This article is written by Taniksha Gupta pursuing a Diploma in M&A, Institutional Finance and Investment Laws. This article has been edited by Ojuswi (Associate Lawsikho). 

This article has been published by Sneha Mahawar.

Introduction 

The goal of contract law is to guarantee that the parties to a contract fulfil their responsibilities more than just to ensure that they enjoy the advantages anticipated by the contract. Confidence is built into any general or commercial contract through the use of the representations and warranties clause, which acts as a statement or declaration made by the parties. Contracts may differ in terms of the concrete agreement and terms, but the concepts of fact-based demonstration and assuredness to safeguard stakeholders are nearly identical across the board.

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Customers/buyers/clients are expected to accept these statements as true unless they can be proven otherwise. Representations and warranties are usually combined in a single contract clause, which provides the best protection for the buyer/client in the event of a dispute. This article discusses the importance of reps and warranties in a Shareholder’s Agreement. 

Who is a shareholder

Someone who owns stock in a company is referred to as a shareholder. Because of his investment, the corporation gives him a set amount of stock options as compensation. In exchange for his shares, he will become a shareholder and have the authority to vote on things pertaining to the corporation.

What is a shareholder’s agreement

The rights and responsibilities of the shareholders, as well as the relationship between the firm and the shareholders, are laid forth in a shareholder agreement. Agreements between the different company partners are akin to a partnership agreement. Shareholders’ agreements are designed to guarantee that shareholders are treated properly and to give them control over who becomes a shareholder at some point in the future. Since this agreement’s stated purpose of protecting all shareholders, it is especially significant to minorities because it defines the majority shareholder’s commitment to safeguard minorities from abuse and provide them with a voice when crucial decisions are taken.

The shareholder agreement serves as a safeguard for existing shareholders against future management abuses of their power. Agreements such as this one assist protect the firm in the event of a change in management or acquisition, such as the distribution of dividends and the issuance of additional shares or debt.

Shareholders’ problems, corporate distributions, the management team of the firm and limitations on authority, minority shareholders’ rights, voting of shares of stock, limits on share transfer and allotment and other matters are addressed in the shareholder agreement. Using the agreement as a reference document in the event of future disputes will safeguard shareholders. However, although articles of incorporation may include some clauses, the scope and protection offered by an SHA much exceeds that of an article of incorporation. When it comes to the special demands of shareholders, there is no standard form. 

Key provisions shareholders agreement usually contain

  • A preamble that specifies the parties, including the firm name and all shareholders involved in the agreement. 
  • The purposes of the agreement. 
  • How shares will be acquired, sold, or transferred (this includes both the optional and mandatory buying-back of shares by the company and what happens in the event of the death of a shareholder).
  • Protection of minority shareholders.
  • Dividends.
  • Fair Price of shares.
  • Facts on the company’s governance and management, including information about board meetings, management information, banking arrangements and other financial details.
  • Methods for resolving disputes between shareholders and the company’s management.

Meaning of representations 

As the name implies, a representation asserts a fact that is expected to be true at the time it is formed. In order to get another party to sign a contract, a representation is made. The following is an example of a mutual representation in a contract:

“Each Party hereby represents to the other Party that all representations contained in this Agreement are true and accurate and that such representations are deemed to be given or repeated by each party, as the case may be, as at the date of this Agreement.”

The term “representation” is not defined under the Indian Contract Act, 1872 (“ICA”), but the act does clarify what constitutes a misrepresentation. A misrepresentation can be classified as either a fraudulent misrepresentation or an innocent deception (no intent to deceive) according to Section 18 of the ICA. These two categories are important since the treatments available for each are different. However, the right to repudiate the contract is contingent on whether the deception could not have been identified with ordinary diligence in cases where there was no intent to deceive. False representations, on the other hand, allow for a claim for damages and a cancellation of a contract. However, the innocent party does not have the right to repudiate the contract if the deception did not lead to the contract.

Under Section 17 of the ICA, Fraud is defined as “the purposeful concealment of a truth by one who has knowledge or belief of the fact,” yet it’s interesting to note that the ICA defines “silence” as “not fraud, save in cases where the quiet is required by law.” If there is no legal responsibility to disclose, then there is no obligation on any party to do so. 

Meaning of warranties

Warranties guarantee the truthfulness of statements or conditions while also covering the other party in the event the statement or condition turns out to be untrue. It is a formal declaration that an assertion or circumstance is and will be accurate when the assertion of fact is made and/or for a set length of time. Again, the ICA fails to define the phrase “warranty.” Intellectual property infringement is a common example of a warranty offered by parties in business contracts. For instance, the agreement can contain a clause stating: “There will be no infringement of another party’s intellectual property rights if the deliverables/work product is delivered by the service provider. The offended party may terminate the contract and seek damages for breach of contract in the instance of a warranty violation.”

In Idemnitsu Kosan Co Ltd v Sumitomo Co Corp, the Court had to decide whether or not warranties might be used as statements in a court of law or arbitration. The Court ruled that warranties and representations are distinct and that the two are not interchangeable. A warranty or representation depends on the intent of the parties involved.  

Importance of representation and warranties clause in shareholders agreement

The representations and warranties contained in a shareholders agreement serve as promises made by one party to the other. Regardless of how the contract and the wording of the agreement differ, the concepts of factual representation and warranty to safeguard the parties involved are common to all contracts. In the absence of compelling evidence to the contrary, a shareholder should take these statements as gospel. A party’s best defence is a combination of representations and warranties.

There are many advantages to including statements and guarantees in a shareholder’s agreement. In the event of contract termination or amendment, the terms of the representations and warranties serve as a solid foundation. The warranty stipulates the steps that one signer can take against the other if one of the claims made is incorrect. Most warranties allow the opposite party in a contract to terminate or deny a transaction if a representation is untrue, but this is not always the case.

Contracts are drafted by lawyers or legal representatives who have a legal obligation to safeguard their clients from any hazards while obtaining the benefits that come from signing a contract. As long as the contract contains representations and warranties, the lawyer can rest easy knowing that their duties have been met. If one includes representations and warranties in your contract, they will safeguard them in the event that any of the claims made by either party are untrue. 

What should the representations and warranties clause include

The Representations and Warranties provision is unique to each contract. To avoid future duties, the parties agree to their respective representations and warranties clauses in their contract. The following issues are primarily addressed by the Representations and Warranties clause:

  1. The corporation is legally constituted and possesses the necessary capacity and authority to perform and carry out the terms, conditions and provisions of the agreement. 
  2. Insolvency proceedings have not been filed against or expected against it, nor has it been declared insolvent.
  3. As a result, it has not been the subject of any civil or criminal liability that in the aggregate could have a significant impact on its ability to perform its responsibilities under this Agreement.

Conclusion

At all stages of a contract’s lifecycle, representations and warranties play an essential role in the negotiation and execution of the agreement itself. For this reason, it is imperative that all parties to a contract make sure that any representations and warranties provided by the other party are truthful. These should also be carefully drafted to avoid any potential future disputes. Using statements in contracts or agreements might place a corporation in danger of being sued for fraud, hence some organizations avoid using them. The terms “representations and warranties” may also be omitted from the contract in order to make it simple and minimize redundancy. Additionally, referring to information as representations in a contract is a way to decrease the contract’s word count while still ensuring that the company and the shareholder are protected.

References

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