Buzz

Distinction between Representations versus Warranties, Special Meeting of the Board and More

Joseph W. Bartlett, Founder of VC Experts.com


In most transactional documents, the section called "Representations and Warranties" contains a lead paragraph which provides that the responsible party both represents and warrants the accuracy (and usually the completeness) of certain factual statements. An article in 15 Bus. Law Today (No. 3.) (Jan/Feb. 2006) by Prof. Stark focuses on the significant difference between a representation and a warranty, differences suggested by words themselves and focused on the remedies available in the case of breach. Thus, if a representation is false and the representing party is charged with knowing of the falsity, the counterparty can bring a claim sounding in tort for deceit. Elements of the claims are, first, scienter … which includes actual knowledge and/or knowledge of facts which tag the party with constructive knowledge, i.e. intentional or reckless ignoring 'red flags.' The tort claim also must include: (i) defendant's intent to induce reliance; and (ii) plaintiff's justifiable reliance on the representation. The tort claim fails if scienter cannot be proved or if the plaintiff knew the representation was false. In addition, since the representation is enshrined in the contract, and assuming (as usual) there are global indemnity provisions in the contract for breach, the plaintiff can sue for breach of the contract … including in the remedy sought the right to rescind based on the false representation.

Prof. Stark is of the opinion that the ability to rescind is not available to the plaintiff suing for a breach of warranty. A second distinction she cites in that, in her view, breach of a representation may trigger a right to punitive damages, which are not typically available for a breach warranty. And, if the complaint sounds in contract, benefit-of-the-bargain damages for breach of contract also are available.

Turning to breach of warranty, and citing the case of CBS Inc. v. Ziff-Davis Publishing Co., 75 N.Y.2d 496 (1990), Prof. Stark suggests that, even if the counterparty has knowledge that the representation is false, nonetheless it can sue on the basis of a breach of warranty; also a claim for a breach of warranty is not dependent on the plaintiff's ability to prove scienter. A warranty is useful in a situation where neither the seller nor the buyer knows or can know the accuracy of the statement at either the time the contract is executed or the transaction closes. A warranty is, in this case, a method of risk allocation regardless of fault … whereas a representation requires both scienter and reliance.

To be sure, these distinctions are generally not material if, as is typically the case, the defendant has executed a document which contains both representations and warranties. The plaintiff will include multiple counts in the complaint, suing on the basis of all available theories.

Every once in a while we want to remind our complimentary users that the Buzz of the Week is just the tip of the iceberg when it comes to our private equity and venture content, commentary and data. Below are a few examples in what you can find in the premium section. for more information, contact Michael Ostendorff at 646-290-9254 or michael@vcexperts.com .

Model Resolutions of Special Meeting of the Board of Directors Establishing Fair Market

[Fair Market Value of Common Stock - INFORMAL VALUATION]

WHEREAS, the Board of Directors (the "Board") of Newco, Inc. (the "Corporation") has determined that it is in the best interests of the Corporation and its shareholders to determine the fair market value of the Corporation's common stock, par value $0.01 per share (the "Common Stock");

WHEREAS, the board has considered the following factors in determining the fair market value of the Common Stock:

  • the value of tangible and intangible assets of the company;
  • the present value of future cash flows;
  • the public trading price or private sale price of comparable companies;
  • control premiums and discounts for lack of marketability;
  • whether the method is used for other purposes; and
  • whether all available information is taken into account in determining value; and

WHEREAS, in accordance with the above factors, the Board [if desired, provide details regarding the Board's analysis as to how FMV determined and] determined that the fair market value of the Common Stock is $___ per share.

NOW, THEREFORE, BE IT HEREBY RESOLVED that based on the factors and the Board's analysis detailed above, the fair market value of the Corporation's Common Stock as of the date hereof is hereby determined to be $____.]

OR

[Fair Market Value of Common Stock - FORMAL VALUATION]

WHEREAS, the Board of Directors (the "Board") of Newco, Inc. (the "Corporation") has determined that it is in the best interests of the Corporation and its shareholders to determine the fair market value of the Corporation's common stock, par value $0.01 per share (the "Common Stock");

WHEREAS, the board has determined that a formal valuation should be prepared by the Corporation considering the following factors in determining the fair market value of the Common Stock:

  • the value of tangible and intangible assets of the company;
  • the present value of future cash flows;
  • the public trading price or private sale price of comparable companies;
  • control premiums and discounts for lack of marketability;
  • whether the method is used for other purposes; and
  • whether all available information is taken into account in determining value; and

NOW, THEREFORE, BE IT HEREBY RESOLVED that within one week of the date hereof, Jane Doe shall prepare a formal valuation of the fair market value of the Corporation's Common Stock, based on the illiquid start-up presumption outlined in the tax regulations pursuant to Internal Revenue Code Section 409A (the "Formal Valuation");

FURTHER RESOLVED, that the fair market value of the Common Stock shall be the fair market value as determined by the Formal Valuation.]

2005 Stock Incentive Plan

WHEREAS, the Board has determined that it is in the best interests of the Corporation that the Corporation adopt the 2005 Stock Incentive Plan, as more fully described below;

NOW, THEREFORE, BE IT HEREBY RESOLVED that the adoption by the Corporation of the 2005 Stock Incentive Plan in the form attached hereto as Exhibit A (the "Plan") be, and it hereby is, approved and authorized in all respects; and that the Corporation reserve 139,800 shares of Common Stock for issuance under the Plan; and that the officers of the Corporation be, and each of them acting singly hereby is, authorized to execute, countersign, issue and deliver such documents, certificates and instruments as may be required to give effect to this resolution, the taking of such action to be conclusive evidence of the authority of the officer so acting pursuant to this resolution.

RESOLVED FURTHER, that the Plan shall be submitted to the stockholders of the Corporation and recommended for adoption and approval within 12 months of the date hereof and before any shares are issued under the Plan.

Stock Option Grants

WHEREAS, the Board has determined that it is advisable and in the best interests of the Corporation to approve certain stock option grants pursuant to the Plan, as more fully described below;

NOW, THEREFORE, BE IT HEREBY RESOLVED, that the granting of stock options under the Plan to the individuals listed on Exhibit B attached hereto, on the dates and in the amounts and subject to the terms set forth on Exhibit B, be, and hereby are, approved and authorized in all respects.

General Authority

RESOLVED, that any and all actions heretofore or hereafter taken by the officers or directors of the Corporation within the terms of any of the foregoing resolutions are hereby ratified and confirmed as the act and deed of the Corporation; and

RESOLVED FURTHER, that the officers of the Corporation be, and each of them acting singly hereby is, authorized and empowered to take any and all actions, and to execute, affix the Corporation's seal to and deliver any and all documents, agreements, certificates and instruments, in the name and on behalf of the Corporation, as the officers or officer so acting may deem necessary or desirable to carry out the purposes and intent of, and to consummate, any and all of the actions, functions and transactions contemplated by any of the foregoing resolutions, the execution and delivery of any such document and the taking of any such action to be conclusive evidence of the authority of the officer so acting pursuant to these resolutions.


joe@vcexperts.com