Insurance for Your Deal: Representations and Warranties

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Clik here to view.Insurance is always something to be desired in most situations. Be it automobile, health or home. However, insurance is also a large piece of importance when discussing business transactions in the urgent care field.

Jim O’Sullivan, partner with Tiffany and Bosco says that representations and warranties in a transaction, essentially are a series of promises that the parties make to each other. He says in a sense, they are part of the parties creating a form of private insurance and are probably the most heavily negotiated pieces of a transaction.

“Really, what it involves most fundamentally, is an allocation of risk. The risk that something might happen or might not happen,” O’ Sullivan says.

Alice Gosfield, attorney and owner of Alice G. Gosfield and Associates says representations and warranties are different kinds of provisions in a contract.

“A Representation is an inducement to the other party to enter into a transaction,” Gosfield says.

“Typical representations will be things like the entity has been dually authorized throughout its existence necessary for it to conduct its to conduct business as it has; the practice has maintained all of the licenses and approvals that are business.”

O’Sullivan says these portions of a transaction are so heavily covered because the seller is looking for peace of mind once the transaction has taken place and the business is in the buyer’s hand.

“The seller is just going to collect their money and not have to wake up at night worrying about the business anymore. Conversely, a buyer is concerned about the idea that if they don’t ask the right questions or get the right promises, that they could wind up with some unperceived difficulties with the business that happen on the buyer’s watch and end up on the buyer’s nickel,” O’Sullivan says.

According to Gosfield when examining representations and warranties, the first thing to do with the representations and warranties is to make sure they say “to the best of our knowledge.” Gosfield says this is important because one of the things they will ask you to represent and warrant if you are the seller is that you have been in compliance with the law meaning Stark, Anti-kickback, false claims, and other regulations.

“There are some that are considered to be essential or fundamental representations and warranties, and there are others that may be a little bit more peripheral, and there may be some that are specific to a particular industry. The more fundamental ones tend to be that the people representing own the business and in fact are the ones who owns the business and nobody else has claim to a portion of the business or a portion of the sale proceeds. Also looked at are the taxes, tax returns paid timely and that taxes owed by the business have been paid. Mostly, it’s that the transaction has been properly authorized and that nobody is going to claim later on that it wasn’t,” Gosfield says.

Vanita Spaulding, managing director of Cogent Valuation agrees on paying attention to regulatory issues and says in order to avoid Stark and Anti-Kickback charges/fears, a representation and warranty should indicate that the Seller has not paid or accepted any funds for any unlawful payments, gifts or entertainment, or that no person authorized to act on behalf of the Seller has accepted or received any payments, gifts, or entertainment that would be in violation of Stark or Anti-Kickback regulations.

O’Sullivan adds that some of the biggest factors in representations and warranties are financial records.

“The business will represent it’s economic performance, not only in terms of billing, but in terms of revenues, in terms of its liabilities. Those tend to be the essential ones,” he says.

Spaulding agrees that one of the areas to take great care is in the representation and warranty statement regarding financial statements.

“A typical representations and warranty statement might be “The “Seller’s” financial statements fairly present the financial condition of the Seller, and are prepared in accordance with generally accepted accounting principles “GAAP”. Only say they are GAAP if they really are, and your auditor agrees,” Spaulding says.

“Saying that the financial statements fairly represent the financial condition of the company may be challenged by the buyer down the road if the future financial conditions of the company change for the worse. The Seller should be very careful about suggesting what the future of the company will be. Your crystal ball might be better than mine, but they are almost always a bit cloudy.”

O’Sullivan says there can be environmental law issues based on the business; there can be employment law issues.

“Some of the really critical ones we see in the world of healthcare are that the business has been in compliance with the applicable laws, most commonly relating to billing and reimbursement practices for services,” he says.

O’Sullivan says to think of a representation as essentially, a promise that is about some aspect of a business. A warranty is essentially the insurance policy that gives the buyer certain rights relative to enforcing that representation. As far as a time frame for the warranties, O’Sullivan says it depends on the nature of the representation that is made.

“Some basic one like the ownership of the business, the fundamental of representations and warranties, do authorization to be able to sell the business or sell its ownership, assets. Those tend to run longer and sometimes things that involve any intentional misrepresentation or fraud, will run indefinitely. Many times there will be a period that is tied to the applicable statute of limitations; and then in other circumstances, seeking to essentially limit it,” O’Sullivan says.

Spaulding says that a breach of representations and warrantees can cause the ultimate purchase price to change in a transaction, can cause the purchase to fail; and can cause litigation to ensue.

“These events can cost significant time and money. Given how problematic and potentially devastating a breach of reps and warranties can be in an M&A transaction, great care should be taken in drafting the purchase agreement, which is where the reps and warranties are generally organized,” Spaulding says.

Spaulding adds that even something as simple as a statement that the seller enjoys a good employer-employee relationship could be problematic if that condition is not exactly true.

“Since one of the valuable assets of a business is its established workforce, a loss of workforce immediately before or after the sale would diminish the value of the business, and could lead to a claim that the seller breached this representation,” Spaulding says.