Legal documents, such as purchase agreements or plans of reorganization or merger, almost always contain representations and warranties. Lawyers often use the phrase “representations and warranties” interchangeably, almost as a word of art. However, representations and warranties are different words that address different concepts and can produce different legal results.
Representations are statements of present or past fact. For example, “The financial statements fairly present the financial condition of the seller.” Future “facts” cannot generally form the basis of representations because no one can know the future. At best, someone can have an opinion. A warranty is a promise that a statement of fact is true.
If a representation is intentionally false, one may claim deceit (a tort) and allege fraudulent misrepresentation. Elements of such a claim include: (a) knowledge or conscious ignorance of the statement’s falsity; (b) an intent to induce reliance; and (c) justifiable reliance. If one cannot prove another’s knowledge, or if the claimant knew that the statement was false so that reliance on its truthfulness is not justifiable, the claim for fraudulent misrepresentation will fail.
Generally, one injured by a fraudulent misrepresentation has a choice of remedies: (a) rescind the contract and obtain restitutionary recovery; or (b) affirm the contract and sue for damages. The ability to rescind — to unwind a closed transaction — is a remedy not available to one suing for a breach of warranty. In addition, one may be able to obtain punitive damages under special circumstances involving fraudulent misrepresentation.
In the past 15 years, courts have been struggling anew with the meaning and implications of a common law warranty — a promise that a statement of fact is true. The seminal case was CBS Inc. v. Ziff-Davis Publishing Co., where Ziff-Davis “represented and warranted” the financial condition of the division it was selling to CBS. CBS, however, as part of its due diligence, sent in its own accountants to review the division’s financial statements. They reported that the financial condition was not as represented and warranted. The parties closed anyway, and then CBS sued.
In New York’s highest court, the issue was whether CBS had a cause of action for breach of warranty. Ziff-Davis argued that CBS did not because it had known about the problems with the financial statements and had not justifiably relied on the warranties. Stated differently, Ziff-Davis argued that the standards for a cause of action for a fraudulent misrepresentation and a breach of warranty both required justifiable reliance on the truthfulness of the statement. Ziff-Davis lost.
According to the New York court, a warranty is a promise of indemnity if a statement of fact is false. A promisee does not have to believe that the statement is true. Indeed, the warranty’s purpose is to relieve a promisee from the obligation of determining a fact’s truthfulness. Since the CBS case was decided, the majority of states have followed it.
The meaning of warranty is critical where a party has made both representations and warranties. A fraudulent misrepresentation claim will fail if a claimant knew that a statement was false; however, in a jurisdiction that follows the CBS rule, a claimant may sue for breach of warranty on the same statement and recover, despite knowledge of the falsity of the statement, subject to some limitations. This is a substantial business and legal reason for a party to receive both representations and warranties.
If you have a question about the implications of representations and warranties when reviewing a legal document, please call us.