M&A Concepts: “Representations and Warranties”

In all sale purchase agreements (SPAs), whether it is a transfer of shares in a company (share deals) or business (asset deals or business transfer agreements), there is a section entitled "Representations and Warranties", often translated in Romanian as "Declarații și Garanții". In Anglo-Saxon law, "Representations and warranties are clauses in the definitive merger agreement that establish the required condition of the buyer and the target firms at the time of signing the agreement, and again at closing. Failure to meet these conditions will usually trigger a renegotiation of price, or even cancellation of the deal."[1] The nuance between the two concepts can be summarized as follows: "A representation (or “rep”) is a statement of fact; a warranty is a commitment that a fact is or will be true. Together, these present a profile of the target (…) at the date of the transaction."[2]

From the perspective of Romanian law, the distinction between the two is not necessarily one of substance, since both the reps and the warranties are in fact guarantees of the seller in respect of (simply put) the company that is the object of the sale.

This comprehensive list of guarantees takes into account not only the subject matter of the sale per se (which, by assumption, represents the shares in question), but the state of the company as a whole. In practice, from the perspective of the Romanian Civil Code, the seller's guarantees in respect of the shares that are the subject of the sale would be limited to the guarantee for eviction (guarantee that the seller is indeed the owner of the goods that are the subject of the sale) and the guarantee for defects (guarantee that the shares were legally issued/subscribed etc.), without the seller guaranteeing in any way the substance of these shares i.e. the business that is taken over following the sale. Therefore, reps & warranties are required to add guarantees by the seller with regard to the value actually conveyed by the transfer/sale of shares/business/goodwill.

Reps & warranties are also a contractual risk allocation tool between seller and buyer, being closely linked to the due diligence process (legal analysis carried out on the target company) and to the disclosure of information by the seller carried out either as part of the due diligence or separately via a disclosure letter (concepts to which we will refer in later articles).

How does this contractual risk allocation work? According to the Romanian Civil Code (art. 1707 para. 4), the seller does not owe a guarantee against defects that the buyer was aware of when the contract was concluded. In other words, the seller cannot be held liable for those defects which, in the contractual understanding of the parties, are deemed to be known by the buyer because they were [fairly] disclosed during the due diligence process. This is in fact a qualification of reps & warranties, which could be interpreted (by way of example) as follows: the seller is liable for matters relating to the condition of the company under a warranty provided that those matters which may diminish the value of the target company or which may create damage to the buyer have not been disclosed to the buyer in a full and fair manner and in sufficient detail to enable the buyer to identify the nature and implications of the matter disclosed (fully and fairly disclosed).

Another example is qualifying reps & warranties by reference to the seller's knowledge. An example of such a clause would be: the seller warrants that, to its/his/her knowledge, the company is not in a position not to perform fully and adequately its obligations towards any of its contractual partners.

The above examples represent reps & warranties qualifications inspired by Anglo-Saxon law but operating under Romanian law with an important nuance. According to Art. 1708 para. (2) of the Romanian Civil Code, "a clause which removes or limits liability for defects is void in respect of defects which the seller knew or ought to have known at the time the contract was concluded". Therefore, Romanian law does not allow for a qualification of reps & warranties by reference to the seller’s knowledge (usually with respect to the object of the sale i.e. shares) to lead to the complete exoneration of the seller from liability for defects she/he/it knew or should have known, but at most to the exoneration from liability for defects she/he/it did not know (and - our addition - was not obliged to know).

In addition, according to the Civil Code, the guarantee for hidden defects also applies when the goods sold do not correspond to the qualities agreed by the parties (Article 1714 of the Civil Code). In other words, the parties can contractually agree that certain characteristics of the target company are "agreed qualities", with the consequence that the limitations agreed by the qualifications in reps & warranties will be removed (or rendered ineffective) by the mandatory provisions of the Civil Code which oblige the seller to be liable for hidden defects even if she/he/it was not aware, but should have been aware of them. The qualification of certain characteristics as "agreed qualities" is usually the result of the buyer's insistence, precisely to obtain the impossibility of exemption from liability for defects which the seller knows of or ought to have known of.

How can such a legal provision be handled from the seller's perspective in the SPA? We believe that full and fair disclosure of all information concerning the target company prior to signing the SPA is the most effective way to limit the seller's liability, as the buyer will not be able to raise a claim for a defect which was made known (or is considered to be made known) in the context of the due diligence process. It should be noted here that the notion of "knowledge of the buyer" is again debatable, as its content can be contractually defined (e.g. it can be the actual knowledge of certain persons in the buyer's management or in the transaction team). If, however, the buyer insists on retaining the right to compensation for a defect that has been disclosed to her/him/it, the parties may discuss whether to introduce into the contract an indemnification mechanism or additional obligations for the seller to remedy the known defect before or after the transaction is completed.

The content of the list of reps & warranties is brough forward in light of the buyer's business requirements and negotiated to match the level of warranty the seller is willing to grant. This list must always be seen by the seller in the context of the contractual provisions as a whole, in particular by reference to the definitions assigned to the concepts of "disclosed", "buyer's knowledge", "seller's knowledge". The final version of the clauses on reps & warranties must however lead to contractual balance, since only such a context is likely to create the premises for voluntary performance of obligations.

[1] Robert F. Bruner, Applied Mergers and acquisitions (Wiley 2004), p. 641. [2] Ibid, p. 769.

M&A Concepts: Intro

LegalBrain aims to produce a short series of articles on the use of the most common Anglo-Saxon law concepts in company acquisitions under Romanian law. What do "reps and warranties", "indemnities" or "limitation of liability" mean and how can they be understood in the light of Romanian law? How do these contractual provisions work and what purpose does each of them serve? In the series of articles "M&A Concepts", we will try to address each of these elements from the perspective of the Romanian entrepreneur (or - to use another term - business owner), who is considering selling his/her business and wants to clarify these notions before entering negotiations with potential buyers (often much more experienced in this kind of transactions).

The term "M&A"/ "mergers and acquisitions" often refers to the sale of shares/stocks or, in simpler terminology, sales of companies. In Romania, for the sale of companies, standard industry models of sales contracts inspired by Anglo-Saxon law (or in some cases, even governed by English law) are used i.e. "sale purchase agreements" or "SPAs". Some of the concepts used in M&A in English law can be found in Romanian civil law, but others require contractual technique to supplement the clarity provided by the (mandatory) case law in English law. The need to understand these standard concepts is particularly acute for those who are in the process of selling their business.

The sale of shares is governed by the Civil Code (as a general law) as well as by Company Law 31/1990 (as a special law). Therefore, the contractual freedom provided for by civil law also applies to M&A transactions, the parties having the possibility to include in their voluntary agreement any provision, within the limits imposed by law, public policy, and morality (art. 1169 Civil Code).

The Civil Code contains concepts similar to the most popular M&A concepts in Anglo-Saxon law. By way of example we could mention: (i) reps and warranties, which can be equated with the seller's warranties (title warranty and warranty for hidden defects) protecting the buyer against losing the title over the purchased asset and against potential defects in the asset being sold (defects of which the buyer was unaware at the time of sale); (ii) limitations of liability are equivalent to the conventional limitations of liability in Romanian civil law, including the nuance that the seller's liability cannot be excluded or limited by contract for material damage caused by an intentional or grossly negligent act - art. 1355(1) Civil Code).

Other concepts do not have such a clear counterpart, such as the qualification of warranties by reference to the knowledge (actual or constructive) of the seller. While in Anglo-Saxon law, the qualification (limitation) may be given by full and fair disclosure (a concept clearly explained in case law), in Romanian law the clause that removes or limits liability for defects is void in respect of defects that the seller knew or should have known at the time the contract was executed - art. 1708(2) C. civ. But what does "should have known" mean? Certainly, the case law of the Romanian courts has also touched on this subject, but without the certainty that in a future case, the solutions given previously will be repeated (with some limited exceptions, the case law in Romanian law being binding only on the parties involved in that dispute).

We will deal separately with each of these concepts typical of M&A transactions in order to try to find their correspondence in Romanian law and to discuss the problems that may arise in their practical interpretation.

New European case law in Towercast

The ECJ has decided that “the prohibition of abuse of a dominant position laid down by the Treaties permits an ex-post control, at national level, of a concentration of undertakings with a non-Community dimension” [1]

In other words, the point of view adopted by Advokate General Kokott in her Opinion – which we have discussed here – has been generally adopted by the European Court of Justice (the “ECJ” or the “Court”).

In brief, in its decision dated 16 March 2023 issued in Case C‑449/21 (the Towercast Decision), the Court notes the following:

1. The fact the EU Merger Regulation[2] constitutes a “one stop shop” for assessing concentrations within the EU ex ante (meaning prior to their completion) does not preclude Art. 102 of the TFUE from being applied by national competition authorities to concentrations which lead to an abuse of dominance ex post (meaning after they have completed) on national markets;

2. The fact the respective concentration has led to a consolidation of the acquirer’s dominance on the relevant market is not automatically equivalent to finding that an abuse of dominance has occurred. Abuse of dominance following the concentration has to manifest at least in the sense that “the degree of dominance thus reached would substantially impede competition, that is to say, that only undertakings whose behaviour depends on the dominant undertaking would remain in the market”.[3]

3. As regards the temporal effects of the Towercast Decision, the Court has clarified once again that, as a rule, its interpretation of European law produces effects for situations occurring prior to rendering of new case-law and that such effects shall be limited only for future situations only if: (i) “those concerned must have acted in good faith”; and (ii) “there must be a risk of serious difficulties” in implementing the new case law to the old facts.[4] In Towercast, the Court found none of the two cumulative conditions to be applicable.

This new case-law casts a brand-new light on how mergers and acquisitions need to be assessed from a competition law perspective by counsels and parties looking at such transactions. Assessing a proposed merger or acquisition from the perspective of notification requirements is quite straightforward and clear. How about doing an assessment by looking at what the completion of the transaction will generate – abuse of dominance by any chance? Because if this is the case, then potentially the transaction could be challenged both by the national competition authority and by competitors looking to gain benefit from such transaction being wound up. Practice will tell.

[1] ECJ press release on Towercast Decision: https://curia.europa.eu/jcms/upload/docs/application/pdf/2023-03/cp230046en.pdf [2] Council Regulation (EC) No 139/2004 of 20 January 2004 on the control of concentrations between undertakings (the EC Merger Regulation). [3] The Towercast Decision, para. 52. [4] Idem, para. 57.