Disclosure letters are an important document in mergers and acquisitions. It is produced by the seller and enables them to make disclosures against the warranties included in the sale and purchase agreement. It is designed to protect the seller from any potential claims by the buyer under the warranties.
Disclosures against the warranties
Warranties are contractual statements of fact regarding a company and its dealings. There are fundamental warranties which usually relate to the seller’s authority, capacity, and title (where you would not expect disclosures to be made) and general warranties which relate more to the company itself such as accounts, contracts, litigation and property (this is a non-exhaustive list).
Warranties and disclosures must be considered together. The disclosure letter is used so the seller can qualify the warranties given, such that if a warranty is untrue, a buyer only has a claim for breach of warranty if the facts giving rise to the claim were not disclosed to the buyer.
Standard for disclosure
There is no universal standard for a disclosure, it could require “full”, “fair”, “clear” or “accurate” or any combination of those and this will be defined within the sale and purchase agreement. If the wording includes the word “fair”, a higher standard is imposed and so the disclosures cannot be vague, wide, or woolly. If disclosure is not sufficient to meet the definition of disclosed, it may not operate to qualify the warranties and as such the seller could not rely on it. Sellers should therefore ensure that disclosures are precise and the buyer should be able to easily ascertain what is being disclosed.
General disclosures cover matters which, for example, appear in public records and of which the buyer ought to be aware of as a result of the due diligence process undertaken. The seller will try to make the general warranties as broad as possible and the buyer will seek to limit these. This is because if matters “in the public domain” are treated as generally disclosed, this could be argued to include something which is on the internet or in newspapers which, in practice, the buyer would have no idea about.
The seller will also want to generally disclose the data room. A buyer should be wary of accepting this as it could include documents which they have not reviewed nor are relevant to any specific disclosure.
General disclosures are therefore likely to be the subject of much negotiation between the parties.
These specifically disclose actual matters which, if not disclosed, would or might constitute a breach of warranty. The specific disclosures are made by reference to the warranties included in the sale and purchase agreement, for example, if the warranty stated that no employees had given notice to terminate their employment in the last 6 months, the seller would have to disclose details of all employees who had given notice in that period. The seller will want to avoid liability for breach of warranty and so will disclose as much information as they can. Specific disclosures therefore serve to flush out information and gives the buyer the opportunity to request further information on things which are disclosed before they commit to acquiring the company.
Failure to disclose
If a seller makes inadequate disclosures or simply no disclosures for a known issue, it could face a claim for breach of warranty which it could have avoided. A claim for breach of warranty could allow a buyer to recover some or even all of the purchase price if the value of the company has been impacted as a result of the breach.
It is therefore important that the seller takes care in preparing the disclosure letter to ensure that everything known to the seller is disclosed where appropriate and the buyer should ensure that the disclosure letter is carefully reviewed so it is aware of any issues and has the opportunity to ask further information if needed or reconsider the deal if something untoward is disclosed.
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