Representations and warranties – remedies for the acquirer

Representations and warranties have been imported into Italian M&A law from US practice and are now one of the main aspects of almost any deal. As such provisions are not specifically regulated by Italian law, the status of representations and warranties and the legal remedies available in the event of an infringement have long been debated by academics and the Supreme Court. Significantly, most decisions in disputes arising from representations and warranties are the result of arbitration, as acquisition agreements commonly include arbitration clauses.

Two main theories have been advanced on the legal nature of representations and warranties. According to the first, the acquisition of interests in the corporate capital of a target constitutes an indirect purchase of the target’s business and assets. Consequently, representations and warranties should be regarded as promises about the qualities and characteristics of the target’s assets. On this interpretation, the rules on the sale of goods in the Civil Code apply.

Under the second theory, representations and warranties are not deemed to be promises given by the vendor to the acquirer, as the acquisition of the target’s interests is not an indirect sale of goods. Rather, the sole purpose of the acquisition agreement is to acquire interests in the target; the representations and warranties are merely a contractual obligation.

Legal remedies for infringement

In terms of the legal remedies available to an acquirer in the event of infringement, the two theories lead to different conclusions and have different litigation implications.

If the sale of goods rules are deemed to apply, they entitle the acquirer to sue the vendor pursuant to Section 1495 of the code in the event of misrepresentation by the vendor. This would give the acquirer the right to seek compensation for damages, termination of the agreement or a reduction in purchase price within the statutory limitation period (ie, one year from closing), provided that the acquirer informed the vendor of the misrepresentation within eight days of becoming aware of it. Although the parties may extend the eight-day term, the one-year statutory limitation cannot be modified by agreement.

Under the second theory, the one-year statutory limitation period and the eight-day term do not apply. On this analysis, in the event of a breach or misrepresentation, the acquirer may sue the vendor within the ordinary 10-year limitation period (as in the case of any other breach of obligation).

Safeguards to add and mistakes to avoid

Neither the legislature nor the Supreme Court has definitively resolved the issue. Therefore, in the event of a dispute arising from a misrepresentation or breach, both vendor and acquirer are subject to the decision of the courts, which may choose which theory to apply.

Therefore, it may be useful for the acquirer to adopt certain precautions when drafting an acquisition agreement, taking into consideration the possibility of future litigation in the event that the representations and warranties are infringed.

Among other things, an acquirer may:

expressly state that the purchase of the interests and assets to which the representations and warranties relate is only a partial performance of the deal. Such a provision seeks to prevent the representations and warranties from being characterised as qualities of the target’s goods;

expressly exclude the application of Section 1495 of the code. The aim of such a provision is to clarify the intention to identify the representations and warranties as contractual obligations (rather than promises about the qualities of the target’s assets), and to make any subsequent legal action by the potential acquirer subject to the ordinary 10-year statutory limitation period (rather than the shorter one-year period);

provide a contractual indemnity procedure, other than the legal remedies set forth by the applicable law, as a basis for the application of the ordinary 10-year statutory limitation period; and

exclude the eight-day term for informing the vendor of the breach or misrepresentation, and stipulate a longer term. This will have the effect of extending the term even if the judge applies the sale of goods rules (and therefore the shorter limitation period).

In addition, other measures (eg, an exclusive remedy clause) may be included in the acquisition agreement, depending on the acquirer’s specific needs.

Court ruling on consequences of infringement

On August 26 2011 the Court of Milan issued a judgment concerning the legal regime applicable to the infringement of representations and warranties clauses in a stock purchase agreement.

The court stated that in the context of a stock purchase agreement, Section 1495 does not apply where the parties agree to a set of indemnity clauses which expressly fix “specific, detailed and exhaustive regulations” on the terms and conditions that govern:

indemnity payments by the vendor; and

any other means to enforce the relevant remedies (provided in favour of the acquirer) in the event of the infringement of representations and warranties.

M&A practitioners and other professionals generally acknowledge that the one-year statutory limitation does not give an acquirer adequate legal protection, in view of its real indemnification needs in an M&A transaction. Therefore, the court’s judgment is largely welcome, as it clearly acknowledges that parties may include specific indemnity regulations for infringement of representations and warranties, to be applied in lieu of the Section 1495 provisions. In so doing, it recognises the clear and unquestionable contractual autonomy of the parties in such matters.

In the case before the court, the vendor and the acquirer had agreed to a detailed indemnity procedure in the event of misrepresentation in relation to the target’s assets and financial position. For example, the procedure required the acquirer to send the vendor a claim notice within 30 days of receiving claims from third parties. If the vendor rejected the claim notice, the procedure required the parties to attempt to settle the disagreement in good faith.

The court stated that this indemnity procedure reflected the actual needs of the parties, and although such procedure was incompatible with the legal framework of Section 1495, the court allowed for the possibility of derogating from this regulation. The court stated that the contractual indemnities agreed by the parties prevailed over the Section 1495 regulations and declared that the two terms for which that section provides (ie, the eight-day and one-year terms) were inapplicable in this case.

Comment

The court’s decision lends weight to the view that in order to give an acquirer the greatest possible protection, it is advisable to draft provisions on indemnity clauses as accurately as possible. In respect of representations and warranties, this will clearly demonstrate to the courts the parties’ intention to establish an indemnity scheme other than that set forth in Section 1495.

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