M&A Vocabulary – Understanding Experts: “Fair Disclosure”

What is a disclosure?

To understand disclosures, one must first understand the meaning of warranties in contracts.

Warranties are contractual statements of fact or assurances made by the seller(s) in the purchase agreement regarding various facts concerning the target company or the asset to be acquired. If warranties prove to be untrue, the buyer can hold the seller liable for breach of contract. The sellers, in turn, can protect themselves by qualifying these warranties—by disclosing information that contradicts the relevant warranty and which, if not disclosed, would result in a breach of warranty.

Further information on “disclosures,” how they work, and why they are important in the M&A process has been presented by our colleague Tobias Kohler in an article that you can read at the following link: M&A Vocabulary – Disclosures.

Disclosures in the context of English M&A can be general in nature or relate to specific facts and are made in a disclosure letter accompanying the purchase agreement.

General disclosures mainly contain circumstances that are accessible in public records or of which the buyer should have knowledge based on pre-contractual investigations of the target (e.g., due diligence). Specific disclosures, in turn, disclose specific information and refer to individual warranties.

What are “fair disclosures”?

In the purchase agreement, the term “disclosure” is defined, and words such as “full,” “fair,” “accurate,” or “complete” are often used to establish the standard of disclosure in the overall context of the transaction. The definition (and the resulting disclosure standard) is negotiated between the parties and depends on the circumstances of the transaction in question, as well as on all information that the parties consider so material that it must be disclosed.

An example of the definition of a disclosure may therefore be circumstances that are “fairly, fully, and accurately disclosed in the disclosure letter (with sufficient detail to identify the nature and scope of the disclosed circumstance).”

Fundamentally, a disclosure is “fair” if it sets out facts not only in terms of content but also in the appropriate place, i.e., in relation to a relevant warranty, in such a way that the buyer can understand them. However, the definition of what constitutes a “fair disclosure” is contentious and has been discussed by English courts on many occasions. We address a few of these cases below.

In the case of Daniel Reeds Ltd v EM ESS Chemicals, the seller warranted that the target company held all necessary licenses to conduct its business, although one of the manufacturer’s essential licenses was about to expire shortly after completion. The seller had listed all of the target company’s licenses in the disclosures except for the license in question. The seller argued that the buyer should have reviewed the list of licenses and concluded from it that the relevant license was missing. The courts rejected this and held that “a fair disclosure requires the active mention of the correct position” and that the omission of material information (in this case, the absence of an essential product license) renders the disclosure void, making the buyer’s claim for breach of warranty successful.

In the case of New Hearts v Cosmopolitan Investments, the court emphasized the need to actively and expressly draw the buyer’s attention to each circumstance being disclosed, as simply referring to a source of information that is complex but in which a diligent reviewer could find the relevant information is not sufficient to meet the requirements of fair disclosure.

Infiniteland Ltd and John Stewart Aviss v Artisan Contracting Ltd is a landmark case on this topic that brings more clarity to what the courts understand by “fair disclosure,” particularly regarding (a) the disclosure standard, which varies depending on the language used in the relevant clause of the purchase agreement, and (b) the reader of the disclosures and whether experts are involved as advisors or not.

The warranty claim in this case related to whether the accounting records provided “a true and fair view of the profit and loss of the company in question.”

The court held that in drafting the disclosure letter, account had been taken of the fact that the documents and other written materials had been made available to the buyer’s accountants so that they could conduct due diligence in advance of the proposed purchase. The buyer could have rejected the general disclosure and insisted on the disclosure of specific facts with regard to the individual warranties. However, he chose not to do so and was content to rely on his accountants to identify the circumstances of which the buyer should necessarily have become aware from the materials provided. In this case, it was determined that the buyer’s accountants knew that the disclosed accounting records were misleading.

Consequently, the seller relied on this knowledge in response to the warranty claim, as the “actual knowledge” of the accountants was attributable to the buyer under the terms of the purchase agreement. Therefore, the court held that the disclosure requirement (“true and fair”) had been met with respect to such circumstances that could reasonably be expected to be noted by the accountants preparing the report during the due diligence of the materials provided.

“Fair” disclosures in different jurisdictions

Given the complexity of disclosures and the often-lacking specificity of what constitutes a “fair” disclosure, it is essential to consult experts when drafting purchase agreements and disclosure letters (who establish the standard of disclosures and ensure their skillful formulation). In cross-border acquisitions, it is particularly important to assess the meaning of “fair” disclosures under the applicable law and to fully comply with the disclosure procedure.

From the newsletter
“Corporate Law, Deals & Capital Markets” To our
M&A Vocabularies