Background
Definitions
Remedies
Opportunities for lawyers
Comment
In the context of an M&A deal, the target must make representations and warranties to the buyer regarding its corporate status, capital structure, legal capacity and business operations.(1) The Securities and Exchange Commission began its regulation of business combinations in 1982.(2) The first successful merger was between AG Leventis & Company Limited and Leventis Stores Limited in 1983, in which 100 ordinary shares in Leventis Stores at N0.50 each were exchanged for 83 ordinary shares in AG Leventis at N0.50 each. The most striking M&A activity took place in 2005, driven by the Central Bank of Nigeria's 2004 directive to all Nigerian banks to increase their shareholder funds to at least N25 billion from the previous N2 billion.(3) When the December 31 2005 deadline for this increase passed, only a few banks had this new minimum capital base, resulting in several mergers and acquisitions, with only 25 out of 89 banks still operating after 2005.(4) A more recent M&A deal in Nigeria involved Forte Oil and was carried out in a bid to increase revenue and ultimately maximise profits for shareholders.(5)
The key difference between a representation and a warranty is that while a representation is a statement of fact regarding a corporate entity's past and its existing status, a warranty is a promise relating to the entity's present and future, stating that the assets are free and clear of all clouds on title to the assets.(6) In particular, Black's Law Dictionary(7) defines a 'representation' as "a presentation of fact – either by words or by conduct – made to induce someone to act, especially to enter into a contract". In Nigeria, contracts are governed by the Sale of Goods Act 1893, applicable under Nigeria law by virtue of Section 45 of the Interpretation Act 2004.(8) The act imposes an implied warranty of enjoyment and quiet possession of goods and provides that goods must be free from any charge or encumbrance.(9) In Nigeria Tools and Die Company Ltd v Dare(10) Judge Adefarasin stated that there was an implied warranty that goods had to be reasonably fit and suitable for the purpose for which they were obtained. Expressed warranties, on the other hand, are written in the contract and legally speaking hold up better in a court of law than implied warranties.
A breach of representations and warranties merely entitles the injured party to indemnification by way of damages. Thus, the connecting thread between representations and warranties stems from the financial responsibility for issues which may not exist or be known to parties at closing.(11) However, the wronged party may have the right to terminate the merger agreement if the breach is fundamental or goes to the root of the contract. The courts have held that damages in respect of such breach of contract should be fair and reasonable, arising naturally from the usual course of things or from breach of the contract itself, or should be reasonably foreseeable as inevitable, arising if one of them broke faith with the other.(12)
The slew of representations and warranties in an M&A deal fall into three camps:
- promises made by the target;
- promises made by the buyer; and
- promises made by both sides in order to avoid material adverse change after closing.
In most deals, representations and warranties are far more onerous for the target than the buyer.(13) However, the target can limit representations and warranties by:
- adding qualifiers;(14)
- carving out instances where it will be liable for any misrepresentation; or
- imposing caps on its liability.
The buyer, on the other hand, has a greater duty to ascertain the accuracy of the representations and warranties. Thus, the role of lawyers in M&A deals is key, including:
- drafting letters of intent;
- conducting due diligence and legal risk analysis;
- providing the requisite framework to review documents;
- preparing legal opinions; and
- renegotiating agreements (earn-outs(15) and price adjustments).
The relevant knowledge for this role can be obtained through corporate finance education and partnering with multinational law firms that have previously been involved in cross-border M&A deals.
It is clear that representations and warranties in M&A deals are crucial to successful closing. Even more important is the role that lawyers and other financial experts play, as they owe a duty of care to protect clients' best interests. Thus, it is hoped that Nigerian lawyers will start to play a more leading role in M&A deals, following the example set by lawyers in the United Kingdom and the United States.
For further information on this topic please contact Kate Okoh at TRLPLAW by telephone (+234 9 413 1897) or email ([email protected]). The TRLPLAW website can be accessed at www.trlplaw.com.
Endnotes
(1) Stephen Kenyon-Slade, Mergers and Takeovers in the US and UK (Oxford University Press Inc, New York 2003) p 33.
(2) O Orojo, Company Law & Practice in Nigeria, Vol 1, LexisNexis, 2006.
(3) Approximately, $190 million and $15 million respectively.
(4) Fabian Ajogwu, "Mergers & Acquisitions: Identifying the Opportunities & Avoiding the Pitfalls".
(5) See http://newtelegraphonline.com/forte-oil-mulls-merger-acquisition/.
(6) William R Anson, Pries of the Law of Contract pp 218, 222 (Arthur L Corbin ed, 3d Am 1919).
(8) Section 45 1) of the Interpretation Act provides that the common law of England, the doctrines of equity and the statutes of general application which were in force in England on January 1 1900 apply in Nigeria insofar as local jurisdiction and circumstances permit.
(11) Sherman, Andrew J, Mergers and acquisitions from A-Z:(3rd ed USA, 2011) p 201.
(12) Omonuwa v Wahabi (1976) 4 SC; Swiss Nigeria Wood Industries v Bogo (1995) 2 NWLR (380) 647 at 671.
(13) Bill Snow, Mergers and acquisitions for Dummies (Wiley Publishing, Inc Indiana, 2011) p 235.
(14) Sindall v Cambridgeshire (1994) 1 WLR 1016, where the court, per Lord Justice Russell, Lord Justice Evans and Lord Justice Hoffmann, held that a target was not liable for damages for misrepresentation if it had taken reasonable steps to make known to the purchaser what it itself knew.
(15) An agreement in which a portion of the purchase price is deferred to a later date based on the target's ability to achieve certain goals.
