Navigating Reps and Warranties: A Seller’s Guide to Contentious Clauses in M&A Transactions

By Zachary Cefaratti

In mergers and acquisitions (M&A) transactions, representations and warranties (reps and warranties) play a crucial role in shaping the risk allocation between buyers and sellers. Sellers must closely examine these clauses to ensure their interests are protected and to minimize potential liabilities post-closing.

Material Adverse Change (MAC) Clauses

A Material Adverse Change clause is a provision in M&A agreements that allows the buyer to walk away from the transaction or renegotiate the terms if a significant negative event or circumstance occurs between signing and closing. MAC clauses can be a source of tension between buyers and sellers, as they may put the deal at risk. To protect their interests, sellers should consider the following:

1. Avoid any MAC clause if possible: if a MAC clause can be struck out, this favors the seller. However, few buyers will agree to a no MAC deal
2. Define the scope: Sellers should work to establish a clear definition of what constitutes a MAC, limiting its scope to specific events or circumstances that are within the seller’s control
3. Include carve-outs: To minimize the risk of triggering a MAC, sellers should negotiate for carve-outs that exclude certain events or changes, such as general economic conditions or industry fluctuations, from the definition
4. Set a materiality threshold: Sellers may want to establish a materiality threshold for the MAC clause, ensuring that only significant events or changes will trigger the provision
5. Minimize time between signing and closing: The less time between signing and closing, the less time there is for a qualifying MAC event to give a walkaway right to a buyer

Business Reps and Warranties

Business reps and warranties are assurances made by the seller regarding various aspects of the target company, such as its financial condition, operations, and compliance with laws and regulations. These clauses can lead to liabilities for the seller post-closing if the representations turn out to be inaccurate. To mitigate these risks, sellers should focus on:

1. Accuracy: Sellers should strive to ensure that all representations and warranties are accurate and complete. Providing a comprehensive disclosure schedule can help shield the seller from potential liabilities arising from inaccuracies in the reps and warranties.
2. Qualifiers: Sellers can negotiate for qualifiers, such as materiality or knowledge, to limit the scope of their representations and warranties. For example, a seller may represent that there are no material breaches of contracts, rather than stating that there are no breaches at all.
3. Survival period: The survival period is the length of time during which a buyer can bring claims against the seller for breaches of reps and warranties. Sellers should negotiate for a shorter survival period to reduce their exposure to post-closing liabilities.

Sellers can also insure themselves should they have concerns about contingent liabilities arising, however due to adverse selection problems this insurance may be prohibitively expensive or unavailable when sellers want it.

Reps and warranties are critical components of M&A agreements that can significantly impact a seller’s risk exposure. By carefully examining and negotiating these clauses, sellers can protect their interests, minimize liabilities, and increase the likelihood of a successful transaction. In particular, understanding and addressing the challenges posed by MAC clauses and business reps and warranties can help sellers navigate the complexities of M&A deals and achieve favorable outcomes.

Recent MAC Example - Credit Suisse & UBS

A recent example highlighting how critical a MAC clause can be related to the Credit Suisse, UBS merger - the negotiations for much of which took place over a weekend. UBS had wanted to include a MAC clause stating that if UBS CDS increased by more than 100bps, they had a walkaway right. Fortunately for the deal, this clause was hotly debated and taken out - the next day, CDS were up 105bps.