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. Last Updated: 07/27/2016

The Use of Warranties in M&A Transactions

Other than a general warranty of quality that is implied into contracts for the sale of goods, the concepts of "representation" and "warranty" have no distinct legal meaning under the law. Although some law acquisition agreements are drafted in an Anglo-American style and include representations and warranties, there is a considerable risk that a Russian judge would be confused by, or even instinctively take a hostile approach toward documents prepared in a legal style other than that traditionally used in Russia.

As a result, many purchasers insist on the use of English law as the governing law of their acquisition agreements. Conversely, because of the difficulties surrounding the enforcement of representations and warranties under Russian law, sellers would normally insist on Russian law as it provides less protection to the purchaser.

As there is no definition of the terms "warranty" and "representation" under Russian law, a warranty or representation will most likely be treated as a mere contractual obligation. The breach of such an obligation entitles the injured party to seek contractual damages and, in the event such breach is material, rescission of the contract. Importantly, it can be difficult to obtain damages for any breach of warranties regarding the business of a target company or the shares that are being purchased (other than warranties regarding title to the shares).

There is no well-established market practice setting out common limits on the seller's liability under share or asset acquisition agreements that are subject to Russian law. However, the following points should be noted:

• The parties are free to expressly limit their contractual liability and/or exclude liability for lost profit. The seller's liability will often be limited to the amount of the consideration or to a percentage thereof.

• The Civil Code sets out statutory time periods for the duration of liability in respect of various types of claim. The statutory time period for breach of warranty claims is generally three years. Any contractual provision which purports to set out a shorter time period risks being held as void.

• Indemnity -- a breach of an indemnity carries no clearly defined legal consequences under Russian law and may confer no greater rights than a claim in damages for breach of a contractual obligation. Many Russian legal commentators have noted that there is a risk that any indemnification provisions written in an English law style may be characterized by Russian courts as "insurance coverage" or as a "bank guarantee." As insurance coverage may only be provided by a licensed insurer and a bank guarantee only by a financial institution, the indemnification provision risks being unenforceable against any Russian party providing an indemnity who is not a licensed insurer or a financial institution.

In common with the right to rescind a contract as a remedy for misrepresentation under English law, a Russian law contract entered into under the influence of a material error may be invalidated by a court at the request of the injured party. However, contractual damages will only be awarded if it can be proven that the error arose as a result of the fault of the other party.

An agreement in which there is a delay between signing and completion may be rescinded if there is a significant change in the circumstances surrounding the transaction before completion occurs. A change is deemed significant when, if the parties could have reasonably foreseen the changed circumstances, the agreement would not have been concluded by them or would have been concluded on significantly different terms. This rule is similar to the 'material adverse change' provisions that can be found in English law agreements.

Under Russian law damages are comprised of two component parts, namely actual losses and lost profit. The concept of lost profit is defined to include all gains that the injured party would have received had there been no breach. In order to bring a successful claim to recover lost profit it is necessary to have proof that the loss was foreseeable. This requirement can make successful claims for lost profits difficult to achieve. Russian law imposes a duty on the injured party to mitigate its losses.

Disclosures against warranties are rarely made in Russian law acquisitions, which is mostly due to the limited role of the warranties themselves. As a result a purchaser will in practice have little recourse to the seller for any matters that it discovers after completion of the acquisition. The purchaser must therefore rely on its own investigations of the target company or business, which it is advised to conduct prior to entering into the transaction.