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Presenting a live 90-minute webinar with interactive Q&A
M&A Disclosure Schedules: Seller and Buyer
Perspectives on Making and Updating
Disclosures in U.S. and Cross-Border Deals
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
THURSDAY, JANUARY 12, 2017
Alexander J. Davie, Co-Founder & Member, Riggs Davie, Nashville, Tenn.
Peter D. Feinberg, Attorney, Hoge Fenton Jones & Appel, San Jose, Calif.
Carol Osborne, Managing Partner, Bryan Cave, London
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Stronger. Together.
Disclosure Schedules in
M&A Transactions: Seller and Buyer Perspectives in
Preparing and Updating
Disclosures
Peter D. Feinberg
January 12, 2017
© 2015 Hoge Fenton Jones & Appel
Purpose of Disclosure Schedules
• Disclosure schedules are one of two parts of the overall due
diligence process in M&A transactions:
– The other part of the process is production of seller’s
documents and usually occurs in steps beginning before
preparation of the disclosure schedules.
• Due diligence helps parties determine the appropriate
purchase price, identify assets and liabilities and allocate
risks.
• Disclosure schedules have two different but important
purposes:
– disclosure of key aspects of seller’s operations, and
– allocation of risk between the parties.
6
© 2015 Hoge Fenton Jones & Appel
Preliminary Steps – Initial Diligence
• Document production begins before preparation of
the letter of intent (LoI) with buyer entering into a
non-disclosure agreement (NDA) or Confidentiality
Agreement with seller.
• Seller should never disclose anything without this
agreement being in place!
• Buyer will want basic financial information before
preparation of the LoI (note that some or all of this
may already be publicly available if seller is a
public company).
7
© 2015 Hoge Fenton Jones & Appel
Preliminary Steps – Initial Diligence
• After the LoI is signed, Buyer will give Seller a
document request covering most aspects of
Seller’s operations including employees,
intellectual property, financials, assets and
liabilities, litigation, etc.
• Timing and extent of disclosures is always a
subject of discussion between the parties.
• Notwithstanding the NDA, Seller may choose to
withhold certain documents until just before or
even after closing, particularly those relating to
specific customers or trade secrets.
8
© 2015 Hoge Fenton Jones & Appel
Buyer Goals in Disclosure Process
• The disclosure process helps the buyer understand the
seller’s business (i.e., key customers, suppliers, employees,
owned assets, liabilities, etc.)
– This is of critical importance to the parties in determining what is the
appropriate purchase price.
• The Buyer also wants to know 2 opposite things on a post-
closing basis:
– Can it continue running the business as the Seller has done on a pre-closing
basis, and if not, what needs to be done for this to be the case? (Pre-closing
consents, regulatory approvals, etc.)
– Alternatively, the buyer wants to know that it can cancel any commitments
that it doesn’t want after the closing without penalty or other financial
consequence.
9
© 2015 Hoge Fenton Jones & Appel
Impact of Buyer’s Knowledge
• The intersection of knowledge obtained in the document
production process and from the disclosure schedules is
somewhat hazy:
– If Buyer learns about a risk in a document provided by Seller
but it isn’t specifically disclosed, would Buyer be deemed to
have constructive notice of the risk, and thus, absent a
provision to the contrary, to be responsible for it?
10
© 2015 Hoge Fenton Jones & Appel
Allocation of Risk - Generally
• Seller representations and warranties (and related disclosure
schedules), gain their importance primarily through the
indemnification provisions which allocate risk.
– A breach of a representation and warranty by seller which
creates liability for buyer after the closing will lead, subject to
some combination of limitations and conditions discussed
below, to an obligation for the seller to indemnify the buyer.
• Customary to have a closing condition in favor of buyer that
seller’s representations and warranties are true and correct
in all material respects.
– If the representations and warranties are not true and correct
in all material respects, buyer will not be required to complete
the transaction.
11
© 2015 Hoge Fenton Jones & Appel
What Constitutes a Breach by
Seller?
• General answer: a statement which is untrue and
not modified by any conditions or disclosures.
• The main conditions on representations and
warranties are:
– materiality (that the breach has a certain level of consequence
on the business; dependent on both the breach and the size
of the business), and
– knowledge (that the statement was absolutely true vs. it was
true as far as the giver of the representation knew).
12
© 2015 Hoge Fenton Jones & Appel
Role of “Knowledge” of Seller and
Disclosures
• Several key negotiation points on Seller’s “knowledge”:
– Whose knowledge is relevant?
– What kind of special inquiry, if any needed, should be made?
– Which representations and warranties can be modified by
knowledge?
• The role of disclosure schedules in modifying seller’s
potential liabilities for breaches will depend on:
– The nature and specificity of the disclosure and
– whether there is anything in the agreement providing that disclosure
will not negate liability or actions which the buyer may take which
would lead to seller retaining the liability or buyer’s liability being
limited
•
13
© 2015 Hoge Fenton Jones & Appel
Indemnification – Key Features
• Indemnification provisions ordinarily contain:
– a minimum loss a buyer must incur (a “basket”) before the buyer may
receive indemnification
– a maximum amount of loss after which the seller is no longer liable
for any of buyer’s losses (a “cap”)
– offsets for insurance or tax benefits which the buyer may receive
– a maximum duration for such indemnification rights
– indemnification procedure under which the seller may choose to
either directly defend the claim, and assume any liability relating
thereto, or tender the claim to the buyer, in which case the seller will
likely waive its right to contest liability as against buyer.
• Note potential common law indemnification rights may exist
in favor of buyer.
14
© 2015 Hoge Fenton Jones & Appel
Case Study - Facts
• Seller is an individual and the 100% owner of a
business selling canned foods to markets and
restaurants. In the course of a transaction to sell
100% of the stock to buyer, seller gives the
following representation and warranty:
– Inventory. To Seller’s knowledge, all inventory, including raw
materials, work in process, finished goods, service parts and
supplies (“Inventory”) consists of items of a quantity and
quality historically useable and/or saleable in the normal
course of business, except for items of obsolete and slow-
moving material and materials that are below standard quality,
all of which have been taken into account for purposes of
valuation in accordance with GAAP.
15
© 2015 Hoge Fenton Jones & Appel
Case Study – The Problem
• A small but material part of Seller’s inventory had passed its
expiration date. Inventory management was normally done
by the company’s chief of operations and not a part of
seller’s own job responsibility so seller was not aware that
these items had passed their expiration dates.
• After the closing, buyer was sued for selling these expired
goods. Buyer sought indemnification from seller, who
defended himself based on the fact that he did not know that
goods had passed their expiration dates.
• Subject to the applicable cap, basket and duration of the
representations and warranties, would the seller have a duty
to indemnify buyer for its loss?
16
© 2015 Hoge Fenton Jones & Appel
Case Study – The Outcome
• Maybe. The questions will be:
– Was “knowledge” defined in the agreement?
– Is the knowledge standard, seller’s actual knowledge, and if so, did
he have a duty of due inquiry, which would have pointed him to the
appropriate manager?
– Is the knowledge standard “knew or should have known”, which
would look less at what this seller should have done and more what
an “objective” seller would have done?
– If “knowledge” wasn’t defined, how would this be determined by the
law of the state in which disputes were to be decided?
• Important note: there is relatively little law on many issues
about which disputes arise relating to disclosure schedules
(or even merger & acquisition agreements generally).
17
© 2015 Hoge Fenton Jones & Appel
Best Practices in Drafting
Disclosure Schedules
• As counsel to Seller, try to limit the scope of the
representations and warranties:
– limits Seller’s potential liabilities
– minimizes the amount of time spent preparing schedules
– Example: rather than having to disclose “all contracts which
have been in place in the past 5 years”, limit disclosure to
“material contracts currently in place or terminated within the
past year”.
• Once the scope is agreed, schedule a review
meeting with the client before drafting.
18
© 2015 Hoge Fenton Jones & Appel
The “Review Meeting” • Attendees:
– A mid-level to senior attorney and a junior attorney should meet with
the seller and any key employees who might have knowledge of
Seller’s operations (CFO, General Counsel, Chief of Operations, VP
of HR, etc.).
– Note: Junior attorneys may not pick up on the intricacies of some of
the representations.
• Explain what the representations mean to your client.
– Example: the representation that the seller is qualified to do
business as a foreign corporation in any state or country so
required is difficult for all but the most knowledgeable client to
grasp, as it may entail a mix of volume of business, persons
engaged, real property used, etc.
19
© 2015 Hoge Fenton Jones & Appel
Drafting the Disclosure Schedules -
Generally
• The process of preparing disclosure schedules really begins
with the circulation of the definitive transaction documents.
– Initial draft of definitive agreements usually prepared by the buyer.
– Separate from the document disclosure, the disclosure schedules
correlate with the representations and warranties given by the seller.
– Negotiations around the representations and warranties can reduce
(or change) the extent of required disclosure.
• Disclosure schedule preparation can be one of the most time
and labor-intensive parts of a merger & acquisition
transaction.
20
© 2015 Hoge Fenton Jones & Appel
Drafting Disclosure Schedules -
Mechanics • Establish a game plan on how to assemble information, both
narrative and documentary, which pertains to each representation.
– Until 10 years or so ago, this information was usually compiled in a
physical data room, but as most lawyers who have done a merger &
acquisition in the 21st century are aware, virtually all information is
now stored online in virtual depository sites such as box.com,
dropbox, etc.
• The information you receive from clients relating to the disclosure
schedules should be the first word, but not necessarily the last one.
• Sellers should reserve the right to update schedules before closing:
– particularly in sign and subsequent close transactions
– the buyer may want a closing “out” for a new post-signing disclosure,
or at least a right to indemnification, regardless of the potential
liability being disclosed.
21
© 2015 Hoge Fenton Jones & Appel
Drafting Disclosure Schedules –
Roles and Resources
• The Law Firm:
– Junior attorney takes the lead in reviewing documents, issue spotting
and preparing schedules.
– Senior attorney is the “gatekeeper” only.
• The Deal Advisors
– Investment bankers or business brokers often tell clients that they
can take a major role in preparing disclosure schedules.
– Be careful! Their knowledge varies greatly, and their conversations
with clients, unlike yours, will not be privileged.
• Other Advisors
– CPA, insurance agent, benefits consultant and any other outside
professionals, and you should send them the representations which
apply to the work which they have done for the company.
22
© 2015 Hoge Fenton Jones & Appel
Drafting Disclosure Schedules –
Roles and Resources • Utilize outside sources to confirm client information when
available:
– Order a certificate of good standing, ideally at the start of preparation
of the disclosures then shortly before closing;
– Order certified copies of the client’s articles/certificate of
incorporation and a lien search.
– Consider performing a litigation docket search as well.
• The disclosure schedule process is interactive; often, the more
information the attorney receives, the more questions he or she will
have for the client.
• Although the attorneys will be the primary drafters and much of the
consideration of what is included, as discussed below, will be legal
in nature, it is critical that the client understands and signs off on
the schedules.
23
© 2015 Hoge Fenton Jones & Appel
How Much Should Seller Disclose?
• Questions inevitably arise over the scope of
disclosures:
– Clients may believe that documents disclosed to buyer may
be sufficient disclosure of an item without putting it in a
schedule to notify the buyer, or that extensive disclosures may
jeopardize a buyer’s willingness to go through with a
transaction.
• Inviolate rule of the schedule preparation process:
– The client should disclose any possibly relevant information to
its lawyer; and
– The lawyer makes the determination of the necessity for
disclosure.
24
© 2015 Hoge Fenton Jones & Appel
How Much Should Seller Disclose? • Unless the disclosure in question is extremely remote or
speculative, more disclosure is generally better than less:
– More disclosure may negate potential liability, and
– Takes the possibility of fraud for non-disclosure off the table
• Language has to be carefully crafted so that the buyer is notified
without being unduly alarmed.
• It is important for seller to get out in front of key disclosures, so
that the first time the buyer hears of them will not be in the
schedules, but:
– Sellers may need to consider the timing of sensitive disclosures.
– Some information, often relating to customers or trade secrets,
should not be disclosed until shortly before closing (or even at the
closing), even with a NDA in place.
25
© 2015 Hoge Fenton Jones & Appel
Should the Buyer Ever Make
Disclosures to Seller?
• Shouldn’t a seller consider receiving something
similar from buyer when seller is receiving a
significant amount of buyer’s stock (or even a note
or contingent cash after the closing) and it needs
to understand the buyer’s operations and ability to
perform?
• Yes, but this is invariably a difficult and
contentious negotiation between the parties.
26
© 2015 Hoge Fenton Jones & Appel
When Are There no Disclosures?
• Rarely, but:
– Bankruptcy when a buyer may be buying “as is”, subject to the
fact that the buyer will likely be receiving a significant discount
for doing so. The trustee or receiver may need to amass all of
the assets of the seller’s estate then distribute them to
creditors, so having contingent liabilities, such as
indemnifications for representations and warranties, may not
be feasible.
– Public company sales where seller will still give
representations and warranties and make disclosures but the
representations and warranties will not survive the closing of
the transaction. Instead, the representations and warranties
act more as covenants, which, if breached, will give the buyer
the opportunity to avoid closing the transaction.
27
© 2015 Hoge Fenton Jones & Appel
Thank You!
If you have any questions . . .
Peter D. Feinberg
(408) 947-2427
This presentation was provided as an educational service. It is an
overview only, and should not be construed as legal advice or advice to
take any specific action. If you have questions regarding any of the
content contained in this presentation, we recommend you seek the
assistance of a knowledgeable legal professional.
Silicon Valley Office • 60 S. Market Street, Suite 1400 • San Jose CA • 95113 • 408.287.9501
Tri-Valley Office • 4309 Hacienda Drive, Suite 350 • Pleasanton CA • 94588 • 925.224.7780
hogefenton.com
29 29
U.K. and U.S. Disclosure Conventions
Compared
Carol Osborne
Bryan Cave - London
30
• U.S.-U.K. acquisitions remain an important element of
middle market deal flow:
– Since 2000, it is estimated that $572.4bn has been invested by
U.S. corporations in mergers and acquisitions into the United
Kingdom and approximately $535.1bn by U.K. Companies in
mergers and acquisitions into the U.S.
– Since 2000, 1,386 U.S. companies, subsidiaries, divisions or assets
have been acquired by British firms and 1,986 U.K. companies,
subsidiaries, divisions or assets have been acquired by U.S. firms.
[Winchester Capital M&A Advisor Symposium 2015]
• U.K. remains a desirable first entry point into the EU for U.S.
companies.
Why relevant to a U.S. practitioner?
31
• Same as in the U.S.
– Post-closing price adjustment mechanism if facts are not as
represented.
– Pre-closing diligence opportunity for the buyer which allows a pre-
closing price adjustment, an opportunity to seek a specific
indemnity (with or without liability caps) or the right to walk away.
• Special situations (auction or bankruptcy/administration)
limit opportunities for full diligence.
Purposes of Disclosure Practice
32
• Warranties given on either a contract or indemnity basis
• Key Wording in the Acquisition Agreement
• The Disclosure Letter and Disclosure Bundle
• General Disclosures
• Specific Disclosures
• Choosing not to disclose…
Overview of the
U.K. Disclosure Process
33
• Make sure the letter of intent (LoI) is clear on this point!
– COMPARE: In the U.S., warranties are always given on an indemnity
basis but the opposite is true in the U.K.
• Damages on a contract basis.
• Damages on an indemnity basis.
Contract vs. Indemnity Basis
34
• Definition of “Disclosed” in acquisition agreement:
– Disclosed: fairly[, fully, clearly and accurately] disclosed (with
sufficient details to identify the nature and scope of the matter
disclosed) in or under the [Disclosure Letter] [Disclosure Schedule].
• English law rule: protection by disclosure will not exist
merely by making known the means of knowledge that will
allow a party to work out certain facts and conclusions.
• Effect of Buyer’s Knowledge or Investigation – Sandbagging
and Anti-Sandbagging discussed below.
Definition of “Disclosed” and Legal
Consequences
35
• Why have a bundle of documents at all?
– “The contents of the documents referred to in this letter are
deemed to be Disclosed [and copies of all these documents are
annexed to this letter and have been initialed by the parties for the
purpose of identification].”
• Can you just disclose the entire data room?
– Different desired outcomes.
• Mechanics:
– Two identical bundles initialed by the parties are delivered.
– Timing is important – especially for the buyer.
The Disclosure Bundle
36
• Preamble – Like a legal opinion letter, the preamble sets the context for the
disclosure letter and what is (and isn’t included).
• General Disclosures – Information available through public sources or which the seller can
obtain independently.
– COMPARE: This is generally not considered disclosure in the U.S.
• Specific Disclosures – Facts, matters or circumstances which, if not disclosed, would result in
a breach of one or more warranties.
– COMPARE: This is the U.S. style disclosure schedule.
• When delivered? – If sign and subsequent close, then usually delivered just prior to signing
and again just prior to closing.
The Disclosure Letter
37
• Contents of Acquisition Agreement
• Companies House searches
• Company books and records
• Property Searches
• Other public record searches (e.g. UK Intellectual Property Office)
• Physical inspections of properties or assets
• Audited accounts
• Documents in the disclosure bundle
• Matters “in the public domain”
General Disclosures
38
• Include details of any specific matters that are known to the seller or persons with
“knowledge.”
• The specific disclosures are produced by reference to the warranties themselves.
– Disclosure against one warranty would normally count as disclosure against all
warranties unless the disclosure is not precise enough to qualify as “fair” disclosure.
– COMPARE: In the U.S., disclosures are usually tied to specific warranties.
• Disclosure must be sufficiently precise or it may not serve as a defense to a breach of
warranty claim.
• Seller’s best defense? Add the following clause:
– “Where brief particulars only of a matter are set out or referred to in this letter, or a
document is referred to but not attached, or a reference is made to a particular part
only of such a document, full particulars of the matter and the full contents of the
document are deemed to be Disclosed and it is assumed that the Buyer does not
require any further particulars."
– COMPARE: In the U.S., brief particulars might be enough.
• The buyer should not hesitate to mark up the specific disclosures if necessary.
Specific Disclosures
39
• Yes, we have it in the U.K. too (we just don’t call it that).
• The definition of “Disclosed” sometimes excludes matters
known to the buyer merely as a result of due diligence or
data room access. If the matter is not discussed in the
disclosure letter or the document is not in the bundle, it is
not considered “fairly disclosed.”
• Case law suggests the buyer may not be able to rely on
such a savings clause if it (directly or through its advisors)
had actual knowledge of a matter.
Sandbagging and Anti-Sandbagging
40
• Full or partial disclosure might be undesirable for
commercial reasons:
– Risk of losing attorney-client privilege in a sensitive litigation matter
– Concern over unduly aggressive pre-closing purchase price
adjustments
• Seller runs the risk of having no defense to a breach of
warranty claim.
• Seller also runs the risk of criminal securities law violation
in a share purchase or civil action for misrepresentation.
• No general obligation to disclose
– But, if the seller speaks at all, the seller must speak completely.
Deciding not to disclose…
41
If you have any questions:
Carol Osborne
Bryan Cave 88 Wood Street, London EC2V 7AJ
This presentation was provided as an educational service. It is an overview only, and should not be construed as legal advice or advice to take any specific action. If you have questions regarding any of the content contained in this presentation, we recommend you seek the assistance of a knowledgeable legal professional.
Thank you!
Disclosure Schedules in M&A
Hot Topics: US and EU
Data Privacy
Alexander Davie
Overview of US Data Privacy Law
• California Online Privacy Protection Act – Requires Privacy Policy
• Federal Trade Commission Act – Requires you to follow privacy policy
• General Principal: privacy is an issue of contract between the parties and only truthful disclosure is mandated.
• Special Categories: HIPAA, Gramm Leach Biley
43
EU Data Protection Directive
• In general, data collection, use, and sharing is much more strictly regulated
• Must register with member state authorities
• Must process data fairly, lawfully, and only for the purposes it is collected
• Cannot transfer data on EU citizens out of EU unless there is an “adequate level of protection.”
• Has broad territorial scope
44
Applications: What is personal data in the EU? The Data Protection Directive defines personal data as "any information relating to an identified or identifiable natural person" (Article 2(a)). As a rule, personal data includes: • Personal details. • Family and lifestyle details. • Education and training. • Medical details. • Employment details. • Financial details. • Contractual details (for example, goods and services
provided to or by a data subject). 45
Cross Border Transfers from EU to US
US does not provide adequate level of protection, therefore you can’t do it, unless there is an exemption:
• US Safe Harbor Filing – No longer available
• Model Contract Clauses • Binding Corporate Rules • Unambiguous Consent
46
Application to Preparation of
Disclosure Schedules
47
Applications: Employees
Schedule X lists, with respect to each Employee, such Employee’s name, position, current rate of compensation, and any entitlement to bonus, commission, severance or other additional compensation, and indicates whether any such Employee is on leave of absence, short-term disability or other similar status.
48
Applications: Suppliers and Customers Schedule X contains an accurate and complete list, and Seller has delivered to Buyer accurate and complete copies, of (i) each Seller Contract that involves performance of services or delivery of goods or materials by Seller of an amount or value in excess of ______ dollars ($______); and (ii) each Seller Contract that involves performance of services or delivery of goods or materials to Seller of an amount or value in excess of ______ dollars ($______).
49
Options?
• Anonymous Format
• Redacting Names is NOT enough
• Obtain consent
50
Dealing With Substantive Data Privacy Law in
Disclosure Schedules
51
Substantive Data Protection Law: Privacy Policies Schedule X identifies each Company Privacy Policy and with respect to such Company Privacy Policy: (A) the period of time during which such privacy policy was or has been in effect, (B) whether the terms of a later Company Privacy Policy apply to the data or information collected under such privacy policy, and (C) if applicable, the mechanism (such as opt-in, opt-out, or notice only) used to apply a later Company Privacy Policy to data or information previously collected under such privacy policy. A copy of each Company Privacy Policy has been provided to Buyer.
52
Substantive Data Protection Law: Types of Data Collected
Schedule X describes the types of all User Data collected by or on behalf of the Company.
53
Substantive Data Protection Law: Technologies Used
Schedule X sets forth a list of technologies the Company uses to collect User Data.
54
Substantive Data Protection Law: Identify Databases & Security Schedule X contains a list of the names of each distinct electronic or other database which contains (in whole or in part) User Data maintained by or for the Company, the types of User Data contained in each such database, and the security policies that have been adopted and maintained with respect to each such database.
55
Substantive Data Protection Law: Contracts with Third Parties Except as set forth Schedule X, in connection with each third party vendor, outsourcing entity or similar third party that has access to the User Data, Company has entered into a written agreement that requires the third party to comply with all applicable Laws with respect to the User Data including implementing and maintaining appropriate physical, administrative and technical safeguards to protect the User Data; restrict use of the User Data to only those with a need to know; and afford Company the right to audit the places of business and systems to test such third party's compliance with the foregoing.
56