Disclosure against Warranties in UK Corporate Transactions
It is common in UK company mergers and acquisitions ("M&A") for warranties to be given by the sellers. Disclosure of information is one way in which sellers seek to protect themselves against claims. However, if not done properly the disclosure will not be effective and may provide false comfort.
Introduction
A warranty is a contractual assurance or promise, which provides the buyer with a potential claim for breach of warranty (a contractual claim for damages) if the statement proves to be untrue. A typical M&A purchase agreement will include an extensive schedule of warranties relating to the target company or business.
It is also common in M&A transactions, where warranties are given by the seller or sellers to the buyer, for the sellers to protect themselves from breach of warranty claims by making disclosures of information and documents to the buyer. This is typically done through a disclosure letter, which sets out matters which are inconsistent with the warranties in two ways:
- General disclosures, which apply to all warranties, and which include matters which the buyer should probably be aware of, such as information on the public record; and
- Specific disclosures, of information which is inconsistent with specific warranties being given, such as details of any litigation where the warranty statement is that the company is not party to any litigation.
For the purposes of the buyer’s due diligence, the sellers typically put documents relating to the target company or business into a virtual data room. The parties normally agree (through a provision in the disclosure letter) that the documents in the data room, or a smaller group of those documents which the sellers want to disclose (a disclosure bundle), are also disclosed to the buyer.
The buyer will want to ensure that the disclosures given to it, both in the disclosure letter and through the disclosure of the data room contents or disclosure bundle, are disclosed in such a way that the disclosures are clearly understandable, so that it can assess the risks associated with those disclosures. In the purchase agreement, the buyer will typically require that the disclosures are made to a certain standard, to be effective disclosure (which protects the sellers). The typical standard of disclosure agreed by the parties is ‘fair’ disclosure and a typical clause in the purchase agreement would look like this:
"The Warranties are given subject to matters fairly disclosed in this Agreement or in the Disclosure Letter with sufficient detail to identify the nature and scope of the matters disclosed[1]"
What is ‘fair’ disclosure?
The concept of ‘fair’ disclosure has been considered by the courts in a number of cases, and it is helpful to consider their analysis.
| Case Summary Levison and others v Farin and others [1978] The seller warranted that there was no material adverse change in the net assets of the target company from the levels shown in the accounts. The target's accounts showed net assets of £44,000. At completion the net assets had reduced by £8,600. The seller had disclosed that the target was making losses due to the seller's illness. The High Court held that there was no adequate disclosure to qualify the warranty – all that was disclosed was a possible cause of loss, not an actual drop in net asset value. |
| Case Summary Daniel Reeds Ltd v EM ESS Chemists Ltd [1995] The target distributed paracetamol tablets. The sellers warranted that the target had all licences necessary to carry on its business. In fact, it did not have a key manufacturer's licence (which had expired). The sellers by way of disclosure had listed all the licences the target did have (the list not including the manufacturer's licence) and sought to argue that the seller should have reviewed the list and determined that the relevant licence was missing. The Court of Appeal rejected this and held that "fair disclosure requires some positive statement of the true position and not just a fortuitous omission from which the buyer may be expected to infer matters of significance". |
| Case Summary New Hearts v Cosmopolitan Investments [1997] In this Scottish case, the seller attempted to use a general disclosure of the target company’s accounts to defend against a claim for breach of a warranty relating to the net assets of the target company. The judge said that: “Mere reference to a source of information, which is itself a complex document, within which the diligent enquirer might find relevant information, will not satisfy the requirements of a clause providing for fair disclosure with sufficient details to identify the nature and scope of the matter disclosed”. The court held that the seller should have specifically disclosed the information in the accounts which impacted upon the net asset warranty. |
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Case Summary
The court rejected this argument. It held that the fraud would not have been apparent to someone who did not know what to look for. |
| Case Summary Infiniteland v Artisan Contracting [2005] The English Court of Appeal considered the effectiveness of a general disclosure of correspondence between the seller and the buyer’s accountants, which revealed a financial issue which later formed the basis of a warranty claim by the buyer. The court held this to be effective disclosure and emphasized the importance of the wording agreed by the parties: “the adequacy of the disclosure in the present case must be measured against the requirements of the share sale agreement into which these parties have entered”[2] |
Conclusions
- The primary consideration is likely to be the wording agreed by the parties:
- The buyer should clearly set-out what is meant by ‘fair’ disclosure (e.g. “…sufficient detail to identify the nature and scope of the matters disclosed”, or similar language).
- The seller could try to disclose matters to be ‘derived’ or ‘inferred’ from documents it has disclosed, but this is unlikely to be acceptable to the buyer and it may not be ‘fair’ disclosure.
- If the buyer accepts the general disclosure of the entire data room of documents or the entire disclosure bundle, that disclosure will be effective, but it will remain subject to the requirement of ‘fair’ disclosure.
- If there is an important issue to be disclosed, the seller should disclose this clearly and specifically to the buyer, giving sufficient detail for the buyer to understand the significance of the matter disclosed and referencing the sections of the documents in the data room or disclosure bundle relevant to that disclosure.
- Important information in complex documents, such as in full accounts or pensions documents, should be specifically disclosed to the buyer.
- Information should not be deliberately hidden in the data room, for example, under an incorrect heading or in a bundle of documents of minimal importance.
- Deliberate non-disclosure could amount to fraud and might affect the limitations on the liability of the seller in the purchase agreement, such as maximum claims limits and time limits, which are often expressly disapplied where there is fraudulent behaviour.
- As a separate consideration, if the buyer is actually aware of a breach of warranty when entering into the purchase agreement, then it may not be able to make a claim[3].
[1] In common with many clauses of this type, this wording is derived from the case of Edwards Prentice v Scottish Power [1996] in which the judge said: "There must be fair disclosure of facts and circumstances sufficient in detail to identify the nature and scope of the matter disclosed and to enable the buyer to form a view"
[2] This general approach to contract interpretation is consistent with the judgment of the English Supreme Court in Arnold v Britton & ors [2015]
[3] Infiniteland v Artisan Contracting
