When acquiring a Luxembourg company, an unexperienced prospective purchaser could expect to benefit from a suitable level of protection pursuant to Luxembourg common law if it discovers, after completion, that the real situation of the purchased company does not match the flawless description thereof made by the seller(s) or, more generally, the prospective purchaser's legitimate expectations about the purchased company's situation, which led to the determination of its purchase price. However, this would be a serious mistake, as any seasoned M&A litigator knows that Luxembourg common law (droit commun luxembourgeois) unfortunately offers very limited protection to the purchaser of a Luxembourg company when, e.g., assets and/or liabilities of the purchased company appear to have been respectively overestimated or underestimated.
First, should a purchaser try to invoke a defect of consent (vice de consentement) — other than an incidental wilful misrepresentation (dol incident) — in connection with a share sale and purchase agreement, such purchaser would realize that it may only obtain a cancelation of the relevant sale, but not a purchase price reduction. Second, evidencing a defect of consent in connection with a share sale and purchase agreement is usually rather challenging as, for example, (a) error (erreur) may only lead to cancelation of a sale when it was joint (commune), substantial (substantielle) and excusable (excusable), (b) wilful concealment (dol) leads to cancelation of a sale only to the extent that the purchaser can demonstrate an intentional element (élément intentionnel) to the seller, which is usually very challenging to do, and (c) lesion (lésion) leads to cancellation of a sale only to the extent that the purchaser can demonstrate an obvious disproportion between the obligations of the parties, which needs to result from a party's abuse of the passion, weakness, inexperience, ignorance or needs of the other party. Third, common law guarantees applicable to sale (garanties de droit commun en matière de vente), such as the guarantee of eviction (garantie d'éviction) or the guarantee for hidden defects (garantie des vices cachés), are largely ineffective in share sale and purchase transactions as they apply to the object of the sale only, i.e., the shares and not the assets and liabilities that form the patrimony (patrimoine) of the purchased company. For example, the courts already considered on several occasions that, in a share deal, (a) a purchaser acquires shares and not the portion they represent in the assets and liabilities of the target or (b) a loss of value of a purchased company's assets or hidden liabilities does not qualify as hidden defects.
In light of the absence of sufficient protection of a purchaser under general Luxembourg law, practitioners — largely inspired by the common law countries' system — developed the contractual mechanism of R&Ws in share sale and purchase agreements. This was designed to enable a purchaser to be indemnified by the seller (or a third-party guarantor as applicable) from any loss or damage it would suffer if the situation of the purchased company turns out not to be as described in such R&W.1
In a nutshell, under Luxembourg law, representations (déclarations) in share deals could be defined as a series of assertions as to facts, true on the date the representations are made, that are given by a party to induce another party to enter into a contract or take some other actions. Warranties (garanties) could be defined as a grantor's promise of such representations to indemnify its beneficiary if the beneficiary proves false in all or in part. In other words, one could also say that R&Ws in share deals provide statements (representations) and security against loss (warranties) if the statements made are not true.
Under a Luxembourg-governed share sale and purchase agreement, R&Ws are predominantly given by the seller, because they include information about the purchased company, its assets and liabilities, its business activities, etc. However, the purchaser may also give, from time to time, some limited R&Ws to the seller, mainly with respect to its existence and legal capacity to enter into the share sale and purchase agreement or, as applicable, with respect to its financial capacity to pay the purchase price for the shares of the target.
As outlined by some eminent legal scholars, the seller's R&Ws have three key functions in any share deal. An "informative" function, a "preventive" function and a "curative" function. Pursuant to their "informative" function, the purpose of the seller's R&Ws is to describe the good legal, patrimonial, financial, economic and operational standing condition of the target as expected by the purchaser on the closing date. Pursuant to their "preventive" function, the purpose of the seller's R&Ws is to encourage the seller to provide the purchaser with information concerning the target, sometimes with much more detail than required or spontaneously disclosed during the due diligence process, if the target is not in such general good standing condition as expected by the purchaser. Why? This enables the parties to discuss openly the allocation of the risks affecting the target before signing and, when available, mitigation measures to take as soon as practically possible. Finally, pursuant to their curative function, the R&Ws offer protection to the purchaser after the closing date if the target was not in general good standing condition as expected by the purchaser and/or the seller did not deem relevant to inform the purchaser of certain risks affecting the company. Ultimately, the seller's R&Ws can occasionally be coupled with a walk-away mechanism to the benefit of the purchaser (or less commonly, the seller) in the case of a breach thereof appearing between the signing and closing date.
Given their functions, a buyer will want the seller's R&Ws to be as comprehensive as possible and to cover a very large range of topics, depending on the target's activities. Furthermore, if the target holds shares in other companies falling within the perimeter of the contemplated transaction, the buyer will want the seller's R&Ws to extend to such other companies wholly or partially held by the target, or at least to the subsidiaries of the target. The parties' legal advisers will have to ensure that the R&Ws agreed upon are in line with the nature of the activities and size of the target, based notably on the due diligence work performed by purchaser.
A seller, on the other hand, will be looking to (a) limit the number of R&Ws, as in the case of a (material) breach thereof, it will have to indemnify the purchaser for the resulting damage and (b) qualify/limit the scope of the R&Ws. The seller may qualify or limit the scope of the R&Ws in different (cumulative) manners, such as (a) by playing on/restricting their wording, (b) by providing that the R&Ws are only made to the "best knowledge of the seller" and by discussing the definition of such best knowledge accordingly, (c) by adding materiality thresholds in some R&Ws and/or (d) by limiting the scope of application of some R&Ws to operations and transactions outside the "ordinary course of business."
In addition, the seller will try to negotiate "disclosures" to the R&Ws, i.e., to ensure that, any time it may demonstrate that the purchaser was informed (or should reasonably have been informed) when entering into the agreement, that all or part of the R&Ws were incorrect. Therefore, the purchaser may not claim indemnification. In this respect, "disclosure" may be globally defined as information and documents made available to the purchaser when negotiating a share deal (a) about which the parties agree that they will constitute exceptions to all or part of the R&Ws, i.e., the purchaser may not claim indemnification for a breach of R&Ws if such a breach is based on the information or documents disclosed to it, and (b) to which certain R&Ws refer and must be provided by the seller. Their purpose is to inform the purchaser and to prevent the purchaser from making claims based thereon. They may be (a) specific, i.e., designed to limit/qualify only one or several specific R&Ws, or (b) general, i.e., designed to limit/qualify all R&Ws.
In this respect, the seller will usually propose that the data room (including Q&As) should be deemed (as a whole) as a disclosure to the R&Ws, whereas the purchaser will usually require a clear disclosure in the text of the R&Ws, a disclosure letter or, eventually, limited disclosure schedules. In any case, if the purchaser accepts the principle of the data room as disclosure (or disclosure schedules), it will usually take care to (a) exclude as disclosure any information that is only "referred to" in the share sale and purchase agreement or the data room, (b) only accept as disclosure information that is "fairly disclosed," i.e., disclosed in a readily apparent manner enabling any prospective purchaser to understand that one or several sellers' R&Ws are incorrect and (c) reasonably assess their adverse impact on the target. Finally, when risks were clearly identified during the purchaser's due diligence, the purchaser will require "specific indemnities" or "indemnities" for such risks, i.e., special R&Ws that will not be limited/qualified by the disclosures of the seller and usually not be limited in addition by any other limitations set out in the indemnification clause of the share sale and purchase agreement (which will be further discussed in one of our next newsletters).
1 It must be noted than under, e.g., the laws of England and Wales, "representations" and "warranties" are specific legal concepts, unknown under Luxembourg law. Basically, representations are statements made by a party (usually before signing, even if they can be repeated in the contract) to induce another to enter into an agreement, where warranties are a statement of fact contained in a contract. The key difference between "representations" and "warranties" under such laws is the remedy available to their beneficiary in the event of a breach thereof. The beneficiary of a "representation" may claim "misrepresentation" when it turns out to be inaccurate and may then be entitled to rescind the relevant contract. The beneficiary of a warranty may normally only claim for a breach of contract and damages when it turns out to be inaccurate, but not rescission of the contract. On the other hand, under US law, it is usually deemed that "representations" are statements on past or current facts, whereas "warranties" are rather promises about current or future facts. It is usually not the intention of the author of a Luxembourg-governed share sale and purchase agreement to refer to these foreign legal concepts when drafting such agreement in the English language.
