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

Yes, it’s very important.
A disclosure letter helps protect the seller from legal claims after completion of the sale. It sets out matters which the seller discloses as exclusions to the warranties given in the sale and purchase agreement.  This means the buyer cannot later bring a warranty claim for issues which have been disclosed in the disclosure letter.

• the disclosure letter works alongside the warranties in the share or business purchase agreement.
  
• warranties are statements of fact made by the seller about the target company or business, such as its compliance with laws or its ownership of assets.
  
• if any of these statements are not true, and this leads to a loss for the buyer, the buyer may have a legal claim against the seller for breach of warranty.
  
• however, if the seller has made a valid disclosure in the disclosure letter that contradicts a warranty, the buyer cannot later claim they didn’t know about it and the agreement will usually provide that the buyer cannot claim for matters validly disclosed.
  
• this protects the seller from liability and helps the buyer make informed decisions about the terms of the purchase.
  

Overall, the disclosure letter plays a key role in sharing information and managing legal risk between buyer and seller.

It is usually prepared towards the latter stages of the transaction.
The disclosure letter is drafted after the buyer has completed its due diligence and on the basis of the warranties in the share or business purchase agreement.  Once the scope and extent of the warranties are known, the seller can then prepare the disclosure letter.

• the seller and its lawyers will always prepare the first draft after reviewing the warranties in the agreement.
• the letter is usually split between:
  • general disclosures of information the buyer is either already aware of or could reasonably be expected to know: these qualify the warranties generally
  • specific disclosures: these are made against specific numbered warranties in the sale and purchase agreement
    
• the letter is reviewed and negotiated by the buyer’s legal team.  The buyer will want to ensure that any general disclosures are acceptable in their nature and scope and that the specific disclosures either confirm what the buyer already knows from its due diligence or flag clear issues so the buyer can assess their impact.
  
• any agreed disclosures must meet the requirement for “fair disclosure” under the sale and purchase agreement.
  
• the process of reviewing and agreeing the letter may lead to further negotiations on indemnities or adjustments to the sale price.  These could include a purchase price reduction or holdback until the identified issues have been resolved following completion of the purchase.
  
• once agreed, the disclosure letter is signed and exchanged alongside the main agreement.

The seller is responsible for providing the disclosure letter.
The disclosure letter is prepared by the seller, usually with help from their solicitors. It is a key tool for managing the seller’s risk under the sale transaction.

• the seller provides disclosures to limit potential warranty claims.
  
• these disclosures may come from issues identified during due diligence or from the seller’s own knowledge of the business.
  
• the letter typically includes both general disclosures (information the buyer is either already aware of or could reasonably be expected to know) and specific disclosures (detailed facts and circumstances).
  
• it is sent as a draft to the buyer’s lawyers.
• the buyer’s lawyers will carefully review the draft and may raise questions, amend the drafting of the disclosures made or seek further protections.
  

The responsibility sits firmly with the seller to ensure the disclosures are fair and accurate.

It directly qualifies the warranties.
The disclosure letter sets out general disclosures of matters which the buyer is deemed to be aware of and specific matters that the seller wishes to disclose as exceptions to the warranties given in the sale and purchase agreement.

• warranties are statements about the target business or company.
  
• the disclosure letter provides details of facts or issues which would otherwise breach these warranties.
  
  • For example, if the seller is aware of a legal dispute involving the company, this would be disclosed against the warranty that there is no ongoing litigation.
    
• proper and fair disclosure helps avoid future claims and disputes.
  
• it enables the buyer to evaluate what risks it is accepting in proceeding with the acquisition.
  
• in some cases, disclosures lead to additional protections like indemnities or price adjustments.
  

The disclosure letter and warranties work together to balance risk between the parties and help ensure that known issues are identified and covered off during the transaction process.

The purpose is the same, but the focus differs.
Both types of disclosure letter protect the seller by disclosing information that qualifies the warranties. However, the nature of the disclosures will reflect the type of sale.

• Business sale: the buyer acquires specific assets, liabilities and contracts. Disclosures focus on these practical matters.
  
• Share sale: the buyer acquires the shares and, indirectly, all assets, liabilities and risks of the company. Disclosures must therefore cover the company as a whole and potential contingent liabilities.
  
• Share purchase disclosure letters tend to be more detailed and wide-ranging.
  
• They may include disclosures about the company’s accounts, disputes, employees, contracts, compliance and more.
  
• Business purchase disclosures are usually narrower, focusing only on the parts of the business being sold.
  

In both cases, the purpose is to ensure the buyer is aware of key issues and to protect the seller from future claims.