Representations and warranties in purchase agreements

NOTE: The following article is from the collection of articles in our Automobile Dealership Buy/Sell Newsletters. The newsletter deals with the complex area of buying and selling automobile dealerships. Some of the material may not be up to date because of changes in the law from the date shown at the end of the article. This article is not to be taken as legal, accounting, tax, or other advice. You should consult your own professionals for such advice and for any updating of the information provided. 

What if the factory had notified the prior dealer that it intended to establish a new dealer within ten miles of the dealership you just purchased? You cry foul, but no one listens. If your purchase agreement had contained a proper representation and warranty that the seller is not aware of any intention on the factory’s part to establish a new dealership, you would have recourse against the seller for breach of warranty if the seller knew of the factory’s plans.

Obviously, representations and warranties in a dealership purchase agreement are extremely important! Representations and warranties consist of statements in the agreement by either the buyer or seller, or both, that certain facts are true.

The buyer usually wants as many representations and warranties as possible from the seller. The representations and warranties help the buyer smoke out anything that might not be proper in the running of the dealership. For example, buyers usually require sellers to make extensive representations and warranties about the environmental and hazardous waste condition of the premises and regarding compliance with laws regulating such substances.

People sometimes want to qualify representations and warranties by limiting them with a phrase such as “to the best of my knowledge….” This is generally unacceptable, especially where the warranty is important. Without this qualifying language, the representations and warranties must be true, regardless of any knowledge or lack of knowledge.

It is a good idea to require the owners of any corporation to also be parties to the agreement so that you will have a personal claim against those owners or shareholders, and not merely a claim against what may become a worthless corporation.

Most attorneys are familiar with the many standard representations and warranties that belong in small business purchase agreements. These so-called “boilerplate provisions” are too numerous to discuss here in detail. However, discussed below are some of the major areas covered by representations and warranties in the context of dealership stock and asset purchases.

Representations and warranties in a stock purchase agreement are often more detailed than in an asset purchase. This is so because when one buys stock, the buyer is taking the corporation with all of its assets and all of its liabilities. The buyer therefore needs to have as many representations and warranties as possible about the liabilities of the dealership, including tax liabilities.

In both asset and stock purchase agreements, the representations and warranties will usually cover areas such as making sure the buyer gets clear title to the assets or stock, the environmental and hazardous waste condition of the dealership premises, litigation the dealer might be involved in, and other matters that might subject the buyer to successor liability for the obligations and debts of the seller.

As most dealers know, COBRA refers to the federal law which gives employees who lose coverage under an employer’s group health plan the right to continue health coverage by paying for their own health coverage. Serious consideration must now be given to including COBRA representations and warranties in the agreement. Does the selling dealer have employees who are on COBRA? Does the selling dealer have employees who are eligible for COBRA, but have not yet elected COBRA coverage? Will the employees the selling dealer terminates be able to elect COBRA? In a stock purchase the buyer assumes all these COBRA liabilities. In an asset purchase agreement there are some strong arguments that the buyer has successor liability for COBRA coverages. COBRA issues will be discussed in more detail at a future time in another edition of this newsletter. (See COBRA Issues in the Buy/Sell Newletter list of artcles written.)

Corporate good standing, approval of execution of the agreement, and other assurances of good faith are customary and important warranties for the seller to obtain from the buyer. If the seller is accepting a promissory note from the buyer as partial payment of the purchase price, the seller will want representations and warranties concerning the buyer’s financial condition.

Can representations made orally, or in letters, take the place of formal representations and warranties in the agreement? No, because purchase agreements almost always contain “integration clauses ” that can make such informal side agreements invalid. It is therefore crucial to have a representation and warranty in the agreement as to each fact that is important to you.

What rights and remedies are available for breach of a warranty? This depends on the terms of the agreement, especially the indemnification clause. Remedies can include a complete rescission and unwind of the buy/sell, payment of damages equal to the loss in value caused by the warranty being untrue, or holding of the non-breaching party harmless from any liability or expense that results from untruthfulness of the warranty.

Representations and warranties are an integral part of any dealership purchase agreement. They must be carefully considered and drafted, and should also be tailored to the specific transaction so that they meet the objectives of the parties. When properly drafted, they can provide much protection for the buyer who usually is the party who is most in need of the protection representations and warranties offer. On the other hand, sellers will negotiate hard to limit their liability by attempting to narrow the scope of their representations and warranties and to have them terminated as soon as possible after the closing.

This article was written in 1993.

This article was written by Joseph E. Berberich, a partner of Manning, Leaver, Bruder & Berberich.