Russian Federation: Russian Civil And Criminal Law Aspects Of Breaching Representations And Warranties In M&A Transactions

Last Updated: 4 April 2014
Article by Valentin Petrov and Petr Shevtsov

Normally M&A transactions, specifically sale and purchase agreements with respect to acquired assets such as companies' interests and fixed assets, contain representations and warranties clause.  R&Ws are a seller's statements in regard of the properties and characteristics of the acquired assets.  R&Ws with respect to a target company usually cover the following areas:

  • title to the shares of the target company;
  • proper incorporation, financial statement, material contracts of the target company;
  • prior relations with state authorities;
  • employees of the target company, etc.

In practice both representation and warranties are considered as legally binding provisions to the agreement.  From a practical standpoint, a breach of representation may cause a claim for rescission of agreement while a breach of warranty may cause a claim for damages.  This is the reason why a well-advised buyer seeks to name all relevant statements in the sale and purchase agreement both "representations" and "warranties" so as in case of breach to be entitled to both claims.  A well-advised seller, on the other hand, shall seek to exclude tortuous remedies and rescission by express provision to that effect.  In any case if the seller breaches the warranty that falls under the Misrepresentation Act 1967, the buyer will be entitled to rescind the agreement and claim for tortuous damages.

Just recently on February 26, 2013 Presidium of the Russian High Arbitrage Court has adopted the letter No 156 "The overview of the practice of implementing by the arbitrage courts of the public policy clause as a rejection in recognizing and enforcing of foreign court and arbitrage awards".  Clause 5 of the letter provides that representations and warranties may be enforced in Russia.  The High Arbitrage Court argued that absence of legal institutions similar to R&Ws in the Russian legal system shall not be a ground for rejection of their enforcement in Russia.  Accordingly, from the civil law standpoint R&Ws may be enforced in Russia.

R&W are widely used in M&A transaction with respect to Russian targets.  The consequences of their breach are not clear cut.  For instance, Article 178 of the Russian Civil Code may be a potential remedy which allows invalidation of the transaction if it was entered into by the party who was significantly confused.  Another option is to consider R&Ws as essential provisions of the agreement.  Any breach of such provisions shall entitle the non-defaulting party to invalidate the transaction.  However, even the revised Article 178 of the Russian Civil Code works only for invalidation of contracts with respect to consumer products rather than businesses/companies.  The article does not allow to determine whether by virtue of breach of R&Ws the value of the target company has been so materially diminished that this constitutes a valid ground to rescind the transaction or claim for damages.  The same uncertainty applies to treating R&Ws as essential provisions of the agreement.

Normally in the Russian law context, there is often an issue whether R&Ws may be enforced and what the consequences of failure to perform R&Ws are.  There is however a criminal law angle which the solicitors' firm "Egorov, Mazavina, Petrov and partners" has recently encountered with.  Thus, the breach of no encumbrance R&W given in the context of a sale of the Russian asset was considered by the Russian prosecution authorities as fraud.  Our law firm represented the interests of the victim and collaborated with prosecution.  The court agreed with the position of prosecution and found defendant guilty of fraud that was, in essence, the breach of no encumbrance R&W.

Given the above, the sellers shall pay more attention to whether they are comfortable with R&W they are ready to give as a part of a sale and purchase agreement.  They should consider both civil law and criminal law consequences of breach of R&Ws.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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