1. What have been the major changes in asset and liability warranties practice since the first edition of the book?
First, I wish to remind readers that our first edition was published in 1995 and that it was the achievement of work undertaken at the end of 1993 and during all of 1994, with Philippe Torre. In twelve years, the law and the corporate world have changed significantly, of which the most striking feature has been the influx of fresh capital investment with the heavy introduction of Anglo-American LBO and venture capital funds.
Tax law has changed too and case law is still growing in this field. The authors have taken into account the growing appeal of alternative dispute resolution mechanisms and wished to insist on the significance of negotiating the terms of the warranty.
2. Can you protect yourself against all of the risks arising out of an acquisition thanks to a warranty?
The answer is obviously no, although we have to mitigate this response. There are two major risks against which it is difficult to protect oneself: firstly, the fraud or the bad faith of the transferor’s guarantor and, secondly, the risk of a catastrophe, or other unforeseeable and by definition random risk.
The former category is self-explanatory. As for the latter category, it refers to claims relating to environmental and security issues as well as claims from third parties that could not be foreseen at the time of the transfer. Of course, a high ceiling, or even no cap at all, insurance and the best possible warranty constitute means to protect a buyer against this type of risk, at least to mitigate its consequences.
In my opinion, there is a third major risk (even more difficult to gauge), which relates to the human capital or asset of the company. The workforce and the management team of a successful company that, under the stewardship of the vendors, was dynamic and unrestrained in its efforts, may lose its motivation as a result of awkwardness, cultural misunderstanding or tentativeness under new governance. All this may, unfortunately, lead to the best managers being the first to leave and clients soon thereafter…
3. Does the warranty agreement exempt buyers from carrying out full due diligence?
The answer is obviously no, insofar as the warranty agreement is first and foremost a strict contract, a snapshot of sorts of the entity’s assets. It does not shed much light on the daily life of the company, its ability to innovate and generally all that constitutes its wealth. The warranty is a transcription of what is observed during the due diligence phase, including the Q&A sessions with management. I am aware of the current trend that consists in focusing audits on simple data room visits, which sometimes resemble attending a garage sale. More and more, a draft warranty agreement is provided with access to the data room and reads much like a standard terms agreement. This is a trend, but not necessarily a long-lasting one. In addition to its ineffectiveness and the frustration that this formal method can bring, the purchaser will try by any means to release itself from this “strait jacket”.
The result is often a waste of time, negotiators reverting, after several laps, to the traditional scheme of direct negotiation and decide to draft an ad hoc warranty agreement. Of course, we have to mitigate this analysis if the targeted company is listed, since the due diligence and the warranty agreement itself will be limited by definition owing to stock exchange regulations. The same applies for secondary or tertiary LBOs, a given fund buying from another fund a company that is already known; in this latter case, the absence of any warranty, or simple declarations, can be explained by a system of corporatist solidarity.
The situation depends also on the target’s activity, its history and its management. A company that acquires its competitor, about which it knows almost everything (products, market price, profit margin, regulation constraints and principal partners) requires fewer warranties than an investment fund making its first foray into a given industry sector.
The company is never entirely risk free, whatever its activity, so a certain degree of due diligence is always essential at the time of the transfer, whether it involves a majority or minority stakeholder. The inquiries are materialized by declarations, allowing the purchaser or rescuer to ensure itself that nothing has been withheld and that the documentation that it has studied during the due diligence phase or in the data room accurately reflects the reality of the situation.
You do understand that I am not in favour of strict schemes that make use of standard term contracts, but rather a keen promoter of a bespoke approach. A company is a complex and living reality that must be analysed with inquisitiveness and without any bias. The price paid and the financial capacities of the guarantor(s) must also be taken into account. Indeed, it is not necessary to ask a foundering member, who is set to receive a modest price, to provide a warranty with a high ceiling, as it is well known that after paying capital gains tax, making gifts to his children and reimbursing any debts, there will not remain many funds for him to purchase his dream holiday home.
4. What are the most adequate alternative dispute resolution mechanisms for a dispute relating to an asset and liability warranty?
The answer to this question differs according to the nature of the claim. In fact, if the claim is merely a request to obtain damages for the debts originating unquestionably prior to the transfer, mediation or conciliation will not modify the bad will of the guarantor who is refusing to pay the indemnity.
However, if the claim requires technical, tax, or accounting analysis, including pertaining to the interpretation of certain provisions, declarations or appendices to the warranty agreement, the option to mediate can be beneficial, and may bring gains to both parties, compared to lengthy and cumbersome judicial proceedings.
More generally, ADR clauses turn out to be ineffective in the presence of a fraudulent party, a bad payer or if the parties’ representatives lack power to negotiate.
You will understand that I am a great promoter of negotiations, respectful of the interests of both parties and also of non-mandatory alternative dispute resolutions which enable parties to quickly resolve true or false issues, in an inexpensive, effective and confidential manner.
More particularly, in the scope of an LBO where the transferor-guarantor is also the beneficiary of shares in the holding purchasing vehicle, the resolution of a claim by means of mediation will enable the partnership to carry on functioning.
5. How do you foresee the evolution of asset and liability warranties in the next ten years?
It is difficult to anticipate the change in these warranties over the next decade, this point in time being so far away from now in view of the rapid evolution of the corporate finance world. I think that the current leadership of the M&A market by private equity corporations is not going to last. Criticism is arising from all strands of business against this situation, the extension of funds being more and more significant financially and often coming from the U.S.A. or the U.K.. I foresee a change of scenery in the near future, with the setting up of a stricter regulatory framework for investment funds. In the absence of such a reform, the world of business will be directed tomorrow by anonymous and powerful funds controlled by corporate finance technocrats, widely described as gravediggers of multinationals and of profitable start-ups. During the recent presidential election campaign, the danger of the increase in power of these funds was debated. Here, as in corporate governance matters, the trend comes directly from the USA.
I do not share some observers’ view that it is the end of the asset and liability warranty agreements. I am of the opinion that these agreements, handmade in the 1980’s, will continue to greatly evolve. Corporate transactions are more and more complex and warranties need to fit in nicely with the reality of the targeted company and not with the standard term contracts produced by the business’ lawyers, whose imagination will, accordingly, be put to the test.
