It protects the seller from being in breach of warranty for matters disclosed.
Why should a seller make full and early disclosure of potential issues
The buyer may refuse to accept late disclosure as fully limiting the seller's liability/the buyer may withdraw from the deal when significant professional costs have been incurred
Why will the buyer not accept every disclosure
It may require further information or contractual protection - if it is an important matter to the buyer, the buyer may request an indemnity/request a lower purchase price/want to withdraw
What are the two main sections of a disclosure letter?
- General matters which buyer will be deemed to be aware of (general/deemed disclosures)
- Specific disclosures
What area will general/deemed disclosures cover?
Information that is publicly available or which has been made available to the buyer during due diligece
Name 8 types of information that general disclosures may contain
1. Information on the target available from Companies Registry
2. Information on properties available from deeds/land searches
3. Matters disclosed by physical inspection - buyer should only accept if surverys of each property have been commissioned
4. Matters which are in the public domain - buyer should try to limit to what it could reasonable be aware as affecting the target
5. Matters in the audited accounts of the company (for the last 3 yrs)
6. Matters in the accountants report - this can be very wide, buyer may only accept if seller warrants accuracy of the report
7. Matters in the preliminary enquiries and replies - buyer may not wish to accept this
8. Information and documents passed to buyer in pre-contract period. If the buyer accepts this they will probably want copies of all that information and documentation to be attached to the disclosure letter.
Do disclosures related to specific warranties
- For ease of reference the disclosures will refer to specific warranties
- As there is often significant overlap, the seller will want each disclosure to be deemed in respect of all warranties
Is effective disclosure made by making known the means of knowledge which may/does enable the other party to work out certain facts and conclusions?
Levinson v Farin
If the buyer has actual knowledge of a problem but it is not disclosed in the disclosure letter. Can they rely on a clause that disclosure only relates to this letter and not actual knowledge?
What is it best to do if the buyer has actual knowledge of an issue?
- It may be able to rely on it but the seller may be able to raise actual knowledge as a defence (Eurocopy v Teesdale)
- It is preferable to the buyer to acknowledge full disclosure and seek an indemnity/reduction in the purchase price.
Will the court give effect to an express provision in a sale and purchase agreement prohibiting warranty claims for constructive knowledge?
Yes (Infiniteland v Artisan)
If the sale and purchase agreement excludes actual knowledge, will this also exclude imputed knowledge?
No. Actual and imputed knowledge deemed to be different (Infiniteland v Artisan)
Why should the seller be careful when putting together its negotiation team/allowing employees to provide information during the transaction (and to a lesser extend during due diligence)?
If information given is wrong, the seller may be held vicariously liable for fraudulent misstatement (MAN v Freightliner)
If the seller is aware of particular facts which may later lead to a warranty claim, why should he disclose them rather than just compensating the buyer later if a claim arises?
If the seller is aware of these facts, the buyer will have been induced to enter into the sale and purchase agreement by way of deliberate concealment and this would constitute fraud
If a liablity under a warranty crystalises (the seller makes a payment to the buyer under the warranty), what tax adjustments will be made?
1. The consideration which the seller is treated as having received on completion will be reduced by the amount paid out under the warranty claim, thus reducing any gain. If the seller has already paid the tax, it will be entitled to a refund.
2. The buyer's acquisition cost is reduced by the same amount; its potential gain on a subsequent disposal of the target is therefore increased because its acquisition cost has been reduced.
s49 TCGA 1992
Why is an indemnity in favour of the target, e.g. for tax liability, a problem?
What should be done instead?
- The indemnity may be regarded as a "chose in action", which has a nil acquisition cost, therefore the amount received would be liable to tax in full.
- To indemnify the target the seller would have to "gross up" the payment (i.e. the amount owed + the tax payable on it).
- Sellers are likely to be unwilling to do this
Zim Propeties v Procter
- Instead, indemnities should be expressed to be in favour of the buyer NOT the target company (sometimes expressed as 'taxation covenants')
Does the principle in Zim Properties v Procter apply to warranty payments?
No (ESC D33).
Therefore no grossing up necessary for a payment under warranty.
Does the principle in Zim Properties v Procter apply to indemnity payments to the purchaser (rather than to the target)?
No (ESC D33)
In Infiniteland v Artisan, why did the court of appeal dismiss the appeal?
There was no contractual provision in the sale and purchase agreement about the standard of disclosure. The disclosure letter included a general disclosure of documentation passed to the Buyer's accountants. it did not matter that no disclosure was made direct to the buyer, it was held that general disclosure of documents in the disclosure letter had been effective under the terms of the SPA
Most acquisition agreements state that the only matters deemed to be disclosed are those disclosed in the disclosure letter (irrespective of the buyer's knowledge).
Is such a clause legally effective?
- Possibly not (Eurocopy) but
- Probably: The terms of the agreement between the parties will be paramount (Infiniteland)
What should the buyer do in reference to general disclosures?
- Make sure they are limited to what is reasonable
- Make sure relevant checks have been carried out
- Reject anything unreasonable on this basis
- Limit where possible
- Where in reference to specific documents, insist that these documents are included in the disclosure bundle.
it is important not to accept widely drafted general disclosures
Who normally prepares the first draft of the disclosure letter?
What should they include?
- The seller's legal team
- Everything relevant - even things they know the buyer is already aware of
- Prudent approach is to include if in doubt
Should a buyer allow the seller to bring a claim against an employee of the target company for failing to make full disclosure.
The buyer should not allow claims to be made against any employees that transfer to the buyer's group with the target business or against the target or its subsidiaries.
What wording will the buyer suggest about the qualification of warranties?
Why will the seller resist this?
Is such a clause legally effective?
That they will only be qualified by matters "fully, fairly and specifically disclosed" and regardless of actual or constructive knowledge.
The seller will often reject this as the common law duty of disclosure is already high and they will not wish to meet a higher standard.
Eurocopy suggests that where the buyer has actual knowlege the buyer may not be able to rely on such a clause (this is a preliminary ruling).
Infiniteland suggests that the buyer could not rely on such a clause to counter a defence by the seller. However, obiter, contstructive/imputed knowledge would not prevent the buyer from relying on such a provision which only included actual knowledge.
Even if a claim was allowed, where the buyer had knowledge, the damages are likely to be reduced. The buyer should therefore seek specific indemnification from the seller +/reduction in sale price.
When there is a clause excluding "actual knowledge" of the buyer from the buyer's ability to bring a claim for breach of warranty, how should the buyer seek to limit it?
By limiting it to actual knowledge of certain people and excludes the knowledge of agents and advisors.
Is a disclosure of a possible loss/giving the means or knowledge to the buyer to work out the facts and conclusions for itself, sufficient disclosure to preclude a breach of warranty claim?
Levinson v Farin
E.g. saying that the business was making a loss is not the same as discloing that net assets had fallen significantly. Where what was disclosed was a "possible cause of loss, not an actual drop in net asset value" then there has not been sufficient disclosure.
Does disclosure have to be fair and in sufficient detail?
How can the seller restrict this?
Should the buyer accept this?
Probably. Edward Prentice v Scottish Power (Scotland): "there must be fiar disclosure of facts and circumstances sufficient in detail to indetify the nature and scope of the matter disclosed and to enable the buyer to form a view".
Seller can add a clause saying "where brief particulars only are set out or a document is referred to but not attached...full particulars are deemed to be disclosed and it is assumed that the buyer does not require further particulars.
Buyer should resist on the basis that it should have a cause of action unless fair disclosure has been made.
Where a list of all positive licences has been disclosed, is this fair disclosure that one license is not valid?
This is not fair disclosure according to Daniel Rees EM ESS Chemists
is it possible to make deemed disclosure on all matters "set out or referred to in the accounts"
New Hearts (Scotland) casts doubt on this. This gives strength to the arugment that disclosures and the documents to which they refer to should be clearly identifiable.
However, if there is no clause requiring "fair disclosure with sufficient details to identify the nature and scope of the matter disclosed" and/or the accompanying documents refer to the disclosure bundle and/or the disclosure letter is deemed to incorporate all matters contained in the documents, then New Hearts may not be followed (Infiniteland). Look at the agreement between the parties.
What level of disclosure should a prudent buyer try to include?
The level in New Hearts - specifying in addition to the disclosure being fair, it must also be full, accurate and clear to enable the buyer to have a complete understanding of the issue
Only the strict contents of the disclosure letter will be deemed to be disclosed unless it is clear from the contract or disclosure letter that all matters to inferred from disclosed documents are also treated as disclosed.
True or False
True (MAN v Freightliner)
Example: disclosing VAT records was insufficient to disclose fraud in them
Should a seller agree to cross-reference disclosures to the warranties to which they relate?
Yes - to help the buyer they will normally agree to do this. They should avoid an absolute obligation to cross-reference every disclosure and warranty by adding a clause stating that headings and numberings are for convenience only.
Usually buyers will accept this and, especially following infiniteland, the buyer may be unwilling to accept general disclosures and want the disclosures cross-referenced.
Name 5 dangers to the seller where the seller knows something but does not disclose/discloses inaccurately?
Share Purchase only:
1. s397(1) FSMA - criminal offence to conceal information/make misleading statements to induce another party to enter into an investment agreement. Unlimited fine/7yrs imprisonment.
2. s397(1) FSA could bring a civil action for breach of this
3. Court could order sellers to pay compensation for breach of s397(1) - Securities and Investments Board v Pantell.
4. Distorting a positive represnetation/saying nothing where warranty demands disclosure that is accurate and not misleading may be misrepresentation
5. If seller gives false representation/warranty and does so dishonestly with the intention of making a gain this may be fraud
Will the buyer seek a warranty that there is nothing in the disclosure letter which is misleading and that it is true and accurate in all respects?
Will the seller accept this?
No - the buyer will have a claim for breach of warranty in any event, they do not really need this. There is also a danger that the warranty could extend to warranting the truth and accuracy of all matters deeme dto be disclosed, including the disclosure bundle.
If unable to resist, try to add "so far as the seller is aware"