Stock Purchase Agreements and Asset Purchase Agreements typically contain extensive representations and warranties regarding the selling entity and, to a much more limited extent, the purchasing entity. These representations and warranties speak to the existence or non-existence of certain facts about the companies and form the basis of understanding for the transaction. In private transactions, reps and warranties typically “survive” the closing and a party can bring a lawsuit after the closing to collect indemnification should they discover a representation or warranty was materially untrue at the time of closing. Buyers frequently want indemnification relating to these reps and warranties to extend as far past the closing as possible – and it is not uncommon to see the extension to last indefinitely – even though such a provision is likely not enforceable under current state law.
A standard practice in purchase agreements is for the period in which a party can recover losses under an indemnification clause to be dictated by the type of representation. Liability for standard factual representations and warranties may extend for 1 to 2 years following the closing; liability for reps and warranties regarding statutory compliance (for example environmental or tax matters) typically extend for their statutory compliance periods; liability for certain “fundamental” representations and warranties (for example the ability of the Seller to enter into the transaction or the Seller’s ownership in the stock it is purporting to sell) may (as written in the contract) extend indefinitely. Parties may agree to extend the liability for fundamental reps because those reps are so vital to a transaction. If a fundamental representation is untrue, the entire transaction could be invalidated.
Recovery of damages for the breach of a rep or warranty is accomplished through the indemnification provisions in a purchase agreement. Each party typically will indemnify the other party for such breaches and allow for recovery of damages caused by the breach. Recovery is limited by various “caps” and “baskets” and then is further limited by the time within which a party can bring a claim – the survival period. Because the Sellers are making the majority of the representations and warranties, Sellers will want the time period to be as short as possible and Buyers tend to want the ability to bring claims long after the closing.
However, under current Delaware law, the statute of limitations for a breach of contract claim (which would cover the breach of a representation and warranty from a purchase agreement), is three years. Case law in Delaware provides that the courts will not extend this time period regardless of what the underlying contract says or what agreement the parties made about survival. Therefore, any claim relating to a breach of contract must be brought within three years of such breach. As the breach relates to a representation and warranty of a party, the clock would start ticking once the representation is made, usually at the closing of the transaction. Parties hurt by a false representation in a purchase agreement must find out about the false representation and bring an action within three years of the closing – much quicker than a casual reading of the purchase agreement would provide.
The public policy rationale for enforcing such a statutory limit is to bring claims quickly and discourage old or stale demands, but it is in direct conflict with Delaware’s oft-stated policy of allowing sophisticated parties freedom of contract. “[W]here parties have ordered their affairs voluntarily through a binding contract, Delaware law is strongly inclined to respect their agreement, and will only interfere upon a strong showing that dishonoring the contract is required to vindicate a public policy interest even stronger than freedom of contract.” Libeau v Fox, 880 A.2d 1049, 1056-57 (Del. Ch. 2005).
Legislation recently proposed in Delaware, and drafted by the Delaware Bar Association’s Commercial Law Section, would amend Delaware’s statute and allow for parties to extend the time period in which to bring a breach of contract claim for up to twenty years, as long as the underlying contract involved at least $100,000. This proposed legislative amendment would negate the current judicial stance on the survival of reps and warranties and allow sophisticated parties to more freely negotiate their contracts.
Should the amendment be approved by Delaware’s legislature, Governor Markell would likely sign the amendment into law at the end of June with an effective date of August 1, 2014.