Liability for representations and warranties concerning the condition of the company in a corporate sale

Making false representations about the state of tax liabilities of a company being sold may make it necessary to cover the buyer’s losses, even years after the transaction.

In today’s practice for acquiring shares in companies, a huge role is played by the seller’s representations and warranties as to the condition of the company being sold. They ensure the equivalence of the consideration provided in the transaction, meaning that in buying the shares, the purchaser acquires a company possessing certain assets and liabilities in exchange for a price reflecting the value of the company being acquired. The price is established by the parties on the basis of an assessment of the value of the assets and liabilities, as well as based on representations and warranties as to the legal, financial and commercial situation of the entity. A failure of any of these key elements, for example a false representation of the state of the company’s obligations, upsets the equivalency of the consideration provided and leads directly to the seller’s liability.

Obviously, not every violation of the representations and warranties by the seller will immediately result in the seller’s liability. Generally the parties regulate this in some way so that the seller’s liability arises only when the false representation causes negative consequences for the company sold: a reduction in the value of the company’s assets, an increase in its obligations, or the need to incur additional costs.

Our law firm encountered such a situation in a lawsuit filed against the seller of shares in a company. Among other representations and warranties, the seller had declared that there were no grounds for disputing the company’s tax settlements. But three years after the transaction, the tax authorities began a tax audit covering the period prior to the date of the sale of shares, as a result of which certain tax differences were assessed for repayment by the company and these amounts were seized in enforcement proceedings.

As of the date of the ruling, the tax proceeding had been completed, but proceedings were still pending in the administrative court. This did not prevent the court from upholding the buyer’s claim and ordering the remedy agreed by the parties in the sale contract consisting of an obligation to cover the losses suffered as a result of the untrue representation in the sale contract.

Under the guarantee-like nature of this liability, the sanction for making representations not consistent with the law is to charge the buyer with the risk of a shortfall in the assets of the company being sold. Consequently, when the tax authorities found that the company’s tax settlements were inconsistent with the representations and warranties, the risk of negative consequences of this condition passed to the seller, and the buyer’s claim was therefore upheld in its entirety.

According to the court’s reasoning, the relief was granted because the buyer had paid the price for the company corresponding to the value of the company determined on the basis of the seller’s representations and warranties. Thus the seller could enjoy the proceeds and should provide the buyer equal consideration, enabling the buyer to enjoy the full value of the company it acquired. As that did not occur, the judgment of the court equalised the mutual consideration provided by the parties to the transaction.

Jan Ciećwierz, Dispute Resolution & Arbitration practice, Wardyński & Partners