Representations and warranties

Representations and warranties (reps and warranties) are the formal statements the seller makes in the definitive agreement about the legal, financial, and operational condition of the business. The seller represents that the financial statements are correct, that there are no undisclosed pending litigations, that contracts are valid, that the business complies with applicable regulation, and that there are no hidden liabilities. If any of these statements turns out to be false or incomplete, the buyer has the right to claim indemnification from the seller for the damages caused.

Why are representations and warranties the heart of the definitive agreement?

The definitive agreement is not just a transfer document — it is an allocation of risk between buyer and seller. The representations and warranties section is where that allocation happens in detail.

The LOI sets the price and structure. The definitive agreement sets the conditions under which that price is paid and the remedies available if those conditions were not met. A seller that misrepresents the condition of the business in the representations and warranties — intentionally or by omission — is liable for the difference between what the buyer paid and what the buyer actually received.

In Mexican SME M&A, representations and warranties serve three functions:

• Formalize the seller’s diligence.

  The seller is forced to state in writing that everything disclosed in the CIM and data room is accurate and complete. This creates accountability for the quality of disclosure.

• Protect the buyer post-closing.

  If a liability arises after closing that was not disclosed, the buyer has a contractual basis to claim indemnification from the seller.

• Allocate the risk of the unknown.

  Through negotiation, both parties agree which risks the seller retains post-closing and which transfer to the buyer.

What are the main categories of representations and warranties?

In Mexican SME transactions, representations and warranties cover six standard categories:

1. Financial: The financial statements present fairly the financial condition of the business. There are no material liabilities not reflected in the financial statements. Revenue and EBITDA figures are accurate. There are no undisclosed related-party transactions.
2. Legal and corporate: The seller has legal authority to sell. The shares or assets being sold are free of liens and encumbrances. The corporate structure is as described. There are no pending litigations that could affect the business.
3. Tax: The company is current on all tax obligations — SAT, IMSS, Infonavit, state taxes. There are no undisclosed audits or disputes. Tax returns have been filed correctly.
4. Labor: All employees are properly registered. Compensation and benefits are as described. There are no pending labor disputes. PTU obligations are accurately quantified.
5. Contracts: Key contracts are valid, enforceable, and in good standing. There are no material contracts requiring counterparty consent for transfer that has not been obtained. There are no contracts with change-of-control clauses triggered by the transaction.
6. Operational: The business is operating in the ordinary course. There have been no material adverse changes since the reference date. Key employees remain employed. There are no undisclosed material events.

How do the survival period and indemnification work?

Representations and warranties do not last forever. The survival period defines how long after closing the buyer may make a claim based on a breach. In Mexican SME transactions:

Indemnification mechanics: When a breach is confirmed, the seller compensates the buyer for actual damages. The definitive agreement defines: a deductible (minimum threshold before claims are payable), a basket (aggregate threshold), and a cap (maximum total indemnification, expressed as a percentage of enterprise value).

Fictional example:

What does a real representations and warranties case look like?

An industrial maintenance services company was acquired for MXN 22,000,000.00. The seller represented that there were no pending labor disputes. Eight months post-closing, the buyer received notice of a labor claim from a former employee who had been terminated informally 18 months before closing — before the representations’ reference date.

The buyer brought a representation and warranty claim against the seller under the survival period (24 months for labor reps). The seller disputed that the termination was “informal” — arguing it was not documented but not hidden. The definitive agreement required the seller to disclose all known labor contingencies. The buyer proved through SAT payroll records that the employee had been on payroll and was removed without a formal agreement. The seller paid MXN 510,000.00 in indemnification — the claim amount minus the agreement’s deductible.

What should the seller review before signing?

Four actions every seller should take before signing the definitive agreement:

• Complete disclosure schedules.

  Every exception to the representations and warranties must be listed in the disclosure schedules. An undisclosed exception is a breach. A disclosed exception is a negotiated risk allocation.

• Verify the survival period.

  Know exactly how long you are exposed to claims after closing. Negotiate survival periods down where possible — especially for general reps.

• Negotiate the indemnification cap.

  The indemnification cap limits total post-closing exposure. A cap of 10–15% of enterprise value is standard in Mexican SME transactions. A cap of 50%+ is aggressive and should be rejected.

• Confirm labor and tax liability status before closing.

  The highest-risk reps are tax and labor. Get a clean opinion from the SAT and verify IMSS/Infonavit are current before signing.

What do buyers and sellers ask about representations and warranties?

Are representations and warranties negotiable?

Yes — fully. Scope, survival period, indemnification cap, deductible, and basket are all negotiable. A seller with a clean data room and a fully disclosed risk profile has more leverage to negotiate favorable terms than a seller whose diligence revealed surprises. Preparation before the process is the best negotiation tool for the representations and warranties section.

What is a disclosure schedule?

A disclosure schedule is the list of exceptions to the representations and warranties. If the seller represents that there are no pending lawsuits "except as disclosed in Schedule 3.8," Schedule 3.8 lists each pending lawsuit. The disclosure schedule turns a potential breach into a disclosed, negotiated risk. Sellers should invest significant time preparing complete disclosure schedules — they are the main defense against post-closing indemnification claims.

Does reps and warranties insurance exist in Mexico?

Representations and warranties insurance (RWI) exists but is not commonly used in Mexican SME transactions below USD 20,000,000.00 enterprise value. Above that threshold, some buyers use RWI to replace or supplement the seller’s indemnification obligation — allowing the seller to receive more cash at closing with less post-closing exposure. Below USD 20,000,000.00, the cost of the premium relative to deal size makes it economically unattractive for most transactions.

What happens if the seller cannot pay an indemnification?

This is a real risk in SME transactions where the seller has already deployed the sale proceeds. Buyers mitigate through: a seller note (which can be set off against indemnification claims), an escrow holdback (a portion of cash at closing held in escrow for 12–24 months to cover potential claims), or a contingent tranche structured to absorb identified risks. The indemnification mechanism is only as valuable as the seller’s ability to pay.