What's the purpose of disclosure?During the sale of shares in a company (“Target”), the buyer will require the seller to respond to a range of due diligence enquiries about the Target’s business so that any risks which may be inherited post-completion are revealed.
Although the seller’s responses and supporting documentation to due diligence enquiries provide information to the buyer enabling the buyer to better understand what it is buying, the process of disclosure is the seller’s opportunity to reduce its liability under warranties in the share purchase agreement (“SPA”) by disclosing facts and/or circumstances which do not accord with the assurances given under the warranties so that the buyer fully understands the current activities of the Target and the potential liability arising from those situations.
Is disclosure important?Yes, disclosure is very important as it protects the seller from potential future claims. By making disclosures the seller is mitigating its risk as any failure to adequately disclose facts and/or circumstances could mean the seller faces a breach of warranty claim. It ensures the buyer fully understands the circumstances of the Target’s business and protects the seller from warranty claims.
The buyer may later say “If I had known of ‘that’ circumstance, I would not have bought or bought at that price” but if the disclosure of the circumstance prior to completion has been clear and unambiguous, then the buyer will have no base upon which to bring a claim for damages/loss. The disclosures are made by the Seller’s solicitor in a disclosure letter with information provided by the seller. The clearer and more comprehensive the information, the better the protection for the seller.
What’s the disclosure letter?The disclosure letter is addressed to the buyer. It often has two distinct parts being the general disclosures and the specific disclosures with the specific disclosures often supported by documentary evidence known as the “disclosure bundle”. The disclosures made must be detailed and must clearly describe the circumstances that could cause the Target cost or liability.
What do I need to know about general disclosures?General disclosures are those which are publicly available or those the buyer should be aware of through its pre-contract searches and enquiries. The seller will attempt to negotiate a range of broad general disclosures that maximise its possible protection, e.g. “all matters that relate to the Target which are in the public domain”, however, the buyer may seek more narrow general disclosures on the basis it is unrealistic for the buyer to know everything about the Target which is in the public domain. Having said that, there are other general disclosures based on records in the public domain that are more widely accepted such as filings at Companies House which the buyer would be expected to review in its due diligence process.
What about the specific disclosures?Specific disclosures are facts and/or details of circumstances disclosed with reference to a particular warranty on the basis that if those facts and/or circumstances were not disclosed the assurance given under the warranty would not be true and there would or may be a breach of the warranty concerned.
The SPA will contain numerous warranties about the Target including, for example, that it is not involved in ongoing litigation and has adequate data protection policies in place and in making the specific disclosures the seller seeks to avoid liability for a breach of the warranties by explaining to the buyer that a circumstance that may be of concern exists.
So, the disclosure process only benefits the seller?Not always. The seller’s disclosure may lead to further enquiries from the buyer and if the facts and/or circumstances give rise to a risk to the buyer the seller might be required to indemnify the buyer for any potential loss that the outcome of the circumstance may ultimately give rise to, or, the seller may have to contend with the buyer renegotiating the purchase price.
What do I need to know about the disclosure bundle?The disclosures in the disclosure letter will refer to the documents in the disclosure bundle. Those documents (if any) will be documents that further explain the circumstances described, such as correspondence between the Target and its opponent in a litigious situation. Much of the documentary evidence that supports those disclosures has usually already been provided to the buyer in the due diligence phase as all due diligence questionnaires are designed to ask about all aspects of the Target’s business and so the issue or circumstance should already be known to the buyer. If there are disclosures which are not supported by documents and the buyer suspects such documents exist, it is likely the buyer will request them from the seller so that they can be reviewed by the buyer and it’s legal advisors.
Anything else I need to know about disclosure?The disclosure exercise often starts whilst the warranties in the SPA are still being negotiated and will continue until just before the deal completes.
The seller should ensure disclosures are accurate and comprehensive, otherwise in the event of a dispute, the court may find the disclosure in question was imprecise and/or lacking the necessary quantity of information in order for the buyer having read the disclosure letter to make an informed decision to continue with the acquisition.
The seller’s solicitor’s skill is in helping the seller to provide the disclosure information in a clear, accurate and measured fashion so that the meaning of the disclosure is capable of being understood by the buyer and its solicitor.
Need assistance?As with all legal aspects connected with the sale of a business disclosure requires specialist advice as the disclosure letter is a legal document that contains significant risk to seller if its isn’t drafted and negotiated by a suitably qualified legal professional.
This article is not intended to be interpreted as advice. If you would like any assistance in relation to your proposed sale or the disclosure process please contact our specialist corporate team on 0151 305 9650 or email firstname.lastname@example.org.
Next article being served up at Glenville Walker is on the juicy topic of pre-completion.