As a leading shareholder representative for merger and acquisition transactions, we have collected data on terms and conditions from the definitive agreements in over 500 completed transactions (with data and analysis available in our Forsite™ M&A Deal Tool). In analyzing the data, we have seen a dramatic shift in the survival period for the “fundamental” representations and warranties in merger agreements. As explained below, this has occurred in response to a ruling by the Delaware Court of Chancery in late 2014.
As background, when negotiating merger and acquisition transactions, the buyer requires the selling company to make multiple representations and warranties regarding, for example, its financial condition, the adequacy of its intellectual property rights, the absence of litigation and claims, and other matters of importance to the buyer. The buyer then requires the selling shareholders to indemnify the buyer for any losses it incurs based on breach of those representations and warranties. The seller, seeking finality around the transaction on behalf of its shareholders, negotiates for a limited window post-closing (the “survival period”) during which the buyer may seek indemnification for any such breach.
Our data in the Forsite™ M&A Deal Tool shows that the survival period for representations and warranties is predominately 12 to 18 months, with little variation outside of that range over the past three years.
The buyer, however, will require that certain “fundamental representations” survive beyond that survival period. Fundamental representations may include matters such as the seller’s capitalization, payment of pre-closing taxes and any breach of representations and warranties based on intentional misrepresentation or fraud. Historically, those fundamental representations survived indefinitely: if the buyer at any time in the future suffered a loss based on breach of a fundamental representation, the buyer could seek redress from the selling company shareholders.
In late 2014, the Delaware Court of Chancery issued an important ruling impacting the survival period of fundamental representations. In Cigna Health and Life Ins. Co. v. Audax Health Solutions, Inc., C.A. No. 9405 (Del. Ch. Nov. 26, 2014), the Court ruled that indemnification obligations in a merger agreement that were indefinite and that could equal the entirety of the consideration received in the merger were potentially unenforceable.
Since that time, based on the data in the Forsite™ M&A Deal Tool, we have seen a major shift in the survival period of fundamental representations, with an indefinite survival period dropping from 34% of all transactions in 2014 to 15% in 2015. We anticipate that the percentage of transactions with indefinite survival of fundamental representations will continue to drop in 2016 as fixed survival periods increasingly become the standard in definitive documents.
Drilling down further into the data, we note that the survival periods for fundamental representations also depend on the specific representations being carved out from the general survival period. For example, claims for breach of representations based on fraud typically survive for the longest periods: indefinitely in 51% of all transactions and through the end of the applicable statute of limitations 32% of the time. Breach of representations based on the capitalization of the seller also survive for extended periods, but the numbers are reversed, with indefinite survival occurring 29% of the time and statute of limitations survival occurring 53% of the time. Per the chart below, breach of representations based on intellectual property have extended survival periods, but for much shorter time frames than fraud and capitalization: in 83% of transactions, the extended survival period for intellectual property representations is two years or less.
Please contact us if you would like to discuss this issue or any other post-closing matter in connection with M&A transactions. As a leading post-closing shareholder representative on private M&A deals, we have collected data on hundreds of M&A agreements. We have used that data to build a reference tool for the M&A community to empower dealmakers with the data they need to understand “market,” negotiate better deals and follow emerging trends. You can explore further in Fortis Advisors’ Forsite™ M&A Deal Tool.