The standard of disclosure in an acquisition
When an acquisition takes place for example like that between AOL and Time Warner there will generally be an agreement about the standard of disclosure between the two companies before the acquisition is complete. In an asset sale the warranty on the standard of this disclosure will be contained in the sale and purchase agreement, commonly information about the target company will then be disclosed by the seller to the buyer in a disclosure letter. Disclosure is an important stage in an acquisition because it enables the buyer to make an informed decision on whether it wishes to complete the purchase of the target company or, ask for an indemnity in relation to any risks from the buyer, or withdraw from the acquisition.
The disclosure letter
In the sale and purchase agreement there will commonly be warranties made by the seller to the buyer which give protection to the buyer. An example of a warranty is that ‘the accounts give a true and fair view of assets, liabilities and profits’. During the disclosure process the seller usually has the opportunity to disclose against such warranties in the form of a disclosure letter, so for example with the above warranty the seller may disclose to the buyer that it had made a loss of Â£3 million. The important point to note however is how this information is disclosed to the buyer and whether it complies with the agreement on the standard of disclosure. For example the agreement may require that the disclosure is to be given fully, clearly and accurately in the disclosure letter. Therefore if the seller disclosed to the buyer orally that the company had made a loss of Â£3 million then this is not likely to meet the agreement as it has not been disclosed in the disclosure letter.
What constitutes effective disclosure?
A brief look shall be taken at the cases which have shaped the standard of disclosure required in the disclosure process.
Levison v Farm (1977)
A warranty was made by the seller that there would be no material adverse change in the net asset value of the company between the balance sheet date and the completion date allowing for normal trade fluctuations. This warranty was breached by the seller as there was a change of Â£8,600 in the net asset value. The seller claimed that it had given effective disclosure against this warranty in the disclosure process, by stating that the company was trading down. It was held that this disclosure was not specific enough, it was general in the sense that it simply stated that the company was trading down, it did not give exact figures. It is therefore not enough to provide information which might show a warranty is untrue, you need to give full and precise details (i.e. that there was a change of Â£8,600 in the net asset value) to enable the buyer to make an informed decision.
Infinteland v Artison (2006)
The seller provided a warranty that the accounts gave a true and fair view of assets, liabilities and profits. This was breached by the seller however as there was a Â£1 million exceptional item miss-described in the accounts, which were given to the buyer. The accounts therefore disguised an operating loss and the warranty was breached on its wording. It was held however that it was sufficient disclosure if the matter could fairly have come to the accountant’s attention during due diligence. The courts applied an objective test and stated that it does not matter what the accountants knew but rather what they should have been able to find out from the disclosure. It was therefore held that effective general disclosure was made. The courts also pointed out that you need to look at the wording of the agreement to see what the standard of disclosure is.
A warranty was made that all material facts and circumstances had been disclosed by the seller. Allegedly this had been breached as the seller did not disclose all material facts and circumstances, this meant that the shares were worth far less than what the buyer had paid for them. The seller however claimed that the buyer knew of certain facts, the buyer then pointed to a warranty in the agreement which stated the standard of disclosure:
‘other than facts and matters fully, clearly and accurately disclosed in the disclosure letter, no other information which the buyer has actual, constructive or implied knowledge will prejudice any claim made by the buyer in respect of the warranties’.
On the basis of this standard of disclosure the buyer asked for the case to be struck out as not all the material facts and circumstances had been disclosed to the buyer by the seller, it was not enough for the buyer to know of them if they were not disclosed accurately in the disclosure letter. Despite this clause the court thought that the seller had an arguable defence and so refused to strike out the case. The parties eventually settled out of court, so there is no real decision. It can be seen though that the knowledge of the buyer may prevent a claim despite what the agreement states, therefore it may not be possible to rely on a clause like above.
In Levison v Farm there was no standard of disclosure in the sale and purchase agreement and the courts inferred that on the facts it was not enough to give a general disclosure and that what was required was a specific disclosure against the trading down. Therefore when there is no standard of disclosure Levison may bite and say that there must be specific disclosure to evade liability. Infiniteland shows that effective general disclosure can be made but that you need to look at the agreement to determine the standard of disclosure. In this case the knowledge of the advisors was imputed to the buyer. In Eurocopy it can be seen that the knowledge of the buyer may prevent a claim despite what the agreement states, so it may not be possible to totally exclude knowledge which is not stated fully, clearly and accurately in the disclosure letter.