M&A Vocabulary – Explained by the experts: Disclosures

In this ongoing series, a number of different M&A experts from the global offices of Rödl & Partner each present an important term from the English specialist language of the mergers and acquisitions world, combined with some comments on how it is used. We are not attempting to provide expert legal precision, review linguistic nuances or present an exhaustive definition, but rather to give a basic understanding or refresher of a term and some useful tips from our consultancy practice.

In practice, we continually see the importance of the disclosure arrangements in company acquisition contracts being significantly underestimated by actors with a continental European legal background, and thus being neglected when structuring and negotiating the contract. In particular for transactions with parties and consultants from countries with a Common Law system on the side of the vendor, this regularly has negative consequences for the buyer. Under the legal tradition in such countries, obligations and rights of disclosure are of substantially greater significance, and are deliberately deployed as tactical measures to reduce the risk of liability.

Disclosure is generally understood to mean the deliberate sharing of certain facts on the part of the vendor to the buyer, or the revealed facts themselves. Obligations and rights of disclosure can arise either from the law or general legal principles, as well as being based on the related contractual agreements. In principle, the buyer cannot assert any claims for liability against the vendor for any facts that the vendor has disclosed to the buyer, as these are known (and accepted) by the buyer from the time of disclosure onwards.

Depending on the legal situation and on any detailed agreements in the purchase contract, it is therefore in the vendor’s interest to actively disclose facts that are disadvantageous to him at a specific point in time – and thereby set up a disclaimer of liability and/or fulfil his obligation of disclosure – or to try to conceal such facts.

For the buyer, a disclosure often provides the last opportunity to walk away from the transaction or to amend the terms and conditions of the transaction, which is why – depending on the agreements reached – the buyer may also have an interest in receiving the relevant information.

There is a very wide range of arrangements available, from extremely buyer friendly to extremely vendor friendly, and the fundamentally accepted standards can vary enormously from one sector and country to another.

So, on the one hand, agreements exist under which the entire contents of the data room are defined as a disclosure, while on the other contractual clauses are used that stipulate that the data room contents may not give rise to any limiting effect on liability.

Disclosures can, for example, be presented as appendices to the purchase contract (disclosure schedules) or as a separate document (disclosure letters) that must be received by the buyer by a specific date.

The following questions are typically part of the subject matter of contract structure and negotiation:

• In what form must a disclosure be provided?
• Until what date should this option be available (at the latest)?
• What specific legal consequences arise from general disclosures and specific disclosures (e.g. exceptions to guarantees)?
• How specific and detailed does the information provided need to be (fair disclosure)?

From the buyer’s perspective, special care needs to be taken to avoid the vendor having the option (or to only permit this option within very strictly defined limits), of making disclosures, perhaps through a disclosure letter involving a disclosure bundle (meaning a number of attached documents) only after signing the contract.

Otherwise, there is a risk of a “flood” of documents, shortly before the closing date which could lead to an exclusion of liability, at a point when there is no longer either the time or the capacity available to properly review the documents, and when the buyer (depending on the agreed withdrawal rights and conditions of completion), often no longer has any real opportunity to withdraw from the contract or to influence the terms and conditions of the purchase.

This is why, given the great significance and long-lasting impact under the liability system of company acquisitions, disclosure arrangements require careful drafting by an experienced party, and in cross-border transactions, also require a thorough review and consideration of the legislation in all applicable jurisdictions.