What are representations and warranties?
Many contracts include terms called representations, warranties and undertakings. The CARE is no exception. Each of those terms have a specific meaning in the eyes of the law but, to simplify things, you can read them all as being a promise. Therefore, under a CARE, the company and the investor will be making promises to each other. These promises must be fully understood as, if they prove to be untrue, there could be significant consequences.
The CARE has a number of ‘standard’ promises given by both the company and the investor. These include promises that they have unconditional authority to enter into the CARE and that their entry into it will not breach any laws or documents.
These mutual promises should be uncontroversial, but it is still vital that both parties check and confirm these statements are true. For example, if the company has previously raised money, it may have agreed that any subsequent fundraising is either prohibited (e.g. without the existing investor’s consent) or conditional on certain events (e.g. it must receive a specified level of board or shareholder approval).
In addition to these standard mutual promises, there are important company-specific promises given for the benefit of the investor.
The company promises that, if and when the investor receives shares, those shares will be entirely and unconditionally owned by the investor. This gives the investor comfort that they will be able to get what they really want, i.e. shares in the company.
To confirm this, the company needs to carefully check all the rules that apply when it issues shares, including those under any laws, contracts (e.g. any shareholders’ agreement) and the company’s constitutional documents. It’s possible, for example, that the company’s existing shareholders may have a right of first refusal over any newly issued shares and, to avoid this becoming an issue, the company may need to seek their prior consent.
The company promises that it will only use the investor’s money as set out in its business plan or budget. This helps avoid a situation where, for example, the company raises money to create a prototype or take a product to market, but then uses that money to settle pre-existing debts or, even worse, pay dividends to the company’s shareholders.
To confirm this, the company will need to share and discuss its business plan with the investor. If the company is very early stage, its business plan may not be excessively detailed. A lack of detail inevitably increases the risk of an argument about whether a payment was (or was not) within the scope of the business plan. The risk of these arguments can, however, be reduced or eliminated by being as open and honest as possible with investors, both during the CARE negotiations and after it has been signed.
What are the potential consequences?
Ultimately, if any of these promises prove untrue, this may lead to a dispute and the person who gave the false promise could face consequences. What those consequences will be depends on a number of factors but, as a minimum, the person in the wrong will likely be responsible for the foreseeable losses and damages resulting from their untrue promise.