Are Representations & Warranties Regarding the Condition of a Company in an SPA Uncertain & Thus Irrelevant?

Last year’s decision by one of the Czech High courts sparked heated controversy in M&A practice when the court concluded that certain representations and warranties in an SPA were uncertain and therefore had no binding legal effect.

The case in question concerned representations and warranties relating to the company’s legal compliance in conducting its business activities and not entering into credit agreements or loan agreements, not providing credit or loans, and not providing guarantees or other security instruments. In the event of a breach of these representations, the SPA entitled the buyer to a contractual penalty.

According to the court, the provisions of the SPA in question did not directly concern the subject of the transfer (share in the company) or the properties of the company’s business enterprise, were not linked to a specific obligation of the seller, and did not define any obligation of the seller that could be breached by its actions or omissions.

The court ruled that such representations and warranties cannot be considered because, under the Czech Civil Code, they are considered putative and thus shall be disregarded. The buyer was therefore not granted the right to payment of the contractual penalty to which it would have been entitled in the event of a breach of the representations.

The decision is controversial because it contradicts the rule and related decisions of the Czech Supreme Court that the interpretation of a legal act that would render it effective should be preferred. At the same time, the decision is not in line with the legal principle of autonomy of will and does not pursue the economic purpose of the agreement in question. According to the Czech Supreme Court, it would be possible to assess the buyer’s claim not as a contractual penalty, but, for example, as an agreement of an unnamed contractual clause confirming the debt.

The question is whether the court decision in question, given its conflict with the Supreme Court’s case law, will stand or whether it will be deemed an excess of judicial decision-making. The impact of such an interpretation on acquisition practice would be obvious and would fundamentally limit the protection provided to the buyer by the above-mentioned standard representations and warranties of the seller. The abovementioned decision of the Czech Supreme Court should be understood in the context of a specific situation in which the contractual parties had structured buyer protection as a contractual penalty. In standard current transaction practice, however, buyer protection is more typically achieved through a purchase price discount mechanism linked to the agreed characteristics of the transferred share, i.e., within the framework of rights arising from defective performance. Where the mechanism is structured in this way, the issue addressed by the court should not arise.  Notwithstanding the above, any broadly formulated provisions should always be subject to careful case-by-case review to ensure that they satisfy the requisite standard of certainty and are not susceptible to challenge on the grounds of vagueness.