5 Keys to Avoiding “Representation Exposure” When Selling A Business

What is a “representation” in the context of a business sale agreement?  Essentially‚ a representation is a statement regarding a particular fact relating to the business seller or the business that is expressed in the business sale agreement.  Almost every agreement contains representations that are being made by both sides‚ the seller and the purchaser.  Why is it important?  The representations are not important…if they are truthful.  The problem arises when the representation is found to be “less than accurate” and you receive a telephone call from your lawyer stating that the buyer is threatening a lawsuit.  A common representation made in business sale agreements will sound something like this:

Except as set forth in this Agreement‚ neither Seller nor any third party is in default in any respect under the Lease and there has not occurred any event under the Lease which with the lapse of time or the giving of notice or both would constitute such a default; such Lease is the legal‚ valid and binding obligation of the Seller enforceable in accordance with its terms.

Basically‚ as a business seller‚ you are stating that there is no default in the lease nor has there been anything done that would later constitute a default.  The problem arises when the buyer‚ after being in possession of the location for six months‚ finds out that the real estate taxes have not been paid in over a year and the landlord is looking to the buyer for reimbursement.

Most of the post-closing problems for a business seller arise from a representation within the agreement.  Following is a list of the keys to avoiding any potential liability resulting from a contract representation:

1. Carefully Review Contract Representations With Your Attorney – this is the most important key to avoiding liability.  Unfortunately‚ many attorneys glance over the representations and do not spend the necessary time focusing on them.  Each representation within the agreement should be reviewed in detail by you to make sure that it is 100% accurate before you sign the agreement.  You should setup a dedicated call or meeting with your lawyer to focus on these representations.  I find that the process of doing this will help trigger a thought that could determine the difference between being sued and avoiding litigation.  If the information in the representation is not 100% accurate‚ your attorney should alter the language to make it fit or remove it completely.
2. Remove Representations – many lawyers representing buyers will throw in the proverbial kitchen sink when it comes time to modifying the representations section of the agreement.  Your attorney should strike any overreaching or unnecessary representations in the agreement to reduce the odds of triggering liability.
3. Limit Time of Representation – many contracts will state that the representations “survive closing”‚ meaning‚ that the representation will still be operative following the closing.  As a seller‚ you should be limiting the time the representation will “survive” so that the representation does not endure indefinitely.
4. Add “To the Best of Seller’s Knowledge” – certain representations‚ in order to know with certainty‚ would require you‚ as the seller‚ to actively investigate certain information before giving the representation.  To avoid an obligation to investigate a matter‚ your attorney should add the term “to the best of seller’s knowledge” to any representations outside of the scope of your knowledge.  For example‚ there will be a representation concerning whether or not something happened in the past that could lead to litigation against the business in the future.  As far as you know‚ nothing happened but you cannot guarantee that something didn’t happen while you were not present.  Adding the term “to the best of seller’s knowledge” would likely cover you in the event you really didn’t know about the incident and something happens following closing.  Without that language‚ you could find yourself in an unfavorable situation post-closing.
5. No Other Representations/Merger Clause – within the agreement‚ you are going to want to state that‚ aside from the representations contained in the contract‚ that there were no other representations made.  In certain situations‚ business sellers get sued because the buyer claims that the seller or business broker made a representation that was not in the contract.  In the event this happens‚ you want to make sure the agreement clearly states that there were no other representations and that there is nothing outside of the agreement that would supersede the terms of the business sale agreement.

Avoiding liability from a representation in a business sale agreement is key to closing your transaction with peace of mind.  However‚ there are many other circumstances that can lead to problems for business sellers and you must be aware of all of them.  For more information on avoiding liability and to learn more about other aspects related to selling your business‚ click on the icon below to get a complimentary copy of ENDWISE the guide to selling your business with peace of mind. 

Category: Business Transactions