The concept of disclosure letter in M&A

Mergers and acquisitions
Article

In a merger and acquisition (“M&A”) transaction, it is common for the seller to give representations and warranties about the subject matter of the sale, be it shares or assets to be disposed of by the seller. The representations and warranties given by the seller are for the purchaser’s benefits, to assure the purchaser that the shares or assets are what the seller represents and warrants them to be. If any of the representations and warranties turn out to be untrue, the purchaser may have a cause of action against the seller.

It is common practice to provide in the sale and purchase agreement (“SPA”) that the representations and warranties will apply save as disclosed in a disclosure letter. A disclosure letter is a letter from the seller to the purchaser which sets out exceptions to the representations and warranties contained in the SPA. In my experience, sellers and purchasers spend a lot of time negotiating on the terms and conditions of the SPAs and then rush through the negotiations on the disclosure letters to close the transactions.

The Seller’s and Purchaser’s Different Perspective

The disclosure letter allows the seller to avoid liability under the representations and warranties in respect of matters which have been disclosed in the disclosure letter. The disclosure letter is also an opportunity for the purchaser to “flush out” disclosures from the seller, which may affect the purchaser’s decision to purchase the shares or assets. It is therefore in both the seller’s and purchaser’s interest to ensure the disclosure exercise is conducted as thoroughly as possible.

Where the purchaser has been given the opportunity to conduct detailed due diligence, the seller may wish to include a wide general disclosure, to the effect that the information provided on behalf of the seller in the course of the due diligence would qualify the representations and warranties in the SPA. The seller may argue that it defeats the purpose of allowing the purchaser the opportunity to conduct due diligence if the seller is still held liable for matters which the purchaser is aware of or should have been aware of from the due diligence. On the other hand, the purchaser may argue that the purpose of the due diligence is not to look out for matters which would constitute exceptions or breach of the representations and warranties, but to find out about key issues which may affect the purchaser’s willingness to proceed with the transaction or the price which the purchaser is willing to pay. When due diligence is conducted, the representations and warranties may not even have been drafted.

In making disclosures, the seller’s purpose is to transfer the risk in respect of the matters disclosed to the purchaser. The seller will want to be able to continue to make disclosure until the last possible moment. On the other hand, the purchaser may only want to accept disclosures which are fairly made and with reasonably sufficient details to enable the purchaser fully comprehend the implications of the disclosures. A purchaser will not wish to be swamped with material disclosures at the eleventh hour. Depending on the circumstances, disclosure at the last minute may be reasonable as the target company carries on with its business, claims may arise or be settled, employees may join or leave, and so on.

Conclusion

A disclosure letter is a powerful instrument in an M&A, both from the seller’s and purchaser’s perspective. It would be in the seller’s and purchaser’s interest to go through the disclosure exercise just as carefully as they would in their negotiations of the terms and conditions in the SPA.

The information in this article is intended only to provide general information and does not constitute legal opinion or professional advice.

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