The Power of Disclosure: How Disclosure Letters Shape Liability in M&A Transactions
Representation and warranties (“Representations”) constitute a large part of the share purchase agreements. Representations are given under several categories such as the material agreements of the company, employment, regulatory, loans and debts and litigation. Prior to the signing of the agreement each and every representation and warranty must be reviewed and confirmed one by one. Otherwise, a false or missing representation may trigger the sellers’ liability.
Representations are usually general declarations such as “There is no lawsuit brought against the company” or “The company has all the legally required licenses”. It is also usual that such general Representations will have certain exceptions.
The document which discloses such exceptions to the Representations, and which protects the sellers is called a disclosure letter. For example, the relevant company has all the legally required licenses except for one which is missing. In such case the sellers will disclose that missing licence in the disclosure letter and the fact that the company is missing one licence will no longer be a violation of the relevant Representation.
In order for a disclosure letter to be efficient, the disclosures must be made specifically and detailed. Disclosure letter, which is in the form of a letter, addressed by the sellers to the buyer, is prepared by the sellers’ lawyers during the interim period between the signing of the share purchase agreement and the closing. Scope and consequences of a disclosure letter is governed by the share purchase agreement, and it must usually be submitted to the buyer one week before the contemplated closing date.
Once the first draft of the disclosure is prepared, it is shared with the buyer’s lawyers. Although the buyer has already conducted a due diligence on the company, it is very common that the disclosure letter will contain certain information which has not been disclosed before. If the buyer’s lawyer is not satisfied by the level of the details in the disclosure letter, they may request more information. Disclosure letter must be signed by both parties at the closing.
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