It is a fact that El Salvador has undergone a substantial change in the way business is conducted. This is largely due to market liberalization and globalization, which have in turn brought about a change in contractual models, particularly influencing business acquisition processes, as Anglo-Saxon models have been adopted that generally have no equivalent in civil law systems. Today, it is common for business acquisition agreements — including the purchase of controlling share packages, mergers, spin-offs, or direct acquisitions — to include an extensive list of representations and warranties intended to protect the purchaser’s interests against future contingencies, that is, supervening liabilities, such as pending litigation, cancellation of concessions, or payment of taxes not reflected in the company’s closing balance sheet at the time of acquisition.
Brief Reference to the Business Acquisition Process in El Salvador.
The business acquisition process — the mergers and acquisitions process in Anglo-Saxon law — begins, like any business transaction, with a decision; namely, when the interested party identifies the need to acquire a productive business unit for its operation. Next, the purchaser conducts a search and selection of the target company that will be the subject of the legal transaction.
In the early stages, it is common for the prospective contracting parties to exchange letters of intent. In such a letter of intent, the purchaser briefly states its intention to acquire the target company, and a confidentiality clause is agreed upon regarding the information to be exchanged thereafter. The purchaser then grants authority to a team of lawyers, financial experts, auditors, and accountants to carry out a legal, financial, and accounting due diligence review of the company to be acquired.
In the case of the lawyers, they prepare a detailed report on the legal status of the company to be acquired, making recommendations and evaluating possible future contingencies. Their general function is to perform the technical review that reveals facts, factors, and circumstances that may affect the contemplated transaction or the valuation of the investment. If no major issues are discovered, and the state of the company is sufficiently attractive to the purchaser’s interests, the parties will proceed to closing and the execution of the corresponding agreement.
Representations and Warranties.
Having briefly analyzed the usual stages of the business acquisition process, it is now appropriate to ask: what are representations and warranties, and what purpose do they serve? In general, these clauses are defined as: “Those statements of fact that one party makes to another and that are included in the contractual document, accompanied by an express undertaking to remedy any lack of truthfulness or inaccuracy.”
Their purpose is for the seller to communicate to the purchaser the circumstances relating to the company being transferred or its environment, while assuring that such circumstances are true; accordingly, the warranty concerns the truthfulness of the content of the statement.
In practice, the list of representations and warranties is usually the longest part of the purchase agreement, in which the seller provides the purchaser with a detailed description of the company, such as its capital, bylaws, powers of attorney, accounting books, taxes, employees, assets and liabilities, contracts and licenses, insurance, environmental and product safety issues, pending judicial proceedings, etc.
These clauses serve two functions. On the one hand, they have an informational function, since they channel information relevant to the legal transaction intended to be carried out, incorporating it into the agreement; for that reason, they are granted at the pre-contractual stage or at closing. They become incentives for disclosure, because if the seller fails to make them, it may lead the purchaser to believe that the information is false, with the consequence of a price reduction or, where applicable, the termination of negotiations. On the other hand, they allocate liability, which consists of extending the scope of potential claims, making the seller liable for certain contingencies, damages, or risks that would otherwise be borne by the purchaser. Their legal consequence is of an indemnificatory nature.
Legal Treatment in El Salvador.
In El Salvador, these clauses are entirely atypical, meaning that they are not regulated by statute; however, there is no legal prohibition against their use, by virtue of the freedom of contract guaranteed by the Constitution of the Republic.
For the most part, the applicable legal framework consists of the general rules of contract law. In that regard, if representations and warranties are statements for whose truthfulness and accuracy liability is assumed, this opens up a range of possibilities regarding the doctrinal classification of such contractual covenants within the Salvadoran legal system in the event of litigation. For this reason, and in order to optimize them, it is recommended that the agreement be drafted under an analytical model, understood as a contractual drafting technique in which all present and future contingencies that may arise in the contractual relationship are incorporated meticulously and exhaustively, since representations and warranties may be subsumed under various remedies, such as fraud, mistake, hidden defects, or breach of contract.
Conclusions.
Taking the foregoing into account, if you are about to enter into a transaction of this nature under Salvadoran law, you should consider the following:
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The due diligence process becomes essential in the business acquisition process, as it reduces information asymmetry for the purchaser and also constitutes a preventive remedy.
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The analytical method is recommended for drafting business acquisition agreements, because this model makes the construction of compensatory remedies more efficient, including the financial calculations on the basis of which the counterparty must perform and pay damages.
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If the seller guarantees a certain fact by means of representations and warranties, the purchaser acquires a right vis-à-vis the counterparty that entitles it to be indemnified for all damages, because the purpose of these clauses is to relieve that contracting party of the burden of verifying the truth of the statements made.
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Representations form part of the contractual agreement, since the contracting party assures the truthfulness of what is stated, so that if such information is not consistent with reality, that party may not exempt itself from liability.
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Representations and warranties affect decisive aspects of the allocation of liability by constituting a means of proof and an expression of diligent conduct. Therefore, they are effective as an instrument for the attribution of liability, generating reliance in favor of the party deserving of it by virtue of its diligent conduct, the exception being the recipient’s actual knowledge of the falsity of the statement or representation.
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From a procedural standpoint, an action for performance is the most appropriate avenue to request payment of the compensatory clause included in the agreement in the event of breach, given the complexity of the transaction, since an action for termination would entail restoring matters to the state in which they were before the closing of the legal transaction, which would imply a greater cost for the purchaser precisely because of the complexity of the acquisition process.
