M&A Disclosure Schedules: Seller and Buyer …media.straffordpub.com/products/m-and-a-disclosure...2017/01/12 · Seller’s operations (CFO, General Counsel, Chief of Operations,

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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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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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


Thank You!

If you have any questions . . .

Peter D. Feinberg

(408) 947-2427

[email protected]

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

[email protected]

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


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


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

If you have any questions: Alexander Davie Riggs Davie PLC (615) 690-4419

[email protected]

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