Between 13% to 23% of all claims made under warranty and indemnity (W&I) insurance policies relate to accounting and financial statement matters.1 This is not surprising given that a loss of any kind will inevitably find its way to the accounts of a company in one way or another. However, in proportion to the number of claims, relatively little time is spent talking about financial statement warranties during M&A negotiations and W&I underwriting. This is owed, at least partially, to court judgments dealing with M&A being rare, given that the majority of disputes are dealt with by way of confidential arbitration.
This article reflects on some of the most relevant considerations, pitfalls and developments of financial statement warranties.
The financial statements warranty
One of the most important provisions in an M&A agreement, be it a share or asset purchase agreement (herein referred to as SPA), is the purchase price clause. Consequently, the financial statement warranty is one of the most important warranties that a buyer will request from the seller, given that the company’s financial results and position are material to the buyer’s decision on whether or not to proceed with the transaction, and on which terms.
As with any other warranty, there is a myriad of ways in which parties can draft a financial statement warranty. It is, for example, technically possible to draft a forwardlooking warranty by which the warrantor guarantees that a certain future event may or may not occur. A warrantor (most often being the seller) could further also give warranties speaking to off-balance sheet items or single line items. All of this will depend on the negotiations between the buyer and the seller. However, W&I insurance has narrowed the playing field, at least to those who want to use the product, because no (conventional) W&I underwriter will cover such warranties. This brings, one could argue, a sense of “balance” to the warranty catalogue.
But what is a financial statement warranty and what does it mean?2
An example of a typical financial statement warranty would be:
The audited financial statements of the target group company for the financial year ending 31 December 2021 (2021 Audited Financial Statements) have been prepared with the due care of a prudent businessman and in accordance with the applicable provisions of the German Commercial Code and generally accepted accounting principles in Germany. The 2021 Audited Financial Statements present, in accordance with such principles, a true and fair view of the net assets, financial position and results of operation of the target group company as of, and with respect to the financial year ending on 31 December 2021.
There are a few essential aspects to consider: firstly, such a financial statement warranty speaks to compliance with the relevant accounting standard (here, the German Commercial Code and generally accepted accounting principles in Germany) and should be distinguished from “correctness”, “completeness” or reflecting the actual circumstances as perceived from an ex-post (or “after the fact”) perspective.