Contractual representations and warranties – why the difference matters6 October, 2014
Representations and warranties can appear very similar, but knowing the difference between them is important because it affects the potential remedies and damages available should the representations turn out to be false or the warranties are breached. These two legal concepts are explained below, along with a worked example to highlight the issue.
1 What is a warranty?
A warranty is a contractual term, which is secondary to the main purpose of a contract. For example, in a contract for the sale of goods a warranty may be given about the condition, age and history of the goods being sold. If a warranty is breached, the aggrieved party is not normally entitled to terminate the contract (unless it can be shown that the breach goes to the ‘heart of the contract’), but may be entitled to claim damages for breach of contract (see below).
2 What is a representation?
A representation is a statement of fact or opinion, which is made prior to a contract being entered into. If the representation is false, and it was relied on by the buyer when entering into the contract, then this may entitle them to rescind (unwind) the contract and claim damages (see below).
3 Why are they often confused?
The words of a representation and a warranty are often very similar and where a verbal agreement is reached it can be difficult to differentiate between what statements were representations (i.e. statements made prior to the contract being formed) and what was a term of the contract. In practice, it is likely that they could amount to a representation, warranty or both.
The best way to tell the difference between the two is for this to be documented in a written contract, which can record any pre-contractual representations and the warranties that are made at the time the contract is entered into. It is important to remember that a contractual term is not also treated as a representation and clear wording is needed if this is the intention, for example, “the seller represents and warrants that…”
4 Why is this important?
Understanding the difference between these two legal concepts is important because it can have a dramatic effect on the way that a claim is argued in court, the remedies available and the amount of damages that can be claimed. To illustrate the difference between a claim for misrepresentation and a claim for breach of warranty a worked example is set out below:
A buyer agrees to buy the seller’s shares in a company (Target Ltd) for £2.5M, with the purchase price to be paid 6 months after completion. When calculating the purchase price the buyer relies on Target Ltd’s last audited accounts (Accounts).
The seller represents and warrants that the Accounts were prepared in accordance with standard accounting practices and fairly represent the current position of Target Ltd. The purchase completes on 31 January 2014 and the money is paid on 31 July 2014.
It later transpires that there were serious errors with the Accounts to the extent that the shares were only worth £2M at completion. Target Ltd then fails and becomes insolvent.
|Basis of claim||The breach of warranty gives rise to a claim for breach of contract.||The representation made by the seller is false and the buyer may bring a claim for misrepresentation.|
|When must the claim be brought?||
A claim for breach of warranty must normally be made within six years from the date the contract is breached.
In these circumstances a claim would need to be made by 31 January 2020.
A claim for misrepresentation must normally be made within six years from the date damage is suffered.
In these circumstances a claim must be made by 31 July 2020 (i.e. six years after payment is made).
|Right to terminate / rescind the contract||
By definition a warranty is a contractual term that is secondary to the main purpose of the contract. As a result, a breach of warranty would not normally entitle the buyer to terminate the contract.
In these circumstances it would be necessary for the buyer to show that the breach of warranty goes to the heart of the contract (and is not merely a ‘warranty’). The buyer would need to show that the errors in the Accounts were sufficiently serious to allow it to terminate the contract.
A claim for misrepresentation may allow the buyer to rescind the contract. The effect of rescission is to put the parties in the position they would have been in prior to the contract being made.
The right to rescind the contract can be lost in certain circumstances, for example, if the buyer affirms the contract or a significant amount of time has passed.
Assuming that the right to rescission has not been lost (and the buyer hasn’t already paid for the shares) the buyer could return the shares to the buyer and avoid making payment of £2.5M.
The general principle when calculating damages for breach of contract is that damages should be assessed so as to put the claimant in the position it would have been in if the contract was properly performed, i.e. if the warranty was true.
In these circumstances the loss would be the difference between the price paid and the actual value of the shares. On the facts stated above the buyer would be entitled to claim £500,000.
The general principle for calculating damages for misrepresentation is to put the parties in the position they would have been in prior to the contract being made.
In these circumstances a claim for misrepresentation could be as much as the price paid for the shares being, £2.5M (assuming the contract has not been rescinded).
The buyer may also be able to claim other losses that were suffered as a result of the transaction under the Misrepresentation Act 1967.
The above example highlights the differences between the two claims, however, it is important to remember that a claim for misrepresentation is not always more advantageous than a claim for breach of contract. For example, if the above example is changed so that the company makes a profit (although not as much profit as would have been expected if the representation was true or the warranty was not breached) then a claim for breach of warranty is likely to be larger than a claim for misrepresentation.
5 Points to note
Representations and warranties can appear similar, but the remedies available for misrepresentation or breach of contract are completely different. It is important for a buyer and seller to understand the differences between the two before entering into a contract.
To avoid a dispute later down the line it is best to document the terms that have been agreed. If it is intended for a contractual term to also be treated as a representation then clear wording is needed to make this clear. Alternatively, if you want to exclude or limit liability for breach of contract / misrepresentation then carefully drafted limitation clauses will be required.
Reviewed in 2015