The disclosure letter is a key document in any acquisition of the shares in, or the business and assets of, a private limited company.

The letter is prepared by the seller in the transaction and includes general and specific disclosures regarding the seller’s warranties in the acquisition agreement. The buyer will usually agree that the seller will not be liable for a breach of warranty where the matter giving rise to the breach was disclosed in the disclosure letter. A bundle of documents is usually attached to the disclosure letter to support the seller’s disclosures.

To understand this more fully, we need to look at what warranties are.

What are warranties in a share purchase or asset purchase agreement?

I always describe warranties as a promise in a contract or a statement that something is true.

On an acquisition of shares, the principle of caveat emptor (buyer beware) applies, that is to say, the law provides no statutory or common law protection for the buyer as to the nature or extent of the assets and liabilities it is acquiring. Hence the need for extensive contractual statements in the form of warranties.

In a share purchase agreement or asset purchase agreement, warranties will cover things like:

1. Fundamentals about the company, shares, structures etc
2. Accounts and particularly matters arising post accounts date
3. Connected party transactions
4. Finance and banking
5. Property
6. Environmental issues
7. IT systems
8. Commercial contracts
9. Employees
10. Data protection
11. Assets
12. Insurances
13. Intellectual Property
14. Legislation
15. Tax
16. Specific issues arising out of due diligence

If a seller or sellers provide a warranty in respect of a particular issue, and it later turns out to be incorrect then the Buyer may have the ability to bring a warranty claim.

A breach of warranty will only give rise to a successful claim in damages if the buyer can show that the warranty was breached and that the effect of the breach is to reduce the value of the company or business acquired. The onus is therefore on the buyer to show breach and quantifiable loss.

Ok, so why do we need a disclosure letter?

Because of the need to ensure there are no surprises to the Buyer, we go through the process of due diligence and then provide a disclosure letter.

As above, the disclosure letter sets out all of the issues and warranties against which the seller is or has disclosed information on.

For example, lets say the warranty says:

“12. The company is not engaged or involved in any litigation in respect of any disputes”

And let’s assume that the Company has in fact recently received a letter of claim which it considers to be without merit but nonetheless needs to be dealt with.

The disclosure letter will therefore disclose to the buyer in relation to paragraph 12, the Company has received a letter of claim from [NAME] dated [DATE] a copy of which is disclosed.

Making the disclosure in the disclosure letter means that we’ve brought the potential claim to the attention of the buyer, and they cannot now claim a breach of warranty or say they were not aware of the potential claim.