Disclosure with paper rock docs

What is a Disclosure Letter?

Company sale and purchase transactions usually involve the seller giving warranties to the buyer relating to the company and its business, financial performance and prospects, assets, contracts, rights and liabilities. 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, often matters which come to light during the buyer’s due diligence process. The disclosure of these matters is intended to protect the seller against a potential warranty claims for breach of the particular warranties.  Instead of amending or qualifying the warranties themselves, the disclosures against specific warranties are set out in a separate letter prepared by the seller (or the seller’s solicitors), known as a “Disclosure Letter”.  Usually, the letter is divided into general disclosures and specific disclosures.

As an example in a share sale transaction, the SPA may include a warranty that the target company has complied with all legal requirements in its business conduct. If the seller is aware of a failure by the company to comply with a specific legal requirement, it would disclose this as an exception to the warranty.  This is done by setting out a narrative of the circumstances of the breach, along with supporting documents, in the Disclosure Letter.  If the disclosure satisfies the defined requirement of “fair disclosure” in the SPA between the buyer and seller, it should protect the seller from a claim by the buyer under the SPA for breach of warranty regarding the disclosed non-compliance.

The warranties may explicitly require that certain facts or documents be included in the Disclosure Letter.  For instance, a warranty might require that the Disclosure Letter contains details and copies of all material contracts entered into by the target company.  Failure to disclose a material contract may result in a claim against the seller for breach of warranty if the omission causes loss to the buyer.

Upon receiving disclosures during transaction negotiations and discussions on the draft Disclosure Letter, the buyer has several options:

• to accept the disclosure, with the result that the buyer has no legal recourse if the disclosed matter leads to an actual liability or loss
• to request specific indemnity cover from the seller in the SPA to cover the disclosed matter, under which the buyer may be able to recover any resulting liability or loss notwithstanding the disclosure
• to renegotiate the transaction terms, such as adjusting the purchase price or holding back some of the consideration until the risk of a liability or loss has expired in the future
• to withdraw from the transaction entirely