Often referred to informally as “reps and warranties“, these concepts are fundamental to commercial contracts of any kind, including share purchase agreements and business sales. Knowing the difference – and the consequences of breach – can help you navigate even the most complex agreements and contracts.
What is a warranty?
In legal terms, a warranty is a contractual promise – a term of the contract itself- that a particular fact or condition is true. That said, it can relate to current and/or future conduct and/or facts.
A good example of the former is: ‘the Supplier warrants that it has sufficient Stock to fulfil the Distributors’ Orders in connection with this Agreement’. Contracts for the sale of goods often contain additional warranties about the condition, fitness, or adherence to a given specification.
With the latter, in a services context, a frequently used or sought warranty is: ‘the Contractor will perform the Services with reasonable care and skill.’
Warranties are also used frequently in the purchase of businesses. A seller of shares would almost certainly warrant something along the lines of: ‘The Sale Share constitutes the whole of the allotted and issued share capital of the Company and is fully paid or credited as fully paid.’ It can get more complicated, depending on the contract. For example, warranties in a Share Purchase Agreement are typically broken down into warranties of quality (of the company) and warranties of reasonable care (that certain figures may not be precisely true, but care has been taken to make sure that they are). If the figures were wrong, a claimant would have to demonstrate that reasonable care was not taken in getting the correct figure and/or it was otherwise reasonable to provide that figure in the context of the sale.
A breach of warranty gives rise to a claim for breach of contract – the main remedy being an award of damages. In England, an award of damages is to compensate for loss. Therefore, a breach of a warranty asserting that a good was in proper condition, but it was not, would entitle the claimant to (potentially) replace the good or to get it fixed. Another way this can be assessed is diminishment in value.
What is a representation?
In legal terms a representation, like a warranty, is a pre-contractual statement of fact but is one which is made during contractual negotiations so that it induces another party to enter into a contract. While representations are usually made prior to the contract they are often repeated and therefore form the basis of a contract.
Prior representations that are not incorporated into the contract are not actionable in contract law. However, the parties must themselves contract for one to bring an action in respect of a representation.
There are three types of action if a representation is untrue (discussed in more detail in our article here):
- Fraudulent misrepresentation: occurs where a representation is made, it is false, and the representor made it knowingly and recklessly as to the truth.
- Negligent misrepresentation (pursuant to the Misrepresentation Act 1967): occurs where a false representation is made by a representor without care or without reasonable ground for belief in its truth.
- Innocent misrepresentation(pursuant to the Misrepresentation Act 1967): where a false representation is made by a representor where it had reasonable grounds for believing in its truth
So, what is the difference between representations and warranties?
The key difference between a representation and a warranty is the remedy available to the innocent party when there is a breach. If a warranty is found to be untrue, the innocent party will be entitled to damages. A breach of warranty does not allow the innocent party to rescind the contract, which would effectively set it aside and put the parties back in the position they were in before the contract was made; a an action in respect of a representation, however, may.
As a warranty is a term of the contract, normal breach of contract considerations apply as set out above.
In contrast, if a representation is found to be untrue the innocent party will be entitled to bring a claim for misrepresentation, as above.
Where a false representation is made fraudulently, the claimant can be awarded tort damages, which differ from contractual damages, in that there is no ‘remoteness’ bar (see our article on remoteness here).
The assessment of damages, in essence, differs because the innocent party will not have to prove that their losses were in the reasonable contemplation of the parties at the time the relevant contract was entered into. Instead, the losses must be “reasonably foreseeable”, which has been held by the courts to be a less onerous test than the test associated with a breach of warranty claim.
The manner in which damages are calculated also differs for a breach of representation claim versus a claim for breach of warranty. Under a claim for breach of warranty, damages are usually assessed at the time of the breach. Under a claim for breach of representation, damages are assessed from the date the misrepresentation was made. This is usually an earlier date and so may give rise to a higher level of damages.
A successful action for fraudulent misrepresentation would also entitle the claimant to rescind the contract (obtain rescission).
A representation made negligently would entitle the claimant to tort damages and rescission, but the Courts have the power to award damages ‘in lieu’ of rescission, meaning that the obligations of each party under the contract continue.
A false representation made innocently only entitles the successful claimant to recession, but the Court does have the discretion to award damages instead.
Given the potential to rescind the contract and the wider scope for damages, it is generally more advantageous for a party to be given representations rather than warranties. However, whether or not a party can insist on this will depend on the bargaining strength of both parties and the type of contract on the table.
Can warranties also be representations?
If you are familiar with contracts, you may have seen wording such as “the seller represents and warrants…”. Where the wording is clear cut, it is likely that the court will view the statement as both a representation and a warranty. However, where the wording does not expressly provide that a warranty is to take effect as a representation, an innocent party will struggle to argue that the warranty is also actionable in misrepresentation.
Take the case of Sycamore Bidco Ltd v Breslin [2012] EWHC 3443 (Ch) as an example. In this case, the Court held that various warranties in the share purchase agreement, which were not expressed to be representations, could not be representations.
The case of Idemitsu Kosan Co Ltd v Sumitomo Co Corp [2016] EWHC 1909 (Comm) further reiterated this point. Here, the Court concluded that it was not enough that the subject matter of the warranty was capable of being a representation; there was no representation because there was no express provision to that effect. The fact that the agreement contained an entire agreement clause also made it clear that any pre-contractual understandings, communications or representations had not been relied upon or had been withdrawn before completion.
The role of entire agreement clauses
The Indemitsu case also highlights the practice importance of the entire agreement clause. In that case, the share purchase agreement contained an entire agreement clause confirming that the buyer had not relied on, or been induced to enter the share purchase agreement by, any representations other than those expressly set out in the agreement. Even if the buyer’s primary argument (that warranties could also be representations) had succeeded, the entire agreement clause would have defeated the claim.
An entire agreement clause is a standard feature of most commercial contracts. From a contracting party’s perspective, it can limit exposure to pre-contractual representations that might otherwise give rise to misrepresentation claims.
However, it is important to consider whether the entire agreement clause properly limits liability for misrepresentation. In Al-Hasawi v Nottingham Forest Football Club Ltd [2018] EWHC 2884 (Ch), the court found that the traditional wording of an entire agreement clause: ‘(This agreement (together with the documents referred to in it) constitutes the entire agreement between the parties and supersedes and extinguishes all previous discussions, correspondence, negotiations, drafts, agreements, promises, assurances, warranties, representations and understandings between them, whether written or oral, relating to its subject matter‘ did not exclude liability for misrepresentation. A ‘non-reliance’ clause is required for this purpose.
Either way, contracting parties should be aware that liability for fraudulent misrepresentation cannot be excluded.
How do indemnities differ from warranties and representations?
Representations and warranties are frequently accompanied by a third contractual mechanism: indemnities. An indemnity is a promise by one party to reimburse the other for a specific loss, regardless of whether that loss flows from a breach of contract.
The key practical distinction is how losses are recovered under an indemnity as opposed to a breach of contract. Under a straightforward breach of warranty claim, the usual rules around damages will apply: the innocent party must prove loss, demonstrate that it was not remote and is altogether under a duty to mitigate its loss. These are inherent protections for defendants. Under an indemnity, it is arguable, that these protections do not apply. Recovery under an indemnity tends to be higher, and parties frequently seek to argue that recovery should be on a pound-for-pound basis – meaning the beneficiary of the indemnity is made whole for the full amount of the specific loss.
Conditions versus warranties: what is the difference?
Above we noted that a warranty does not entitle the innocent party to terminate the contract. The phrase ‘warranty’ also has a wider use in contract law, in that a warranty is a specific type of contractual term that does not entitle the innocent party to terminate if it is breach of a warranty, because a warranty is a secondary aspect of the contract.
This is to be contrasted with a contractual term that is classified as a ‘condition.’ A condition is typically described as a term that is essential to the contract – if it is breached then the contract has no or much less purpose. A breach of a condition gives the innocent party the right to terminate the contract (or not) and claim damages.
Further: the courts have come up with a middle ground – an intermediate term. These will be most terms of the contract. The consequence of a breach of an intermediate term depends on the effect. If the breach of an intermediate term deprives the innocent party of substantially the whole benefit which it was the intention of the parties as expressed in the contract that it should obtain, then the innocent party will obtain the right to terminate the contract and claim damages.
Representations and Warranties – final thoughts
EM Law’s commercial contract and corporate lawyers advise on representations, warranties and indemnities across a wide range of transactions – from services contracts to share purchase agreements and business acquisitions. If you have questions about representation and warranties, disclosure obligations, or how to structure indemnity protection in your contract, please contact Neil Williamson or Colin Lambertus, or visit our Contract Lawyers and Corporate Law pages to find out more.
