More Representations and Warranties
I wrote a post in 2021 about an important part of many commercial agreements: representations and warranties. More than five years later, having read hundreds more of these clauses, I’d like to share additional thoughts.
A plaintiff may be upset to learn that a defendant’s representation was false or that an event the defendant warranted wouldn’t happen came to pass. But justifying litigation could still be difficult. A court may say “so what?” when a plaintiff complains only about a broken promise. What tangible harm did the broken promise cause? Establishing the resulting financial costs may take a lot of legal hours. If the contract had also included a fee-shifting provision where the losing party in a case pays the other’s legal fees, the plaintiff could have used this provision to threaten a costly lawsuit—even for nominal damages—as a mechanism to enforce compliance.
Some contracting parties believe that they can insert a “penalty clause,” which would require a punitive payment if a promise is broken. Courts, however, often do not enforce these clauses.
It can be hard to predict how much money a party should pay for a breach of representations or warranties in a contract. Parties usually limit their exposure by writing into the contract a liability “cap” or maximum amount of money the party in the wrong would need to pay. This passes the risk on to the other side to assess how much they may accept as a loss if the breaching side deceived them. A payment up to a pre-agreed limit can keep everyone out of court. Similarly, parties may agree on a materiality “basket,” or minimum threshold of damages a plaintiff must suffer before she may bring a claim in court, to avoid wasting energy on small disputes.
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A standard part of a commercial contract is a list of representations and warranties. These reflect the understanding of the parties that led them to enter the contract and, if any of them turn out to be false, may lead to litigation. It is important to understand them well before entering into a contract; otherwise litigators will be the ones studying them intensely after a dispute arises.
Why should you continue to read this post about representations and warranties?
You promised someone you would read it.
You have a contract and want to know why a lengthy section recites obvious facts.
This is more interesting than reading an actual list of representations and warranties.
Image Credit: Henry Kissinger 1973, public domain, Wikimedia Commons.
Representations Are Promises That Certain Facts Are True
When parties decide to enter into a contract, they usually do so because they have a common understanding of a certain set of facts. For example, if I agree to buy your house, it is because we both agree that you currently own the house you are selling. But, as you may imagine, sometimes these pre-contract assumptions are false.
To give assurance to contract parties that their assumptions are correct, a contract lists the exact “representations” that one party makes to the other, upon which they can rely when making the contract.
In a sales contract, one of these representations is often that the seller really owns the property being sold and has the ability to sell it. Sellers commonly also represent that there are no undisclosed problems with the thing being sold or that financial disclosures made in connection with the sale are accurate.
Buyers have to make representations, too. Usually these representations are about the buyer’s authority to make the purchase.
Before making these representations, a party should investigate to make sure that the statements are true. (This work is often called “due diligence.”) The party receiving the representations may be relieved of the obligation to investigate independently, since they are entitled to rely on the representations. But even so, discovering a problem before a transaction is a lot less painful than discovering it later and needing to litigate.
Warranties Are Promises That Certain Things Will Happen
A representations and warranties clause may also include “warranties,” or promises about the future. The distinction between “representations” and “warranties” may be academic, as they both are promises about the truth of certain facts, but generally, a representation is a promise about the present, and a warranty is a promise about the future. For example, a product seller may represent that they are not aware of any defects in a product, but they may warrant that, if defects are found, the seller will repair or replace the product in the future. Warranties in a contract may be limited by time, or only to parts of a product or service.
Remedies for Breaches
If one of the representations is false, a plaintiff may bring a lawsuit for damages. But courts are divided about whether a plaintiff can prevail if she knew that the statements were false at the time they were made.
Many contracts have “indemnification” provisions, that state exactly what a defendant needs to do if a representation is false. For example, the provision may state that the defendant is only responsible for a certain amount of damages or that the plaintiff needs to follow a specific procedure before it can bring a lawsuit.
If a plaintiff succeeds on a breach of representation claim, she still needs to establish what damages the defendant must pay. One way that courts calculate damages to compare the value of the asset that a buyer bought with the value of the asset if the representations were true, and to award the difference to the plaintiff.
Representation Claims Differ From Fraud Claims
When a plaintiff is deceived by a defendant, she may feel as if she is a victim of a fraud. But courts are very specific about what situations are fraud and which are breaches of contract. And although a plaintiff may have both types of claims, they are technically distinct.
One key distinction is the defendant’s awareness of the falsity of the statement (also called “scienter”), A fraud claim usually arises when a defendant knowingly makes a false statement of fact upon which a plaintiff relies. In a breach of warranty case, however, a plaintiff may need only to show the representation was false, not that the defendant deliberately lied.
Despite the distinction, fraud claims and contract claims often have the same damages. But a contract claim may have limitations on damages pursuant to the contract’s own terms that may not apply to a fraud claim. And a fraud claim could involve punitive damages that are unavailable in a contract claim, but courts do not often award them in commercial cases.