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M&A Disclosure Schedules: What They Are and Why They Matter

What are Disclosure Schedules?

Disclosure schedules are formal legal attachments that accompany the definitive purchase or merger agreement in an M&A transaction. Think of disclosure schedules as a series of exhibits to the definitive agreement. The content of the disclosure schedules is either “incorporated into” the definitive agreement, or it qualifies and supplements the terms and provisions of the definitive agreement. Among other things, disclosure schedules also serve as formal legal informational documents in an M&A deal where virtually every element of the acquired business is disclosed by the seller to the buyer in writing. 

Why do Disclosure Schedules Matter? 

One key function of disclosure schedules is the identification and description of the inner workings of the acquired business. For example, a buyer wants to have an organized location and list of the key contracts of the target business, the seller’s financial statements, a list of personnel of the business (and their terms of employment or engagement), the meaningful intellectual property, the seller liabilities not intended to be assumed by the buyer (think lawsuits or unpaid taxes, for example), and much more. While you might ask why buyers don’t obtain this information during due diligence, the answer is they do, but the information is only as good as what the seller provides. So, the disclosure schedules not only formalize and aggregate due diligence information on the target business in a central and organized document, but the formality of disclosure schedules (and the information included or not included in them) has legal consequences for the seller. From this perspective, properly prepared disclosure schedules provide buyers with a level of risk insulation.

Disclosure schedules are equally (or more) important for sellers and their own risk insulation in M&A deals. First, most M&A sellers provide representations and warranties on virtually every – if not every – aspect of their business. The disclosure schedules provide sellers with the opportunity to address and manage liability concerns in instances where “unqualified” representations and warranties cannot be given without the seller breaching the rep. 

  • Simple example 1: “The business has always paid its taxes except for immaterial local taxes where we believe they are not legally owed as described in Section ABC of the disclosure schedules.” 
  • Simple example 2: “The business has always prepared its financial statements in accordance with GAAP, except as described in Section XYZ of the disclosure schedules.” 

In both examples, the seller has avoided breaching a representation and warranty that it would otherwise have breached absent the disclosure (“we’ve always paid our taxes” – which isn’t true in example 1, and “we’ve always prepared our financials in accordance with GAAP” – which isn’t true in example 2). In each case, and assuming the disclosure was adequate (particularly in the case of example 2), the seller would avoid liability for any resulting liabilities to the buyer from the local tax issue in example 1 or deviations from GAAP accounting in example 2.

Proper disclosure alerts the buyer to the possible issue and permits it to make a decision about whether it will willingly accept the liability, or request some other protections from the seller, such as an escrow holdback of some amount to address any resulting issue, a written affirmation from the seller providing for indemnification on the issue, and/or some other mutually acceptable outcome agreed by the parties in the definitive agreement (i.e., subsequent lawsuit avoided). 

What Happens if Disclosure Schedules Don’t Include Required Information or are Incorrect? 

At a baseline minimum, a seller breaches the underlying representation and warranty if it: (a) does not disclose information required by the rep/warranty, or (b) discloses the information incorrectly. In either case, if the buyer incurs any liability associated with the underlying matter, the seller will be contractually obligated to indemnify the buyer.  

If the seller’s failure to disclose the information is intentional or reckless (or if the disclosure made is intentionally or recklessly incorrect or misleading), then arguably the seller has committed fraud. This is especially problematic for a seller because the seller’s indemnification liability in such instances will rightfully be outside of customary contractually negotiated limits on the amount of indemnification which buyers may claim for breaches of representations/warranties. What’s more is that “civil fraud” can and does occur in M&A deals where sellers are perfectly genuine and ethical individuals with no desire to ‘defraud’ anyone in the typical sense. Civil fraud or its equivalent (like securities fraud) can occur simply as a result a seller’s failure (even if no sinister motive exists) to disclose information that a reasonable buyer would be expected to consider in the ‘mix of available information’ in making the decision to purchase the business or not. In short, plenty of fair-hearted M&A sellers have been sued for fraud around issues of disclosure and non-disclosure in M&A.   

Types of Information Included in Disclosure Schedules

While the nature and extent of disclosure information depends on the deal, the items below outline some of the more common types of information M&A sellers must include in disclosure schedules:

  • Material contracts 
  • Employees and employee benefit plans
  • Financial statements and accounting matters
  • Key customers and suppliers
  • Title to assets and indebtedness
  • Pending litigation 
  • Tax information
  • Insurance policies
  • Compliance with laws
  • Intellectual property
  • Licenses and permits

Conclusion

Preparing proper disclosure schedules is a tedious and time-consuming, but important aspect of M&A, especially for sellers. Even the most seasoned business owner can run into significant legal issues when preparing disclosure schedules. Like most of M&A, it’s highly advisable that you have a seasoned M&A attorney on your side to assist with the preparation and review of disclosure schedules, as well as to advise you regarding the impact they will have on the representations and warranties made in the definitive agreement. At Linden Law Partners, we’ve advised hundreds of business owners on all aspects of M&A. Contact us to discuss how we can help.  

© 2021 Linden Law Partners, LLC. All rights reserved.

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Linden Law Partners

Linden Law Partners is a boutique law firm that represents clients throughout their business life cycles, from formation to exit. We are business and transactional law specialists with extensive experience in all aspects of corporate law and governance, partnerships, joint ventures, emerging companies, private equity and venture capital, private and public securities offerings, and mergers and acquisitions. We offer clients big firm experience at a better price.

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