|

Revisiting Representation and Warranty Clauses

Clauses related to representations, warranties and indemnifications are widely negotiated clauses of commercial contracts especially in M&A transactions. The interests of the parties to a contract typically do not align with respect to the representation and warranties clause of the contract, which usually comprises a major chunk of the agreement. In M&A transactions, while the seller would potentially like to tighten the scope of the representations and warranties and reduce the potential for inaccuracy and claims of breach, the buyer on the flip side wants the broadest set possible to insulate itself from risks. The representations differ case to case, based on particulars such as size and nature of the target company, stake being acquired, type of investors and the risk appetite of the parties involved. Representations and warranties are typically backed by an indemnity from the party providing them. Thus, the party may be liable for an indemnity claim by the counter-party for a breach of such representations and warranties.

Given the importance of representation and warranty clauses in all commercial contracts, in this article we will be looking into the position of Representations and Warranties under Indian and foreign law as well as the distinction between Representations and Warranties.

Representations

Representations are assertions which the parties to an agreement make to each other which shield the contracting parties from any misgivings related to the transaction. Representation can be defined as ‘a presentation of fact either by words of by conduct, made to induce someone enter into a contract’. Representations can be explicit or implied and apply to either a past or present fact.

The Indian Contract Act, 1872 (“ICA“) does not define the word ‘Representation’; however, it does define what a misrepresentation is. It classifies misrepresentation in two – fraudulent misrepresentation (intent to deceive) and innocent misrepresentation (no intent to receive). This classification is crucial as the remedies available are different for both. In a misrepresentation where there was no intent to deceive, the counter party gets the right to claim damages, however, the right to repudiate the contract is subject to whether the misrepresentation could not have been discovered with ordinary diligence. On the other hand, fraudulent misrepresentation bestows upon the innocent party the right to claim damages and repudiate the contract. However, the right to repudiate the contract does not arise in a case where the misrepresentation was not an inducement to the contract for the innocent party.

While the ICA defines fraud amongst others things as the active concealment of a fact by one having knowledge or belief of the fact, very interestingly the ICA also provides that mere silence is not fraud, unless there is a duty to speak. Therefore, there is no obligation on the parties to disclose unless there exists a legal duty to disclose. In fact, the law places the burden on the buyer to be aware and conduct an ordinary due diligence i.e. caveat emptor principle – buyer beware. In the case of Shri Krishnan v. The Kurukshetra University, the Supreme Court of India confirmed the principle that mere silence is not fraud. However, it may be noted that the ICA distinguishes between ‘mere silence (passive concealment)’ and ‘active concealment’ which courts can determine on the basis of a factual enquiry.

Warranties

A warranty is a promise that a condition or an assertion of fact is true and is typically supported by an implied promise of indemnity if the condition or assertion is false. A warranty may apply to the present and future. A warranty is a contractual statement that a condition is, and/or will be, true when made and/or for a period of time, often for the term of the agreement. Once again, the term ‘Warranty’ is not defined under the ICA. One common example of a warranty provided by parties in commercial contracts is with respect to infringement of intellectual property. A service provider will warrant that the deliverables/ work product provided will not infringe the intellectual property rights of a third party.

Distinction between Representations and Warranties 

Conceptually, ‘representations’ and ‘warranties’ are different; however, in practice, they have often been bundled together and used interchangeably. This is especially true in India, where the terms have not been defined under the ICA, thereby leaving room for ambiguity. However, the two terms are separate and distinct from each other having different characteristics and also different remedies under law for breach of the same.  Understanding the differences between the two and using them appropriately is essential to ensure that a contract is well drafted and the interests of both parties well protected. 

Clarity from Foreign Jurisdictions.

The theoretical distinction between representations and warranties can be understood from English law. A representation is basically an assertion of a past or existing fact, true on the date that it is made. It is generally given to induce another party to enter into a contract. A warranty on the other hand, is similar to a representation but it refers to the present or future i.e. a present or future promise of a fact. Further, it is not the basis for inducing the other party to enter into the contract. 

One of the utmost essential differences between Representations and Warranties, is the remedies available to the parties in case of a breach. In case of a breach of warranty, the non-breaching party has the right to claim damages in accordance with the principle of restitution. On the other hand, a breach of representation (misrepresentation) gives the innocent party a right to terminate the contract and also claim damages on the basis of the principle of restitution. Furthermore, the amount of damages one can claim also varies significantly in a claim of misrepresentation vis a vis breach of warranty as the principle of remoteness of damage and the relevant date from which damage is assessed, operate differently under both the concepts.

Since the remedial rights arising out of the two are completely different, it is critical for contracting parties to draft them carefully in their contract. In the case of Idemnitsu Kosan Co Ltd v Sumitomo Co Corp, the Court was faced with the question of whether warranties can be actionable as representations. The Court answered in the negative and held that representations and warranties are different. To determine if something is a warranty or a representation, parties’ intention reigns supreme.  

Indian Law

As already pointed out above, the ICA which is the statutory law on contracts in India, does not define ‘representation’ and ‘warranty’. In fact, the word warranty does not see mention in the statute. This raises the obvious question about whether Indian law distinguishes between representations and warranties in normal contracts. 

It is clear however that Indian law does distinguish between warranties and representation in relation to certain specific contracts. These contracts are those contracts which relate to goods or services which qualify as ‘Goods’ under the Sale of Goods Act, 1930 (“SOGA“) The SOGA defines the term ‘warranty’ under its framework. Warranties under the SOGA have been defined as a stipulation, collateral to the main purpose of the contract, meaning warranties are stipulations that do not touch upon the heart of the contract and are in some way secondary to the main purpose of the contract. In the case of All India General Insurance Co. Ltd. and Anr. v. S.P. Maheswari, the Madras High Court, in the context of insurance contracts, recognized the two different terms and the difference in the remedies for a breach of either. The Madras High Court states that “The duty of disclosure comes under two heads, viz. (i) representation and (ii) warranties: representations which are made the basis of the contract and those which do not constitute the basis of the contract of insurance.”

Further the court holds “Therefore the main distinction between representation and warranty is that as a general rule answers to questions are representations and not warranties, though it is possible for persons to stipulate that answers to certain questions shall be the basis of the contract, in which case they become part of the warranties. In the case of a warranty materiality or immateriality of the fact warranted signifies nothing. Its incorrectness constitutes a defence to an action on the policy, even though it be not material and be made in perfect good faith. But, in the case of a representation, the insurer can avoid the policy only by proving that the statement is false and fraudulent or that it was false and material to the risk. In other words, it is only a material misrepresentation that can avoid a policy if the truth of the facts contained in the representations be not warranted by the policy.”

This distinction between representations and warranties adopted in the case of Life Insurance Corporation of India vs. Permanent Lok Adalat and Ors. The breach of a warranty gives rise to claim for damages but does not give the right to repudiate the contract. On the other hand, misrepresentation is defined under the ICA, and the remedies are provided therein. 

A simple illustration which beautifully sets forth the distinction between Representations and Warranties is as provided below:

A representation A warranty
is a statement statement or promise
of fact condition
that applies to the past or present present and future 
giving rise to remedies that may include right to void contract and claim damages claim damages

While Courts in India have demarcated the difference between representations and warranties in the context of insurance contracts, the same distinction has not been elucidated upon for other types of contracts. Most commercial contracts in India use language stating that the parties ‘represent and warrant’. Courts have often overlooked this formal distinction of words and have not dwelled upon whether an assertion is a representation or warranty merely from the words used.

LEAVE A REPLY