Importance of “Knowledge” in a Purchase Agreement
In a Purchase Agreement, knowledge must be defined so that both parties can understand the rules of the deal and their representations and warranties. Along with information, knowledge qualifications provide a scope of each parties’ knowledge and thus allocate risks between the Buyer and Seller, with respect to matters covered in the contract. Fundamentally, knowledge definitions seek to delineate whose knowledge matters to determine whether a knowledge qualification has been breached and who is liable for this breach.
Without these knowledge definitions, there is a significant risk that the knowledge of the employees could be imputed, even if they were not involved in preparing the representations and warranties. Therefore, these risks have resulted in a universal trend to tie the definition of knowledge to a list of knowledge parties – so these knowledge definitions are used to tell a court whose knowledge can be imputed to the seller.
So, when entering into a Purchase Agreement, both parties should be aware of these four knowledge definitions:
- Actual Knowledge
- Constructive Knowledge
- Imputed Knowledge
- To the Seller’s Knowledge
Actual knowledge is direct and clear knowledge where the relevant party knows of a particular item of event that causes a breach; it can be demonstrated through circumstantial evidence and if the circumstances are such that the defendant must have known,’ an inference of actual knowledge is permitted.
Constructive knowledge is knowledge that a person is presumed by law to have, regardless of whether he/she actually does, since knowledge is obtainable by the exercise of reasonable care. This type of knowledge contains language referencing a duty that the parties have as this knowledge is attributed by law to a given person, for example, the court held that the partners had constructive knowledge of the partnership agreement even though none of them had read it.
Imputed knowledge is attributed to a party if it is within the scope of their authority or employment or their relationship with or responsibility for another party. Such knowledge is attributed to the reason that the facts in issue are open to discovery and it is that person’s duty to be aware of that information.
To the Seller’s Knowledge
To the Seller’s Knowledge means the actual or constructive knowledge of any director or officer of the Seller or the Company, after due inquiry. With this type of knowledge, the risk of any unthreatened litigation is shifted away from the seller and onto the buyer. Therefore, it is added to an agreement to excuse the Seller from post-closing liability. If there ends up being a breach of an agreement, these ‘knowledge qualifiers’ protect the Seller if they did not have knowledge of the facts that resulted in the breach.
The key differences between Constructive Knowledge and Actual Knowledge
The main differences between these two types is that constructive knowledge has a duty of enquiry as the parties are presumed by law to have it. It is important to differentiate between these two types of knowledge as they can have an extensive effect when determining if a party is liable or not.
Both knowledges have advantages and disadvantages for the Buyer and Seller.
Usually, Sellers will prefer an actual knowledge definition as it is less stringent whilst Buyers will prefer a constructive knowledge definition in the contract, as it is more stringent.
Advantages of Actual Knowledge include:
- Unlike the uncertainty of constructive knowledge, actual knowledge is clear and does not presume the knowledge of either party.
- The List of Actual knowledge makes the party specify which employees have knowledge, unlike constructive knowledge which assumes that by duty, all employees have knowledge.
- Actual knowledge fairly protects the buyer.
Advantages of Constructive Knowledge include:
- The diligence inherent in this type of knowledge provides a contractual backstop to ensure that sellers are identifying the appropriate knowledge parties to the right employees.
- This knowledge also provides fairness – liability should not be allocated to the buyer simply because the seller has chosen not the bring certain employees into the knowledge of a private deal. This knowledge asserts that everyone has a duty to be aware of the knowledge.
Above all, it is important that both parties involved in the contract (the Seller and Buyer) are aware of the definitions of the different types of knowledge and more importantly their potential implications on the parties’ responsibilities in the contract.