Representations and warranties, indemnity caps, holdbacks and insurance. How the seller defines, during negotiation, what will still be owed after the price is received.
One of the things that separates a well-run transaction from one that merely closed is the definition of who answers for what happened before closing, for how long and up to what amount. For the seller, that is the difference between receiving the price and keeping it.
The parties' freedom in designing that allocation is broad and was reinforced by the legislature. Article 421-A of the Brazilian Civil Code, introduced by Law No. 13,874/2019, presumes civil and business contracts to be at arm's length and symmetrical and provides, in item II, that the risk allocation agreed by the parties must be respected and observed.
Representations and warranties matter in risk allocation. In them the seller asserts facts about the company, its corporate, accounting, tax, labour, contractual, environmental and regulatory position, and undertakes to respond if those facts do not match reality. Each representation is a potential indemnity obligation.
The representation given by the seller documents the state of affairs owed and qualifies the parties' knowledge.
Three tools reduce that exposure without hollowing out the buyer's legitimate protection. The first is the knowledge qualifier, limiting the representation to what the seller actually knows, with a contractual definition of whose knowledge counts and what degree of inquiry is required. The second is the materiality qualifier, excluding from the scope of the representation anything that is not material by an objective, preferably numerical, standard. The third, and the most effective, is organized disclosure.
Everything the seller discloses to the buyer, in documented and specific form, ceases to be the seller's risk and becomes a fact known to the buyer. Disclosure schedules exist for that purpose, and the practical difference between a disclosed contingency and a silent one is the difference between a negotiated price discount and an indemnity claim later.
Two cautions matter. Disclosure must be specific, since general reference to documents made available in a data room is treated with reserve in negotiating practice and may not produce the intended effect. And the relationship between disclosure and indemnity should be express, providing that the buyer may not claim in respect of a fact disclosed to it.
The seller's liability should be bounded along four axes.
| Parameter | Function |
|---|---|
| Indemnity cap | Limit the maximum amount returned by the seller |
| Basket and de minimis | Screen out small claims and the friction they generate |
| Survival period | End the exposure on a fixed date |
| Scope and exclusions | Define what triggers indemnity and what does not |
A low cap with a long survival period can cost more than a high cap with a short one, and a poorly calibrated basket turns the post-closing period into the administration of minor claims.
Holding back part of the price in an escrow account is one of the solutions and one of the most expensive in liquidity terms, since it locks up funds for a set period. Payment in instalments with a right of set-off achieves a similar effect and preserves cash flow, although it shifts the buyer's credit risk to the seller. Security over part of the interests sold is an effective instrument where it is the seller who needs security, in the converse case of deferred price. And representations and warranties insurance, now available in the Brazilian market for transactions of meaningful size, allows the exposure to be transferred to the insurer, substantially shortening the survival period and releasing the full price at closing.
The choice among them depends on several factors, including the buyer's perception of the quality of the information provided and the relative cost of each mechanism. Where preparatory diligence has been well conducted, the discussion about security is less complex, because there is less uncertainty to price.
They are the seller's assertions about the company's position, including its corporate, accounting, tax, labour, contractual, environmental and regulatory aspects and other relevant matters, coupled with an obligation to indemnify if they do not match reality.
There is no statutory rule.
Yes, both under the contract and by operation of law.
It is a provision stating that the buyer may not claim indemnity in respect of a fact disclosed to it before closing. Without it, there is room to argue whether a buyer who knew of the contingency may still claim, a dispute that express drafting avoids.
It depends on the size and profile of the transaction. Insurance allows the price holdback to be reduced or eliminated and the seller's exposure period shortened, transferring the risk to the insurer.
The Gotlib Rocha team acts on preparing the company, running the competitive process, negotiating the agreement and managing the post-closing period.
Talk to the teamAbout the practiceThis piece reflects the firm’s analysis of the subject as at the date of publication. It is informative in nature and does not constitute legal advice on any specific matter. For advice on a particular situation, please contact our team.
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