In the third and final of our series of articles entitled ‘Getting Yourself Deal Ready’, Corporate Associate at Mishcon de Reya, Ammar Thair discusses the importance of Disclosure in a transaction.
Following completion of the due diligence stage, after any and all interested parties have satisfied themselves with (a) the contents of the data room, and (b) the responses to the due diligence questionnaire (and any follow-up questions therein), what follows will be the final and most important stage in terms of seller protection: disclosure.
What is disclosure?
Disclosure is the process by which the warrantors (i.e. certain specified persons, usually the sellers, founders and/or the company) will be given the opportunity to disclose any details as to why certain statements of fact (warranties) contained in the relevant purchase agreement (or investment agreement) and otherwise purported to be given by the warrantors, are untrue.
The warranties will usually be included within a separate schedule to the purchase/ investment agreement, and their specific detail (and number) will be a matter for negotiation throughout the data room and due diligence stage.
Depending on the scale of the transaction (except for the case of any simple investments or acquisitions), the number of warranties is likely to be quite high, covering matters such as the company’s corporate standing, general compliance history, data protection policies, ownership of assets, intellectual property, real estate and details of employees or contractors.
Why is the disclosure letter important?
If any of the warranties later turned out to be untrue, then the buyer (or investor) would theoretically be entitled to bring a breach of warranty claim against the warrantors.
Whilst such claims are rare in practice, given the presence of limitations in the relevant purchase/ investment agreement (including time limits, caps and financial thresholds, all subject to negotiation), a buyer/ investor will not be able to bring a warranty claim if the warrantors have first provided sufficient details of any matters contradicting the warranties (i.e., a disclosure) within a disclosure letter, delivered in accordance with the transaction.
Therefore, the disclosure letter provides:
- An opportunity for the warrantors to shield themselves from a potential breach of warranty claim; and
- Reassurance for the buyer, confirming its understanding of the company and its affairs to be correct, with the warrantors willing to ‘stand behind’ the promises made.
What does the disclosure process involve?
This will usually take the form of a long call (a disclosure call) between a representative for the warrantors (often, the company’s management team), and the company’s legal advisors. The aim of this call (or series of calls) will be to go through the warranties schedule together and in detail, with the aim of discussing any potential disclosures against the warranties.
What else should I consider?
- Input may be needed from different stakeholders in the company, ranging from the HR and IT departments to any data protection officer (if appointed). You should ensure that representatives from these teams (alongside their input) are readily available.
- Similarly, your legal advisors may also co-ordinate across teams for any specialist warranties.
- Even if the buyer/ investor was previously made aware of facts contradicting a warranty (perhaps in the course of commercial discussions or the due diligence stage), details should once again be provided wherever possible in the disclosure letter.
How much detail is needed for a disclosure?
The first reference point should be the purchase agreement (or investment agreement), as this is likely to contain a definition for ‘Disclosed’, setting out the detail required for a disclosure to be accepted (otherwise known as the ‘disclosure standard’).
The disclosure standard is therefore a point for negotiation between both parties, but if the deal is particularly buyer/investor friendly, you should expect that for a disclosure to be valid, any disclosures made against the warranties should be made fully, fairly and accurately (allowing the buyer/investor to identify the nature and scope of any matter disclosed).
Key points of note:
- Any statements in the disclosure letter which do not provide enough detail and consequently fall short of this standard would risk leaving the warrantors open to a breach of warranty claim.
- Accordingly, your disclosures must include references to supporting documents (in the majority of cases, you will be able to provide cross-references in your disclosure letter to the virtual data room, itself forming part of the disclosure bundle).
- Will the contents of the data room be generally disclosed to the Buyer? If so, this would mean that the sellers could rely on any of those documents in rebutting a potential breach of warranty claim, on the basis that the documents were generally disclosed (i.e., provided and made visible) to the Buyer.
Whilst general disclosure of the data room is increasingly being recognised as market standard, if the data room itself has not been open for a sufficient period of time, or one has not been organised in a clear and efficient way, then it may not be reasonable to expect that one could adequately review all such documents, and general disclosure of the same would not be accepted. Therefore, a thorough disclosure exercise (with the help of your legal team) will still be in both parties’ interests, ensuring a smooth and positive outcome for all.
For more information, please contact Ammar Thair, Associate in Mishcon de Reya's Corporate team.
Other articles in the 'Getting yourself deal ready' series:
Due Diligence: Getting yourself deal ready.
Data Rooms: Getting deal ready.