Introduction

This report summarizes a presentation by Dennis Spector regarding the concept of representations and warranties in the context of selling a company. The discussion covers the contractual obligations that sellers agree to, the importance of due diligence, and the role of warranty insurance to mitigate risks associated with these representations.

Key Topics Discussed

1. Definitions and Importance of Representations and Warranties

• Representations and Warranties: These are statements made by the seller in a contract when selling a company. They can range in complexity and length, typically being between 40 to 400 pages, inclusive of various schedules.
• Components: Sellers must verify and guarantee a multitude of elements, including:
  • Ownership of the company stock.
  • Absence of liens or encumbrances affecting the stock.
  • Compliance with tax obligations.
  • Accuracy of warranty expenses and indications of any unexpired warranties.
  • Ownership and operational status of listed machinery.
  • Disclosure and explanation of significant relationships pertinent to employment contracts.

2. Due Diligence Process

Due diligence involves a thorough examination of a company’s legal and financial standing prior to the sale. Ensuring that all representations and warranties are complete and accurate is crucial to avoid disputes post-sale.

3. Warranty Insurance

• Representation Warranty Insurance: A common practice for companies undergoing transactions valued between $25 million to $30 million, where the cost of warranty insurance typically ranges from $200,000 to $250,000.
• Functionality: This insurance serves as a safety net, covering potential issues that arise after the sale. Similar to auto insurance, it alleviates financial strain if a problem occurs.
• Agreement Splits: Generally, the first portion of any claims (often the first $50,000) is shared between the buyer and seller, emphasizing the importance of trust and cooperation post-sale.

4. Duration of Representations and Warranties

Most warranties are effective for a period of 12 to 18 months post-transaction, with exceptions known as "fundamental warranties." These fundamental warranties include assurances of rightful ownership of stock and the assurance that the stock is indeed of good standing, akin to a title policy in real estate transactions.

5. Case Example and Lessons Learned

Dennis shared a case where a terminated employee caused a significant penalty related to workman’s compensation insurance, which was discovered after the 18-month warranty protection period had expired. This incident reinforced the need for diligent monitoring of contractual obligations and the potential risks involved in overlooking details.

Advice to Clients: Dennis emphasized the importance of honesty and thoroughness in any transaction, stating that "you can't sign a contract with a dishonest person." He encouraged clients to document all agreements meticulously.

Conclusion

Representations and warranties are critical components of a business sale that require careful attention and understanding from both buyers and sellers. The use of warranty insurance can act as a protective mechanism for unforeseen liabilities post-sale. Dennis Specter's insights underline the necessity of due diligence and the formulation of clear, honest contracts to safeguard interests throughout the transaction process.

Next Steps

• Clients and stakeholders involved in company sales should consult with legal and financial advisors to fully grasp their representations and warranties and how they can protect their interests through appropriate insurance and meticulous documentation.