Corporate, Securities & Tax
M&A Representation and Warranty Damages: The Myth of Lost Revenues into Perpetuity
What can the buyer of an operating business recover as damages when the seller fails to indemnify the buyer for harm caused by the seller’s breach of a representation or warranty in the transaction contract? Modern case law and commentary describe mutually exclusive options: either dollar-for-dollar damages to recover out-of-pocket losses, or damages equal to the diminution in value of the business, which is often misleadingly described as damages “subject to a multiplier” or “at the multiple.”[1] The determinative question for deciding between these options, we are told, is whether the business has been permanently injured as a result of the issue giving rise to the breach. For example, if the breached representation concerns the status of a material customer relationship, some would suggest that the buyer must establish lost revenues from that customer “into perpetuity” to be entitled to diminution in value damages.[2] However, the notion that diminution in value damages are only appropriate if the business has suffered harm that will linger for eternity is a false construct, and a confusing way of expressing the simple concept that diminution in value damages are warranted only when the value of the business as acquired has actually been diminished by the seller’s breach. The confusion is compounded when the best way of calculating the diminution in the entity’s value involves using a multiple of earnings, and the valuation methodology is mischaracterized as producing a multiple of damages. Determining whether the value of a business has been diminished by a seller’s breach of representation or warranty (really, its breach of its obligation to indemnify for the loss caused by that breach) is hard enough, without muddying the waters with a misleading standard. This article will endeavor to dispel some myths haunting the measurement of damages in representation and warranties claims arising out of mergers and acquisitions.
Click here to read the full article written by Hutch Robbins and published in Business Law Today.
