Substantive clauses and risk allocation - Representations vs...

Learning Outcomes

After reading this article, you will be able to distinguish between representations, warranties, and conditions; explain their legal significance and effect on risk allocation; and identify remedies available for breach of each, as required for SQE2 exam scenarios and practice drafting or analysing commercial contracts.

SQE2 Syllabus

For SQE2, you are required to understand the legal and practical distinction between representations, warranties, and conditions in commercial agreements. Particular focus is placed on the consequences of each for risk allocation and available remedies. In your revision, focus on:

• understanding what constitutes a representation, a warranty, and a condition
• explaining the difference in legal effect between these terms
• identifying the remedies available for breach of each, including damages and/or termination
• analysing the impact of incorrect statements or breaches on parties’ rights and obligations in commercial contracts
• applying these concepts to practical fact patterns as found in contract drafting and examination scenarios

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. If a statement in pre-contract negotiations turns out to be false but is not included in the contract, what is the usual legal remedy available?
2. What is the principal legal effect of classifying a contractual clause as a 'condition' rather than a 'warranty'?
3. In what circumstances can a party terminate a contract for breach of a warranty?
4. How does a misrepresentation differ from a breach of warranty, and what are the typical remedies in each case?

Introduction

Clear contract drafting requires an appreciation of how risk is allocated through key substantive clauses. In SQE2, a common focus is on the difference between representations, warranties, and conditions, and the consequences of their breach. This article provides the essential knowledge to approach such scenarios systematically and advise on practical outcomes in commercial agreements.

Representations, Warranties, and Conditions: Definitions and Legal Effect

Commercial contracts use the terminology of representations, warranties, and conditions to allocate risk between the parties. Each term carries distinct legal consequences for breach or inaccuracy, affecting both the remedies and the contract’s future.

Key Term: Representation
A statement of fact made by one party before or at the time of contracting, which induces the other to enter into the contract. If untrue, a misrepresentation may entitle the other party to rescind or claim damages (in defined circumstances).

Key Term: Warranty
A contractual promise by one party concerning facts or future events, included as a term (but not as a condition) in the contract. Breach allows for a claim in damages but not termination, unless otherwise stated.

Key Term: Condition
A fundamental term of the contract that goes to the root of the agreement. Breach entitles the innocent party to terminate the contract and/or claim damages.

Representations

A representation induces the contract but usually does not form part of its terms. If untrue, it constitutes a misrepresentation rather than a breach of contract.

Key Term: Misrepresentation
A false statement of fact or law by one party to another, which induces that party to enter into the contract. Remedies may include rescission and, in some cases, damages.

Warranties

A warranty is a contractual statement promising that certain facts or circumstances are true. Warranties are included in the contract and generally relate to less critical matters than conditions.

Conditions

A condition is a term whose performance or truth is fundamental to the contract’s entire purpose. Parties often expressly define certain terms as “conditions” to establish clear rights to terminate for their breach.

Risk Allocation: The Commercial Effect

The classification of a contractual statement significantly affects each party’s legal risk. Particularly in business transactions involving significant sums—such as business sales, asset purchases, or supply contracts—the risk of loss is managed by carefully negotiated representations, warranties, and conditions. The parties’ ability to claim damages or to terminate the contract hinges on this classification.

Worked Example 1.1

A buyer is purchasing a company. The seller’s contract includes a warranty that “the accounts give a true and fair view of the company’s financial position.” After completion, the buyer discovers the accounts are inaccurate but the contract does not classify this warranty as a condition.

Answer:
The buyer may sue for damages for breach of warranty. However, unless the warranty is classified as a condition or “material,” the buyer cannot terminate the contract based solely on this breach.

Remedies: What Happens When Clauses Are Breached?

Breach of Representation (Misrepresentation)

If a statement is a representation but not a term, an untruthful statement may allow for:

• Rescission (setting aside) of the contract; and/or
• Damages, depending on whether the misrepresentation was fraudulent, negligent, or innocent.

Remedies for misrepresentation depend on the type and relevant statutes, most importantly the Misrepresentation Act 1967.

Breach of Warranty

If a statement is included as a warranty, breach enables the innocent party to claim damages only. The contract remains in force—there is no general right of termination for breach of warranty.

Breach of Condition

Where a condition is breached, the innocent party may:

• Terminate the contract (repudiate); and/or
• Claim damages for any loss caused.

Failures to perform conditions permit a substantially more severe remedy than breaches of warranties.

Worked Example 1.2

A contract states, “Time for delivery is of the essence.” Delivery is late.

Answer:
Because time is 'of the essence' (making it a condition), late delivery allows the aggrieved party to terminate the contract and claim damages.

Contracts with Both Warranties and Representations

Warranties and representations are frequently set out together but serve distinct functions. Warranties allocate contractual risk. Representations address pre-contractual factual accuracy. Commonly, contracts try to exclude liability for pre-contractual representations (via an 'entire agreement' clause), but courts may scrutinize or override such limitations based on reasonableness.

Worked Example 1.3

A seller states in pre-contract discussions that equipment meets certain emission standards. The signed contract includes an entire agreement clause and a warranty that the machinery complies. Equipment fails the standard.

Answer:
The buyer can likely claim damages for breach of warranty. Whether rescission or misrepresentation damages are available depends on factors, including the entire agreement clause’s validity and the nature of the seller’s statement.

Exam Warning

The classification of a term as a condition or warranty affects available remedies. Terms not expressly labelled may be interpreted by the courts, considering the parties’ intentions and statutory provisions (e.g., Sale of Goods Act 1979). Misclassification can result in the wrong remedy being sought in SQE2 scenarios.

Summary Table: Key Differences

*Damages only available for (negligent or fraudulent) misrepresentation

Key Point Checklist

This article has covered the following key knowledge points:

• Representations are statements inducing a contract; their breach gives rise to misrepresentation remedies.
• Warranties are promises within the contract; breach gives rise to damages only.
• Conditions are primary terms; breach permits termination and a damages claim.
• Commercial contracts use these terms to allocate risk and define available remedies.
• Classification of terms may be governed by contract wording or statutory interpretation.
• Available remedies differ significantly and must be correctly identified in SQE2 problem scenarios.

Key Terms and Concepts

• Representation
• Warranty
• Condition
• Misrepresentation