truthfulness" of the Agreement exists
only in the context of the correctness of the negotiated representations and warranties. Turning to the second
element, relating to omissions, the situation becomes even more troubling to the Seller. Take the example of a
litigation involving the Target which is discovered by the Buyer after the Closing. If the litigation is within the
ambit of the negotiated representations and warranties, it is hard to imagine how its existence could have been
omitted by the Seller without the relevant representations and warranties being breached, raising the question of
what the value of the additional "no omissions" representation is in this scenario. However, if the discovered
litigation is not within the ambit of the negotiated representations and warranties, can it properly be said to
render the representations and warranties "misleading"? While the answer would appear to be "no" as a matter
of logic, practitioners representing a Seller, familiar with the bias in the rules of contractual interpretation
against construing a provision so as to have no independent meaning, will be forgiven by the Authors for being
uneasy regarding the inclusion of the "no omissions" representation.
182.2For example, "The 2019 ABA Private Target Mergers and Acquisitions Deal Points Study" indicated that only 4% of the studied
transactions included "Full Disclosure" representations, 3% when representations relating to untrue statements of material facts and omissions
were included and 1% in the absence of such representations.
183 The representation smacks a little of the Buyer saying "I'm not very smart, protect me. I know that I've just asked for forty pages of
representations from you, but tell me that I didn't miss anything."
184For example, not every piece of paper delivered by the Company to the Buyer is material. It should not constitute a breach of the
acquisition agreement for an immaterial disclosure to be materially wrong. This problem can perhaps be solved, or at least alleviated, by
having the representation refer to the acquisition agreement and all documents delivered in connection therewith "taken together."
A key issue that is hiding below the surface here is whether the representation, if it stays in, applies to any projections delivered to the Buyer.
These representations, like many other aspects of the negotiations over the representations and warranties, are a function of the attractiveness
of the purchase price and the parties' expectations and appetites as to risk. Viewed in this light, for example, there will certainly be cases
where the Buyer will expect the Company to provide even the last two of the formulations set forth in the text.
185 It puts too much of a burden on Seller. It is as if the Buyer said: "I'm not smart enough to know what I should ask about in buying the
business. So, tell me that what I've asked about or been told about is everything." Buyers in this position should not be doing the deal. It is as
if the Buyer is getting into an area or industry of which it is totally ignorant. There are consultants available for Buyer to hire to educate them
about the industry. For specific seller-based risks, there are the detailed representations and warranties. It is quite dangerous for a Seller to
make this type of representation. See, e.g., Merrill Lynch & Co. v. Allegheny Energy, Inc., 2003 WL 22795650 (S.D.N.Y. Nov. 25, 2003),
discussed at § 15.02[4] N. 53.1 infra.
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The language of the representation closely parallels that of Rule 10b-5 186 under the Securities Exchange Act of
1934 and Section 12(2) 187 of the Securities Act of 1933. After years of conflict among the various circuits, the
Supreme Court, in Landreth Timber Co. v. Landreth, 188 rejected the "sales of business" doctrine 189 and
concluded that a sale of stock, even 100% of the stock of a company (in a single transaction), was a sale of a
security and, accordingly, subject to the antifraud provisions of the securities laws. 190
In light of this, the question arises, at least in a stock sale or merger transaction, as to why the Buyer cares about
this representation. After all, the Buyer now has its securities law remedies. What more does the representation
add?
The answer is "many things." Causes of action and remedies under the securities laws (other than against the
issuer under Section 11 of the Securities Act of 1933) 191 have many elements other than a material
misstatement or omission that must be proved, including, for example, reasonable reliance by the plaintiff, and
scienter of the defendant. 192 They are also subject to statutes of limitations that may be different from those
applicable to the indemnification provisions of the acquisition agreement. 193
From the Seller's perspective again, even without a contractual provision, the Buyer has the benefit of a Rule
10b-5 claim against the Seller, subject to proof of scienter and reasonable reliance, above and beyond all the
carefully negotiated representations and warranties. Can the Seller do anything about this? In other words, can
the acquisition agreement provide that the Buyer effectively waives these claims-for example through a
186 17 C.F.R. 240.10b-5. The Rule provides:
"It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the
mails or of any facility of any national securities exchange,
"(a) To employ any device, scheme, or artifice to defraud,
"(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made,
in the light of the circumstances under which they were made, not misleading, or
"(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in
connection with the purchase or sale of any security."
187 15 U.S.C. § 771(2). Section 12(2) provides in relevant part:
"Sec. 12. Any person who . . . (2) offers or sells a security (whether or not exempted by the provisions of Section 77c, other than
paragraph (2) of subsection (a) of said section . . . by means of a prospectus or oral communication, which includes an untrue statement
of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under
which they were made, not misleading (the purchaser not knowing of such untruth or omission), and who shall not sustain the burden of
proof that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission, shall be liable to
the person purchasing such security from him. . . ."
188 Landreth Timber Co. v. Landreth, 471 U.S. 681, 105 S.Ct. 2297, 85 L. Ed.2d 692 ( 1985).
189The proposition that the sale of stock should not be considered a "security" for the purposes of the Securities Act of 1933 and the
Securities Exchange Act of 1934, as amended, when managerial control of the business passes with such stock.
190 While it is difficult to argue with the proposition that stock is a "security," it is unfortunate that the sale of a (noncorporate) sole
proprietorship is not subject to the securities laws, whereas the sale by the sole shareholder of a corporation is; that a sale of all of a
corporation's assets and liabilities is not, while a sale of such corporation's stock is.
191 See § 5.02[1] supra.
192 See, e.g., List v. Fashion Park, Inc., 340 F.2d 457, 463 ( 2d Cir.) (reliance requirement), cert. denied sub nom. List v. Lerner382 U.S. 811
( 1965). See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 ( 1976) (scienter).
193 See: 15 U.S.C. §§ 77m, 78i(e), 78r(c).

Page 789 of 901
"nonreliance" clause wherein the Buyer agrees and acknowledges that (1) the Seller (and its representatives)
have not made any representations, except as set forth in the specific article of the acquisition agreement, and
(2) in acquiring the company, Buyer is not relying on any representation or statement by any person except for
the representations set forth in such specific article of the acquisition agreement?
While it might be expected that freedom of contract would permit such a provision, the outcome is not clear.
The problem is Section 29(a) of the Securities Exchange Act of 1934, as amended, 194 which provides that any
provision requiring any person to waive compliance with any provision of the Exchange Act is void. So one
key issue is whether a nonreliance clause is a provision that effectively waives a Buyer's rights under Rule 10b-
5 and, accordingly, is void? 195 Alternatively, is the provision enforceable or, is it unenforceable as a waiver, but
still of some effect? 195.1
The courts are split, although we are aware of no decision that treats the provision as if it did not exist for any
purpose whatsoever. 196 The Second and Seventh Circuits permit sophisticated parties, in the context of an
acquisition agreement 196.1 that contains detailed representations and warranties, to agree, through a nonreliance
clause, that 10b-5 claims cannot be brought. 197 In contrast, the First and Third Circuits have ruled that any such
agreements are not enforceable insofar as they purport to bar 10b-5 claims. 198 However, even those courts
recognize that the presence of a nonreliance clause may be relevant evidence that can be used to defeat the
194 15 U.S.C. § 78cc(a).
195 To the extent the Buyer wished to proceed with an antifraud claim under the Securities Act of 1933, such as Section 12(2), 15 U.S.C. § 77
l(2) (see N. 187 supra), Section 14 of the Securities Act, 15 U.S.C. § 77n, is similar to Section 29(a) of the Exchange Act.
195.1 Despite this uncertainty regarding the enforceability of non-reliance clauses, they are relatively common in acquisition agreements. For
example, "The 2019 ABA "Private Target Mergers and Acquisitions Deal Points Study" indicated that 63% of the studied transactions
included a non-reliance clause and 64% included a clause stating that the Seller made no other representations outside those included in the
acquisition agreement; however, in the case of each type of clause, they were commonly accompanied by a carve-out for fraud claims giving
rise to uncertainty regarding their effectiveness where fraud was not specifically defined to extend only to the ambit of the representations
and warranties in the agreement.
196 For a fuller discussion, see § 15.02[4] Ns. 57-67 infra and accompanying text.
196.1Purchasers of stock from significant shareholders of a target often obtain letters (known as "big boy" letters) similar to the provisions
discussed in the text (i.e., they contain an acknowledgement by the seller that the purchaser has or may have material nonpublic information
which it is not disclosing to the seller, that such information may affect the value of the seller's stock and that the seller does not wish (or
agrees not) to receive such information.
197 See:
Second Circuit:Harsco Corp. v. Segui, 91 F.3d 337 ( 2d Cir. 1996) (Section 29(a) not violated because the nonreliance clause did not waive
Rule 10b-5 claims, but limited them to the reasonably extensive representations included); Citibank, N.A. v. Itochu International, Inc., CCH
Fed. Sec. L. Rep. ¶ 92,403 (S.D.N.Y. 2003).
Seventh Circuit:Rissman v. Rissman, 213 F.3d 381 ( 7th Cir. 2000).

198
See:
First Circuit:Rogen v. Ilikon Corp., 361 F.2d 360 ( 1st Cir. 1966).
Third Circuit:AES Corp. v. Dow Chemical Co., 325 F.3d 174 ( 3d Cir. 2003).
It should be noted that Rogen v. Ilikon Corp., supra, involved two individuals, neither of whom were sophisticated, selling back their stock in
pressured circumstances.
Page 790 of 901
reasonable reliance element of a 10b-5 claim. 199 Such non-reliance clauses might have greater effect as
enforceable waivers defeating state law claims of fraud, misrepresentations, etc.199.1
[16]-Other Representations
There are numerous other representations that sometimes appear in acquisition agreements. While the list
will vary from transaction to transaction, those discussed briefly below are fairly common. 200 In any given
transaction, there may also be several representations specifically addressed to the business of the
Company. For example, if the Company is engaged in drilling for oil, there will be representations about its
oil reserves. If it is a bank, there will be representations concerning, among other things, its loan portfolio.
A computer company is likely to be asked about title to and licenses covering its software. Indeed, apart
from the most basic representations covering due organization, authorization of the transaction and the
financial statements, these may be the most important representations in the agreement.
[a]-Inventory and Accounts Receivable
199 See, e.g.:
Third Circuit:AES Corp. v. Dow Chemical Co., 325 F.3d 174, 180-181 ( 3d Cir. 2003).
Fourth Circuit:Poth v. Russey, 281 F. Supp.2d 814, 821-822 ( E.D. Va. 2003), aff'd 2004 U.S. App. LEXIS 5861 (4th Cir. March 30, 2004).
The Sixth Circuit also appears to view it as relevant to, but not dispositive of, the issue of reasonable reliance, see Brown v. Earthboard
Sports USA, 481 F.3d 901 ( 6th Cir. 2007). See also, § 15.02[4] N. 62 infra and accompanying text. It should be noted that the SEC does not
need to prove reliance when it brings an enforcement action (although it still must show deception). Thus, a "big boy" letter might not avoid
an SEC claim. See SEC v. Barclays Bank, PLC, Litigation Rel. No. 20132 (May 30, 2007), discussed in Bodner, Green & Welsh, "Big Boy
Letters in the Spotlight," 21 Insights 2 (June 2007). A similar result might occur under the "misappropriation" theory of 10b-5 liability of
United States v. O'Hagan, 521 U.S. 642 ( 1997), discussed in McLaughlin, "Big Boy Letters and Non-Reliance Provisions," N.Y.L.J. (Dec.
13, 2012).
See In re National Century Financial Enterprises, Inc., Investment Litigation, 905 F. Supp.2d 814 (S.D. Ohio 2012), discussed in
199.1
McLaughlin, "Big Boy Letters and Non-Reliance Provisions," N.Y.L.J. (Dec. 13, 2012).
It should also be noted that case law, at least at the Chancery Court level, makes the effectiveness of non-reliance clauses in barring fraud
claims based on extra-contractual representations less clear than might be expected. For example, cases such as Anvil Holdings Corp v. Iron
Acquisition Co., 2013 Del. Ch. LEXIS 129 (Del. Ch. May 17, 2013), have called into question whether a non-reliance clause that states merely
that the parties have made no representations and warranties outside of the purchase agreement is effective without also including specific
language in which the Buyer disclaims reliance on extra-contractual representations and warranties. A somewhat curious result, in the
Authors' view, given the plain language of the provision, but a source of uncertainty nonetheless. In addition, cases like Airborne Health, Inc.
v. Squid Soap, LP, 984 A.2d 126 ( Del. Ch. 2009), have held that a provision excluding fraud claims from the indemnification provisions of a
purchase agreement, without more specific language, raises the question of whether the parties have excluded fraud claims not just based on
the express representations and warranties in the contract but also extra-contractual representations and warranties: "[w]hen drafters
specifically preserve the right to assert fraud claims, they must say so if they intend to limit that right to claims based on written
representations in the contract." But see, Vice Chancellor Laster's 2015 opinion in Prairie Capital III v. Double E Holding Corp, C.A. No.
10127-VCL (Del. Ch. Nov. 24, 2015), rejecting Anvil's focus on specific formulations, or "magic words," in favor of giving effect to the plain
meaning of a non-reliance clause, and also making clear that a fraud exclusion clause "does not address the representations that a party can
rely on. . . ." See also, Sparton Corp. v. O'Neil, C.A. No. 12403-VCMR (Del. Ch. Aug. 9, 2017). For an example of the pitfalls of ambiguity
in fraud carve-out language, see also, EMSI Acquisition v. Contrarian Funds LLC, C.A. No. 12648-VCS (Del. Ch. May 3, 2017). Faced with
these divergent case outcomes, the Authors advise practitioners to be as specific as possible in drafting non-reliance clauses to include an
express agreement from the Buyer that it is not relying on extra-contractual representations and warranties and express language regarding
the specific fraud claims that are excluded from the ambit of the indemnification regime.
200 Other representations often found in acquisition agreements include those dealing with labor matters (absence of labor disputes, strikes,
EEOC claims, status of collective bargaining agreements), bank accounts and powers of attorney (particularly in asset transactions), property
plant and equipment (good operating condition), brokers or finders, insider interests (insider transactions with the Company), and ownership
of assets used by the Company (interests in competitors).
Page 791 of 901
In transactions where inventory and accounts receivable are a significant part of the total value of the
Company or of the assets being acquired, the Buyer often asks for specific representations covering these
assets.
With respect to inventory, the Seller may be asked to represent that the Company's inventory consists of
merchandise of a quality and quantity usable and saleable in the ordinary course of business, without mark-
downs, and that it is valued at the lower of cost (on a FIFO or LIFO basis, as applicable) or market in
accordance with generally accepted accounting principles consistently applied.
There are several facts that a representation as to accounts receivable can cover. First, that the accounts
represent actual sales made in the ordinary course of business. Second, as to the aging schedule of the
accounts. Third, that the accounts are free of rights of set-off and are current and collectible, net of reserves,
in the ordinary course of business, without resort to litigation. 201
A good portion of the above representations goes beyond the financial statements representation in certain
respects. Most importantly, they speak as of the date of signing the agreement (and, through the bringdown
condition, closing). These dates will be subsequent to the date of the most recent balance sheet. In addition,
the accounts receivable representation arguably constitutes a guaranty of collectibility (as opposed to
GAAP, which merely requires reserves based on expectations and past practice). The "proper" approach to
inventory and receivables depends upon the business terms of the deal. For example, it is much more
appropriate for the Buyer to obtain a guarantee of collection if it is buying the accounts for their full face
amount, net of reserves, than if the receivables are merely a part of the overall transaction without any
specific allocation of purchase price to them. It is critical, when dealing with representations concerning
inventory and accounts receivable, that the parties' accountants be involved.
[b]-Insurance
With respect to insurance, the Buyer is looking for a list of the Company's insurance policies and, in some
cases, comfort that the Company is adequately insured and that the transaction will not result in termination
of the policies. In addition, the situation can become quite complicated if a subsidiary or a division is being
purchased and the Seller's policies (such as liability and casualty policies) cover all of the Seller's
businesses, not just the Company.
Specific matters covered by an insurance representation will include representations as to:
(1) the effect of the closing of the transaction on the availability of such insurance;
(2) the nature and extent of such insurance, including as to whether it was "claims made" or
"occurrence"-based insurance;
(3) the enforceability of such policies;
(4) whether any material breach or default has occurred with respect to such policies which would
permit termination or modification of such policies;
(5) the giving of timely notice with respect to insured litigation; and
(6) whether any party to the policy has or has expressed an intention to repudiate all or a part of such
policies.
[c]-Customers and Suppliers

Again, this representation can be both informational (who are the Company's ten largest customers and
suppliers?) and directed to a substantive business concern (what is the quality of the Company's relationship
with such customers and suppliers? have any of such persons indicated to the Company an intention to
201 Consider the interrelationship between this representation and "baskets" in indemnification provisions; some Buyers would argue that
losses on the collection of these accounts in excess of the applicable reserves should be on a dollar-for-dollar basis. See § 15.03[1] infra.
Page 792 of 901
terminate their relationship?). Generally, the Seller will be concerned about the risk, if the representation is
brought down to speak as of the closing, that the announcement of the deal itself causes a problem with
customers and suppliers, thus causing the representation to be untrue at closing. 202 However, a lot of
"threats" can be uttered by a customer or supplier, purely as a matter of ordinary business negotiation. In
many cases, the Company will not be so dependent on a few customers or suppliers that the representation
is needed. In other cases, perhaps the Buyer could approach the relevant third parties directly, although this
could cause significant problems if (as is almost always the case) the parties are trying to avoid pre-signing
disclosure or rumors.
[d]-Contracts and Leases

In many acquisitions of nonpublic companies, and in some cases in public company transactions, the
Company is asked to assure the Buyer that it is not in default under any of its agreements (including leases).
This often ends up being limited in some way by materiality 203 (including in many cases by reference to a
specified, detailed list of the types of agreements that are subject to the representation). 204 In acquisitions of
public companies, the detailed list is often replaced by a reference to agreements of a type which would be
required to be filed as exhibits pursuant to Item 601 of Regulation S-K. 205
Buyers often ask the Company to also provide comfort that the other parties to material agreements are not
in default. The theory behind the representation is that a defaulted contract is not as valuable an asset of the
Company as one which is being performed in the same manner as it always had been (and as it has always
been reflected in the financial statements). Depending on the type of contract involved, the Company may
be entitled to a knowledge qualification as to this portion of the representation. 206 In addition, Sellers might
be able to argue, with some logic, that the other party being in breach is usual for their course of conduct
and that no negative inferences should be drawn from this.
[e]-Securities Filings
An extremely important representation in acquisitions involving public companies is that they have made
all filings required by the Securities Act of 1933, the Securities Exchange Act of 1934, as amended, and the
Sarbanes-Oxley Act of 2002, 207 and that such filings did not contain a material misstatement or omit to
state a material fact required to make the statements therein not misleading. This representation, which is
one of the cornerstones of "bare bones" merger agreements is discussed elsewhere. 208
202It is true, however, that the Seller is likely to be subjected to this risk in any event as a result of the bringdown, as applied to the material
adverse change representation (although it is possible that it requires a larger problem and will "take more" to render that representation false
than the specific one dealing with customers and suppliers).
203 See § 11.03 supra.

204 There is often a requirement to deliver copies of such agreements to the Buyer. The Seller should be careful as to the combined effect of
the wording of the representation, the bringdown condition and its ability to enter into additional agreements in the ordinary course between
signing and closing.
205 See 17 C.F.R. § 229.601.
206 Again, the Company must be very careful about the bringdown; otherwise a post-closing breach by the other party, something which is
totally out of the Company's control and which might not constitute a material adverse change, might allow the Buyer to refuse to close.
207 This often appears in public company acquisitions and is expanded to include a representation that the statements contained in or
accompanying the reports filed with the SEC in accordance with Sections 302 and 906 of the Sarbanes-Oxley Act are true and correct. See §
5.10[2][a] supra.
208 See: §§ 16.01, 16.03 infra.

Page 793 of 901
[f]-Proxy Statement
If a proxy or information statement is being used in connection with shareholder approval of the
transaction, the Company will represent as to the accuracy of the information furnished by it for inclusion
therein. 209 A similar representation is made for statements on Schedule 14D-9 in the case of two-step
transactions involving a tender offer. 210 It is important to realize that since the proxy statement is normally
not drafted until after signing, it will not be able to serve as a disclosure document to give the Buyer
substantive comforts about the Company's business.
[g]-Sufficiency of Assets
The Buyer may want the Seller to represent that the assets being conveyed to it in the transaction are all the
assets which are necessary or sufficient to run the business in the manner in which it has been operated or,
perhaps, in the manner the Buyer intends to run it. Although this may seem more appropriate in the asset
purchase context, it may also make sense if a stock purchase or merger involving the Company takes place,
particularly if the Company was a subsidiary or division of a larger entity and some of the assets of the
business used by the Company were actually owned by a different entity. Similarly, if the business being
acquired is conducted on a world-wide basis, and the transaction is structured as a combination of asset and
stock purchases, it will be important for the Buyer to receive comfort from the Seller that the sum of what it
is buying comprises all of the assets necessary to run the business.
[h]-Intellectual Property
Intellectual property representations are now customary. The specific representation as to the existence,
scope, and status of the Company's intellectual property will depend on the type of business in which the
Company is engaged in general, and the importance the Buyer has placed on intellectual property rights in
determining the value of the Company. Accordingly, depending on these factors, a Buyer may insist on a
variety of intellectual property representations.
It is likely that in the intellectual property representation, the Buyer will define "intellectual property"
broadly to encompass intellectual property that is registrable in the United States Patent and Trademark
Office, the United States Copyright Office, and other foreign registries, as well as other tangible and
intangible items of intellectual property. Accordingly, the definition of "intellectual property" generally will
include, among other things, all patents, trademarks, service marks, trade names, domain names,
copyrights, rights of publicity, computer software, trade secrets, confidential information, know-how,
proprietary processes and methodologies, and all applications and registrations for the foregoing.
Typically, a Buyer will want to identify the types of intellectual property that it will be acquiring and will
request that the acquisition agreement schedule complete lists of all registrations and applications of
patents, trademarks and copyrights (and, in certain cases, material unregistered trademarks and copyrights),
and domain names that are owned by the Company. With respect to such intellectual property, the Buyer
may require the Company to represent that (1) it is the exclusive beneficial and record owner of such
intellectual property, (2) it has paid all fees and filed all documents necessary for obtaining, maintaining,
perfecting, preserving, and renewing any rights in such intellectual property, and, perhaps, (3) such
intellectual property is subsisting, valid, and enforceable. A careful Buyer may also wish to review and
conduct due diligence of the corresponding disclosure schedule to determine if there are any ownership
issues, gaps in the chain of title, and/or security interests filed on any of the intellectual property listed.
209 See § 5.03[2][a] Ns. 70.1-70.9 supra.
210 See: §§ 5.03[3] supra, 16.02 infra.

Page 794 of 901
In addition, a Buyer typically will request that the Company schedule material license agreements or other
contracts in which the Company grants or obtains any right to use any intellectual property. With respect to
such contracts, the Buyer will usually request that the Company represent that such contracts are valid,
binding, and enforceable by or against the parties to the contract and that the Company is not in breach of
any such contract. 211
One of the most important matters covered by an intellectual property representation relates to the
Company's rights to use intellectual property. Accordingly, the Buyer will request that the Company
represent that it owns or has a valid right to use, free and clear of all liens, all intellectual property used in,
or necessary to conduct, the Company's business.
Another important matter covered by the intellectual property representation relates to claims of
infringement by and against third parties. Therefore, the Buyer usually will insist that the Company
represent that, other than scheduled, there are no claims pending or threatened by or against the Company
concerning alleged infringement or other violation of intellectual property rights. Sometimes a
representation will be requested that goes beyond asserted infringement claims, such as that the conduct of
the Company's business, and the products and services offered by the Company, do not infringe or
otherwise violate intellectual property rights, or to the Company's knowledge, no person is infringing or
otherwise violating any intellectual property rights of the Company.
In addition, a Buyer may want to confirm that the acquisition of the Company or the Company's assets will
not result in the loss of any of the Company's intellectual property rights. 212 Accordingly, the Buyer may
insist that the Company represent that the consummation of the transactions contemplated by the
acquisition agreement will not result in the loss or impairment of or payment of any additional amounts
with respect to, the Company's rights to own or use intellectual property. Furthermore, because of the
Buyer's concern that parties related to the Company may claim ownership of certain intellectual property of
the Company after the acquisition is completed, the Buyer may request a representation that no affiliate,
stockholder, officer, or employee of the Company will, after giving effect to the transactions contemplated
under the acquisition agreement, own or retain any rights to use any intellectual property of the Company.
To the extent that the Company is engaged in certain types of businesses, additional specialized
representations may be requested by the Buyer. For example, where the Company:
(1) is involved in research and/or the development of proprietary methodologies, formulas, or
processes, or otherwise possesses commercially valuable confidential information a Buyer may request
the Company to represent that it takes certain measures to protect the confidentiality of its trade
secrets.
(2) owns, develops, or licenses proprietary software significant to its business, a Buyer may request
certain representations concerning the functioning of such software, and, perhaps, that the software is
not subject to the terms of any "open source" or other similar license that provides for the source code
of the software to be publicly distributed or dedicated to the public.
(3) has developed customer lists that may be of value to the Buyer or has accumulated personal
information about its customers, including on its websites, the Buyer may request that the Company
represent that it takes reasonable measures to ensure that such information is protected against
unauthorized access or other misuse and that it has complied with applicable laws, as well as its own
policies, and procedure, relating to privacy, data protection, and the collection and use of personal
211 The above representation may be covered in part by other representations in the agreement. See, for example, § 11.04[16][d] supra
concerning representations with respect to contracts. However, because certain representations regarding contracts limit such representations
to "material contracts" as specifically defined in the acquisition agreement, and such a definition of "material contracts" may exclude all or
certain intellectual property licenses, the Buyer may request the additional representation described above.
212 This sometimes is covered more generally by the title to assets representation. See § 11.04[12] supra.
Page 795 of 901
information, and that no claims have been asserted or threatened against the Company alleging
violation thereof.
Finally, if particular identifiable intellectual property (e.g., software, a compound for a pharmaceutical
product, a brand name) is particularly significant to the business of the Company, a Buyer may request
certain representations particularized to such intellectual property, such as representations concerning the
scope of ownership, rights to use, and noninfringement.
[i]-Affiliated Transactions
Sometimes the Buyer will request that the Seller disclose all of the transactions between the Company and
its subsidiaries and the Seller and its other subsidiaries or other affiliated companies which took place
during a specified period and involved more than a specified amount. The Buyer may want such
information in order to test the effect of such transactions on the Company's financial statements or to be
able to determine whether such arrangements need to be replaced post-closing.
[j]-Labor Matters
As is the case with other representations, the existence of a separate representation as to labor matter as
well as its breadth will depend upon whether the Company has unionized employees, the history of labor
relations at the Company and the importance of uninterrupted production to the value of the business. If
included, the representation will often require the Seller to:
(1) list or attach copies of all of the Company's collective bargaining agreements;
(2) represent that there is no pending or threatened material labor dispute or work stoppage;
(3) represent as to the nonexistence of charges of unfair labor practices pending or threatened before
the National Labor Relations Board;
(4) represent as to the Company's compliance with all applicable labor laws, rules, regulations and
orders.
The Buyer may also ask the Seller to represent that the Company is in compliance with, and has no
liabilities under, the WARN Act (the Worker Adjustment and Retraining Notification Act).
Acquisitions of companies which manufacture or sell consumer goods, particularly those companies in the
garment and apparel industry, may present special problems if labor or employment law violations have
occurred. 213 In addition to the representations outlined above, the Buyer may wish to obtain a
representation from the Seller that:
(1) the Company is in compliance with all applicable laws governing employment, including but not
limited to minimum wage and overtime requirements, child labor laws, health and safety requirements,
immigration laws and anti-discrimination laws;
(2) all of the suppliers, manufacturers and subcontractors engaged by the Company in the manufacture
of the Company's products are in compliance with such laws;
(3) the Company uses its reasonable best efforts to require all of its suppliers, manufacturers and
subcontractors to provide written assurance that they have complied and will fully comply with all
such laws; and
(4) there have been no claims against the Company or any of its suppliers, manufacturers and
subcontractors by any governmental entity, regulatory authority or any other person of any violation of
any such laws.
[k]-Brokers and Finders
213 See § 19.06 infra.

Page 796 of 901
It has become typical in acquisition agreements for both parties to represent as to which investment firm, if
any, has been engaged in connection with the transaction and as to how and by whom such firm's fee will
be paid.

End of Document
Negotiated Acquisitions of Companies, Subsidiaries and Divisions (LJP) > CHAPTER 12: Representations and
Warranties of the Buyer
§ 12.01 General Considerations
The article in the acquisition agreement pertaining to representations and warranties of the Buyer may, as often as
not, be included for the purposes of symmetry since the reasons for the Seller arguing to obtain the benefit of such
representations may be somewhat obscure. This is particularly the case in transactions where the acquisition
purchase price is to be paid in cash. 1 Nonetheless, it is virtually unheard of for the Seller not to obtain at least the
"bare bones" representations from the Buyer and, if the deal has a financing condition, additional representations
concerning the status of such financing. If the Company is to be highly leveraged after the transaction, the Seller
may also ask the Buyer to make certain representations designed to give the Seller some comfort that the
transaction will not be viewed later as a "fraudulent conveyance." 2
In this chapter the Authors will examine the purposes for obtaining representations from the Buyer, which type of
representations are usually obtained and the content and advantages of representations concerning the status of the
financing. All of the Authors' observations concerning the use of materiality limitations 3 and knowledge
qualifications 4 in representations and warranties of the Seller are as true for Buyer's representations as they are for
those of the Seller-although perhaps less important in this context only because the representations are themselves
less important. It is often the case that the use of such qualifications are negotiated at length in the context of the
Seller's representations and then "mirrored" in the Buyer's representations on the same topics. 5

1 This analysis may also apply when securities of the Buyer form all or a part of the consideration since securities of the Buyer may be
tantamount to cash in situations where the Buyer is a large, publicly held corporation with an actively traded, highly liquid stock. See § 16.05
for a discussion of ways to minimize the impact of market price fluctuations of the Buyer's stock.
5 It may not always be the case that the standard representations are accepted in the same format, however. For example, while a Buyer may
be willing to await the approval of a Seller's shareholders (perhaps because it can't be avoided, see §§ 2.03, 2.04, 11.04[6] supra.), a Seller
may be totally unwilling to agree to sell itself (and have to announce that fact) or even an important division. or subsidiary without its Buyer
having all of the necessary corporate approvals in hand.
Page 798 of 901
End of Document
§ 12.02 Purposes of Representations of the Buyer
We have previously discussed the purposes a Seller's representations serve in the acquisition process:
1. "paint a picture" of the business being sold, thus assisting the Buyer in understanding the business it is
acquiring and doing its due diligence;
2. allow the Buyer to refuse to close the transaction if such representations are not true at closing;
3. enable the Buyer to recover damages if a representation turns out to have been false, generally whether or
not the transaction closes; and
4. provide a "road map" from signing to closing, thus assisting the Buyer in managing and completing the
acquisition process. 1
The Buyer's representations generally provide the same advantages to a Seller, except for the first one, which is
usually unnecessary for the Seller and accounts for the omission in a typical acquisition agreement of all
representations that would serve as a description of the Buyer's business. 2 The other above-mentioned goals are in
fact served by the Buyer's representations but do not generally accomplish the Seller's main aim of selling the
business. If the Buyer's representations are false at closing, the Seller will be able to refuse to close and, if false then
or at signing, they may provide the basis for recovery of damages. However, except in the rare circumstance where
the Seller has another buyer "waiting in the wings" at a higher price, 3 the last thing the Seller needs is the ability not
to close an already announced sale, particularly given the employee morale problems and the difficulties which may
be encountered later in trying to sell a business which may then be viewed as "damaged goods." The possibility of
later recovering damages against the Buyer may do little to minimize this problem. Similarly, the theoretical ability
to sue for a breach may be of minimal use where there are little or no provable damages.4
So, we come to the Seller's prime motivation in obtaining representations from the Buyer: to know "who" it is
dealing with, to understand exactly what has to happen before the Buyer can close the deal (by way of approvals,
etc.) and to be as sure as possible that on the day of closing the Buyer can actually come up with the purchase price.
1 See § 11.01[1] supra.
2 The exception, of course, is when the acquisition price is being paid in securities of the Buyer, particularly if the Buyer is of a similar size
to the Seller. In that circumstance, the Seller is quite interested in the Buyer's business, particularly in the presence or absence of contingent
liabilities. In this situation, the Buyer's representations will be much more extensive, touching on many of the same matters as the Seller's
representations. See § 12.03[2] infra.
3 This is an unlikely event in the sale of a division or subsidiary where competitors, even if there were any before signing, are unlikely to
have continued to express their interest to a Seller who has signed an agreement with another party.
4 Except again, in the situation where the Seller has received securities of the Buyer and the Buyer's business turns out to be not in the
condition (financial or otherwise) represented.
Page 800 of 901
The identity and financial wherewithal of the Buyer become critical to each part of this analysis: financial capability
not only affects the Buyer's ability to close-but what good is a breach of contract action for failure to pay the
purchase price against a Buyer which is unable to pay it? 5
As a result of these concerns, the Buyer's representations are more "transactional" in nature than those of the Seller.
What the Seller finds important is centered around the Buyer's ability to consummate the transaction. Indeed, while
the Buyer's representations generally must be "brought down" to closing in the same manner as the Seller's
representations (and this is important to the Seller from a damages point of view), it can be said that it is the giving
of representations by the Buyer that is important to the Seller, for the Seller wants to know the Buyer's ability to
close the transaction before the Seller signs on to (and perhaps announces) the transaction. This is analogous to the
information about a business which an acquiror may gain merely by asking for certain representations. 6

End of Document
5An important aspect of the ability to recover damages will relate to the identity of the entity making the representations. A shell subsidiary
may be "judgment proof" unless a plaintiff is able to "pierce the corporate veil" and collect damages from a corporate parent.
6 See § 11.01[1] supra.

§ 12.03 Specific Representations of the Buyer
[1]-Buyer's Ability to Consummate the Transaction

The goals of the Seller in establishing the "identity" of the Buyer and the status of its necessary approvals are
generally well served by obtaining "bare bones" representations. 1 In the Authors' experience, in an acquisition
transaction in which the purchase price is to be paid in cash, the Buyer will generally represent to the Seller:
1. as to due organization and good standing;
2. as to due authorization to consummate the transaction;
3. that execution, delivery and performance of the acquisition agreement will not violate the Buyer's
governing documents, any agreement to which it is a party or any law or regulation applicable to it;
and
4. that execution, delivery and performance of the acquisition agreement will not require a filing with or
consent or approval by any governmental or judicial entity or any third party.
All of these representations (except arguably the first) go to the Buyer's ability to do the deal "without a hitch."
It is important for a Seller to know whether or not a prospective Buyer has in hand all the necessary Board and
stockholder (or general and limited partner) approvals. Similarly, if a third party has an ability to disapprove of
the deal, for instance a lender to whom the Buyer has covenanted that it will not make an acquisition outside of
its existing line of business or unless certain financial ratios are maintained, the Seller (before the agreement is
signed) may appropriately demand an explanation from the Buyer as to its view as to whether such approval
will be obtained and what the Buyer's plans are if it is not obtained. Except in special circumstances, it is
unlikely that a Seller would accept this risk and the possibility that a third party will be able to determine
whether or not the transaction is consummated. 2
1 The satisfaction of the financial wherewithal goal will be dealt with in § 12.04 infra.
2 Assuming a Seller is willing to proceed with a Buyer who needs such third party consent, but the parties have agreed that the risk of not
obtaining it is to be the Buyer's, careful attention needs to be paid to the drafting of the acquisition agreement. The Buyer's representation as
to approvals will contain an exception for the third party consent and so be true at signing and will be true at closing whether or not the
approval is obtained. However, careful attention needs to be paid to any closing condition relating to "all approvals relating to the transaction
having been obtained" (or the delivery of legal opinions to the same effect) to make sure that it is within the Seller's ability to waive such
condition and make the Buyer go forward. Indeed, if the Buyer has agreed to take certain steps if such approval is not obtained (e.g.,
refinance the objecting lender's debt), it may well be wise for the Seller to insist on including a specific covenant to that effect. For a
discussion of the interaction in an acquisition agreement among representations and warranties and conditions to closing, see §§ 1.05, 11.0[1]
supra.It should be noted that the issue of third party consents may be more complicated if the Seller needs such consent in order to go
forward; the failure to obtain such a third party consent may deprive the Company of the benefit of a favorable lease or supply arrangement or
other matter which significantly affects the nature of the Company's business resulting in the Buyer being unwilling to go forward unless such
approval is obtained or other arrangements (satisfactory to the Buyer) can be made. See § 2.08[2] supra. The issue becomes particularly
Page 802 of 901
It is also critical for the Seller to know (and to analyze the significance of) the necessity of governmental or
judicial filings or approvals by specific buyers. While some types of filings may be applicable to most if not all
prospective buyers, the ability of any specific buyer to obtain the approval of the governmental entity (or
merely the time required to bring the matter to a close) may differ from other prospective buyers bidding for the
Company. For example, while each of two prospective bidders may need to do Hart-Scott-Rodino filings with
the Federal Trade Commission, 3 if one of the parties is a competitor of the Company, the FTC (or Department
of Justice) may be inclined to look more closely at the filing and, perhaps, issue a request for additional
information which (even if the investigation is not pursued to a problematic conclusion) will delay the closing
of the transaction. If the other prospective buyer had been a "financial bidder" like an investment firm with no
competitive interests, and if the bids were close, the Seller might well be tempted to take a lower bid if it would
result in a quicker and more certain closing. This issue is even more obvious in the case of a bidder, perhaps
one in a specially regulated industry or a foreign entity, which may require a type of approval that is somewhat
atypical and not required of other prospective bidders.
[2]-Valuation of the Buyer's Equity

There may be circumstances where the Seller requests and obtains more extensive representations from the
Buyer than the "bare bones" representations discussed previously. The Buyer may decide to make these
additional representations because it makes sense to do so (for example, all or part of the purchase price is in
the form of securities of the Buyer) or merely because the Seller has the leverage to ask for them and, given
that, the Buyer believes that it should proceed to give them. 4
In the latter situation, the representations which will be included beyond the "bare bones" ones will essentially
be at the whim of the Seller and are therefore hard to analyze outside of the specific instance. However, in the
other, more typical situation, the additional representations requested and given form a pattern that is consistent
with the purchase of the Buyer's equity: they describe the Buyer's business in order to provide information
about the value of the underlying equity. As a result, the extra representations emphasize the financial condition
of the Buyer and the absence of contingent liabilities. Thus, the addition of the following types of Buyer
representations (in the varying forms discussed in Chapter 11) would be typical in this situation:
s. the Buyer's financial statements have been prepared from and in accordance with the books and records
of the Buyer in accordance with generally accepted accounting principles; 5
t. the Buyer has no liabilities-absolute, contingent, known or unknown-which are not reflected on its
balance sheet or otherwise disclosed; 6
u. the Buyer has not had a material adverse change in its business since the date of the most recent
balance sheet delivered to the Seller; 7
troubling if the mere execution of the acquisition agreement breaches the third party agreement. Not only are the consequences worse for the
Company, the third party will often have greater negotiating leverage.

4 This is not a "zero-risk" situation, though, due to the possibility of the Seller's recovery of damages for the Buyer's misrepresentations.
5 See § 11.04[8] supra.
6 Id.Interestingly, the Buyer's willingness to give this representation in a stock transaction may increase its chances of obtaining parallel
comfort from the Seller. This representation may also be limited to liabilities which are required to be reflected on the balance sheet. See
text accompanying § 11.04[8] N.84 supra.
7 See § 11.04[9] supra.

Page 803 of 901
v. there is no litigation pending or threatened against the Buyer that would have a material adverse
effect on its business; 8 and
w. the Buyer has filed the required tax returns through an appropriate date and has paid, or made adequate
provision for, the payment of all required taxes. 9
This package of representations will provide the Seller with the basics in order to value the Buyer's equity in
light of knowledge of the presence (or absence) of contingent non-balance sheet liabilities. Depending on the
relative size of the Buyer and the Company, 10 some other representations may be added, most of which go to
the nature of the Buyer's contingent liabilities in a more specific way: compliance with law,11 compliance with
environmental regulations 12 and ERISA compliance. 13 Certain of the representations requested of a Seller make
less sense in the Buyer context 14 while others present the same advantages and disadvantages and will be
resisted in either the Seller or the Buyer context.15
Buyers will sometimes seek to avoid giving some or all of these representations by arguing that the market has
already reflected any problems in the Buyer's stock price, which also factored in the problems when
determining the acquisition price (i.e., exchange ratio). This argument is generally unsuccessful, except
possibly where the buyer is very large relative to the seller, its stock is almost a cash equivalent and the final
ratio is determined by a formula price at closing. 16 Of course, this requires Buyers to have disclosed all adverse
events; moreover, what might be material for the market is not necessarily what is material to the target.
Similarly, not everything is instantly reflected in the buyer's stock price. Contingent liabilities might not be for
some time. Moreover, there is the issue of disclosures and events subsequent to signing; the buyer's only
protection may be the bringdown and this, in turn, will depend on the representation having been made 17 in the
acquisition agreement. 18
8 See § 11.04[10] supra.
9 See § 11.04[13] supra.
10 The larger the Buyer's enterprise in relation to that of the Company, the less likely it is that the Seller will feel it necessary to demand (and
less likely that it will receive) more extensive representations from the Buyer. The Buyer's argument is that the Seller is merely acquiring
securities of the Buyer (and, as such, is entitled to its public disclosure documents much like a customer in a public offering would receive),
whereas the Buyer is acquiring a business.As a rule of thumb, the Authors have generally found that the representations are essentially
symmetrical on stock acquisitions if the Company is of a sufficiently large size so as to require the Buyer to obtain shareholder approval
under state law or stock exchange regulations. See §§ 2.03, 2.04 supra.
11 See § 11.04[11] supra.
12 Ibid.
13 See § 11.04[14] supra.
14For example, representations concerning the value of the Buyer's inventory or accounts receivables or the condition of property, plant and
equipment are generally unnecessary in a stock transaction because they provide no useful information not already adequately covered by the
Buyer representations previously discussed. See § 11.04[16][a] supra.
15 For example, a "10b-5" representation is quite useful to get from the Buyer in a stock transaction but the Seller will meet with the same
level of resistance; see § 11.04[15] supra. The Seller is, of course, protected by the securities laws in such a stock transaction but causes of
actions and remedies will differ under the securities laws and the negotiated acquisition agreement. See § 11.04[15] Ns. 143-145 supra, and
accompanying text.
16 See: § 14.11[5] N.10.1, § 16.05 infra.

17Alternatively, there can be a closing condition without the representation, although this will generally not result in indemnification being
available.
18 See: §§ 14.02, 14.11[5] infra.

Page 804 of 901

End of Document
§ 12.04 Financing Representations of the Buyer
The Buyer's ability to pay the purchase price negotiated with the Seller is the most serious concern a Seller has
when entering into a transaction with a prospective buyer. Thus, the most important representation the Seller can
request of the Buyer is one as to its ability to pay. This is the case even if the Buyer's obligation to close is not
conditioned on its ability to obtain financing; after all, what representation goes more to the question of "who" the
Buyer is than a representation about its financial wherewithal?
Thus, in its simplest form, this representation will state that: "the Buyer has the funds (or has available
commitments from creditworthy financial institutions to provide the funds) required to pay the purchase price and
consummate the transactions contemplated hereby." The last phrase is important since the Buyer may need funds to
pay fees and expenses or obtain third party consents, or indeed the commitment fees of the above-mentioned
financial institutions, in order to completely satisfy its obligations to the Seller.
Again, the advantages of such a representation are two-fold. Hopefully, a Buyer which is unable to make this
representation will hesitate to do so, allowing the Seller perhaps to "pull out" of the deal before it is announced. If
the representation is made and the contract is signed, the breach of the representation may well form the basis for a
claim for damages and this on a more clear-cut, straightforward basis than the Buyer merely failing to pay the
purchase price for the business. 1
If the Buyer's obligations in the acquisition agreement are conditioned upon the receipt of financing, the
representation needs to be more complex and the agreement might include other provisions in order to protect the
Seller. In this situation, the representation should at a minimum describe the status of the Buyer's financing: a
signed commitment letter from a bank; an expression of interest from a bank; a "highly confident" letter from an
investment banker. 2 For example, the representation might read:
"The Buyer has delivered to the Seller written commitments from (i) X Bank to act as agent for, and to
participate in, a syndicate of banks (the "Banks"), and from such Banks, that such Banks will provide a term
loan to the Buyer upon terms and conditions [to be negotiated] [substantially similar to those set forth on
Exhibit A hereto] (the "Bank Commitment") and (ii) Y Underwriter to sell or purchase for its own account an
aggregate of $Z debentures from the Buyer upon terms and conditions identical to those set forth on Exhibit B
hereto (the "Debenture Commitment").
1 This is so in large part because it can be argued that such a misrepresentation is in the nature of "fraud in the inducement."
2 "Highly confident" letters are what they sound like: a letter representing a view by a financial institution or an investment bank that it is
"highly confident" that appropriate financing can be arranged. See § 20.04 infra.
Page 806 of 901
In order to complete the "package," in addition to such a representation, the agreement should include a covenant
obligating the Buyer to use its "best efforts" 3 to proceed with the financing on the basis described in the Buyer's
representation, to satisfy the lender's conditions to the financing and to obtain the proceeds of the financing. Using
the defined terms set forth above, one possible (but very tough) covenant might read as follows:
"Buyer will enter into agreements containing the terms to be set forth therein as specified in the Bank
Commitment and the Debenture Commitment and such other terms as are reasonably satisfactory to it and will
obtain the financing thereunder subject to the satisfaction of the terms and conditions thereof; provided,
however, that the conditions contained therein shall be the same as the conditions set forth in the Bank
Commitment and the Debenture Commitment."
This is a very Seller-oriented approach and will only be obtained from a Buyer in rare situations. These provisions
obligate the Buyer to enter into agreements along the lines of the commitment letters (not to merely use its "best
efforts" to do so). 4 Note, too, the restraint upon the addition of new conditions to the financing.
Finally, the agreement should include a condition which provides that if the proceeds are not obtained, the Buyer
will not have an obligation to proceed. 5
At first blush, this may seem like needless complication but upon further reflection the advantages to the Seller
(even with less Seller oriented provisions than those discussed here) will be quite clear. If only a financing
condition is included in the acquisition agreement and the Buyer does not get the financing, the transaction need not
close and the Seller has no further redress. However, in the latter formulation, the Seller may have a claim for
damages if the Buyer has not obtained the financing due to its lack of efforts to do so (breach of the covenant) or if
it initially misrepresented the status of the financing, perhaps inducing the Seller to enter into a transaction in a
situation it would not otherwise have done so (breach of the representation).

End of Document
4 Even "best efforts" obligations can have teeth. See § 13.06 infra.
5 See § 14.11[4] infra. Conversely, the Seller may require that it have the right to terminate the agreement if the financing commitments have
not been received by a certain date. See § 20.04 infra.

Negotiated Acquisitions of Companies Subsidiaries and Divisions CH 11 + 12

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Negotiated Acquisitions of Companies Subsidiaries and Divisions § 11.

§ 11.01 General Considerations

6 See Chapter 13 infra.

11 See Chapter 14 infra.

12 See Chapter 15 infra.

[2]-Scope of the Representations

26 See Chapter 20 infra for a discussion of leveraged buy-outs.

29 See § 11.04[2] infra.

30 See § 11.04[6] infra.

31 See § 11.04[7] infra.

32 See § 11.04[4] infra.

33 See § 11.04[8] infra.

34 See § 11.04[9] infra.

35 See § 11.04[16][e] infra.

42 See: §§ 11.02, 11.03 infra.

43 See the discussion in the text (first paragraph of § 11.01[2]) supra.

43.1 See § 11.04[11] infra.

43.3 See § 11.04[8] infra.

43.4 See § 11.04[16][e] infra.

43.5 See § 11.04[8] infra.

[3]-Timing Considerations and Representations: Effect of the Bringdown

45 The so-called "bringdown condition." See § 14.02 infra.

Negotiated Acquisitions of Companies, Subsidiaries and Divisions (LJP)

§ 11.02 Knowledge Qualifications

5 See § 11.01[1] supra.

5.1 See § 11.01[3] supra.

Negotiated Acquisitions of Companies, Subsidiaries and Divisions (LJP)

§ 11.03 Materiality Limitations

2 See § 14.02 infra.

[2]-Appropriate Use of Materiality Qualifications

12 As is the case with many public company deals.

13 See § 15.03 infra.

Negotiated Acquisitions of Companies, Subsidiaries and Divisions (LJP)

§ 11.04 Specific Representations of the Seller

[2]-Corporate Organization and Existence

1 See § 10.02 supra.

1.1 See § 11.02 supra.

4 See § 11.04[3] infra.

6 See § 14.09 infra.

8.1 See § 15.03[1] infra.

Delaware:8 Del. Code Ann. §§ 102(b)(5), 122(1).

New York:N.Y. Bus. Corp. L. § 402(a)(9).

California:Cal. Corp. Code § 1801.

Delaware:8 Del. Code Ann. §§ 136(c), 284, 502(e).

Maryland:Md. Corps. & Ass'ns Code Ann. § 3.503.

Ohio:Ohio Rev. Code Ann. § 5733.20.

[3]-Good Standing as a Foreign Corporation

Delaware:8 Del. Code Ann. § 122.

New York:N.Y. Bus. Corp. L. § 202.

Connecticut:Conn. Gen. Stat. Ann. § 33-397.

Delaware:8 Del. Code Ann. § 373.

Georgia:Ga. Code Ann. § 14-2-1501.

New York:N.Y. Bus. Corp. L. § 1301(b).

Kansas:Kan. Stat. Ann. § 17-7303.

Massachusetts:Mass. Gen. L. Ann., Ch. 181, § 3.

Delaware:8 Del. Code Ann. § 383(a).

New York:N.Y. Bus. Corp. L. § 1312(a).

But see, each allowing non-qualified foreign companies to defend actions:

Delaware:8 Del. Code Ann. § 383(b).

New York:N.Y. Bus. Corp. L. § 1312(b).

[4]-Capitalization and Title to Stock

26.1 See: §§ 2.03, 2.04 supra.

30 See § 1.02 supra.