Copyright 2009, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Commercial Real Estate, September 2009
Risk Allocation
Representations and warranties given by the vendor in favour of the purchaser are the primary means of allocating the risk of loss between the parties in the event that, either before or after closing, the condition or value of the property falls below expectations in some respect. While the scope of such representations and warranties may vary widely from one transaction to another, and may be influenced by factors such as the length of the due diligence period, generally speaking the vendor will be of the view that it should only provide assurances with respect to matters that the purchaser cannot otherwise discover for itself in the course of its own due diligence investigations. In practice, however, the scope of representations and warranties often goes farther than that. Also, in the current market environment, the purchaser may be inclined to request, and the vendor may be inclined to give, assurances which are broader in scope. Thus, it is useful to have in mind various ways in which the effect of the representations and warranties can be limited, to avoid a one-sided allocation of risk to the vendor.
Qualifiers
Wherever possible, the vendor should ensure that its representations and warranties are appropriately qualified. In many instances, exceptions should be made for matters which are disclosed in the documents provided to the purchaser during the due diligence process. Also, when speaking to a matter that the vendor is unable to state with certainty (for example, statements as to the condition, environmental or otherwise, of the building or the lands), it is helpful to qualify the statement such that it is made "to the best of the vendor's knowledge." In this context, it may also be useful to define "to the best of the vendor's knowledge" as being to the knowledge of specific individuals in the vendor organization.
Materiality
Another frequently used qualifier is a materiality threshold, to the effect that the assurances given are true "in all material respects." This is especially important if the truth of the representations and warranties is a condition of closing the transaction. It would be a significant deviation from the rights of the parties at law, and likely not within either parties' expectation, for the purchaser to be able to rescind the agreement of purchase and sale in the event that, at closing, one or more of the vendor's representations and warranties was untrue but only in a trivial sense or where the loss resulting from the breach was nominal. To address the vagueness of the term "material," the parties may consider agreeing on a threshold dollar amount of loss to which the purchaser must be subject before the breach is considered material.
Survival Period
The potential exposure to which the vendor is subject can be curtailed by specifying a shorter period of time within which the purchaser must make a claim based on a breach by the vendor of a representation and warranty. While a period of somewhere between six months and two years is typical, it is open to the parties to specify a shorter or longer period. It is also open to the parties to specify a longer period for specific representations such as environmental matters, or, where the transaction is structured as a purchase of shares, tax matters. Such differentiation between the various representations and warranties may be useful in helping the parties reach agreement on the transaction.
Other
The following provisions, which in most situations should not be difficult for the purchaser to accept, may also serve to limit the effect of the assurances given by the vendor and should not be overlooked in drafting the agreement of purchase and sale:
- An express disclaimer by the vendor of any representations and warranties other than those specifically set out in the agreement of purchase and sale, and a statement to the effect that, except for the representations and warranties contained in the agreement, the purchaser is purchasing the property "as is, where is, with all faults" and without representation or warranty of any kind.
- An obligation of the purchaser, if it becomes aware of a breach of a representation and warranty by the vendor, to notify the vendor and afford the vendor an opportunity to remedy the situation giving rise to the breach.
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