In M&A transactions, the dance between a buyer and seller is much like a tango—carefully choreographed yet full of potential twists and turns.
When a seller is on the verge of finalising an M&A purchase agreement, it must consider how to step through changes to its business that occur before the deal closes. Those changes may affect disclosures made to the buyer during due diligence and contract negotiations. Sellers want flexibility in updating these disclosures after the agreement is signed as new situations unfold before the closing date – events that may increase the risk of warranty and indemnity claims.
In this dance around risk, buyers counter by imposing constraints, controls, or additional rights regarding these updates. These include options for terminating the agreement, indemnification rights, or other conditions, depending on the nature, significance, and timing of the newly disclosed information.
Here, we’ll examine approaches to updating disclosures most frequently used during M&A purchase agreements.
Why do disclosures need to be updated?
Sometimes, signing and completing the purchase agreement is not simultaneous because the parties need to deal with pre-completion conditions (such as obtaining regulatory approval or consents under contracts). The intervening period can vary, ranging from just a few days to several months, depending on the pre-conditions needed before the deal can close.
While disclosure schedules typically reflect details known as at the signing date, buyers usually want to see up-to-date disclosures as of the actual closing date. This could be either as a pre-condition for the transaction’s completion or for thorough due diligence. Consequently, both buyers and sellers must reach a consensus on whether and how the seller should have the latitude—or obligation—to revise these disclosure schedules or to inform the buyer about relevant changes that take place before completion. They must also set “ground rules” governing updates or notifications.
During the gap between contract signing and the deal closing, the seller will continue business activities, such as entering into new contracts, hiring or terminating employees, handling emerging liabilities or claims, etc. As a result, the disclosure schedules provided when the purchase agreement is signed may only partially capture new facts or developments that arise before the deal closes. This could pose issues, especially when a seller’s warranties and representations are given as of both the signing date and the closing date, unless a mechanism for updating facts is in place.
Affirmative and Negative Disclosures
Generally, disclosure schedules in a purchase agreement are “Affirmative” or “Negative.”
“Affirmative” Disclosures refer to the seller’s obligation to proactively disclose specific information, as mandated by the corresponding representations and warranties in the purchase agreement. Generally, the purchase agreement will contain clauses requiring the seller’s disclosure schedules to enumerate particular elements like key contracts, personnel and their associated benefits plans, ongoing legal disputes, etc.
“Negative” Disclosures serve as counterpoints or limitations to the seller’s representations and warranties. In other words, these disclosures act as exceptions or qualifiers to the seller’s statements. For instance, a purchase agreement might contain a seller’s representation stating that the target business complies with all relevant laws. However, this would be subject to exceptions detailed in the disclosure schedules.
What to know before updating disclosure schedules
Three interconnected factors in the purchase agreement influence a seller’s ability to modify the disclosure schedules.
- Closing Conditions: In many purchase agreements, one of the buyer’s closing conditions is that the seller’s representations and warranties must remain true and correct until the transaction closes. The buyer’s ability to rely on this condition to call off the deal will reduce if the seller has the latitude to unilaterally revise the disclosure schedules, thereby effectively changing its original representations and warranties.
- Termination Rights: Should a seller be able to modify the disclosure schedules, the question arises as to whether the buyer should, at a minimum, have the option to walk away from the deal and terminate the purchase agreement.
- Liability Implications: The third consideration revolves around whether updates to the disclosure schedules should relieve the seller from any liability under those warranties disclosed against. In other words, can a seller “cure” a pre-existing breach of a warranty by simply amending the disclosure schedules, thereby altering the original terms?
Final Considerations
The type of seller disclosure matters. For example, a buyer is more likely to accept an updated schedule that includes a significant new contract that the seller has entered into before closing than a schedule that is updated to reflect the loss of a key contract.
Additionally, tied to termination rights and the seller’s potential liability, the timing of the facts disclosed matters. Sellers often have latitude for modifying disclosure schedules to include new developments that occur after signing than incorporating information or events that existed at or before the signing but went undisclosed due to oversight, ignorance, or other factors.
Lastly, the importance of a new disclosure, in the context of the deal, also influences the consequences flowing from that disclosure. It stands to reason that a buyer should have additional rights (such as termination rights) when a significant matter — legal, financial or operational—is newly disclosed.
Takeaways
Disclosures are a pivotal part of transaction risk management and the risk allocation dance between buyers and sellers.
For sellers, updating disclosures offers a mechanism to adapt to new circumstances between an agreement’s signing and closing – reducing liability and clearing the path to completing the deal.
For buyers, the practice increases risks and introduces questions around managing the financial impact of disclosures, making the negotiation around updating disclosure schedules a critical aspect of the transaction.