Selling a business – Disclosure

Barry Riley

Selling a business – Disclosure

When selling a business (either by share or asset sale), one of the main areas that needs to be looked at very carefully is disclosure, and we often get asked by clients just exactly what that process entails. It may be a concept that people have heard thrown around in conversation a lot, but a lot of people often don’t know what the reason for this element of the disposal process is for, why it is of such great importance, or even what it is all about.

The main sale and purchase agreement will often contain lengthy and comprehensive warranties, which are contractual statements which take the form of assurances from the seller as to the condition of the target company or business and, in particular, any existing liabilities. They are usually contained in a separate schedule to the agreement.

Generally, the warranties contained within the agreement will provide the buyer with a remedy (a claim for breach of warranty) in the event that any of the statements made about the company by the seller later prove to be incorrect. It also encourages the seller to disclose known problems to the buyer prior to completion. The main purpose of the disclosure letter is to enable the seller to effectively “water-down” (to some extent) the warranties that the buyer demands, and inform the buyer of any known problems or any instances where the warranties prepared and contained with the agreement are not true to the fullest extent. This is therefore a very important part of the disposal process.

The disclosure letter is a key document in any private acquisition. If a seller makes inadequate disclosures, it may find itself on the receiving end of breach of warranty claims which it could have avoided. If a buyer fails to review a disclosure letter properly, it may be in for some unpleasant surprises. Despite this, parties often dedicate far more time to the negotiation of warranties than they do to the consideration of the disclosure letter.

It is imperative that warranties and disclosures are considered together. If a warranted fact turns out to be untrue, the buyer has a claim for breach of contract regardless of whether he relied on the warranty in question. However, no claim will lie if the facts which give rise to the breach were disclosed by the seller in the disclosure letter. This is the main reason why the seller and their solicitors should be reviewing each warranty at length, and ensuring that there is nothing in the document that is at all problematic or untrue (to any extent). If there is, it must be disclosed.

Litigation is time consuming, distracts management from the day-to-day running of the business, is expensive, and can ultimately be avoided by the simple inclusion of any required statements in the disclosure letter. Sellers and their solicitors will negotiate a provision in the contract to the effect that a seller will not be liable for breach of warranties to the extent that it has disclosed to the buyer the nature of the claim (or circumstances giving rise to the claim).

So why is so much time spent negotiating the warranties and the disclosures? The main reason for this is that the purpose of warranties is not just to act as a post-completion price adjustment mechanism to the extent that unknown liabilities arise and the buyer suffers loss. The other (and arguably more important) purpose is to seek disclosure and warranties to provide a mechanism to extract this information before the sale is concluded, enabling the buyer to obtain an up-front price adjustment, an indemnity, or to walk away if a particularly unpalatable disclosure is made.

It is for these reasons above that the disclosure letter is such a key document in a private acquisition/disposal. In addition, with the increasing use of auctions, buyers are finding themselves with ever more limited time to conduct full due diligence. In these circumstances, the disclosure letter may provide the best source of information on the target business for the buyer and its advisers.

The disclosure letter usually takes the form of a letter from the seller to the buyer, and is usually divided into two parts: “general disclosures” and “specific disclosures”, and will have attached to it copies of the documentation being disclosed (known as the disclosure bundle).

For further assistance or guidance in respect of anything contained in the above blog post, please feel to contact Barry Riley on 0117 9453 042 or briley@metcalfes.co.uk

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