We will track here amendments to this resource that reflect changes in law and practice.
The disclosure schedules are an important part of any acquisition. Disclosure schedules are a collection of lists attached to the acquisition agreement. These lists include exceptions to the representations and warranties (www.practicallaw.com/8-382-3760) and other information too lengthy to include in the acquisition agreement. If a seller makes inadequate disclosures, it may find itself in a position where the buyer does not have to close the transaction or on the receiving end of indemnification (www.practicallaw.com/2-382-3536) claims (in the case of a private acquisition) it could have avoided. If a buyer fails to adequately review the disclosure schedules, it may be stuck with liabilities it did not account for. A junior associate is often in charge of coordinating the review and drafting of disclosure schedules. It can be a difficult task, but drafting or reviewing the disclosure schedules is often the first time a junior associate gets significant client contact.
This Note provides an introduction to disclosure schedules. It explains why they are important and highlights the key drafting and reviewing considerations.
Disclosure schedules have two main functions:
To provide information to the buyer about the target business.
To provide exceptions to the representations and warranties.
In connection with any M&A transaction, the buyer conducts a substantial amount of due diligence and the seller discloses a substantial amount of information to the buyer. The disclosure schedules serve as a means of ordering this information in a way that is acceptable to both parties. For example, if a buyer wants to review a certain type of the seller's contracts, the buyer may require the seller to make a representation and warranty that all of those contracts are listed on the disclosure schedules. Likewise, the seller may disclose a litigation to the buyer and allow the buyer to conduct due diligence on the matter. As a result, the seller would typically expect to schedule that litigation as an exception to its litigation representation and warranty by including the litigation as an item on the disclosure schedules.
The disclosure schedules allow the seller to make exceptions to its representations and warranties. In a typical acquisition, the buyer requires the seller to make extensive representations and warranties regarding the target business. If any of the representations and warranties turn out to be untrue, the buyer may not be obligated to close the transaction or, if the transaction has closed, the seller will be in breach of the agreement, allowing the buyer to make a claim for indemnification. Since every target business has some problems and liabilities, a seller usually cannot make its representations and warranties without qualification. To solve this problem, the seller qualifies a representation and warranty by disclosures in the seller's public filings (in the case of a public company), materiality, knowledge or by the disclosure schedules (or sometimes a combination of all of the above). For example, rather than stating that there are no environmental liabilities, the seller can state that there are no material environmental liabilities or that there are no environmental liabilities except as listed on a disclosure schedule. If a representation and warranty is qualified by knowledge or materiality, the corresponding disclosure schedule can contain fewer exceptions, though, in practice, sellers often include as much information as possible on the disclosure schedules rather than relying on a materiality or knowledge qualifier. Buyers typically prefer a schedule of specific exceptions over a general qualification of materiality or knowledge.
Once a seller lists an item on a schedule, it is disclosed to the buyer. The disclosure is part of the acquisition agreement and qualifies the representation and warranty. Generally, this means that the buyer cannot terminate the transaction prior to closing as a result of that matter or make a claim for indemnification when a disclosed liability ends up costing the buyer money after closing. For example, if the seller lists a litigation on the disclosure schedules as an exception to the litigation representation and warranty, the buyer typically cannot make an indemnification claim for breach of that particular representation and warranty if the target company loses the trial after closing. Whether the buyer has a claim for breach of a different representation and warranty (for example, if the financial statements did not have an adequate reserve for the litigation and it was not listed on a schedule to the financial statements representation and warranty) depends on how the disclosure schedules are drafted (see What to Include).
When a seller lists a liability on the disclosure schedules it passes the risk of that liability to the buyer. As the liability is disclosed in writing before the consummation of the transaction, the buyer has the opportunity to factor the liability into its purchase price or make provisions in the agreement to shield itself from excess cost (see Buyer Response to Disclosure Schedules). The liability is part of what the buyer is buying, including the risk that the liability may become a problem in the future.
The disclosure schedules provide the buyer with important information about the target business. Even though most buyers conduct extensive due diligence on the target business (see Practice Note, Due Diligence for Private Mergers and Acquisitions (www.practicallaw.com/resource.do?item=:40992467)), there are some things that they cannot learn about the target business from reading documents. Sometimes the buyer may not have enough time or access to do a thorough due diligence investigation. The buyer often uses the disclosure schedules to elicit information about the target business. For example, the buyer may ask for a representation and warranty that says "schedule 3.4 sets forth all of the material copyrights owned by the target business". Since the target business may not have registered all of its material copyrights (copyright registrations are public information), the schedule is the only way for the buyer to be confident that it has the whole list. Likewise, if the seller has not disclosed any material litigation to the buyer in the due diligence process, the buyer will want a representation and warranty that says "except as set forth on schedule 3.5, there is no material litigation" and expects schedule 3.5 to say "none". As a process matter, this approach often facilitates the due diligence process since the seller wants to list any items that could be material.
The disclosure schedules are also a way for the buyer to confirm that the data room is complete. For example, if the seller discloses contracts on the material contracts schedule that were not provided in the data room, the buyer can request a copy of those contracts for review. The seller must provide complete and accurate information on its schedules, or risk an indemnification claim for breach of representation and warranty.
The disclosure schedules and the representations and warranties must be considered together. If a representation and warranty turns out to be untrue, then a buyer may not have to close the transaction (if discovered prior to closing) or may have a claim for indemnification. If the problem is disclosed in the schedules, then the buyer has no claim. A buyer should be comfortable with all of the disclosures in the schedules and confirm that the purchase price and other the acquisition terms are still appropriate in light of all disclosures.
Certain definitions necessary to understand the representations and warranties may be contained in the disclosure schedules. For example, the definition of "Seller's Knowledge" is often qualified by a list of employees, in a disclosure schedule, whose knowledge is imputed to the seller. Lists of "Transferred Employees" or "Key Employees" are also often listed in the disclosure schedules because they are too lengthy to include in the main agreement.
Disclosure schedules do not typically contain as much information in a public acquisition for several reasons:
The value of the target business is reflected by the market and material information is available in public filings.
The seller often qualifies its representations and warranties by material adverse change (www.practicallaw.com/0-382-3617). If exceptions to the representations and warranties are listed on the disclosure schedules, they are significant.
In a public acquisition there is no provision for post-closing indemnification so the buyer must evaluate the accuracy of the representations and warranties before it moves ahead with the closing.
The seller typically does not make detailed representations and warranties.
Since the seller does not need to disclose as many exceptions to the representations and warranties and some information is available publicly, the disclosure schedules are usually much shorter than in private acquisitions.
The seller and its counsel typically draft the disclosure schedules together. Often counsel takes responsibility for compiling and coordinating all of the individual schedules and drafting the disclosure letter (see What to Include) and legal disclosures (such as contracts that require consent). The seller usually drafts any business schedules (for example, detailing how the purchase price is calculated or listing inventory).
Disclosure schedules can be lengthy and include a large amount of important information. They are time-consuming to draft and time-consuming to review. Below are a few basic steps that will help you stay organized.
Although the allocation of drafting responsibility varies from deal to deal, it is important to assign one representative of the seller and one member of the seller's corporate legal team to be in charge of the schedules. A junior corporate attorney usually takes the lead on the legal side. Typically the same representative of the seller that handles the data room takes the lead on the disclosure schedules. The lead parties on the legal and business team have the daunting task of coordinating with many other people and keeping everyone on track for distribution deadlines. Each lead party should be in charge of coordinating with its own internal team and then reporting back to the other lead party.
Constant communication is vital between the legal and business teams. Even if the seller's counsel has done its own extensive diligence on the target business, the management of the seller and the employees of the target business are in a much better position to have information. Since management will be busy with other activities related to the acquisition (and the everyday operation of the business) constant communication helps keep people focused on the disclosure schedules. Counsel should explain what disclosure is required by the representations and warranties and alert the seller if this changes as the acquisition agreement is negotiated (for example, if a materiality threshold on litigation moves from $1 million to $500,000). Seller's counsel also needs to ensure that the disclosure is properly drafted (see What to Include) and that the schedules conform with the agreed upon format and numbering. It is helpful to provide a summary to the seller explaining what information is required for each schedule.
It is important to ensure that the seller's representatives who are drafting (or reviewing drafts of) the disclosure schedules have sufficient knowledge about the target business. If the disclosure schedules are incomplete, the buyer may be able to avoid closing the transaction and the seller risks an indemnification claim from the buyer for breach of representation and warranty. If the target business is a subsidiary or division of the seller, the executive management of the seller may not have sufficient knowledge (for example, knowledge of the trademark registrations or employee benefit plans of the target business). The seller's management may be in a difficult position because they do not want to announce the acquisition to all of their employees at this early stage. The best approach is to bring in key employees from all relevant areas (on which the seller is making representations and warranties) to review the disclosure schedules before they are distributed to the buyer. If the seller limits which of its employees know about the transaction early on, sufficient care must be taken at a later point (prior to signing the acquisition agreement) to make sure the disclosure is accurate.
It is important to involve relevant legal specialists when drafting the disclosure schedules. For example, if a real estate attorney advised on the drafting of the real property representation and warranty, that specialist should also advise the seller on what it should disclose in the corresponding schedule.
Both the seller and its counsel should ensure that the materials in the data room support the disclosure schedules. If there is conflicting information or if the seller discloses information that is not in the data room, the buyer will bring this up in negotiations. Since the buyer is likely to raise any discrepancies with the seller, it is best practice to preemptively add any necessary information to the data room and to give the buyer notice of the addition or change.
The disclosure schedules should be sent to the buyer as early in the process as possible. Generally the disclosure schedules are distributed after a first draft of the acquisition agreement has been exchanged. This gives the buyer adequate time to review the disclosures and raise any potential issues without compromising the timing of the acquisition. Since the disclosure schedules are usually distributed before the acquisition agreement is final, it is important to monitor any changes in the acquisition agreement that require a corresponding change to the disclosure schedules.
How schedules are drafted affects the allocation of risk between the buyer and seller. Consider the following:
Over disclose. Generally it is better for the seller to disclose more rather than less information because it shifts the risk of the disclosed liabilities to the buyer. The schedules are exceptions to the representations and warranties and limit the claims a buyer can make for indemnification. If the seller fails to disclose all relevant information, it may breach its representations and warranties.
Make broad disclosures. Wording disclosures more generally saves the drafter time (rather than listing all items specifically) and can act as a safeguard if an item is omitted. Even though the disclosure may be general, it should not be so vague that it is meaningless. The seller will have difficulty claiming that a liability has been disclosed if it is not reasonably apparent from the text of the schedules. If the schedules are not accurate then the seller risks liability. Some sellers try to qualify the entire agreement by a general reference to the data room or by reference to publicly available information, but the buyer will strongly resist this.
Cross reference. Often sellers make a general statement that all disclosures made under one particular section of the schedules are deemed made under other sections of the schedules if the contents are relevant, whether or not there is an actual cross reference. Buyers usually tighten that statement by adding a requirement of reasonableness. For clarity (since the seller should over-disclose), the seller should also include specific cross references. If a schedule is not cross-referenced, the seller opens the door for the buyer to argue that the seller did not intend to make a disclosure against a particular representation and warranty. It is often helpful to cross reference other schedules broadly (the buyer may resist this) when listing an exception to the acquisition agreement. For example, cross reference an entire schedule rather than one item number.
Track the acquisition agreement. The disclosure schedules are meant to correspond to the acquisition agreement and are usually numbered the same as the related section of the agreement. It is important to draft the schedules together with the corresponding sections in the main agreement. The disclosure schedules must be revised as the agreement is negotiated (as representations and other provisions are modified, added or deleted).
Confidentiality concerns. Some contracts contain confidentiality provisions that restrict the disclosure of the identity of the parties or the existence of the agreement. If any of the seller's contracts contain these provisions, the contracts should be described generally so as not to breach the provision.
Public disclosure. Disclosure schedules are almost never publicly filed even when the main acquisition agreement is filed. If the parties determine that they need to file the disclosure schedules to comply with the federal securities laws, they should carefully consider the implications of any public disclosures.
Disclosure letter. There is often an opening letter to the disclosure schedules or an introductory paragraph in which the seller makes certain disclaimers. The buyer often objects to many of these disclaimers and the parties typically negotiate the language. Common disclaimers are:
certain disclosures are made for informational purposes only and do not broaden the representations and warranties;
the fact that an item is disclosed on the schedules is not an admission by the seller that it is required to be disclosed by the representations and warranties; and
disclosures made under one particular section of the schedules are deemed made under other sections of the schedules with or without a cross reference (as noted above, buyers usually require that this is reasonable).
Like the acquisition agreement, disclosure schedules should be reviewed by the buyer's legal team and the business team. If any schedules relate to any speciality areas (such as intellectual property or employee benefits) it is important for the appropriate specialists to review those schedules. Disclosure schedules vary from deal to deal, but there are certain issues common to most disclosure schedules. Key issues to focus on when reviewing a draft of the disclosure schedules are:
Read the disclosure schedules with the acquisition agreement. The disclosure schedules cannot be reviewed without reference to the acquisition agreement. It is very important to read both side by side when conducting the review.
Does the disclosure fit with the buyer's due diligence investigation? Ideally the buyer should already know everything that is disclosed in the schedules. If there is new information or information that conflicts with the due diligence investigation, the buyer should request more information (whether documents or a conversation with the seller) before accepting the disclosure.
Is the disclosure too general or vague? Because the disclosure schedules limit the buyer's ability to make future indemnification claims, make sure that the disclosure is as specific as possible. The buyer needs to fully understand what is being disclosed.
General or broad cross references? Cross references are typically acceptable, but should be specific so that the buyer knows exactly what is excluded from each representation and warranty. Be wary of statements that include a broad cross reference across the entire document or reference items in the data room.
References to the data room. Broad references to the data room are troubling for the buyer. If the reference is to materials in the data room it is generally difficult to know what is being disclosed. The most thorough diligence review is bound to miss a few items. Even if the materials are referenced specifically with index numbers, the buyer should make sure that it has a hard copy or electronically saved copy of the materials. Otherwise the reference will be meaningless when the electronic data site is dismantled.
Do changes need to be made to the acquisition agreement? Sometimes information is disclosed that the buyer is not willing to accept. The buyer may ask for a specific indemnification for any liabilities related to that disclosure. Other times the buyer may ask that the seller take an action related to an unacceptable disclosure either before or after closing (for example, satisfying a lien on an asset).
Is specialist review required? Often a junior attorney on the corporate team is in charge of coordinating the specialist review. This entails distributing the schedules to any relevant specialists (along with a current draft of the acquisition agreement). It is often helpful to point out what schedules contain items for the specialist's review since it is not always clear from the schedule headings.
Is the disclosure accurate? The disclosure schedules should be accurate. This includes correcting typographical errors and information such as the proper date of an agreement. The buyer should not add to the disclosure schedules in most cases. It is helpful to fix the date of a material contract on the material contracts schedule, but it is not in the buyer's interest to add other material contracts that the buyer believes belong on the schedule. In all cases the buyer should look at the relevant provision in the agreement when deciding whether to add language to the disclosure schedules.
Is any action required? If the disclosure schedules list any actions that are necessary to consummate the transaction (such as obtaining third party consents), it is important to focus on these actions. All parties should agree on the steps needed to close the transaction. If the disclosure does not match up with the due diligence review or if the buyer thinks additional actions are necessary, this should be discussed with the seller and its team as soon as possible.
When reviewing the schedules it is important to think about what information the buyer's management should focus on. Although the buyer should review all of the disclosure, it is helpful for management to focus on certain schedules. The buyer should focus on any schedules which involve business terms (such as calculation of purchase price), schedules which disclose material liabilities, any new information or actions that need to be completed prior to closing.
Sometimes the seller discloses a liability on the disclosure schedules that was not previously disclosed in due diligence. Even if a liability was previously disclosed, the buyer may not have understood its significance. If the buyer is not comfortable with the disclosure it has several options. Depending on the size of the liability and how easily the buyer can quantify the risk the buyer may:
Accept the disclosure. If the buyer fully understands the disclosure and it is typical of companies like the target business, it may choose to accept the disclosure without further modification or negotiation.
Conduct due diligence. If the seller makes a disclosure that the buyer does not have sufficient information on, it may conduct further due diligence. This due diligence may include requesting documents, conducting interviews with the seller or consulting specialized counsel or third party consultants (such as environmental engineers).
Adjust the purchase price. If the disclosure affects the valuation of the target business, the buyer may adjust the purchase price. For example, if the seller discloses a $10 million liability that was previously unknown, the buyer may reduce its offer by that amount.
Seek indemnification. If seller discloses a liability that the buyer is unwilling to acquire, the seller may agree to indemnify the buyer for that specific liability. For example, the seller may indemnify buyer for any costs or expenses incurred in connection with a particular litigation.
Impose a closing condition. If seller discloses a problem that the buyer is unwilling to acquire, the buyer may require the seller to fix the problem before closing. For example, if the seller discloses liens against its assets, the buyer may require the seller to get the liens released before it closes the acquisition.
Terminate the deal. In extreme situations, a last minute disclosure may cause the buyer to terminate the transaction. There may be certain issues which either drastically affect the value of the target business or otherwise impact the buyer's desire to make the acquisition. For example, if a buyer is acquiring a company primarily for its supply channels and the seller discloses that the contracts with those suppliers are currently in breach, the buyer may decide to abandon the transaction.
After review of the disclosure schedules, usually the buyer sends the seller a mark-up. Often this mark-up is handwritten rather than electronic (electronic mark-ups are typically used for negotiating the acquisition agreement). Handwritten mark-ups are usually easier since many disclosure schedule comments are deletions or requests for further information.
Once a draft of the schedules has gone back and forth once or twice it is usually helpful to have a conference call or meeting in person to discuss any outstanding issues. It is often necessary to involve management and specialists in the relevant part of the discussions.
The target company cannot stop operating to accommodate the disclosure process. Therefore, revisions and updates to the disclosure schedules should be monitored up to completion. The disclosure schedules must also be revised as the agreement is negotiated (as representations and warranties and other provisions are modified, added or deleted). Subject to any right to update, the disclosure schedules are delivered in final form when the acquisition agreement is executed.
If there is a gap of time between signing and closing, the seller often wants the right to update the schedules before closing. The buyer often completely resists or limits this right to update. If the seller has the complete right to update the disclosure schedules, then the buyer takes the risk that something might be disclosed that is not properly reflected in the purchase price or the acquisition agreement. If the seller does not have the right to update the disclosure schedules, then the seller takes the risk that some unknown liability may arise between signing and closing which will put it in breach of the agreement.
Most buyers recognize that some facts change between signing and closing (for example, the list of employees). A compromise is often struck where the seller can only update certain schedules. Other times the seller has the right to update all schedules, but the buyer can terminate the deal, seek a purchase price adjustment or get specifically indemnified in connection with the new disclosure if it meets a certain materiality threshold.