Disclosure in M&A transactions: getting the process right
In any share sale, the agreed purchase price is only part of the deal. The parties must also decide who bears the risk if the target’s business is not quite as the buyer expected. Warranties, disclosure and, increasingly, warranty and indemnity insurance, are central to that allocation of risk.
For sellers, early and carefully managed disclosure can reduce the risk of post-completion warranty claims. For buyers, robust disclosure analysis helps ensure that any material issues are understood, priced and addressed before the transaction completes. The disclosure process is therefore far more than a legal formality and one that needs to be managed carefully from the outset.
Warranties and the purpose of disclosure
A share purchase agreement (SPA) will usually contain a detailed suite of warranties: statements of fact that are given by the sellers regarding the target company and its affairs. These may include warranties relating to its accounts, key contracts, employees, disputes, regulatory compliance, and assets. If a warranty statement is untrue, the buyer may have a claim for breach of warranty, subject to the contractual terms governing liability and loss set out in the SPA.
Disclosure gives the seller an opportunity to flag known exceptions to the warranty statements: for example, a threatened dispute, a material customer issue, a non-standard contractual commitment or an unresolved compliance matter. If that matter is properly disclosed in accordance with the SPA, it will generally qualify the relevant warranty and prevent a buyer bringing a warranty claim in respect of the issue.
The disclosure letter structure: general and specific disclosures
The disclosure exercise is generally documented through a disclosure letter and supported by information provided in a transaction data room. The disclosure letter will be split into two parts: the general disclosures, which seek to disclose defined categories of information such as documents in a transaction data room or information held in public registers, and specific disclosures, which address identified matters against particular warranties.
The scope and effect of general disclosures are often the subject of negotiation – from the seller’s perspective, broad general disclosures can provide useful protection, but a buyer will often seek to limit this approach. The SPA and disclosure letter therefore need to be clear about precisely what materials are covered and whether they are intended to qualify all or only particular warranties.
Fair disclosure: clarity matters
A disclosure will only protect a seller if it meets the disclosure standard agreed in the SPA. A common formulation requires a matter to be fairly disclosed with sufficient detail to enable a reasonable buyer to make an informed assessment of its nature and scope. That standard is highly fact-specific, but the recent High Court decision in Veranova Bidco LP v Johnson Matthey plc underlines the importance of the contractual disclosure mechanics. The Court considered whether the seller had adequately disclosed negotiations affecting a key customer contract and confirmed that statements outside the disclosure letter could not be used to supplement the contractual disclosure process where the SPA defined how disclosure was to be made.
Warranty and indemnity insurance: a further consideration
Warranty and indemnity insurance (W&I) is now a well-established feature of UK M&A transactions. In a typical buy-side policy, the insurer provides the buyer with a route of recovery for financial loss arising from an insured breach of the seller’s SPA warranties and, in some cases, specified indemnities. This can enable a buyer to obtain meaningful protection while allowing sellers to achieve a cleaner exit, with their direct liability for insured general business warranties often reduced to a nominal cap. The precise liability position will, however, depend on the SPA, the policy wording, any retention, exclusions and the commercial terms agreed between the parties.
W&I does not reduce the importance of disclosure; if anything, it makes a disciplined process more important. Insurance is principally intended to address unknown risks. Matters which are known to the buyer, disclosed in the disclosure letter, identified through due diligence or otherwise excluded by the insurer are unlikely to be covered under the policy. A material identified risk may instead need to be addressed through a specific indemnity, a purchase-price adjustment, or other bespoke SPA protection. The buyer’s diligence, the seller’s disclosures and the insurer’s underwriting process must therefore be carefully aligned from an early stage, so that the parties understand which risks are insured and which remain with the seller.
The key practical takeaway
The practical message is straightforward: a disclosure should be clear, specific and sufficiently informative in its own right. A seller should not assume that the buyer can be expected to join the dots between separate documents, informal discussions and data-room materials. A well-run process will begin early, run alongside the negotiation of the warranties and allow sufficient time for follow-up questions, further diligence and, where appropriate, a commercial solution in the SPA.
How we can help
Our Corporate M&A team regularly advises on complex domestic and cross-border transactions and has substantial experience acting for both buyers and sellers throughout the disclosure process. This will include:
- Drafting and negotiating warranty packages
- Coordinating and managing the seller’s disclosure exercise
- Preparing and reviewing disclosure letters
- Advising on the interaction between disclosure, indemnities and contractual liability limitations
- Supporting transactions involving W&I insurance, including ensuring that the SPA, disclosure process and underwriting workstreams are appropriately aligned.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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