Answer ... Representations and warranties have long been an essential part of Italian SPA agreements, even in exclusively ‘domestic’ acquisitions. Although they are tough to negotiate and gaining acceptance is difficult – especially from the sellers of family-owned businesses – no transaction will take place unless the sellers provide a full set of representations and warranties. These typically cover everything from the parties’ authority and power to enter into the agreement to virtually all areas of operation of the target. The main issues covered by the representations and warranties will include:
- the target’s balance sheet (and that of its controlled or participated companies, if any);
- contracts;
- litigation;
- employment;
- real estate;
- environmental;
- tax; and
- privacy.
Additional specific representations and warranties will be made as required due to the nature of the business to be acquired. In such case, these will concern the level of the working capital, along with a commitment by the target to keep this unchanged, or substantially unchanged, until the closing date.
The period of validity of the representations and warranties must be negotiated very carefully. In extreme cases, a private equity buyer may demand (albeit seldom successfully) that this period coincide with the statute of limitations provided by law for each representation and warranty. In broad terms, and at the risk of over-generalising, such representations and warranties remain valid for three to five years (the latter term applying in particular to tax and employment representations and warranties). Exceptions to this rule, which require the provision of a longer period of validity, will involve situations which have been identified in the due diligence as constituting areas of concern for the buyer. The provision of ‘specific’ or ‘analytical’ representations and warranties, as they have previously been labelled by the courts, is a remedy available for the buyer to seek indemnification for their breach. Indeed, apart from a scant but troubling number of cases in which the courts have held that the warranties afforded by operation of law in connection with sale and purchase contracts will also apply to the acquisition of shares, according to the prevailing case law, such warranties will not apply to the acquisition of a corporate interest. The courts’ reasoning in these cases is based on the fact that shares are not representative of the quality of the business and of the assets that are indirectly acquired through their purchase. For this reason, representations and warranties in Italian deals tend to be as lengthy and detailed as they would be in the SPA that are typically used in Anglo-Saxon jurisdictions.
With the exclusion of cases involving fraud or misrepresentations – which, irrespective of the remedy of indemnification set out in the SPA, may lead to the award of damages suffered by the injured party or even to the criminal liability of the responsible party – the consequences of breach of a representation and warranty are typically addressed in the agreement and are usually covered by a standard indemnification system. This will invariably contemplate:
- a de minimis provision;
- a basket provision; and
- a number of threshold amounts over and above which the buyer is entitled to be fully indemnified within the limits agreed with the seller.
The distinction between representations and warranties under Italian law does not appear to be as sharp as it is in common law countries, where an action for misrepresentation will be in tort and not in contract. One reason for this distinction is the fact that a representation is a statement, whereas a warranty is per se a commitment whose violation will result in a breach of contract. Suffice to say that while a few scholars have disputed the tort nature of representations versus the full contract nature of warranties, we would argue that, depending on the relevance of the representation, its violation can lead not only to a claim for damages, but also to an action for termination of the SPA.
The indemnification system will typically be backed by a bank or at least an insurance policy guarantee – which, in the expectation of the buyer and invariably at its initial request, will be of first demand type (see question 5.4). To overcome the discussions that inevitably take place between the parties on this issue, the use of ‘transactional insurance’ has become increasingly common in recent years, especially in connection with transactions made by private equity funds. The type of insurance that is most commonly used in such cases is a warranty and indemnity policy, which covers the risks of misrepresentation and breach. In a note issued in July 2019, the Insurance Authority (IVASS) expressly acknowledged the validity of warranty and indemnity insurance, albeit under certain conditions, thus clearing up doubts in this regard which were grounded on a 2009 regulation issued by IVASS.
Other forms of insurance that can be very useful in acquisitions include those covering contingent liability, tax and known litigation risks.