Is it worth risking inaccurate statements in the representations and warranties?
In transactions involving the sale of shares in companies in Poland, as well as agreements on sale of enterprises or significant assets, the representations and warranties of sellers are becoming more and more extensive.
The notion of representations and warranties was adopted from common law systems and has become part of Polish legal practice. Although they are not specifically regulated in the Polish codes, they are commonly used in transactions on the basis of freedom of contract.
Representations and warranties may concern both legal and financial aspects of the enterprise being sold. From the buyers’ perspective, it is particularly important to obtain assurances that the financial reports of the entity they are acquiring accurately reflect the true financial condition of the target. It should be borne in mind that indicators such as EBIDTA generally serve as the basis for valuation of an enterprise and in the parties’ negotiations are fundamental for determining the final sale price. It is thus not surprising that the contract will often require the owner of the enterprise or a controlling stake of shares to provide assurances that the balance sheet and the profit and loss account accurately reflect the company’s results and all of its material obligations as of the date of the transaction.
Liability for the accuracy of representations and warranties may be analysed in terms of both civil law and criminal law.
From the point of view of civil liability, it is important to determine whether the representations and warranties are given on the basis of fault or risk. If the latter, the seller’s liability will be unconditional, and the seller will not be able to release itself from liability by proving that it used due care in preparing or verifying the financial statements. In practice, it may happen that the owner does not serve on the management board or supervisory board of the company, and must make representations and warranties in reliance on information provided by the company authorities, accountants and auditors. Nonetheless, the seller is still contractually liable, and the effectiveness of recourse claims against the individuals guilty of negligence in such cases appears doubtful in practice. The scope of the seller’s liability will obviously depend on the nature and details of the transaction, but often it represents a significant proportion of the overall value of the transaction, resulting in an obligation to pay the buyer millions in damages.
In terms of criminal liability, there is no separate offence of making false representations and warranties. Nonetheless, making representations and warranties that do not reflect the true state of affairs may be viewed under criminal law as a species of fraud if the other party acts to its disadvantage in reliance on the representations and warranties. Making inaccurate representations and warranties concerning legal or financial circumstances material to the transaction involves creation of a false picture of reality, misleading the other party. Thus, if as a result of the inaccurate impression on the buyer’s part based on inaccurate representations and warranties by the seller, the buyer decides to acquire an enterprise or a stake of shares (which then proves to be a less favourable transaction than could be expected on the basis of the seller’s representations and warranties), there are grounds for a finding of fraud.
It should be pointed out, however, that making false representations and warranties may result in criminal liability only if it is proved that the seller knowingly and intentionally made false statements in order to induce the buyer to enter into an unfavourable transaction.
Nonetheless, it is increasingly common for businesses injured as a result of inaccurate representations and warranties to file a criminal complaint in addition to pursuing civil claims.
Dominika Stępińska-Duch and Paweł Mazur, Dispute Resolution & Arbitration Practice, Wardyński & Partners