By Stephen Dietrich, Greenberg Traurig LLP
In a recent transaction, I confronted an issue that is becoming more common as different types of buyers enter the auto retail space: The importance and scope of representations and warranties and the survivability of the representations and warranties.
A representation and warranty is a statement by one party about a particular set of facts or circumstances that the other party cares about in connection with a transaction. These typically relate to the ownership of assets, the authority to complete a transaction, third parties that may have an interest in a transaction (lenders, manufacturers, landlords), condition of assets or real property involved in the transaction and risks to future operations. Both the buyer and the seller provide representations and warranties, but sellers provide significantly more detailed information as it is their business being sold and the buyer is looking to learn.
The seller took the position that I have heard all too often, “Look at what you want, but I am not giving any representations or warranties other than that I own the dealership.” In addition, the seller stated that none of the representations and warranties being given (other than that the seller owned the assets) would survive closing.
The buyer on the other hand expected fairly detailed representations and warranties, subject to disclosure items, and believed that they should survive closing for some period of time. The buyer even expected some sort of escrow or holdback to protect against a breach of the representations and warranties.
It is not unusual to have some survival period and it is even relatively common to have some sort of escrow to provide incentive to the seller to provide complete disclosure and candor in the selling process.
While the seller position described above is very aggressive and I have not seen that severity in most other transactions, some lesser version of that position has become more prevalent and is creating additional stress on transactions. In the past, more limited buyer protections may have been the norm as the buyer of the dealership was likely experienced in the industry and was using his/her own funds to complete the transaction. There may have been some acquisition debt, but nothing monumental.
In more recent times the buyer may be a first time buyer or investing equity funds from a group of individuals. The financing may be more complicated or all encompassing. For whatever the reason, the buyer now needs to answer to more actors than themselves, and those actors look at the deal documentation in a different way than traditional buyers historically have done in this space.
To new buyers, representations and warranties serve both a diligence function and a recourse function if the business is not as represented. Buyers want to have the protections that come with these expectations. This use of representations and warranties and related escrows post-closing is a norm in most other industries and certainly when the transaction values are pushing to over $10,000,000 in blue sky amounts for one dealership, not to mention the real estate and other assets.
I understand the views and positions of both the seller and the buyer on this topic, and up until the past several years the issue was often able to be resolved between the parties because of a common understanding of the underlying business. But the retail auto space is developing, dealership structures and financing are becoming more complex, and a wider range of histories of the parties is influencing transactions. The disconnect on core aspects of a transaction are going to start to create stress and strain on deal dynamics.
I have seen several deals in the past 2 years become mired in negotiations on representations and warranties and related diligence matters. While we have been able to work through the issues ultimately, the strain on the transaction was evident and created a foundation of stress at the start of a deal when the parties would be better served working together.
I do not have a magic solution to this developing trend of stress, but note that in most cases it was helpful to moving forward when both parties took the time to try and understand the other side’s position and situation. Injecting some empathy into the conversation allowed for understanding and vision to see that the other side was rational in their thought. This does not mean the positions changed, but it allowed for some creative solutions and kept dialogue moving forward.
Stephen Dietrich is a partner in the Greenberg Traurig LLP law firm’s Denver office. He can be reached at 1-303-572-6502 or DietrichS@gtlaw.com.
