A sale and purchase agreement that governs the sale of shares in a company will commonly include a detailed list of warranties (supported by an indemnity) made by a seller to the buyer. These warranties are statements of fact regarding (among other things) the shares being sold, the business conducted by the company (and any subsidiaries), and the accuracy and completeness of the information provided by the sellers. If a warranty is breached in the sale agreement (that is, is not true or correct as at the relevant time), the buyer will be able to claim for breach of such warranty.
As such, a seller will typically look to include a provision in the sale agreement that the warranties are qualified by information that has been disclosed to the buyer. Generally, this means that the buyer will not be able to claim for breach of a warranty if a seller has previously disclosed information against that warranty. However, it is important to set out in the sale agreement the parameters of such disclosure and this is often a negotiated point. The key parameters which are often the subject of negotiation include:
- the materials or channels of disclosure (i.e. data room, disclosure letter, or all other information provided by the seller);
- what constitutes disclosure (i.e. the level of detail, accuracy and specificity which constitutes actual disclosure); and
- the time frame within which disclosures can be made.
Disclosure materials and channels
Parties must agree on how documents and disclosures are made, that is what channels of disclosure will constitute disclosure for the purposes of qualifying the warranties in a sale agreement. It is in the buyer’s interests to limit the acceptable modes or channels of disclosure, whereas a seller will want this to be as broad as possible and include any information provided by any means (e.g. via email or verbally) to the buyer. As a buyer, this should be heavily resisted.
Ideally for the buyer, all disclosures will be housed in one place, whether that be an electronic data room, a disclosure letter addressed to the buyer from the sellers, or, as is common in Australia, a combination of both. Where disclosures are made in a disclosure letter, a seller will often want these disclosures to apply generally to all the warranties, however, a buyer may push for a seller to identify specific warranties which each disclosure is said to qualify.
What constitutes disclosure?
A seller and buyer will also have to agree on the level of disclosure required by the seller for a matter to be considered ‘disclosed’ for the purposes of the disclosure qualification. The level of disclosure can range from ‘as disclosed’ to ‘fully, fairly and accurately disclosed’ and the parties will likely land at a formulation somewhere in between. For example, a common disclosure shield would capture disclosures made by a seller ‘fully and fairly’, and ‘with sufficient detail such that a reasonable buyer, experienced in transactions of this nature, would understand the nature and substance of the matter disclosed‘.
Time frame for disclosures
From the buyer’s perspective, all disclosures by a seller should be made before signing the sale agreement, and with sufficient time to allow the buyer sufficient opportunity to assess any risks identified in the disclosures, and make any adjustments to price, the warranty regime, or include any specific indemnities.
In very limited circumstances (such as where the period between signing the sale agreement and ‘completion’ is expected to be lengthy or protracted), the buyer may be willing to accept further disclosures (in a ‘disclosure letter’) immediately prior to ‘completion’. In this case, the buyer should ensure that the sale agreement has mechanisms to protect the buyer against a material loss arising in connection with a late disclosure. One such protection might be a right to terminate the sale agreement if the actual or expected loss is above a certain threshold.
Summary
For parties to avoid surprising or unintended outcomes, it is important that the sale agreement clearly prescribes the standard of disclosure which has been agreed. The disclosure regime is a key negotiation point in a sale agreement given the risks for both buyers and sellers.
For more information, please contact Gordon McCann, Debbie Tran and Stephen Vrettos.
