13.3 Legal Requirements and Legal Constraints 441However, buyer due diligence should be influenced by legal background rules.
In particular, there may be rules according to which the buyer has constructive no-
tice of certain characteristics of the target.^34
Due diligence instead of warranties? The vendor is sometimes unwilling to
provide warranties but offers the buyer an opportunity to perform a due diligence
inspection instead. Should the buyer accept the vendor’s offer to replace vendor’s
warranties with a chance to perform a due diligence inspection?
The buyer should not accept that offer. First, due diligence is necessary in any
case (see above). Second, even the vendor’s warranties are necessary in any case,
because the buyer is not sufficiently protected without warranties and there can be
things that the buyer may not notice in a due diligence inspection.
Where the buyer requires both warranties and a chance to perform due dili-
gence, the contents of warranties and their legal relevance are influenced by due
diligence.
The vendor’s first draft typically contains few warranties. Furthermore, they
tend to be qualified by the entire contents of the vendor’s data room, and diluted
by: high materiality thresholds; restrictions on the liability of the vendor for
breach of warranty (caps such as reduction of purchase price up to a certain
maximum amount or percentage of purchase price); and time bars for claiming
breaches of warranty that expire upon completion of the acquisition.^35
In principle, the buyer can seek multiple detailed warranties on various items.
In practice, this would make negotiations more complicated and increase transac-
tion costs.
The parties can therefore try to simplify negotiations in various ways. If the
parties use detailed warranties, they will often be qualified by information “fairly
disclosed” (section 16.2) in the data room. If the parties agree on broadly formu-
lated warranties, the warranties will be complemented by specific detailed warran-
ties limited to areas of concern identified in due diligence. Some buyers can take
out a warranty insurance and transfer part of the risk to a third party (section
16.4).^36
Warranties instead of due diligence? In some cases, the vendor might refuse to
permit a sufficient buyer due diligence. Instead, the vendor might offer warranties.
Should the buyer accept the vendor’s offer to substitute warranties for a chance to
perform a sufficient due diligence inspection?
The buyer should not accept that offer either. The warranties of the vendor
would not be a sufficient way to protect the buyer. In the absence of a sufficient
due diligence inspection, the buyer would be exposed to a high commercial risk
and counterparty commercial risk. The buyer would simply buy a “pig in the bag”.
For many reasons, this would be unacceptable. It is difficult both de facto and de
jure to rescind a business acquisition contract (see below). It can be time-
(^34) See CISG Article 36(1), CISG Article 35(3), and CISG Article 39(1). For German law,
see nevertheless § 442(1) BGB.
(^35) Schmidt KM, Private Equity: Current M&A Issues for Buyers. In: PLI, Eighth Annual
Private Equity Forum, Corporate Law and Practice Course Handbook Series (2007).
(^36) Ibid.