We recently conducted a number of disclosure exercises for both buyers and sellers. Frequently, similar themes pop-up. Therefore, we thought it would be helpful to summarise the points below to help demystify what can be quite a complex and time consuming exercise for management on either side of a transaction.

What are Disclosure Letters? Generally, Disclosure Letters serve to qualify the warranties sellers give in a sale. Of interest is a share sale because when a buyer acquires a target entity in a share sale, it acquires all of its assets and liabilities. Contrast that with an asset purchase in which a buyer can pick and choose assets and leave behind liabilities (although lots of careful work is needed to accurately capture the perimeter of what is moving across or stays behind in an asset purchase).

How do they work? Sellers make disclosures against warranties contained in a share purchase agreement (SPA), the warranties will be both general and specific. Warranties may relate to items such as: customer and supplier contracts, property, employees, the seller’s ownership of its shares or even tax matters.

Why use them? From a seller’s perspective, making disclosures serves to protect them against future claims for breach of warranty. If a seller discloses against a specific warranty, a buyer will find it difficult to argue its case for a breach of said warranty. Meaning that a seller gets greater certainty with regards to the amount of the purchase price it will realise once the conditions of the SPA are met. From a buyer’s perspective, it serves to tease out information that may otherwise remain out of sight. This is important because as noted above, in a share purchase the buyer takes on all of an entity’s assets and liabilities. Meaning that a buyer gets a fuller picture of the business it is acquiring.

What are the potential downsides? For a seller, a downside could be where a buyer uses information revealed by the seller to chip away at the purchase price or push for a harder negotiated position elsewhere in the SPA, using the disclosure as leverage to protect its position elsewhere. For the buyer, a downside is that a seller may disclose information which leads to a larger future liability than either side could foresee today, however, as it was disclosed, the buyer would find it difficult to pursue the seller for breach of warranty.

Are there additional benefits outside the letter itself? Yes. The conduct of the disclosure exercise can help bring the buyer and seller together and reinforce their commitment to the deal, bringing a greater level of understanding about each other’s concerns. Additionally, when the buyer intends to employ the seller afterwards and / or there is an element of earn out in the deal, clarity of communication between the parties may give each of them greater confidence in their future working relationship.  

If you'd like assistance in relation to the issues raised please do contact Bruce Horton-Gabell at bhortongabell@ortolan.com