What you need to know about assurances and guarantees in contracts for publishing and attracting investments — REVERA column

Anastasia and Alexandra
The section under the promising title “assurances and guarantees” can be found in many contracts.

Why is it needed and what consequences does it create for the founders? Let’s look at the example of two key transactions: attracting investment and publishing.

In order for a startup to “raise investments”, the founders need to attract the investor’s attention and convince him to invest in the product. Since investing in a startup is already associated with high risk, it is important for an investor to prevent the possibility of at least those losses that he is able to foresee.

Firstly, for these purposes, a comprehensive Due Diligence is carried out — a legal check of a startup. But Due Diligence is not a “panacea”, since many points that potentially entail losses can manifest themselves after it is carried out.

Secondly, in order to remove possible future risks, investors will insist on providing them with a number of assurances and guarantees regarding the business and the product (software, applications, games).

Similarly, in the situation with publishing. It is possible that the publisher will conduct minimal Due Diligence with respect to the product, but the key mechanism for guaranteeing the purity of rights will be the assurances and guarantees of the developer.

What are guarantees?

Guarantees (or guarantees) are understood as statements of founders/developers about facts related to the object of the transaction (company or product). In fact, guarantees are promises that some fact definitely exists, has been or will be, and the founder/developer “fits in” for it.

Guarantees can be given about facts from the past, present and future (most often). For example, the developer guarantees that BY:

• developed without using Open Source licenses (past);
• does not violate the rights of third parties (present);
• cannot become the object of a dispute with a third party (future).

The function of guarantees is informational and compensatory. On the one hand, the investor/publisher receives reliable information about the object of the transaction. On the other hand, he has the right to compensation for damages in case of inconsistency of such information with reality.

What are assurances?

Assurances (or representations) are understood to mean the statements of the founders /developers about the facts related to the object of the transaction, as a result of which the contract was concluded. I.e., these are the key facts because of which the investor / publisher, in fact, decided to conclude the contract. Without them and assurances about them, there would be no deal.

Unlike guarantees, assurances are given only about facts that took place in the past or exist in the present. Assurances are not given for the future.

Initially (in English law), the assurances were of a non-contractual/pre-contractual nature, since they were given before the transaction, “predetermined” it. However, today the practice is different: assurances, as well as guarantees, are recorded in binding documents.

The function of assurances is informational and compensatory. In addition, the violation of assurances, as a rule, gives the injured party the opportunity to terminate the contract. This possibility should be directly fixed in the contract and follows from the essence of the assurances: since I was based on the validity of the fact at the conclusion of the contract, and now it has turned out that the fact does not correspond to reality, then I no longer need such an agreement (and with it a share in the business or software).

In practice, assurances and guarantees are overlapping instruments. Contracts usually include a common block of “assurances and guarantees”, and no distinction is made between them.

What are the consequences of violating the assurances and guarantees?

If the founder or developer violates the assurances and guarantees provided by him, he may face the following consequences:

• compensation of losses to the investor/publisher;
• compensation of property losses (indemnity);
• payment of the penalty;
• termination of the contract.

The investor/publisher has the right to claim damages even if the provision on compensation for losses is not directly spelled out in the contract. At the same time, the investor / publisher will need to prove a causal relationship between the fact of violation of the assurance and losses, as well as justify and confirm the amount of losses.

Indemnity, in contrast to losses, are defined in the contract and represent a pre-agreed amount of compensation that the founder /developer is obliged to reimburse the investor /publisher if the fact of violation of assurances or guarantees is revealed. An investor/publisher in such a situation should not prove either a cause-and-effect relationship or the amount of losses. The obligation to pay compensation arises simply when the fact of a violation is revealed.

Examples of assurances and guarantees that are given to the investor

The investor, as a rule, needs to provide assurances and guarantees that relate directly to the startup itself. The following blocks of “statements” are most often found in key transaction documents:

1. on whether the founders have the authority to conclude a transaction and on the proper establishment of the company;
In this block, the founders or their representatives confirm that a) they have the right to sign all documents on the transaction, and b) the startup is registered and legally carries out its activities.

2. about IP rights;
The most important block in deals on investing in startups.

The investor needs to get assurances and guarantees from the founders that all IP objects belong to the startup on a legal basis.

3. about taxes;
It is also an important block of assurances and guarantees, since non-compliance with tax legislation by a startup before or during the conclusion of a transaction may entail additional taxes, which is not at all part of the investor’s plans.

Here the investor receives assurances and guarantees that the startup has fulfilled and fulfills all tax obligations and has no tax debts.

4. about the key employees of the company;
The investor receives assurances and guarantees from the founders that certain key employees will work in the company for a certain period (on average 3 years), and that the employment relationship with them is properly formed.

As a rule, these are the very key developers whose efforts and work create a startup product.

Examples of assurances and guarantees that are given to the publisher

The publisher usually wants to get assurances and guarantees from the developer that relate directly to the application, game or other software.

Publishing contracts most often contain the developer’s assurances and guarantees that:

1. the developer is the sole owner of the software and legally owns it;
2. The software is not the subject of any legal dispute;
3. The software does not violate the rights of third parties;
4. The software was developed without the use of Open Source licenses;
5. The software does not contain content that violates the law.

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Assurances and guarantees are usually used in transactions to protect the interests of the investor/publisher.

Founders and developers also need to be extremely careful when taking on such guarantees.

Having received the long-awaited contract from the investor / publisher, do not rush to sign it. Carefully study all the conditions, including pay attention to the section on assurances and guarantees. Having signed a contract and assurances without looking, there is a risk of encountering very adverse consequences by assuring and guaranteeing what you cannot actually provide and guarantee.