The importance of representations in finance transactions
A representation is a statement of fact made to induce the party to whom it is made to enter into the agreement. Representations are commonly taken in commercial agreements where there is no general duty of disclosure on a party that enters into such contract. In facility agreements representations as to the status of the borrowing entity and the other security providers, the secured assets as well as other matters of fact, which have no other way of being safely verified, such as the ranking of the security or the absence of adverse circumstances such as borrower insolvency, are usually granted by the borrower. Without them, the borrower could remain silent on matters that might make financiers unwilling to grant the financing, were they aware of them. The representations are therefore designed to reveal anything which might affect the bank’s decision to advance the loan. If it turns out that any representation was indeed untrue, this should normally give the bank the right to stop lending further money and/or declare the outstanding loan payable, since in most financings a misrepresentation would normally be an automatic event of default.
It should be noted, though, that, apart from the contractual aspects, there are also non-contractual remedies for misrepresentation such as rescission and damages. As damages for negligent or fraudulent misrepresentation can be higher than those for breach of the terms of a contract this is a useful alternative for a financier. However, in most cases banks would prefer to declare the loan payable and enforce their security rather than embark on years of costly litigation on the grounds of tortious misrepresentation, especially if the borrower has no substantial assets save for those already secured to the bank’s favour.
The scope of the representations does largely depend on the type of financing and the corporate structure. If the Borrower is a single purpose company, it is sometimes only the borrower that will be required to make representations in relation to its own situation. However, in deals where the borrower is either a parent company or a member of a group structure or where the financing involves a guarantor or other security providers, the scope of representations granted by the borrower can be extended to cover other entities as well. This means, though, that the giver of representations should carefully consider if it is able to make the relevant statements in relation to the other entities, particularly if it is being asked to make representations in respect of a parent or sister company, over which it cannot normally exercise control or obtain all relevant information. The director signing the agreement needs to be also satisfied that all the representations are true or otherwise runs the risk of being personally liable for deceit.¹ Now, from a financier’s point of view, if a borrower insists that it cannot provide a particular representation, it is important that the bank inquires as to the reason for such refusal, so that it can assess the potential risks.
A bank’s reluctance to remove representations normally leads most borrowers, apart from narrowing down the entities in respect of which such representation is granted, to also seek to further qualify the representation itself. To that effect borrowers commonly request that a representation is granted “to the best of the borrower’s knowledge” or that a representation is true “in all material respects”.
The knowledge qualification is commonly agreed upon by financiers, but it will usually be for those representations which, if untrue, are not considered “deal breakers”. For instance, qualifications as to knowledge will normally be unacceptable in situations where, if the representation is not true, the effect is potentially disastrous to the bank.
With respect to the materiality qualification, banks are often willing to agree a degree of materiality, if only on the basis that they are unlikely to care if the matter in question is not 'material'. However, in practice this makes it harder for a representation to be relied on, as banks cannot be certain that a judge will agree with their view that the relevant act, omission or amount was 'material'. Materiality is ultimately a relative term, and its meaning will generally depend on the facts and the context in which it is used; thus, this makes it really hard for a financier’s lawyer to draw hard and fast lines as to what may be considered material so that the bank can proceed accordingly.
