Disclosure Letter

Disclosure letter from the seller of a business, disclosing general and specific matters against the warranties in the business purchase agreement

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Disclosure letter for a business purchase transaction

What is a Disclosure Letter?

Business purchase transactions usually involve the seller giving warranties to the buyer in the business purchase agreement relating to the business and assets which are the subject of the transaction.  A breach of the warranties may result in a legal claim against the seller for damages for breach of contract.

The seller may wish to disclose specific events or circumstances as exceptions to certain warranties. The disclosure of these matters is intended to protect the seller against a potential claim for breach of those warranties. Rather than amending or qualifying the warranties themselves for these specific events and circumstances, the disclosures against specific warranties are set out in a separate letter from (and prepared by) the seller to the buyer , known as a “Disclosure Letter”.

As an example in the context of a business purchase, the agreement may include a warranty that the seller, as the warrantor, has complied with all customer contracts in the conduct of its business. The seller may be aware of an ongoing claim from a third party that the seller has failed to comply with a particular contract. The seller would want to disclose this matter as an exception to the warranty.  This is done by setting out a narrative of the circumstances relating to the matter, together with supporting documents, in the Disclosure Letter. Provided that the disclosure satisfies the defined requirement in the agreement of what constitutes “fair disclosure” for these purposes, the disclosure of this potential breach of contract should protect the seller from a claim under the agreement for breach of this warranty in relation to such non-compliance.

The warranties may also expressly require that certain facts or documents are set out in the Disclosure Letter. As an example, there may be a warranty that the Disclosure Letter sets out details and copies of all employment contracts for the employees of the seller who will transfer to the buyer as part of the business purchase. The seller should include details and copies of the employment contracts in the Disclosure Letter, failing which the seller may be subject to a claim for breach of warranty if the failure to disclose one or more employment contracts has caused loss to the buyer.

Once a particular matter or document has been disclosed by the seller during the course of the transaction negotiations, the buyer will need to decide:

    • to accept the disclosure, with the result that the buyer will have no legal recourse should the disclosed matter result in an actual liability or loss
    • to require that the disclosed matter is covered by a specific indemnity from the seller in the agreement, with the result that the buyer may be able to recover any resulting liability or loss notwithstanding the disclosure
    • to renegotiate the price for the transaction or hold back some of the consideration until the risk of a liability of loss has expired in the future
    • to withdraw from the transaction
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