When “Reps and Warranties” Don’t Provide Adequate Protection
A large financial services firm in the late-1990s acquired a
small database company that provided data supporting the lending process. The
seller signed a contract with all the necessary reps and warranties that all
their computer systems were fully operational and in compliance with prevailing
laws. The buyer also withheld about 20% of the purchase price in the event that
the operational effectiveness of the systems was not at the level specified in
the contract. It became apparent almost immediately after closing that the
seller had misstated dramatically the viability of his business. The buyer had
to eventually shut down the business and write off the full extent of the
purchase price. The buyer also had to submit to binding arbitration to recover
that portion of the purchase price that had been placed in escrow. The buyer
had virtually no recourse to the seller who had few assets in his own name and
who may have moved the bulk of the cash received for his stock to banks that
were beyond the jurisdiction of the U.S. legal system.
Case Study Discussion Questions
1. Comment on the statement that there is no substitute for
thorough due diligence.
2. How might the acquirer have been better able to protect
itself in this situation?