Reps & Warranties in M&A

What Reps & Warranties are and why the seller does not want them

Reps & Warranties (representations and warranties) are the seller’s contractual statements that certain facts are true at the time the sale is completed and for a certain period thereafter. The buyer relies on these statements and, if they prove untrue, has the right to claim damages.

Typically, the seller states that they are the owner of the company and have the right to sell it. The company also has no hidden liabilities, litigation, or tax deficiencies. All contracts are in order and are not being breached. It is also stated that employees are not involved in employment-law disputes and that the assets are not encumbered by third-party rights.

Why is this uncomfortable for the seller? Because you are liable for matters that may surface months or years after the transaction. When setting the scope and limits of these statements in the purchase agreement, the transaction structure and negotiation of key provisions are typically addressed as well, with support from company sales and transaction advisory services. The buyer may send you a claim for damages within 18–36 months and you must prove that your statements were true. For specific warranties (e.g., tax warranties), these periods may be longer, usually until the end of the statutory limitation periods under Czech law.

In practice: You sell a company for CZK 50 million. Six months after the sale, a tax audit takes place and the inspection finds that the company had been failing to pay certain insurance contributions. The additional payments and penalties amount to CZK 2 million. The buyer sends you a claim: you are in breach of the R&W in which you stated that all tax obligations had been met. You now either litigate with the buyer or have to pay out of your own pocket. On how to avoid similar consequences already at the verification stage and when setting liability, see also the article Vendor Due Diligence: Why have your own company reviewed before the buyer does?.

How R&W work in M&A transactions

The process has several key phases that are often underestimated:

Preparing R&W in the purchase agreement

The purchase agreement (Sales & Purchase Agreement, SPA) usually contains an extensive chapter on R&W. It sets out which facts the seller represents and for how long the statements apply.

Example from practice: The seller’s agreement includes R&W stating that “all obligations have been fulfilled, and there is no debt to the state, financial institutions, or third parties.” It sounds simple, but in practice:

What counts as an “obligation” — only legally formalised ones, or also factual ones? If VAT was paid late, does that count as a breach? Is there any tolerance for minor discrepancies?

Without precise definitions, you and the buyer will interpret the agreement differently and a dispute is effectively built in. That is precisely why, in practice, it pays to rely on contracts and negotiations, so that terms such as “obligation”, “knowledge”, or “material adverse change” are defined unambiguously. The attorneys at ARROWS advokátní kancelář can help you with linguistically precise R&W wording that fits your interests.

Quantification and limits of liability

This is where the amount and mechanism of damages are determined. A threshold/basket means the buyer does not need to bring claims below a certain minimum amount. This is often 0.5–1% of the purchase price, which may be CZK 500,000–1,000,000 in the case of a sale for CZK 100 million.

A cap, on the other hand, means the seller does not have to compensate more than a certain maximum amount. This often reaches 10–15% of the purchase price.

A deductible then determines the amount the buyer bears themselves, for example the first CZK X, before the seller’s obligation to compensate arises.

Practical risk: A threshold protects you from small claims, but a cap can expose you in the event of major issues. If the cap is too low and a serious problem emerges, such as hidden litigation with a higher contractual penalty, you may not be able to limit your risk.

Escrow and retention of the purchase price

To ensure that the seller will be able to pay damages, part of the purchase price (sometimes 10–20%) is often retained in a special account (a so-called escrow account) for the duration of the R&W period.

In practice: You sell a company for CZK 100 million, but you receive only CZK 80 million immediately. The remaining CZK 20 million sits in an escrow account for, for example, 24 months. During that time, the buyer may assert claims, which are then satisfied from the funds held in this way.

This also means: If after the sale you find that you are missing CZK 20 million in income and you are no longer part of the company, you may face liquidity issues. This is a common surprise for sellers who do not factor escrow into their planning. Approaches to setting the purchase price, retaining part of the price, and the cash-flow impact are also discussed in the article How the final price is determined in a company sale: Closing accounts vs. locked box.

Reps & Warranties insurance: a modern solution for sellers

Traditional approach: The seller bears all R&W risks for 3 years, and if an issue arises, the seller pays damages.

The modern approach is Reps & Warranties insurance (R&W insurance). This is a special insurance policy purchased by the seller (or sometimes the buyer) that covers damages claims arising from a breach of the R&W. Key benefits:

The seller is relieved of long-term liability because, instead of responding to claims for 24–36 months, compensation is handled under the insurance policy. At the same time, the transaction price remains higher, because instead of a price reduction due to escrow you can negotiate a higher upfront price. The buyer also has the comfort that the insurer will pay under the policy rather than the seller, and routine situations are therefore often resolved without court proceedings.

In practice: You sell a company for CZK 100 million with traditional R&W. The escrow is CZK 15 million, the cap is CZK 12 million, the period is 24 months. Later, an issue of CZK 5 million arises and you would have to pay. Alternative: Purchase R&W insurance for CZK 600,000; the average cost is 0.5–1% of the transaction value, you receive the full price immediately, and the policy covers the risks.

However, you should know: R&W insurance also has exclusions, deductibles, and conditions. When negotiating the policy, you need a lawyer to ensure the policy truly covers your key risks.

Typical risks and how to address them

Practical steps before a sale

If you are planning to sell a company, you should consider the following steps:

Contact a lawyer before officially marketing the company

Too many sellers initiate a sale without legal advice. When the volume of legal issues then comes to light, it may already be too late. The ARROWS team can assist you with a pre-transaction audit: a systematic review of all legal aspects of the company. This allows us to identify risks you can address in advance and those you must record in the SPA.

Prepare a list of all facts and documents

The buyer will send you detailed information requests (data request lists) with details about legal agreements, liabilities, disputes, etc. If you do not have this organised, the transaction will drag on for months and create unnecessary stress.

Clarify your R&W position

What R&W are you willing to give? What exceptions or limitations do you want? What about insurance? This should be a clear subject of negotiation with the buyer and the lawyers.

The ARROWS team will help you set a realistic position and anticipate what the buyer will require.

Arrange R&W insurance

If it is strategic for you (and it usually is), contact the insurer or the R&W insurance broker at an early stage. Although the policy is typically arranged in parallel with signing the SPA, the first discussions with the broker or insurer should start already in the early phase of the transaction.

The relationship between R&W and the seller’s credibility in the M&A process

R&W also play an important role in signalling the seller’s credibility to potential buyers. A seller who offers reasonable and specific R&W presents themselves in the market as confident and transparent. Conversely, excessive limitations of R&W or vague wording raises suspicion.

In practice: One seller claims they only want to give minimal R&W and with a long validity period. Another seller offers standard R&W with a reasonable cap and deductible. For the buyer, it is clear who is likely hiding problems and who is open and reliable.

This is another reason why it is good to have a lawyer. Contact the attorneys at ARROWS, a Prague-based law firm - consultation@arws.cz. They will not only protect you from overly strict R&W, but also help you with precise drafting that inspires trust.

Final summary

Reps & Warranties are not a pointless legal ritual. They are real money. When you sell a company, the risk that hidden issues will emerge after the transaction is not zero. Representations and warranties determine who will bear that risk—you or the buyer.

Without proper negotiation, you risk a 10–20% reduction in the company’s price due to uncertainty. You also risk long-term liability for issues that may arise even years after the sale. There is also the risk of litigation with the buyer for damages and the loss of funds held in an escrow account if claims are asserted.

At the same time, there are ways to protect yourself: first, thorough preparation and clarification of all R&W in advance; and second, R&W insurance, which relieves you of long-term liability. ARROWS attorneys, a Prague-based law firm, specialise in M&A transactions and, through the ARROWS International network, also handle cross-border sales. Understanding R&W and setting them up correctly is not something you should handle on your own.

If you do not want to take risks and want to be sure that your R&W position is set optimally and that all risks are identified, contact the attorneys at ARROWS, a Prague-based law firm, at consultation@arws.cz. They know what to watch out for.

Read also:

• Vendor Due Diligence: Benefits, Scope and Key Phases for Sellers
• Transactional Risk Insurance (W&I): How to Close a Deal Without the Risk of Litigation
• Managing Seller Risks Between Signing and Closing in Company Sales
• Pre-Closing Covenants in Share Deals: Seller Obligations and Key Risks
• How to Respond to a Damages Claim for Breach of Due Managerial Care