contractual representation legal definition

Trending News

Related Practices & Jurisdictions

• Corporate & Business Organizations
• All Federal

“Representations,” “warranties” and “covenants” are so common in contracts that the words are likely to be overlooked. They appear not only as nouns, but as verb forms as well. Sometimes there is a separate section for each word, implying that they have distinct meanings. Often they are grouped together as “represents and warrants” or “represents, warrants and covenants.” Unfortunately, these repetitious phrases blur their meanings. Their imprecise use does not frequently result in litigation, but there’s much to be said for reducing redundancy and ambiguity.

These words are basic building blocks of contracts and have a long history. Each has traditionally had a distinct meaning and purpose. The key difference among these words is temporal – past and present for representations; past, present, but mainly future for warranties; and mainly future for covenants. The remedies for a false representation, breach of a warranty or violation of a covenant also have differed. Giving attention when drafting or editing a contract to their backgrounds and the traditional distinctions among them will promote clarity.

Representations

In traditional usage, a representation precedes and induces a contract. It is information by which a contracting party decides whether to proceed with the contract. A representation is an express or implied statement that one party to the contract makes to the other before or at the time the contract is entered into regarding a past or existing fact. An example might be that a seller of equipment represents that no notice of patent infringement had been received.

A representation traditionally was not part of a contract, and a claim for damages due to a misrepresentation generally would not be allowed. Instead, a claim that a misrepresentation induced a contract might be pursued in fraud, either to rescind the contract or for damages. In some instances, a claim might be based on the tort of negligent misrepresentation.

If a representation was included as part of a contract, it typically would function as a “condition” or “warranty.” A condition is a vital term going to the root of the contract (for example, that a lawyer hired under an employment agreement must be licensed to practice law), which, if the condition were false, would entitle the employer to repudiate the contract. In contrast, a representation in a contract might be a “warranty,” which would be an independent, subsidiary promise that did not go to the root of the contract (such as that the lawyer claims to always wear a suit to the office), and, if false, might give rise only to a claim for damages.

Warranties generally are promises that appear on the face of the contract. They are important parts of the contract, requiring strict compliance. Warranties may include representations, agreements or promises that a proposition of fact is true at the time of the contract and will be true in the future. A warranty provides that something in furtherance of the contract is guaranteed by a contracting party, often to give assurances that a product is as promised. It often is equivalent in effect to a promise that the warranting party will indemnify the other if the assurances are not satisfied.

Warranties may be categorized as affirmative warranties, i.e., those that focus on assurances that certain facts are true or acts have been performed at the time of the contract, and promissory warranties, i.e., those that are agreements for the future. Either type of warranty entitles the protected party to damages for breach or to the particular remedies set forth in the contract. Damages are based on the difference between the value of contract as agreed upon compared to the value of the contract given the facts at the breach.

Warranties now commonly provide protection for consumer products, and are subject to the Uniform Commercial Code and federal law. An “extended warranty” protects beyond the initial agreement between a buyer and seller. It is a form of insurance and may be regulated as such depending on state law and the particulars involved.

Comparing Representations and Warranties

Justifiable reliance generally is an element for a misrepresentation claim, but the state of mind of the party to whom the warranty is given is not pertinent to a warranty claim, and a party may enforce an express warranty even if the beneficiary believes the warranty will be breached and the problem it covers will arise.

Traditionally, a warranty also differed from a representation in these ways: (1) a warranty was always part of a contract, while a representation usually was a collateral (or a separate) inducement prior to the contract; (2) a warranty was on the face of a contract, while a representation might be written or even oral; (3) a warranty was conclusively presumed to be material, while a party claiming a misrepresentation had to establish materiality; (4) a warranty had to be strictly complied with, while substantial truth was enough for a representation; (5) a contract remained binding if a warranty was breached (unless the warranty was also a condition that was vital to the contract, e.g., that the lawyer hired under an employment agreement was licensed); and (6) only damages were recoverable from a breach of warranty, while a party defrauded by a misrepresentation might in some circumstances rescind the contract or recover damages for fraud.

A covenant in a contract traditionally has been a solemn promise in writing, signed, sealed and delivered, by which a party pledges that something has been or will be done or that certain facts are true. Historically, a covenant was in a sealed document that was self-authenticating, and witnesses were not required to establish the terms in the document. Of course, with the abolition of private seals over the last hundred years or more, contracts have been enforceable without being sealed documents.

Covenants usually are formal agreements or promises in a written contract, and are usually in agreements relating to real property. Covenants in or related to a contract usually are secondary to the main reason for the contract. They are an undertaking to do or not do something in the future; for example, that conditions will be maintained between the signing of a contract and the closing of the transaction, or while a loan is unpaid, or that a party will not compete or sue. A covenant – similar to a warranty – has always been part of the contract. A claim for breach of a covenant may be for damages or specific performance, or, potentially, if the covenant is important enough, for rescission or termination.

Dispensing with “representations,” “warranties” or “covenants” might be the norm for contracts in the future. Some commentators and model forms avoid the words, substituting “agree” or “obligate” or use “represent” to also cover “warrant.” Distinctions based on these terms have been important – perhaps to an excessive degree – in the past. Courts today are more willing than before to excuse formalism related to particular words, but it’s safe to warrant that archaic distinctions still matter in the digital age.

Current Legal Analysis

More from dykema gossett pllc, upcoming legal education events.

Sign Up for e-NewsBulletins

Representations and Warranties | Practical Law

Representations and Warranties

Practical law glossary item 8-382-3760  (approx. 3 pages).

The Law Dictionary

Your Free Online Legal Dictionary • Featuring Black’s Law Dictionary, 2nd Ed.

REPRESENTATION Definition & Legal Meaning

Definition & citations:.

In Contracts. A statement made by one of two contracting parties to the other, before or at the time of making the contract, in regard to some fact, circumstance, or state of facts pertinent to the contract, which is influential in bringing about the agreement. In insurance. A collateral statement, either by writing not inserted in the policy or by parol, of such facts or circumstances , relative to the proposed adventure, as are necessary to be communicated to the underwriters, to enable them to form a just estimate of tlie risks. 1 Marsh. Ins. 450. The allegation of any facts, by the applicant to the insurer, or vice versa, preliminary to making the contract, and directly bearing upon it, having a plain and evident tendency to induce the making of the policy. The statements may or may not be in writing, and may be either express or by obvious implication . Lee v. Howard Fire Ins. Co., 11 Cush. (Mass.) 324; Augusta Insurance & Banking Co. of Georgia v. Abbott, 12 Md. 34S. In relation to the contract of insurance , there is an important distinction between a representation and a warranty.The former, which precedes the contract of insurance, and is no part of it, need he only materially true: the latter is a part of the contract, and must be exactly and literally fulfilled, or else the contract is broken and inoperative. Glendale Woolen Co. v. Protection Ins. Co., 21 Conn. 19, 54 Am. Dec. 309. In the law of distribution and descent. The principle upon which the issue of a deceased person take or inherit the share of an estate which their immediate ancestor would have taken or Inherited, if living; the taking or inheriting per stirpes . 2 Bl. Comm. 217, 517. In Scotch law . The name of a plea or statement presented to a lord ordinary of the court of session , when his judgment is brought under review.

This article contains general legal information but does not constitute professional legal advice for your particular situation. The Law Dictionary is not a law firm, and this page does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.

Browse Legal Articles

Business Formation

Business Law

Child Custody & Support

Criminal Law

Employment & Labor Law

Estate Planning

Immigration

Intellectual Property

Landlord-Tenant

Motor Vehicle Accidents

Personal Injury

Real Estate & Property Law

Traffic Violations

Browse by Area of Law

Powered by Black’s Law Dictionary, Free 2nd ed., and The Law Dictionary .

About The Law Dictionary

Terms and Conditions

Privacy Policy

Representation Agreement

Jump to section, what is a representation agreement.

A representation agreement is a legal document that sets the terms of the relationship between two parties, with one acting on behalf of another. This agreement can apply to attorney and client relationships, sales representative and company relationships, or personal representatives of other individuals in a healthcare or financial situation.

A representation agreement between a sales representative and a company outlines the terms and conditions for both the sales representative and the company. It determines pay structure, if the sales representative works on commission, and protects intellectual property and confidential information of the company.

Common Sections in Representation Agreements

Below is a list of common sections included in Representation Agreements. These sections are linked to the below sample agreement for you to explore.

Representation Agreement Sample

Reference : Security Exchange Commission - Edgar Database, EX-10.8.1 5 d193541dex1081.htm SALES REPRESENTATIVE AGREEMENT , Viewed October 14, 2021, View Source on SEC .

Who Helps With Representation Agreements?

Lawyers with backgrounds working on representation agreements work with clients to help. Do you need help with a representation agreement?

Post a project  in ContractsCounsel's marketplace to get free bids from lawyers to draft, review, or negotiate representation agreements. All lawyers are vetted by our team and peer reviewed by our customers for you to explore before hiring.

Meet some of our Representation Agreement Lawyers

Brian C. Restivo, the managing member of Restivo Legal, PLLC, has been licensed by the State Bar of Texas and continuously practicing as an attorney since November of 2000. Over these years, he has represented customers across the spectrum - from a Fortune 500 company to individuals - and is seasoned at tailoring his services to the unique needs of each customer.

Antonella C.

I am a business transactional & trademark attorney with 15 years experience in the law firm and in-house settings. I am barred in Pennsylvania and New Jersey. I currently own my own practice serving businesses and entrepreneurs with business transactional and IP law.

Christopher L.

Christopher M. Lapinig is an experienced attorney, admitted to practice in California and New York, with extensive experience in civil litigation at the trial and appellate levels in various areas of the law, including, but not limited to, constitutional law, labor and employment, and consumer protection. He also has experience in immigration law and with administrative wage-and-hour claims. Chris currently works in impact litigation, and he also teaches legal writing at the University of Southern California. Chris also has significant experience in journalism and lay writing; his work has been published in The New York Times, The Atlantic, CNN, and other prominent media outlets. Born and raised in Queens, New York, Chris previously served as a Deputy Attorney General in the Consumer Protection Section at the California Department of Justice. He also served as a Skadden Fellow and Staff Attorney in the Impact Litigation Unit at Asian Americans Advancing Justice – Los Angeles, where his work focused on providing holistic and culturally sensitive legal services to victims and survivors of human trafficking in the Filipino community. At Advancing Justice-LA, Chris also litigated voting rights and immigrant rights cases. At the beginning of his legal career, Chris served as a law clerk to the Honorable Denny Chin of United States Court of Appeals for the Second Circuit and was the first Filipino American Clerk for the Honorable Lorna G. Schofield of United States District Court for the Southern District of New York, the first federal Article III judge of Filipino descent in United States history. Chris was also a Fulbright Research Scholar in the Philippines. A Phi Beta Kappa member, Chris graduated summa cum laude from Yale College and earned a B.A. with Distinction in Linguistics and with Distinction in Ethnicity, Race and Migration. In college, Chris served as President of Kasama: The Filipino Club at Yale, Moderator of the Asian American Students Alliance, and Head Coordinator of the Asian American Cultural Center. Chris returned to Yale for law school and received his J.D. in 2013. In law school, Chris served as the Co-Chair of the Asian Pacific American Law Students Association, the Co-Coordinator of the Critical Race Theory Conference, the inaugural Diversity Editor of the Yale Law Journal, and the Founding Coordinator of the Alliance for Diversity. He was a member of the Worker and Immigrant Rights’ Advocacy Clinic.

Background in Engineering, Masters in Business, Licensed Patent Attorney. Reviewed countless title reports, and land contracts. If you have a problem with Real Estate I can solve it.

I have been in business development for 15 years before becoming an attorney. As an attorney, I help companies navigate legal challenges that they face.

Anthony M. Verna III, is the managing partner at Verna Law, P.C. With a strong focus on Trademark, Copyright, Domain Names, Entertainment, and Advertising law, Verna Law, P.C. strives to provide all Intellectual Property services a modern business of any size may need to market and promote itself better. From the very early concept stage, Verna Law, P.C. can conduct a comprehensive, all-encompassing search and analysis on any proposed trademark to head off complications. Once the proposed concept enters the Alpha stage, Verna Law, P.C. can seamlessly switch to handling registration, protection, and if needed, defense of registered trademarks, copyrights, and domain names, as well as prosecution of entities violating said rights. Verna Law, P.C. also provides intellectual property counseling and services tailored to fit into your business’ comprehensive growth strategy. This shows as many of Verna Law, P.C.’s clients are international: from China, the United Kingdom, Canada, and Germany, Verna Law’s reach is worldwide. Additionally, Verna Law, P.C., can handle your business’ Entertainment and Advertising law needs by helping your business create advertising and promotions that keep competitors and regulators at bay. Located in the shadow of New York City, Verna Law, P.C. has a global reach that will provide clients with the most vigorous Intellectual Property advocate available. Anthony M. Verna III is a member of the New York and New Jersey Bars, as well as the U.S. District Court Southern District of New York. He is a sought-after business speaker, including regular appearances at the World Board Gaming Championships, Business Marketing Association of New Jersey, and Columbian Lawyers Association.

Find the best lawyer for your project

How it works.

Post Your Project

Get Free Bids to Compare

Hire Your Lawyer

Business lawyers by top cities

• Austin Business Lawyers
• Boston Business Lawyers
• Chicago Business Lawyers
• Dallas Business Lawyers
• Denver Business Lawyers
• Houston Business Lawyers
• Los Angeles Business Lawyers
• New York Business Lawyers
• Phoenix Business Lawyers
• San Diego Business Lawyers
• Tampa Business Lawyers

Representation Agreement lawyers by city

• Austin Representation Agreement Lawyers
• Boston Representation Agreement Lawyers
• Chicago Representation Agreement Lawyers
• Dallas Representation Agreement Lawyers
• Denver Representation Agreement Lawyers
• Houston Representation Agreement Lawyers
• Los Angeles Representation Agreement Lawyers
• New York Representation Agreement Lawyers
• Phoenix Representation Agreement Lawyers
• San Diego Representation Agreement Lawyers
• Tampa Representation Agreement Lawyers

related contracts

• 93a Demand Letter
• Accounting Services Agreement
• Accounts Receivable Purchase Agreement
• Ad Agency Contract
• Adhesion Contract
• Advertising Services Agreement
• Agency Agreement
• Agency Contract

other helpful articles

• How much does it cost to draft a contract?
• Do Contract Lawyers Use Templates?
• How do Contract Lawyers charge?
• Business Contract Lawyers: How Can They Help?
• What to look for when hiring a lawyer

Quick, user friendly and one of the better ways I've come across to get ahold of lawyers willing to take new clients.

Contracts Counsel was incredibly helpful and easy to use. I submitted a project for a lawyer's help within a day I had received over 6 proposals from qualified lawyers. I submitted a bid that works best for my business and we went forward with the project.

I never knew how difficult it was to obtain representation or a lawyer, and ContractsCounsel was EXACTLY the type of service I was hoping for when I was in a pinch. Working with their service was efficient, effective and made me feel in control. Thank you so much and should I ever need attorney services down the road, I'll certainly be a repeat customer.

I got 5 bids within 24h of posting my project. I choose the person who provided the most detailed and relevant intro letter, highlighting their experience relevant to my project. I am very satisfied with the outcome and quality of the two agreements that were produced, they actually far exceed my expectations.

Want to speak to someone?

Get in touch below and we will schedule a time to connect!

Find lawyers and attorneys by city

Understanding Contract Recitals, Covenants, Representations, and Warranties

Recitals are usually one of the first sections of a contract. They are not required, but they are very helpful. Recitals provide general information about the parties and the agreement, such as the contracting parties’ intentions or understanding of the purpose for the contract. They are a good way to ensure that the contract is interpreted correctly by all parties.

Covenants are the center piece of a contract. They are what you think of when someone says there were “promises” made under a contract. Covenants are the promises that each party makes to the other regarding the contract. When one party fails to keep one of these promises, that party is said to have “breached” the contract.

Representations are statements made by one of the contracting parties about a fact concerning the contract. Representations and covenants can look very similar, but they are technically very different. The difference is in the details even though both look like promises.

The difference between a covenant and a representation is that a covenant is a promise that one party will do something in the future while a representation is a promise that a present fact or circumstance is true .

For example, in a real estate contract a representation would be a statement by the seller that there are no defects in the sewer system (i.e. a present fact or circumstance). While a covenant in a real estate contract would be a statement by the buyer that the buyer will pay the purchase price on a certain date (i.e. a promise to do something in the future).

Warranties are one step deeper. A warranty is a statement that the representations are true. The function of a warranty is that if a representation is untrue, then the contracting party who made the representation is on the hook for breach of warranty—a separate and distinct cause of action with its own set of remedies (money awards).

If you have any questions about a contract or would like to speak with an experienced Florida business attorney or contract attorney, contact Boyer Law Firm today and set up a consultation .

Representations and Warranties: Everything You Need to Know

Representations and warranties in business contracts provide facts (representations) and security against loss (warranties) if the statements made are not true. 7 min read updated on February 01, 2023

What are Representations and Warranties?

Representations and warranties in business contracts  provide facts (representations) and security against loss (warranties) if the statements made are not true. Representations and warranties may also be shortened to "represents and warrants" in a contract.

If the representation in the contract is found to be false, it is called "inaccurate," while a false warranty is considered breached. Representations always refer to past information, as it is impossible for a company or individual to present future information as factual.

Every contract between two parties includes representations and warranties. For example, if you decide to go to an auto dealership to  buy a car , you would enter this transaction with several representations, such as:

• The car is actually what the seller represents it to be, in terms of model and make
• The dealership is legally authorized to sell cars to consumers
• The car will actually work when used properly

The warranty made by the dealership is that all of these concepts are valid. If it turns out that one or all of these representations are not true, the contract to buy the car may be cancelled. Another warranty made by the seller might be to repair any defect that arose because of the misrepresentation.

But the warranty may not last forever. In this example, the seller or manufacturer of the car might offer a period that the unit will work without any defects. Beyond that period, the warranty is no longer in effect. However, some warranties do last for the life of the product. In this case, the buyer in the agreement can expect the seller to repair or replace the product any time it malfunctions.

Warranties help provide protection to consumers on products, and they are subject to federal laws and the Uniform Commercial Code . If the seller offers an extended warranty, it must protect the product beyond the initial agreement made between the buyer and seller. A warranty is a form of insurance and is subject to the same regulations per state laws and the parties involved.

Representations and warranties  are commonly used in acquisition, joint venture , publishing, employment, and loan contracts . In a loan contract, the borrower involved in a financial transaction will provide representations and warranties to the lender as a way to convince the lender to issue a loan. But if the borrower's representation is no longer true, the lender can enforce the penalties spelled out in the contract.

In an acquisition or merger agreement, the company buying or acquiring the other company will likely want the other company to agree to a number of representations and warranties in the deal. These issues could include:

• Material contracts
• Compliance with laws
• Intellectual property
• Financial statements
• Capitalization

In an agreement of this nature, the company acquiring the other party will typically limit the contract to a few specific issues to have it "narrowly drawn."  

The three main purposes of representations and warranties are:

• To allow the buyer to gather information, learn as much as possible about the seller (or other company involved in the transaction), and make an informed decision
• To support both involved parties by spelling out the framework for the penalties and course of action if the contract issuer's representations are found to be false
• To protect the buyer and give him/her options to cancel or re-negotiate the contract terms before or after signing

Representations and warranties are especially important during the due diligence period, since this is the time that allows the signers to further investigate claims made before entering into the agreement. This section of a contract will also include an indemnification , or detail the protections and options given to the buyer in the terms.

Different laws might have different definitions of representations and warranties. But in loans and other contracts, representations refer to facts made by one party and warranties refer to the security for the involved party if the representations are not actually true.

The purpose of representations and warranties is to disclose information between the two parties. Those given by the seller in a business contract tend to be more extensive because they could include information about stocks, liabilities, assets, and any target companies involved in the transaction.

There are implied warranties and expressed warranties. Implied warranties fall within the restrictions of the Uniform Commercial Code, which means that all goods sold should be "fit for a specific purpose." Expressed warranties are included in written contracts and signed by both parties. If a buyer is trying to take legal action against a seller, it is easier to prove that the seller violated the terms of an expressed warranty than an implied warranty .

Why are Representations and Warranties Important?

In a contract or business agreement, the representations and warranties act as assurances given by one party to the other. While the actual contract and terms of the agreement may differ, the ideas of representation of facts and warranty to protect the involved parties are the same across all contracts. A buyer should rely on these representations as fact unless proven otherwise. Representations and warranties used together serve as the best form of protection for a buyer.

Both buyers and sellers should note that exaggerating the good points of a product or service does not constitute a false representation. Salespeople are expected to "puff" their products or services to a certain extent to help make them more appealing. But if any of the information presented as fact is found to be an outright lie, it would constitute a false representation.

Reasons to Consider Not Using Representations and Warranties

Some companies choose to never include representations in contracts or agreements because using representations puts the company at risk of being sued for fraud. You may also find that contract drafters leave the words "representations and warranties" off  the contract to keep it concise and eliminate redundancy. Simply referring to the information as representations can also reduce wordiness of a contract while accomplishing the same goal, which is to protect the buyer and seller.

Reasons to Consider Using Representations and Warranties

Including representations and warranties in a contract helps to allocate risk between both signers. Representations and warranties also become the foundation for security and protection to terminate or amend the contract. If one of the representations made is inaccurate, the warranty included outlines the action that the one signer can take against the other. In most cases when a representation is false, the warranty allows the other person involved in the contract to terminate or decline the transaction.

When a lawyer or legal representative drafts a contract, he or she has a legal obligation to protect the client against risks while securing advantages that will come from entering into the agreement. With representations and warranties included in the contract, the lawyer can feel confident that the contract fulfills both of these responsibilities.

If one party involved in a contract intentionally makes a false representation, the other party can make a common law claim of deceit, also referred to as a tort. In order to qualify as a common law of deceit, the party must prove:

• Conscious ignorance or knowledge of what makes the representation false
• Intent to make the contract signer rely on the other
• Justifiable reliance

Without proof of these elements, the claim will fail. If the contract issuer can prove that the other party knew about the falsity of the claim prior to signing, this will also cause the common law claim of deceit to fail in court.

What Could Happen When You Use Representations and Warranties? 

If your contract includes representations and warranties, they will help to protect you in case any of the claims made by the seller turn out to be false. The affected party can typically rescind or void the terms of the contract, then go on to obtain funds for recovery of the time and money spent as part of the transaction.

In some states, courts will use out-of-pocket measures to determine the damages when representations are false. The first way to measure damages limits the amount returned to the buyer. The measurement takes the amount the buyer paid for the item, then deducts what the item was worth. The resulting amount is what would be owed to the buyer in damages.

The second out-of-pocket measure to calculate damages looks at the benefit of the bargain. This method is more commonly used in violations of representations and warranties written into contracts. The formula for this method takes the value of the item as represented by the seller, then deducts the actual worth of the item.

What Could Happen When You Don't Use Representations and Warranties? 

One of the problems that many people face in relation to representations and warranties is implied warranties and how well those are protected. In the event that your contract or agreement doesn't include a spelled-out warranty, it's hard to claim that the representations made don't come with some type of common law warranty. If a seller is making claims about a product or service, the buyer should have protection even if the warranty isn't clearly stated.

In one example of this struggle, CBS Inc. took legal action against Ziff-Davis Publishing Co. in 1990. CBS claimed that Ziff-Davis falsely represented and warranted the financial condition of a division that it would be selling to CBS. During the due diligence period, CBS had its accountants review all financial statements of that division. The accountants reported that the financial statements did not match up with what was represented and warranted in the contract, but CBS representatives signed anyway.

In this example, which went to the highest court In New York, the issue was whether or not CBS could state a breach of the warranted claims, as those involved in the transaction had evidence that they were not true. But in this case, CBS won the fight and could end the contract without penalty.

Not using representations and warranties at all in a contract could put you at risk for signing an agreement with invalid terms. However, there is still some implied protection, which is how CBS won its case against Ziff-Davis. 

Frequently Asked Questions

• I signed a contract with representations of facts that I have found to be false. What can I do?

The warranties spelled out in the contract offer protection for false representations. Read your contract carefully to determine what your options are in the event that the representation is false. Most buyers can end the contract without penalty and sue for damages to recover any time and money spent on the transaction.

• My company has an expiring contract with a big customer. Should this be included as part of the representations and warranties in a contract with another customer?

Yes, because the contract with the other customer could impact the valuation of your company. It's important to be upfront about any changes to the company or value that could occur during the terms of any contract, in order to avoid legal action based on false representations.

If you need help with representations and warranties, you can  post your job  on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.

Hire the top business lawyers and save up to 60% on legal fees

Content Approved by UpCounsel

• What is a Warranty Clause
• Commercial Real Estate Contract Provisions
• Contract of Representation
• Express Warranty
• Difference Between Warranty and Condition in Contract Law
• Product Warranty
• Types of Warranty
• What Is Warranty and Condition in Contract Law?
• Breach Of Warranty Remedies
• Requirements for Disclaiming a Warranty
• Atlanta Contract Lawyers
• Austin Contract Lawyers
• Boston Contract Lawyers
• Chicago Contract Lawyers
• Dallas Contract Lawyers
• Houston Contract Lawyers
• Los Angeles Contract Lawyers
• New York Contract Lawyers
• Philadelphia Contract Lawyers
• San Francisco Contract Lawyers
• Seattle Contract Lawyers
• Charlotte Contract Lawyers
• Denver Contract Lawyers
• Jacksonville Contract Lawyers
• Las Vegas Contract Lawyers
• Phoenix Contract Lawyers
• Portland Contract Lawyers
• San Antonio Contract Lawyers
• San Diego Contract Lawyers
• San Jose Contract Lawyers
• View All Contract Lawyers

• Contract Management

Supplier Management

Savings Management

• Data & Security

FAQ’s

oboloo Articles

Why representation is crucial in any contract: a comprehensive guide.

In today’s world, contracts are an integral part of any business transaction. They help define rights and responsibilities between parties, protect interests, and ensure that agreements are legally binding . However, the success of a contract depends heavily on representation. Without proper representation, a contract can be a recipe for disaster. In this comprehensive guide to procurement contracts , we will explore why representation is crucial in any contract and what it entails. Whether you’re new to the world of procurement or an experienced professional looking to brush up on your knowledge base, this post has got you covered!

The Importance of Representation

Representation is a vital aspect of any contract, as it ensures that each party’s interests are protected. It provides the parties with legal recourse in case of any breach or non-performance. In essence, representation helps to minimize risks and ensure that both parties can rely on the terms agreed upon.

Moreover, representation offers an opportunity for negotiation and clarification between the involved parties. A representative acts as an intermediary between the two sides and can help bridge communication gaps and misunderstandings. This means that having proper representation in a contract can lead to smoother negotiations , resulting in more favorable outcomes for all parties involved.

In addition to this, representation also ensures compliance with relevant laws and regulations. An experienced representative understands the legal requirements specific to different industries and markets. Thus they can help draft contracts that align with these rules while still meeting clients’ needs.

Ultimately, whether you’re signing a procurement agreement or any other type of contract – having proper representation is crucial for ensuring your best interests are met while minimizing risk exposure at every turn!

What is a Contract?

A contract is a legally binding agreement between two or more parties that outlines their obligations and responsibilities. It can be in written or verbal form, but most contracts are documented to avoid misunderstandings.

Contracts can cover various aspects of business transactions , including procurement deals. They may contain terms and conditions that specify payment terms, delivery schedules, quality standards, warranties, liabilities, and dispute resolution mechanisms.

In essence, a well-drafted contract serves as the foundation for any successful transaction by ensuring clarity and accountability among all involved parties . Parties must agree to the terms of the contract before signing it since once signed; both parties have legal obligations they must fulfill.

Understanding what constitutes a valid contract is crucial when undertaking any procurement activities as it ensures fairness throughout the entire process from inception to completion.

What is Representation?

Representation refers to the act of designating someone to act on your behalf in a legal matter. In contract law , representation is crucial as it helps ensure that both parties receive fair and equitable treatment.

In essence, representation allows you to have an advocate who can negotiate terms and conditions on your behalf. This is particularly important when dealing with complex contracts or agreements where one party has significant bargaining power over the other.

A representative can be anyone whom you designate to act on your behalf, including lawyers, agents, or specialized consultants. It’s essential to choose someone who understands the specifics of your industry and has experience negotiating similar types of contracts .

Moreover, representation does not always mean that you will be absolved from all responsibilities under the contract; instead, it simply means that there is someone else working alongside you towards achieving mutually beneficial outcomes .

Ultimately, having proper representation in any procurement process ensures better negotiations and more favorable outcomes for all involved parties.

Who can be a Representative?

In any contract, representation plays a crucial role in ensuring its validity and enforcement. But who can be a representative? Generally, anyone can act as a representative as long as they are authorized to do so by the principal.

A principal is the person or entity that appoints someone else to act on their behalf in the contract . The representative, also called an agent or attorney-in-fact, must have the legal capacity to enter into contracts and make decisions for the principal.

The most common types of representatives include lawyers, agents, trustees, and fiduciaries. Lawyers are often appointed when dealing with complex legal matters such as mergers and acquisitions. Agents are typically used in business transactions where one party represents another in negotiations.

Trustees are commonly used when managing trusts or other financial assets while fiduciaries represent beneficiaries under certain circumstances.

It’s important to note that not all representatives have equal authority or powers. Some may only have limited authority while others may have broad discretion to make decisions on behalf of their principals.

Ultimately, it’s up to the parties involved in the contract to determine who should act as their representative based on their individual needs and goals.

What are the Duties of a Representative?

In any contract, representation plays a key role. A representative is chosen to act on behalf of another party, and it is crucial that they fulfill their duties in order for the agreement to be successful. So, what are the specific duties of a representative?

Firstly, a representative must act in good faith and with loyalty towards the party who appointed them. They are expected to make decisions that align with their client’s best interests while also fulfilling their obligations under the contract .

Secondly, a representative should have an in-depth knowledge of the subject matter at hand. This includes understanding industry-specific terminology and legal jargon related to procurement contracts .

Thirdly, communication skills are essential for representatives. They must effectively convey information between parties and ensure that everyone is aware of any changes or updates regarding the contract .

Representatives must maintain accurate records throughout all stages of the procurement process . This includes documenting negotiations and correspondence between parties as well as keeping track of deadlines outlined in the agreement.

It is vital that representatives take their duties seriously and work diligently throughout every step of procuring goods or services.

What are the Powers of a Representative?

The representative in a contract is given certain powers to act on behalf of the represented party. These powers include the ability to negotiate, enter into agreements, and make decisions regarding the performance of the contract .

One major power that a representative has is the ability to bind their represented party legally . This means that any agreement made by the representative on behalf of their client will be binding and enforceable under law . It’s essential for representatives to understand this power fully before entering into negotiations or signing contracts .

A representative also has the authority to make decisions about changes or modifications to an existing contract . They can renegotiate terms, extend deadlines, or terminate a contract if necessary. However, these powers must align with their duties as outlined in their representation agreement and should always serve in the best interest of their client.

Another critical power that a representative possesses is access to confidential information related to the contract and parties involved. This includes financial statements, trade secrets, intellectual property details among others which they may use solely for purposes defined within his/her mandate while supporting due diligence requirements .

It’s important for both represented parties and representatives themselves alike t0 understand what powers are granted when entering into a contractual relationship . By doing so ensures smooth negotiations without lawsuits while promoting ethical business practices between all stakeholders in procurement contracts

Representation is a crucial aspect of any contract. It ensures that the parties involved are properly represented and their interests are protected. A representative has important duties and powers that can make or break a contract .

If you’re involved in procurement or any other kind of business transaction , it’s essential to have proper representation. Choose someone who is knowledgeable, trustworthy, and experienced in your industry.

Remember that a well-drafted contract with appropriate representation can save you time , money, and headaches down the line. So don’t underestimate the importance of this critical element when entering into any agreement!

Want to find out more about procurement?

Access more blogs, articles and FAQ's relating to procurement

The smarter way to have full visibility & control of your suppliers

Contract Management 

Partnerships 

Charities/Non-Profits

Service Status

Release Notes

Feel free to contact us here. Our support team will get back to you as soon as possible

Sustainability

• Practical Law

Representations and Warranties

Practical law glossary item 8-382-3760  (approx. 3 pages).

• United States

• Houston: 713-255-4422
• Dallas: 214-307-2840
• Fort Worth: 817-953-8826
• Austin: 512-501-4148
• San Antonio: 210-714-6999
• Beaumont: 409-240-9766
• Corpus Christi: 361-480-03333
• [email protected]

Understanding the Difference between Representation and Warranty in Contracts

In contract law, the terms "representation" and "warranty" are often used interchangeably, leading to confusion about their meanings and legal implications. This article aims to clarify the distinction between the two concepts and provide a legal overview of warranties in contracts.

Black's Law Dictionary defines "warranty" as "an express or implied promise by one of the contracting parties to guarantee something in furtherance of the contract, especially a seller's promise that the thing being sold is as represented or promised." Black's Law Dictionary 1618 (8th ed. 2004). In contrast, Black’s defines “representation” to be: “A presentation of fact – either by words or by conduct – made to induce someone to act, especially to enter into a contract; especially, the manifestation to another that a fact, including a state of mind, exists.” Black's Law Dictionary 1327 (8th ed. 2004).

In the context of the sale of goods, an express warranty is usually written on the face of the contract, while a representation may be written or oral. A warranty is conclusively presumed to be material, whereas the burden is on the party claiming breach to show that a representation is material. Moreover, a warranty must be strictly complied with, while substantial truth is the only requirement for a representation.

Case law in Texas has held that a "warranty" is an expressed or implied statement of something that a party undertakes to be part of a contract but that is collateral to the expressed object of it. Great Atlantic & Pacific Tea Co. v. Walker , 104 S.W.2d 627, 632 (Tex. Civ. App.— Eastland 1938), rev’d , 112 S.W.2d 170 (Tex. 1938). In a sale of goods, a "warranty" signifies an independent, subsidiary promise collateral to the main object of the contract, a breach of which gives rise to a claim for damages. Whiddon v. General Mills, Inc. , 347 S.W.2d 7, 10 (Tex. Civ. App.—Fort Worth 1961, no writ).

Furthermore, an expressed warranty is a definitive affirmation of fact or promise that becomes part of the basis of the bargain, and upon which the parties rely. The test of whether a salesman's statements constituted these "affirmations of fact" going to the very "basis of the bargain," so as to create an expressed warranty, is whether the salesman was asserting a fact of which the buyer was ignorant, or whether the salesman was merely declaring his belief with reference to a matter of which he had no special knowledge and of which the buyer might also have been expected to have an opinion. Valley Datsun v. Martinez , 578 S.W.2d 485, 490 (Tex. Civ. App.—Corpus Christi 1979, no writ) (construing TEX. BUS. & COM. CODE ANN. §§2.313 and 17.50(a)(2)).

In conclusion, understanding the difference between representation and warranty is critical in contract law. A warranty is a guarantee of a product's quality or condition, while a representation is a statement of fact or opinion that may induce a party to enter into a contract. When drafting contracts, it is important to be clear about the warranties and representations made to avoid confusion and potential litigation down the line.

All information provided on Silblawfirm.com (hereinafter "website") is provided for informational purposes only, and is not intended to be used for legal advice. Users of this website should not take any actions or refrain from taking any actions based upon content or information on this website. Users of this site should contact a licensed Texas attorney for a full and complete review of their legal issues.

• « Time is of the Essence in Contracts
• Having a Life Estate Provision in a Will »

What Is a Representation in Contract Law: Definition and Examples

• September 22, 2023

What is a Representation in Contract Law?

Representations are an essential aspect of contract law, playing a crucial role in the formation and execution of contracts. Understanding the nature and implications of representations is key to navigating contractual relationships effectively. In this blog post, we`ll explore the concept of representations in contract law, including their definition, significance, and practical implications.

Defining Representations

In contract law, a representation refers to a statement of fact made by one party to another during the negotiation and formation of a contract. Representations are meant to provide information and induce the other party to enter into the contract. Unlike contractual terms, representations do not form part of the contract itself, but they can still play a significant role in the overall contractual relationship.

Significance of Representations

Representations serve several important functions in contract law:

Practical Implications

Understanding the nature of representations is crucial for both parties involved in a contract. For the party making the representation, it`s important to ensure the accuracy and truthfulness of the information provided to avoid potential legal consequences. On the other hand, the party receiving the representation should carefully assess the information and consider its implications before entering into the contract.

Case Study: Representations in Real Estate Contracts

Real estate contracts often involve multiple representations made by the seller to the buyer regarding the property being sold. These representations can pertain to the property`s condition, history, and other relevant details. In landmark case, Smith v. Jones , court ruled seller`s misrepresentation property`s square footage constituted breach contract, leading legal remedies buyer.

Representations are a fundamental aspect of contract law, shaping the dynamics of contractual relationships and influencing the rights and obligations of the parties involved. By understanding nature Significance of Representations, individuals businesses navigate contractual matters greater clarity confidence.

Exploring Representations in Contract Law

Representation in contract law.

In legal realm, concept Representation in Contract Law holds significant importance. This document aims outline specifics Representation in Contract Law implications.

Contract Representation Legal Matters

It essential understand legal implications Representation in Contract Law. By signing below, the involved parties acknowledge their understanding and acceptance of the terms outlined above.

Free delivery on UK orders over £200

Username or email address  *

Password  *

No account yet?

Privacy Overview

• Escritura Legal
• Testimonios

912 907 842

• Search Search Please fill out this field.

What Is a Misrepresentation?

• How It Works

Special Considerations

• How to Prove It

The Bottom Line

• Financial Crime & Fraud
• Definitions M - Z

What Is Misrepresentation? Types and How It Works

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Investopedia / Hilary Allison

A misrepresentation is a false statement of a material fact made by one party which affects the other party's decision in agreeing to a contract.

If the misrepresentation is discovered, the contract can be declared void. Depending on the situation, the adversely impacted party may seek damages. In this type of contract dispute, the party that is accused of making the misrepresentation is the defendant, and the party making the claim is the plaintiff.

Key Takeaways

• Misrepresentations are false statements of truth that affect another party's decision related to a contract.
• Such false statements can void a contract and in some cases, allow the other party to seek damages.
• Misrepresentation is a basis of contract breach in transactions, no matter the size, but applies only to statements of fact, not to opinions or predictions.
• There are three types of misrepresentations—innocent misrepresentation, negligent misrepresentation, and fraudulent misrepresentation—all of which have varying remedies.

How Misrepresentation Works

Misrepresentation applies only to statements of fact, not to opinions or predictions. Misrepresentation is a basis for contract breach in transactions, no matter the size.

A seller of a car in a private transaction could misrepresent the number of miles to a prospective buyer, which could cause the person to purchase the car. If the buyer later finds out that the car had much more wear and tear than represented, they can file a suit against the seller.

In higher stakes situations, a misrepresentation can be considered an event of default by a lender, for instance, in a credit agreement. Meanwhile, misrepresentations can be grounds for termination of a mergers and acquisitions (M&A) deal, in which case a substantial break fee could apply.

In some situations, such as where a fiduciary relationship is involved, misrepresentation can occur by omission. That is, misrepresentation may occur when a fiduciary fails to disclose material facts of which they have knowledge.

A duty also exists to correct any statements of fact that later become known to be untrue. In this case, the failure to correct a previous false statement would be a misrepresentation.

Types of Misrepresentations

There are three types of misrepresentations.

• Innocent misrepresentation is a false statement of material fact by the defendant, who was unaware at the time of contract signing that the statement was untrue. The remedy in this situation is usually rescission or cancellation of the contract.
• Negligent misrepresentation is a statement that the defendant did not attempt to verify was true before executing a contract. This is a violation of the concept of "reasonable care" that a party must undertake before entering an agreement. The remedy for negligent misrepresentation is contract rescission and possibly damages.
• Fraudulent misrepresentation is a statement that the defendant made knowing it was false or that the defendant made recklessly to induce the other party to enter a contract. The injured party can seek to void the contract and to recover damages from the defendant.

How to Prove Misrepresentation

In order to recover damages due to misrepresentation, there are six legal bars for the plaintiff to overcome. The plaintiff must be able to show that:

• A representation was made.
• The representation was false.
• The defendant knew at the time that the representation was false, or recklessly made the statement without knowledge of its truth.
• The representation was made with the intention that the plaintiff would rely on it.
• The plaintiff did rely on the false representation.
• The plaintiff suffered harm by relying on the false representation.

All six of these requirements must be met in order for a plaintiff to win a case for misrepresentation. A defendant in one of these cases need not disprove all six of these claims.

Example of Misrepresentation

In 2022, Tesla CEO Elon Musk offered to purchase X platform (formerly Twitter) for $43 billion, an offer which the company at first resisted and then accepted. A few weeks later, and after a substantial fall in the company's share price, Musk attempted to back out of the deal, claiming that X misrepresented the number of human users on the platform.

According to his termination letter, Musk alleged that the company knowingly misrepresented the number of live users on its platform and that he had relied on those false representations when he made his takeover offer. In response, the social media company claimed that Musk's allegations were "factually inaccurate" and that the billionaire was simply trying to back out of the merger that he himself had initiated.

What Is a Material Misrepresentation?

A material misrepresentation is a promise, false statement, or omission of facts that would cause another party to act differently if the whole truth were known. An example of a material misrepresentation is incorrectly stating one's income on a mortgage application or omitting key risk factors on an application for insurance coverage.

What Is Misrepresentation in Insurance?

In insurance, a misrepresentation is a lie or concealment of facts that can void an insurance contract if the insurer discovers the misrepresentation. For example, if a homeowner installs a pool but tells their insurer that they do not have a pool, the insurer may be able to void the policy if they discover the misrepresentation.

What Is Misrepresentation in Real Estate?

In real estate, misrepresentation is a lie or reckless untruth that affects the market value of a home or property. A common example of this is misrepresenting the square footage of a property. Since sales prices are often based on square footage, a buyer can often sue for misrepresentation even after a purchase is finalized.

Misrepresentation is a legal term for any type of falsehood or omission of fact that affects the behavior of a contractor or other party. Contrary to popular belief, misrepresentation does not just mean deliberate lies—it can also include accidental omissions or reckless statements without certainty of the facts. Misrepresentation can void a contract and in some cases allow the misled party to seek damages.

Cornell Law School, Legal Information Institute. " Misrepresentation ."

Campbell Law Review. " Fraudulent, Negligent, and Innocent Misrepresentation in the Employment Context: The Deceitful, Careless, and Thoughtless Employer ," Pages 61-62.

University of North Caroline, School of Government. " N.C.P.I.—Civil 800.10: Negligent Misrepresentation, General Civil Volume, March 2020 ."

Cornell Law School, Legal Information Institute. " Fraudulent Misrepresentation ."

Legal Information Institute. " Fraudulent Misrepresentation ."

The Hill. " Twitter Slams Musk Countersuit: 'Factually Inaccurate, Legally Insufficient, and Commercially Irrelevant .'"

• Terms of Service
• Editorial Policy
• Privacy Policy
• Your Privacy Choices

• Contract of Representation

Learn about the definition for this legal term.

• Bar Exam Prep
• Legal Terms

What is Contract of Representation?

The scope and charges for legal services should always be established in a written contract of representation, also referred to as a fee agreement.

Related Ethics Terms

• Contingent Fee
• Division of Fees
• Acquiring an Interest in Litigation
• Terminating Representation

Pass the Bar, Guaranteed

• TheFreeDictionary
• Word / Article
• Starts with
• Free toolbar & extensions
• Word of the Day
• Free content
• representation

Representation

Any action or conduct that can be turned into a statement of fact.

For example, displaying a car with an odometer reading of ten miles constitutes a representation to a prospective buyer that the car has only been driven ten miles.The term representation is used in reference to any express or implied statement made by one of the parties to a contract to another, regarding a particular fact or circumstance that serves to influence the consummation of the deal.

As applied to the law of Descent and Distribution , representation is the principle by which the issue of an individual who has died inherits the portion of an estate that such person would have taken if he or she had lived.

n. 1) the act of being another's agent. 2) acting as an attorney for a client. 3) a statement of alleged fact either in negotiations or in court. (See: represent )

REPRESENTATION, insurances. A representation is a collateral statement, either by writing not inserted in the policy, or by parol, of such facts or circumstances relative to the proposed adventure, as are necessary to be communicated to the underwriters, to enable them to form a just estimate of the risk.      2. A representation, like a warranty, may be either affirmative, as where the insured avers the existence of some fact or circumstance which may affect the risk; or promissory, as where he engages the performance of, something executory.      3. There is a material difference between a representation and a warranty.      4. A warranty, being a condition upon which the contract is to take effect, is always a part of the written policy, and must appear on the face of it. Marsh. Ins. c. 9, Sec. 2. Whereas a representation is only a matter of collateral information or intelligence on the subject of the voyage insured, and makes no part of the policy. A warranty being in the nature of a condition precedent, must be strictly and literally complied with; but it is sufficient if the representation be true in substance, whether a warranty be material to the risk or not, the insured stakes his claim of indemnity upon the precise truth of it, if it be affirmative, or upon the exact performance of it, if executory; but it is sufficient if a representation be made without fraud, and be not false in any material point, or if it be substantially, though not literally, fulfilled. A false warranty avoids the policy, as being a breach of the condition upon which the contract is to take effect; and the insurer is not liable for any loss though it do not happen in consequence of the breach of the warranty; a false representation is no breach of the contract, but if material, avoids the policy on the ground of fraud, or at least because the insurer has been misled by it. Marsh. Insur. B. 1, c. 10, s. 1; Dougl. R. 247: 4 Bro. P. C. 482.      See 2 Caines' R. 155; 1 Johns. Cas. 408; 2 Caines' Cas. 173, n.; 3 Johns. Cas. 47; 1 Caines' Rep. 288; 2 Caines' R. 22; Id. 329; Sugd. Vend. 6; Bouv. Inst. Index, h.t. and Concealment; Misrepresentation.

REPRESENTATION, Scotch law. The name of a plea or statement presented to a lord ordinary of the court of sessions, when his judgment is brought under review.

• Adversary System
• Affirmative Action
• American Bar Association
• Attorney Misconduct
• Attorney-Client Privilege
• attorney's advertising
• attorney's work product
• Bailey, Francis Lee
• Baker v. Carr
• Barbour, Philip Pendleton
• Carpenter, Matthew Hale
• Carswell, George Harrold
• Certification Proceeding
• Chase, Salmon Portland
• Child Pornography
• Children's Commissioner for Wales
• repatriation
• Repellitur a sacramento infamis
• replacement
• replication
• reply brief
• Reply Brief for Appellants in Nos. 1, 2 and 3 and for Respondents
• Repo and balance due
• Repossession
• Representation of persons; a fiction of the law
• Representative
• Representative Action
• Representative democracy
• Reprobata pecunia liberat solventum
• Reprobation
• Reproduction
• Republican government
• Republican Party
• Republication
• Repudiation
• Repugnant condition
• Reputatio est vulgaris opinio ubi non est veritas
• represent to
• represent to (someone or something)
• Represent to Witness
• represent us as
• represent us in
• represent us to
• represent you as
• represent you in
• represent you to
• represent yourself as
• represent yourself in
• represent yourself to
• Represent/Represented
• representability
• representable
• Representable functor
• representablely
• Representaciones Riquelme y Cerramientos Murcia
• Representamen
• Representance
• Representant
• Representante Especial del Secretario General
• Representatieve Vakorganisaties
• Representation (arts)
• Representation (disambiguation)
• Representation (psychology)
• Representation Agreement Resource Centre
• Representation and Maintenance of Process Knowledge
• Representation and Transportation Allowances
• Representation and Welfare Unit
• representation condition
• Représentation des Institutions Françaises de Sécurité Sociale
• Representation Fund Custodian
• Representation Language Language
• Représentation Militaire Française
• Representation of People's Act
• Representation of Stimuli as Neural Activity Project
• Representation of the People Act
• Representation of the People Acts
• Representation of the People Order
• Representation oligonucleotide microarray analysis
• Representation Oligonucleotide Microarray Analysis (ROMA)
• Representation Quality
• Representation theory
• Facebook Share

Sewell & Kettle Lawyers

Home » Dictionary » Representation (in the context of contract law)

Representation (in the context of contract law)

A statement of fact, oral or in writing, made by one party to another, before or at the time of entering into a contract, of some matter or circumstance relating to it.

A promise made as a representation to induce the other party to enter into the contract must be carried out to a substantial degree, and if the representation is a statement of fact it must be substantially true.

In contrast to a condition, a representation is something outside the contract. Nevertheless, if a representation is material to the contract and is acted upon by the representee, the representor may be legally liable for it. A representation that is false is a misrepresentation .

Legal Dictionary

The Law Dictionary for Everyone

Misrepresentation

In the legal word, the term “misrepresentation” refers to a statement someone makes an untrue statement in order to encourage someone else to sign a contract. For example, misrepresentation occurs when a person signs a contract, then suffers damages as the result of taking the other person’s advice.

In this case, the wronged party can then sue for misrepresentation, and the court may order compensatory or punitive damages , or both. To explore this concept, consider the following misrepresentation definition.

Definition of Misrepresentation

• A statement, which is untrue, made by someone for the purpose of encouraging another party to enter into a contract.

What is Misrepresentation?

A misrepresentation is information that is untrue, but which convinces someone to enter into a contract. For a better understanding, consider the following example of misrepresentation:

Tom agrees to a contract with RealMan Magazine Company. The details of the contract state that, if Tom subscribes to the magazine for a year, he will receive a gift worth over $100. After signing the contract, Tom realizes that the gift is not actually free, but the company has instead incorporated the price of the gift into the contract for the magazine subscription.

Had Tom known that beforehand, he would never have subscribed. Now, he is out over $100 because he has both an expensive magazine subscription and a “free” gift that he ultimately ended up paying for anyway.

The above is an example of fraudulent misrepresentation. The company knew they were baiting Tom to pay for the gift over the life of the magazine subscription, but they told Tom the gift was “free” to get him to sign up. Once Tom signed up, however, and read the fine print, he realized the company had taken him for a fool.

Three Types of Misrepresentation

There are three types of misrepresentation in contract law :

Fraudulent Misrepresentation

Negligent misrepresentation, innocent misrepresentation.

It is important to understand that all three types of misrepresentation is a misconstrued “fact,” not an opinion . If someone relies on another person’s opinion and suffers damages, that is not misrepresentation. If, however, that person claimed something was true when it wasn’t, that is a misrepresentation.

Fraudulent misrepresentation is the worst of the three types. This is because the person who shared the information knew that it was untrue, but he made the claim in order to convince another person to enter into a contract. Someone who falls victim to fraudulent misrepresentation can sue the offender for damages and ask the court for rescission .

Compensatory Damages

Compensatory damages are monies that a court awards to an individual who suffers damages or injury as the result of another person’s wrongful actions. This applies whether the acts are intentional or negligent. These damages are “compensatory” because they compensate for the costs incurred in replacing an item or seeking medical attention.

Courts typically award compensatory damages in cases concerning negligence or illegal conduct engaged in by the other party. In misrepresentation cases, courts can award compensatory damages to make up for the loss of money a person can suffer as the result of believing a lie.

Negligent misrepresentation occurs when a party to a contract does not care enough to verify information before passing it on to those whom he is encouraging to sign a contract. As a result, the other parties suffer loss of some type for believing his misinformation. Had he vetted the information properly, then he would have realized it was bogus before passing it on and damaging others. Victims of negligent misrepresentation can also sue for damages, and ask the court for rescission.

A party makes an innocent misrepresentation when he has no reason to believe that the information he has is untrue. He then shares that information with those who are entering into the contract, and they all suffer damages as a result. The victims here can sue for damages, but they cannot ask the court for rescission. To succeed on a claim of damages, the victims must be able to prove they suffered a loss by believing a misrepresentation.

Misrepresentation Example Involving

An example of misrepresentation, specifically fraudulent misrepresentation, exists in the matter of Nielsen v. Adams (1986). Here, Don Nielsen was looking for a house to purchase for his son in Nebraska in 1984. A house owned by Orlene Adams was one of the houses he considered.

On Nielsen’s inspection of the house, he noticed a sump pump in a closet near the basement stairs. When he asked Adams about it, she told him the sump pump was there to solve a minor issue involving moisture collecting at the bottom of the stairs.

Nielsen asked Adams if she had ever had issues with water in the basement, and she told him “absolutely not.” Nielsen bought the house shortly thereafter, and about one month after moving in, the basement flooded during a spring rain and suffered significant damage.

Nielsen sued Adams, alleging fraudulent misrepresentation, and asked the court for damages. During the trial , Adams admitted hiding information from Nielsen regarding past basement floods, but she claimed that telling him anything about it would have been irrelevant, as she believed someone had fixed the problem. However, Nielsen knew better because when he removed the paneling, he discovered enough damage to prove that the basement had suffered water issues for years.

The jury ultimately ruled in Adams’ favor, finding that Nielsen was unable to prove that Adams had deliberately lied to him. She stated that she believed the problem no longer existed when she sold the house to Nielsen, and the jury believed her.

Nielsen appealed the case to the Supreme Court of Nebraska, and the Court admitted that the trial court should not have instructed the jury to rule in the way that it did. Ultimately, the Court reversed and remanded the case back to the trial court for reconsideration. In the Court’s own words, this decision said:

“Having considered the history of the matter and the various cases within this jurisdiction , we conclude that adding ‘intent to deceive’ as a separate element rather than its being included in the element of knowledge or belief is error. Our earlier holding in Peterson v. Schaberg, ( citation omitted), and our recent holding in ServiceMaster Indus. v. J.R.L. Enterprises, (citation omitted), therefore, are correct statements of the law and ones which we should continuously, consistently, and uniformly follow. In doing so we believe we will nevertheless be true to the rules of law regarding the necessary elements of the offense of a tort action for false representation or deceit.

We therefore hold that in order to maintain an action for damages for false representation, the plaintiff must allege and prove by a preponderance of the evidence the following elements: (1) that a representation was made; (2) that the representation was false; (3) that, when made, the representation was known to be false, or made recklessly without knowledge of its truth and as a positive assertion; (4) that it was made with the intention that the plaintiff should rely upon it; (5) that the plaintiff reasonably did so rely; and (6) that he or she suffered damages as a result.

If the defendant can establish by a preponderance of the evidence that the defendant had a reasonable basis to believe that the statement of fact was true, then recovery will be denied. If, on the other hand, the evidence is such that a reasonable person in the position of the defendant could not have honestly believed the statement to be true, recovery may be had. In any event, it need not be shown that the defendant also had a ‘bad’ motive in doing what he or she did. The fact that the defendant deceives, itself, establishes scienter even though the defendant may have been unaware of the deception.”

Related Legal Terms and Issues

• Compensatory Damages – An award of money in compensation for actual economic loss, property damage , or injury, not including punitive damages.
• Contract – An agreement between two or more parties in which they make a promise to do or provide something in return for a valuable benefit.
• Damages – A monetary award in compensation for a financial loss, loss of or damage to personal or real property , or an injury.
• Fraud – A false representation of fact, whether by words, conduct, or concealment, intended to deceive another.
• Jury – A group of people sworn to render a verdict in a trial, based on evidence presented.
• Negligent – Failure to act as, or to exercise the level of care of, another reasonably prudent person would likely to act.
• Punitive Damages – Money awarded to the injured party above and beyond their actual damages, to punish the wrongdoer for outrageous misconduct in a civil matter.
• Rescission – The revocation or cancellation of an agreement or contract.

Transactional

Acquiring an AI Company

Recent advances in generative AI (GenAI) have led to more M&A activity in the AI sector. Counsel representing a prospective buyer of an AI company must understand the unique due diligence issues relating to AI and machine learning (ML) and strategies to mitigate or allocate risks in these types of M&A transactions.

K&L Gates LLP

Table of contents.

This is an excerpt, published on April 1, 2024.

• Developments in AI, and in particular GenAI, have led to more M&A activity in AI sector
• Buyers, targets, and counsel should understand key due diligence issues related to AI companies
• There have been several legal disputes and regulatory changes concerning AI
• There are major risks with AI-company transactions and strategies to mitigate these risks

AI is a field of computer science that aims to mimic human intelligence with machines, including the abilities to learn, reason, generalize, and infer meaning. These types of abilities are components of many AI tasks, including speech recognition, computer vision, translation, and generation of text and images. Despite the increasing focus on AI, AI is not new. AI and ML have been in development since at least the 1950s but have only recently entered into the public domain. Recent advances in AI primarily involve GenAI, which is a subset of AI that uses computer algorithms that often employ large language models (LLMs) to generate outputs that resemble human-created content. Examples of GenAI tools include Open AI’s ChatGPT chatbot and DALL-E image generator. (For more information, see AI and Machine Learning: Overview and IT Basics: Generative AI and Large Language Models: Overview on Practical Law.)

Developments in AI, and in particular GenAI, have led to more M&A activity in the AI sector. Buyers seeking to integrate AI into their products or services may find it more expedient to acquire an AI company or its assets than to build the AI technologies themselves. While there are many issues a buyer must evaluate when considering a M&A transaction involving an AI company, this article addresses key issues for the buyer, the target (the AI business being acquired), and their counsel when planning an acquisition of or large investment in an AI company. It specifically focuses on AI companies that are:

• Involved in the research, development, or monetization of a product or service that is primarily powered by an ML algorithm or model that creates functionality or utility through the use of AI. Companies that merely use AI or ML in some manner are not AI companies because almost every company does or will make use of AI in some form.
• Private, although the discussion regarding due diligence is also relevant to the acquisition of a public AI company.

In general, the structure of a M&A transaction with an AI company target is similar to a M&A transaction with a target in another industry. However, M&A transactions with AI company targets introduce different regulatory and due diligence considerations, so counsel should make some modifications to the transaction documents and implement certain risk mitigation strategies. This article primarily aims to assist buyers and their counsel, with a focus on:

• The key due diligence issues for buyers to consider and address when evaluating an acquisition of an AI company.
• The mitigation strategies for limiting the risks identified during the due diligence process.

This article does not address:

• All proposed or recently enacted laws at the international, federal, state, and local levels that could impact AI businesses.
• All aspects of conducting a M&A transaction (for non-industry-specific resources to assist counsel in a private M&A transaction, see Private Stock Acquisitions Toolkit and Asset Acquisitions Toolkit on Practical Law).
• Regulatory risks that may arise from the acquisition of AI companies operating in highly regulated industries such as healthcare, financial services, and certain manufacturing industries (for a discussion of AI in health care, see AI for Health Care Providers: Overview on Practical Law).

(For resources to assist counsel in identifying potential legal issues concerning AI, see AI Toolkit (US) on Practical Law.)

Due Diligence Issues

Buyers should conduct extensive due diligence to evaluate both the magnitude of the risks and the steps that they should take to allocate and mitigate risks in the acquisition agreements. The focus of this article is on key diligence areas that are unique to an AI company. Buyers should also perform a comprehensive due diligence review covering all of the standard due diligence areas that are applicable to most companies generally, including organizational, capitalization, compliance with laws, financial, tax, litigation, and employee due diligence (for more information, see Private Mergers and Acquisitions Due Diligence Checklist on Practical Law).

Intellectual Property

Intellectual property (IP) legal due diligence of an AI company should follow the typical due diligence process that is conducted for a technology-focused business, such as a software, social media, or computer hardware company. This due diligence typically involves a review and analysis of the following areas:

• Owned IP. This includes identifying the target’s proprietary IP (registered and unregistered), proprietary software, and other information technology (IT) assets. It also includes understanding how the target’s IP and IT assets may be encumbered or subject to restrictions or obligations that could adversely affect the buyer or the target’s value.
• IP-related agreements. This includes reviewing:
• inbound license agreements relating to third-party IP and IT assets used by the target;
• outbound licenses and customer agreements relating to the target’s products and services (see Target’s AI-Related Contracts below); and
• development, distribution, consulting, settlement, and other IP-related agreements.
• IP disputes. This includes reviewing actual or potential IP-related disputes and assessing their potential impact on the target.

(For more on IP and IT issues to cover in legal due diligence, see IP Due Diligence Issues in M&A Transactions Checklist and Software, Cloud & Other IT Due Diligence in M&A Transactions Checklist on Practical Law.)

AI companies present unique IP due diligence issues that require attention in several key areas.

AI company assets typically consist of software, computer systems, and the materials used to develop AI technologies, primarily input data and training materials, among others. Though these assets are similar in certain ways to the assets of other technology companies, there are important differences. As a result, AI companies present unique IP due diligence issues that require attention in several key areas, including issues involving:

• AI ownership.
• Permission to use training materials.
• IP protection for AI-generated materials.
• Trade secret protection.

Ownership of AI Algorithm or Model

Every AI company owns or uses one or more AI algorithms or models. This business-critical asset is one of the main components of an AI-based system. Many AI companies use another company’s algorithms or models rather than owning them themselves. Buyers should carefully evaluate companies that do not own 100% of their models or algorithms to assess the risks created by this lack of complete ownership.

For example, many companies purport to build products or services using OpenAI’s application programming interface (API), but these companies do not own the underlying AI technology and so their businesses are dependent on a third party’s continued existence and development of the AI technology. Additionally, creating and maintaining certain kinds of AI products, such as LLMs, is so enormously expensive that smaller companies are usually unable to create them independently. These companies are called API-dependent AI companies to differentiate them from companies seeking to build their own wholly owned AI products and services. (For more on APIs, see IT Basics: Application Programming Interfaces (APIs): Overview on Practical Law.)

To help understand the algorithms or models a buyer should investigate, the buyer should request that the target identify AI products and services that are:

• Offered to its customers.
• Used internally.
• In development.

The buyer should use this information to further identify and investigate potential IP and other related risks.

AI Training Materials

Another business-critical asset for an AI company is its training materials, also called training data sets, which refer to materials used to train the AI models. Training materials are an essential component of the ML process but are not simple to obtain.

AI training materials may consist of data and databases, text or words, computer source code, images, or video, among other types of materials. AI companies obtain and use training materials through a variety of methods, such as by:

• Creating the data.
• Buying the data.
• Licensing the data.
• Tracking or modeling real-world observational data obtained from proprietary or publicly available sources.
• Web scraping or harvesting other publicly available data.

A key point the buyer should confirm is that the target has the right to obtain and use the training materials for the development of AI products and services. The buyer should evaluate the risks arising from use of the training materials based on the source and nature of the training materials. There are some primary risks relating to training materials that are:

• Owned. With owned training materials, privacy issues may arise from the unauthorized use of personal data (see Data Privacy and Cybersecurity below).
• Licensed. Licensed training materials may have contractual and copyright issues. There may be limitations on the scope of the license, such as a prohibition on the use of licensed training materials for AI development or training or a requirement that the training materials must be used for non-commercial purposes only. Additionally, the licensor itself may not have sufficient rights to use or license the training materials. Licensors of training materials typically provide few, if any, representations and warranties regarding their own rights to gather and license the training materials.
• Obtained through web scraping or harvesting tools. In these cases, third parties may bring legal actions, such as under the Computer Fraud and Abuse Act (CFAA) for unauthorized access. However, these claims have had mixed results (for more information, see Key Issues in Computer Fraud and Abuse Act (CFAA) Civil Litigation on Practical Law). There may also be tort claims, such as trespass to chattels or conversion, and claims for unjust enrichment.

Several legal disputes concerning the use of various types of materials for AI training purposes have raised copyright and contract issues, including the following cases, each of which is currently at an early stage of the litigation process:

• Doe 1 v. GitHub, Inc. This case was brought by plaintiff software developers against GitHub, Inc. and other companies. The plaintiffs challenged the defendants’ development and operation of two AI-based coding tools that were trained on code published by the software developers and subject to open-source licenses. The software developers alleged in part that the defendants’ use of the licensed code as training data harmed their property interests in the code. A California court rejected the defendants’ argument that the software developers had no standing to sue. The court determined that the software developers’ property rights had been harmed and that there is a “realistic danger” that the defendants’ AI products will recreate the software developers’ licensed code. (2023 WL 3449131, at *4, *6 (N.D. Cal. May 11, 2023).)
• Andersen v. Stability AI Ltd. This case involves allegations by individual plaintiffs that the defendants, Stability AI, Midjourney, and DeviantArt, use copyrighted images to train models for their AI image generation products without consent from or compensation to the plaintiff image rightsholders. The plaintiffs claim that the “new” images created by the defendants’ products are actually derivative composites assembled from inputs of the artists’ original works. (First Amended Complaint, Anderson v. Stability AI Ltd. , No. 23-201 (N.D. Cal. Nov. 29, 2023).)
• Getty Images (US), Inc. v. Stability AI, Inc. This case involves allegations that the defendant Stability copied millions of its photos without a license and used them to train its AI product, Stable Diffusion, to generate more accurate depictions based on user prompts. The plaintiff Getty claims it licensed millions of digital assets to other leading technology innovators to train their AI models and, therefore, Stability infringes Getty’s copyrights and engages in unfair competition. (No. 23-135 (D. Del.).)
• UAB “Planner5D” v. Facebook, Inc. This case arose from a home design tool, offered on the plaintiff Planner 5D’s website, which customers may use to design home interiors online. The tool uses object and scene files to train ML algorithms. According to Planner 5D, Princeton University used software to access hidden internet addresses where Planner 5D kept its object and scene files. The complaint further alleges that Princeton scraped Planner 5D’s website to obtain its files and then shared them with the defendant, Facebook. Planner 5D contends that, despite being publicly visible, underlying data, hidden internet addresses, and file locations are trade secrets unfairly obtained by Princeton. (First Amended Complaint, UAB “Planner5D” v. Facebook Inc. , No. 19-3132 (N.D. Cal. Dec. 16, 2019).)

(For more on pending AI copyright and other cases, see Generative AI: Federal Litigation Tracker on Practical Law.)

Because AI training materials are typically reproduced, the reproduction, even if transitory, arguably is copyright infringement (17 U.S.C. § 106(1)). Therefore, the fair use and de minimis defenses to copyright infringement are available, though they are untested and unresolved (for more on these defenses, see Copyright Fair Use and Copyright Litigation: Analyzing Substantial Similarity on Practical Law).

Similarly, an argument could be made that the AI model is an infringing derivative work because it is “based upon” the underlying training materials (17 U.S.C. § 101 (defining derivative work as “a work based upon one or more preexisting works, such as a translation, musical arrangement, dramatization, fictionalization, motion picture version, sound recording, art reproduction, abridgment, condensation, or any other form in which a work may be recast, transformed, or adapted”); 17 U.S.C. § 106(2)). This argument seems unlikely to succeed, however, except in specific circumstances such as where the prompt directed the AI model to either one specific work or a very small number of works. (For more on derivative works under US copyright law, see Protection of Derivative Works on Practical Law.)

Additionally, obtaining data for AI training purposes from the public-facing internet via web scraping tools raises issues beyond copyright, which are currently largely unresolved. Key sources of internet data may seek to limit access by setting access controls and licensing requirements, and generally impose contractual restrictions that prohibit commercial uses. Those contractual restrictions are difficult to enforce broadly but may be successfully asserted against certain users or categories of users.

The laws governing the right to use publicly available materials for AI training purposes vary from country to country. Some jurisdictions have statutes that explicitly provide some rights to use publicly available materials for AI training purposes, including the UK, the EU, Singapore, South Africa, Australia, Thailand, and China.

IP Protection for AI-Generated Materials

To the extent the target is relying on AI-generated materials in its business, the target may be unable to protect those materials (whether they consist of computer code, texts, images, videos, or music) from use and exploitation by others. The US Copyright Office has issued guidance generally rejecting claims of copyright authorship for works generated by AI tools based on the reasoning that they are distinct from human authors (see Copyright Office, Copyright Registration Guidance: Works Containing Material Generated by Artificial Intelligence (Guidance), 88 Fed. Reg. 16,190 (Mar. 16, 2023); for more information, see Copyright Office Issues Registration Guidance on AI-Generated Content on Practical Law).

Copyright Office decisions rejecting copyright registrations for AI-authored works have generally been upheld in litigation (see Thaler v. Perlmutter , 2023 WL 5333236, at *6-7 (D.D.C. Aug. 18, 2023)). Similarly, the Federal Circuit confirmed that AI-created inventions are not eligible for patent protection (see Thaler v. Vidal , 43 F.4th 1207 (Fed. Cir. 2022); for more information, see Federal Circuit Confirms That Inventor Must Be Natural Person on Practical Law). More recently, the US Patent and Trademark Office (USPTO) issued its Inventorship Guidance for AI-Assisted Inventions , in which the USPTO explained that “while AI-assisted inventions are not categorically unpatentable, the inventorship analysis should focus on human contributions, as patents function to incentivize and reward human ingenuity. Patent protection may be sought for inventions for which a natural person provided a significant contribution to the invention, and the guidance provides procedures for determining the same.”

Outside the US, some jurisdictions recognize copyright protection for AI-generated works, but many do not. Hong Kong, India, Ireland, New Zealand, South Africa, and the UK provide copyright protection for computer-generated works, while Australia, Brazil, Colombia, Germany, Mexico, and Spain require human creation.

Trade Secret Policies and Practices

If the target provides AI products and services, the buyer should review the target’s trade secret policies and practices. Other forms of IP protection (patent, copyright, and trademark) are not well suited to protecting the most valuable aspects of AI technologies, and targets most likely rely on trade secret rights to protect and maintain the value of their AI technologies. (For information on trade secrets generally, see Protection of Employers’ Trade Secrets and Confidential Information on Practical Law.)

Target’s AI-Related Contracts

Buyers should review the target’s agreements for AI products and services, regardless of whether the target is a party to the agreements as a customer or provider. In addition to standard contract due diligence issues (for more information, see Due Diligence for Private Mergers and Acquisitions on Practical Law), the buyer should consider how the target has allocated the various risks inherent in offering or using AI products and services between the contracting parties.

If the target is providing AI products or services, the buyer should review:

• Whether the target’s terms of service include or disclaim any representations and warranties regarding:
• reliability;
• non-infringement; or
• use in sensitive areas such as health care or financial services.
• The indemnification obligations the target owes to its customers or the indemnification rights the target has against its customers.
• Whether the target limits its liability with damages caps and exclusions of certain damages types (such as consequential, indirect, or lost profits damages).
• The means of resolving disputes.
• Whether the target has ongoing obligations to provide support and updates.
• The use of open source software, in light of whether the AI technology is distributed to customers or provided as a hosted service (for more information, see Open Source Software: Use and Compliance on Practical Law).

If the target is the user of third-party AI products and services, the buyer should review:

• The same issues listed above but viewed from the opposite perspective (for example, whether the third-party provider disclaims key representations and warranties).
• Whether the target uses third-party AI products and services in compliance with contractual restrictions and in recognition of the limitations of the AI technology, including hallucinations and other errors.

Data Privacy and Cybersecurity

US federal and state laws regulate the collection, use, processing, and disclosure of personal information and address broad cybersecurity standards. Buyers should assess a target’s data privacy and cybersecurity programs, giving special attention to the target’s:

• Algorithms and models.
• Training data.

(For more on addressing data privacy and cybersecurity issues in M&A transactions generally, including performing data privacy and cybersecurity program assessments, see Privacy and Data Security Due Diligence in M&A Transactions and Privacy and Data Security Due Diligence in M&A Transactions Checklist on Practical Law.)

US Federal Data Privacy and Cybersecurity Laws and Regulations

Some federal laws regulating data privacy and cybersecurity that may apply to AI products and services include:

• Section 5 of the Federal Trade Commission Act, which is a broad consumer protection law prohibiting unfair or deceptive trade practices that the Federal Trade Commission (FTC) has long applied to business practices that affect consumer privacy and cybersecurity.
• Sector-specific regimes, such as:
• the Gramm-Leach Bliley Act, which applies to financial institutions; and
• the Health Insurance Portability and Accountability Act of 1996, which applies to most health care providers, health plans, and their service providers.
• Other laws that apply to certain activities or groups, such as the Children’s Online Privacy Protection Act.

(For more on these and other federal data privacy and cybersecurity laws that may apply to AI products and services, see US Privacy and Data Security Law: Overview Practical Law.)

Federal regulators are also increasingly promulgating regulations regarding cybersecurity incidents, which may include personal data breaches and risk management. For example, the US Securities and Exchange Commission (SEC) issued final rules in July 2023 requiring public companies to disclose:

• Cybersecurity incidents within four business days of determining materiality.
• Information regarding their cybersecurity risk management, strategy, and governance programs.

(For more information, see SEC Adopts Cybersecurity Risk Management and Incident Disclosure Rules on Practical Law.)

AI companies often hold substantial amounts of data, so cybersecurity attacks can put a significant amount of data at risk. Buyers should therefore closely scrutinize how the target protects its data and assess the sophistication of the target’s cybersecurity capabilities and processes.

US State Data Privacy and Cybersecurity Laws and Regulations

States have often taken a leading role in protecting their residents’ personal information, for example, by establishing data breach notification requirements and standards for reasonable data security practices. Similarities among these state laws exist, but there are also many differences that make nationwide compliance challenging.

Given the dependence of AI models’ functionality on enormous amounts of data, often including personal information, the buyer must critically examine:

• The applicability of these state data privacy and cybersecurity laws to the target’s business.
• The target’s data privacy and cybersecurity compliance programs, including any history of data breaches or related regulatory enforcement actions or private litigation.

More recently, the US has seen a rapid proliferation of state consumer data privacy laws since California passed its first-in-the-nation California Consumer Privacy Act of 2018 (CCPA), as amended by the California Privacy Rights Act of 2020 (CPRA) (for resources to help counsel understand and comply with California’s consumer data privacy laws, see California Privacy Toolkit (CCPA and CPRA) on Practical Law). Additional states have passed similar consumer data privacy laws, including Colorado, Connecticut, Delaware, Florida, Indiana, Iowa, Montana, Oregon, Tennessee, Texas, Utah, and Virginia, while others are considering them. These laws vary significantly in their scope and requirements, although they share some common themes nationwide and with the EU General Data Protection Regulation (Regulation (EU) 2016/679) (GDPR).

State consumer data privacy laws, and in some cases their implementing regulations, are important for AI companies that fall within their scope to consider because these laws:

• Give residents of their states various rights to control the use of their personal information, including the right to opt out of certain types of data processing and to request deletion of their personal information under certain conditions.
• Impose various obligations on covered entities regarding how they communicate with individuals and process and protect personal information.
• Potentially limit AI companies from using their AI models to engage in automated decision-making, potentially impacting the value of those models to the buyer.

(For resources to assist counsel with the state data privacy and cybersecurity laws that may apply to AI companies, see State Data Privacy Laws Toolkit on Practical Law.)

EU and UK Data Privacy and Data Protection Laws

M&A transactions may involve multiple jurisdictions, so buyers should also consider non-US law. Most international jurisdictions have not yet created AI-specific laws or rules, but the EU and the UK have stringent personal data protection laws and some AI-specific laws to consider in a M&A context. (For more information, see Acquiring an AI Company on Practical Law.)

Corporate Governance and Data Quality

Buyers should consider as part of their due diligence process data quality issues, which have a direct impact on the reliability of ai outputs, and the target’s corporate policies regarding data collection and responsible ai use., bias and quality of data.

AI models are trained on existing data sets, which reflect societal biases and can therefore continue to entrench these biases. As noted in the National Institute of Standards and Technology’s (NIST’s) Artificial Intelligence Risk Management Framework (AI RMF), AI “systems are inherently socio-technical in nature, meaning they are influenced by societal dynamics and human behavior.” Because these models often draw on biased data, generate outputs that reflect these biases, and in turn incorporate those outputs into their training materials, these biases will tend to be magnified via adverse feedback loops if intentional remediation measures are not taken.

If a target’s data collection process systemically excludes or underrepresents members of certain groups based on race, ethnicity, gender identity, sexual orientation, or otherwise, training materials are likely to reflect and reinforce these biases. Similarly, if time or monetary resources are required to access data collection tools, training materials will exclude those who lack access to these resources. Understanding a target’s data collection processes and reviewing them critically is a vital component of conducting due diligence on an AI company.

When performing due diligence on an AI company, the buyer should seek to understand the impact that the target’s organizational culture and employees have on the development of the AI system. An approach of “moving fast and breaking things” can create significant risk for AI companies in cases where haphazard practices could violate antidiscrimination and other laws. Due diligence processes should focus on how:

• Datasets are created or used by a target.
• The target’s culture influences the generation of datasets.

Recently enacted laws have focused on bias at AI companies, and buyers should be aware of and ensure compliance with evolving state regulations. For example, New York City recently passed NYC Local Law 144, which took effect in July 2023 and requires companies using automated decision-making technologies (ADMTs) for employment decisions to conduct a bias audit on ADMTs within one year of using them and to notify candidates and employees of their use of such tools.

Internal Governance Policies

The buyer should also seek to understand the target’s governance policies regarding data collection. Just as company boards of directors routinely undertake materiality assessments regarding environmental, social, and governance practices, boards can also mandate responsible use of AI tools.

Due diligence processes should focus on the steps the target’s board has taken to ensure responsible use of AI and ethical gathering of data, including:

• Putting in place clear procedures regarding responsible AI use, such as developing employee handbooks and training policies to instruct employees on using AI models responsibly. The more clearly defined acceptable use policies are, the more likely it is that a target will avoid relying on untrustworthy or inaccurate AI models.
• Identifying and mitigating bias.
• Establishing an organizational culture that is attuned to discrimination and bias issues.

Failure to implement appropriate measures can result in losses arising directly out of litigation or indirectly out of loss of business from reputational damage.

At an organizational level, reviewing the target’s risk management framework, such as whether it has implemented the NIST’s AI RMF, can help to assess whether the target aligns its values and goals in connection with its AI products. While NIST’s AI RMF is voluntary, organizations that implement its standards demonstrate a commitment to the responsible use and development of its GenAI models. Identifying whether the target uses the AI RMF provides useful signals to the buyer in assessing the target’s risk profile.

(For more on the legal issues implicated by the use of AI in the workplace, see AI in the Workplace in the September 2023 issue of Practical Law The Journal ; for a model employee policy governing the use of AI in the workplace, with explanatory notes and drafting tips, see Generative AI Use in the Workplace Policy on Practical Law.)

Antitrust and Merger Control Considerations

Buyers must consider antitrust issues during the due diligence process. They should evaluate the risk that an acquisition could be blocked through merger control procedures because it has an anticompetitive effect on the market or that the acquisition could be cleared subject to the acceptance of commitments, restrictions (such as not relocating the target), or dispositions of assets. In recent years, competition authorities have been increasingly tracking whether and to what extent new forms of anticompetitive agreements and behavior are or could conceivably be taking place.

In nascent industries such as GenAI, antitrust risks are uncertain due to the lack of established dominant players. However, given the high profile of AI, the FTC and the Department of Justice (DOJ) may closely scrutinize M&A involving AI companies. The FTC, for example, has highlighted control of important AI inputs as a key part of their antitrust analysis, including control over:

• Computational resources.

M&A deals that consolidate these inputs or other critical or complementary applications in the hands of larger players may raise antitrust concerns. Acquisitions of nascent competitors may also raise antitrust concerns. (See FTC: Generative AI Raises Competition Concerns (June 29, 2023) .)

The agencies have been aggressive in the technology space generally. For example, they have recently sought to:

• Enjoin acquisitions by large market players of nascent companies on the grounds that these companies could feasibly develop competitive products internally. For example, in 2022, the FTC unsuccessfully sought to enjoin Meta’s acquisition of Within Unlimited, Inc. on these grounds.
• Unwind acquisitions that they have since determined have an anticompetitive effect. For example, the DOJ is currently seeking to unwind Google’s successful 2008 acquisition of DoubleClick.

Buyers should also review the target for potential antitrust liabilities (for more information, see Antitrust Due Diligence Checklist on Practical Law). The DOJ offers a safe harbor for any antitrust misconduct disclosed by the acquiring company within six months after the closing date of an acquisition (see Speech by Deputy Attorney General Lisa O. Monaco (October 4, 2023) ).

Additionally, buyers should consider any non-US laws that may apply in a M&A transaction that involves multiple jurisdictions (for more information, see Acquiring an AI Company on Practical Law).

(For more on antitrust and merger control procedures in the US, see Corporate Transactions and Merger Control: Overview and US Antitrust Laws: Overview on Practical Law; for information on the Hart-Scott-Rodino Act, which requires parties to certain M&A transactions to file a notification with the FTC and DOJ, see Hart-Scott-Rodino Act: Overview on Practical Law.)

Insurance Coverage

Buyers should perform due diligence on the target’s insurance policies with a special focus on cyber insurance. Cyber insurance policies typically provide coverage for a variety of AI-related exposures, including privacy and copyright-related liabilities. Most cyber insurance policies provide coverage on a claims-made basis, which means the trigger for coverage is a claim made during the policy period. Many cyber policies also have change of control provisions that effectively terminate coverage when an acquisition occurs. Because cyber incidents may go undiscovered for months (or even years), buyers should consider purchasing tail coverage for post-closing claims that arise out of pre-closing events.

(For more on cyber insurance, see Cyber Insurance: Insuring for Data Breach Risk on Practical Law.)

Mitigating Risks

Buyers may mitigate many of the risks discussed in this article with diligent drafting of the definitive acquisition transaction document, such as a stock or equity purchase agreement, merger agreement, or asset purchase agreement (generally referred to in this article as acquisition agreements). There are several sections of the acquisition agreement where a buyer can effectively allocate risks to the seller in ways that protect the buyer from significant liabilities. As used in this discussion, the term “seller” refers to either the equity holders in the target (if the acquisition involves the acquisition of equity in a private AI company or a merger of a private AI company) or the target (if the acquisition involves the sale of the AI assets of the target in an asset sale).

Representations and Warranties

Representations and warranties in an acquisition agreement help a buyer mitigate risk because they provide the buyer with:

• Disclosure information to help identify risks.
• A basis for indemnification claims or representation and warranty insurance (RWI) claims if the seller breaches a representation (see Indemnification and Representation and Warranty Insurance below).
• A basis for terminating the purchase agreement if the seller materially breaches a representation.

The typical representations and warranties used in M&A transactions offer a useful starting point for acquisitions of AI companies but require customization to address specific AI company risks. (For a model non-industry-specific purchase agreement with comprehensive representations and warranties that can be used as a starting point for customized AI representations, with explanatory notes and drafting tips, see Stock Purchase Agreement (Pro-Buyer Long Form) on Practical Law; for resources to provide counsel with examples of comprehensive representations addressing IP and data privacy and cybersecurity matters that can be customized for AI issues, see Intellectual Property in M&A Transactions Toolkit on Practical Law.)

There are several sections of the acquisition agreement where a buyer can effectively allocate risks to the seller in ways that protect the buyer from significant liabilities.

To customize standard representations and warranties to an acquisition of an AI company, the parties to the transaction should include an appropriately robust and accurate description of the AI technologies, products, and services that are the subject matter of the transaction. The target should make representations regarding:

• The AI technologies that it uses.
• What AI it offers as a product or service.
• What AI it plans to offer in the future.

The buyer should also seek to require the seller to bear the risks relating to the procurement and use of training materials and claims relating to the AI’s outputs by including representations and warranties in the acquisition agreement confirming that:

• The target has identified or scheduled in the acquisition agreement all sources of training data.
• The target has:
• the right to use each of those sources for training purposes; and
• provided the buyer with the documentation establishing the target’s right to use those training materials for training purposes.
• The quality of the sources of training materials is appropriate for their intended uses.
• The target has adequately designed and tested its AI products and services.

If the target provides AI products and services, the representations and warranties should confirm that:

• Those AI products and services:
• have operated as intended;
• have not been the subject of customer or third-party complaints or regulatory actions; and
• are the subject of appropriately limiting contractual terms regarding proper use and limitation of liability.
• The target has not conveyed ownership or exclusive rights in any AI technology.

The representations and warranties should also address ethical and regulatory concerns by:

• Confirming that the target has appropriate guardrail policies and oversight in place.
• Requiring disclosure of complaints, investigations, proceedings, and litigation relating to ethical or regulatory concerns without a materiality or significance qualifier.

If the target uses third-party AI products and services, the representations and warranties should:

• Require disclosure of all contracts for the AI products and services.
• Confirm that the target:
• is protected against liability for using the third-party AI products and services;
• owns the output of its use of the third-party AI products and services; and
• owns the IP rights in any third-party AI technology developed by a third party for the target, as with any customized technology paid for by the target.

(For model AI representations by the seller, with explanatory notes and drafting tips, see AI Representations: Asset Purchase and AI Representations: Stock Purchase or Merger on Practical Law.)

The buyer should also ensure the acquisition agreement contains robust representations and warranties regarding compliance with applicable laws, including data privacy laws, addressing both current and past compliance (for model data privacy and cybersecurity representations, with explanatory notes and drafting tips, see Privacy and Data Security Representations: Stock Purchase or Merger on Practical Law).

The seller, conversely, should try to limit the representations and minimize the seller’s related liability exposure by qualifying the representations with knowledge, materiality, or material adverse effect provisions and time period qualifiers (for an overview of ways to use these and other qualifiers to limit representations and warranties, see Stock Purchase Agreement Commentary on Practical Law).

Indemnification

Indemnification provisions in the purchase agreement can mitigate risks for a buyer by requiring the seller to compensate the buyer for losses relating to specified issues that arise before closing. Indemnification is commonly available to a buyer of a private company for losses resulting from inaccuracies or breaches of the seller’s representations and warranties in the acquisition agreement.

Although, a seller’s indemnification obligations in an acquisition agreement are often subject to survival periods, caps, and baskets that limit the seller’s liability in the event of a breach of a representation, representations about fundamental matters are often carved out of these limitations.

Buyers should consider which representations and warranties may warrant a longer survival period or exclusions from the indemnification caps and baskets that are applicable to general representations and warranties. In particular, in the acquisition of an AI business, data privacy, IP, and regulatory representations may merit special consideration in that they could pose particular risks warranting exclusion from these limitations. (For more on indemnity limitations, see Indemnification Clauses in Private M&A Agreements on Practical Law.)

In addition to indemnification for breaches of representations and warranties, a buyer may also negotiate for a special indemnity that obligates the seller to indemnify the buyer for losses arising out of specified matters. These special indemnities may cover specific known risk areas, such as data privacy, IP, and regulatory issues, as well as any losses arising out of pre-closing noncompliance with laws, pre-closing litigation, or any other high-risk areas identified during the buyer’s due diligence of the target.

Representation and Warranty Insurance

RWI in M&A transactions has become an increasingly common means of allocating unknown risks with respect to breaches of representations and warranties by targets and minimizing the potential for post-closing disputes between buyers and sellers (for more information, see Representation and Warranty Insurance for M&A Transactions on Practical Law).

Third-party insurers are particularly aware of and sensitive to areas of risk in transactions involving AI companies. As the first GenAI company acquisitions have been completed, RWI insurers have noted that, similar to other technology M&A transactions, buyers seek to cover representations regarding sufficiency of assets, use of open-source software in company products, and data privacy. To date, underwriting practices and standards in transactions involving AI companies have not differed materially from transactions in the broader technology industry. However, insurers continue to be diligent in evaluating risks in AI companies, and their practices may evolve as more insured transactions involving AI companies are completed and insurers continue to compile data on salient risks.

Closing Conditions

If there is a gap of time between signing and closing, each party to the acquisition agreement may require that the other party fulfill certain conditions before the transaction closes. Therefore, if the buyer identifies any significant issues and risks in due diligence, the buyer should consider requiring the target to make specified corrective actions as a closing condition. These may take the form of:

• Contractual amendments.
• Technology remediation.
• The withdrawal or cancellation of certain AI products or services.

If the seller does not satisfy the closing conditions, the buyer is not required to close and may terminate the transaction.

Post-Closing Remediation

Any significant issues and risks identified in due diligence that are not corrected before closing should be addressed and corrected by the buyer after closing, such as through contractual amendments, technology remediation, or the withdrawal or cancellation of certain products or services. For example, affirmative post-closing steps may be required to ensure ongoing compliance in the area of data privacy. Additionally, if the target lacks or has deficiencies in its policies and procedures, post-closing measures may be required to institute appropriate policies and procedures to ensure compliance with applicable laws and to develop risk management practices that allow the business to limit liability and risk as it grows in an evolving legal environment.

The following attorneys from K&L Gates LLP contributed to this article: Annette E. Becker , Alex V. Imas , Mark H. Wittow , Jake E. Bernstein , Julie F. Rizzo , Kenneth S. Knox , and Nicole H. Buckley .

Related Content on Practical Law

Ai toolkit (us), ai key legal issues: overview, ai and machine learning: overview, it basics: generative ai and large language models: overview, ai representations: stock purchase or merger, ai representations: asset purchase.

Practical Law now has generative AI.

With Ask Practical Law AI on Practical Law, simply ask a question in everyday language and get a summarized answer grounded in content expertly written and maintained by 650+ attorney-editors.

Join the ABA M&A Committee!

Join the M&A Committee meetings, April 4-6, 2024, virtually or in-person in Orlando, Florida, to hear the latest M&A developments, trends, and more.

Read More in The Journal

Advertising and promotions on....

Key legal issues for companies to consider when advertising on social media or running a contest,...

Gonzalo E. Mon, Kelley Drye & Warren LLP

Conducting the Annual Meeting

Guidance for a public company on conducting its annual meeting of stockholders, including following...

Joshua Ford Bonnie, Karen Hsu Kelley, and Brandon Adoni, Simpson Thacher & Bartlett LLP

Data Privacy and Cybersecurity in...

An outline of data privacy and cybersecurity issues for organizations to address when engaging a...

Practical Law Data Privacy & Cybersecurity

Implementing Workplace AI Tools

Steps employers should take before using AI tools for hiring or recruiting practices, including...

Adam S. Forman and Nathaniel M. Glasser, Epstein Becker & Green, P.C.

NFTs: Overview

NFTs have become the subject of much attention within the legal community because of the novel...

Baker & Hostetler LLP

ESG Covenant of Ongoing Compliance

A model environmental, social, and governance (ESG) covenant in which a supplier or service...

Practical Law Commercial Transactions

See-Through Trusts for Retirement...

An overview of issues counsel must consider when estate planning for clients who want the proceeds...

Practical Law Trusts & Estates

State Laws Restricting Foreign...

A comparison of state legislation that restricts the foreign ownership of land in Alabama, Florida,...

Practical Law Real Estate

CBD Food and Dietary Supplement...

A discussion of hemp-derived cannabidiol (CBD) product labeling requirements, highlighting best...

Griffen Jacob Thorne, Harris Sliwoski LLP

Transparency in Coverage Notice

A model notice for use by employer-sponsored group health plans and health insurers in complying...

Practical Law Employee Benefits & Executive Compensation

Understanding the Washington My...

An explanation of the Washington My Health My Data (MHMD) Act’s consumer health data rights and...

Legal Industry

In-House Counsel File

Laura Wilkinson, PayPal, Inc.

Commercial Real Estate: Trends and...

Practical Law Real Estate asked leading real estate practitioners to share their thoughts on recent...

Practical Law Real Estate Contributors

A Geopolitical Outlook for...

A discussion of geopolitical risks in 2024 and the steps investors can take to manage these risks,...

David J. E. Chmiel, Global Torchlight Limited

GC Agenda: March 2024

A round-up of major horizon issues for general counsel.

Practical Law The Journal

Antitrust Issues in Private Equity

An expert Q&A on the antitrust risks facing private equity firms, the current views of the...

Sara Y. Razi, Geoffrey Schmelkin, and Allison Davido, Simpson Thacher & Bartlett LLP

How Antitrust Agencies Analyze M&A

An overview of the revised Merger Guidelines recently released by the Antitrust Division of the...

Practical Law Antitrust

Managing the Energy Transition:...

A discussion of how the different segments of the oil and gas industry are responding to...

Michael J. Blankenship, Scott M. Delaney, Samuel C. Peca, and Luke Smith, Winston & Strawn LLP

Accounting Basics for In-House...

To better advise their clients, in-house counsel should understand key accounting principles and...

Practical Law

Filing a Claim Under a Property...

A checklist identifying the steps that a commercial policyholder should take when filing a claim...

Checking In

Joshua Milgrim, Dechert LLP

Nadine Jones, Kuehne + Nagel

The Corporate Transparency Act’s...

An expert Q&A on the Corporate Transparency Act (CTA), which became effective on January 1, 2024,...

Robert L. Bodansky and Trevor Tullius, Seyfarth Shaw LLP

Borrower Strategies: Increased...

Businesses struggling with the steep rise in interest rates since 2022 may consider a number of...

Jill Eiseman Bronson and Nicole J. Leimer, Drinker Biddle & Reath LLP

Data Privacy and Cybersecurity:...

Key data privacy and cybersecurity developments in 2023 and emerging trends for 2024, including...

• Advertise With Us , opens new tab
• Advertising Guidelines , opens new tab
• Cookies , opens new tab
• Terms of Use , opens new tab
• Privacy , opens new tab
• Digital Accessibility , opens new tab
• Corrections , opens new tab
• Site Feedback , opens new tab

Opinions expressed do not reflect the views of Reuters News, which operates independently of Practical Law.

© 2024 Reuters. All rights reserved