Disclosure schedules are one of the most important — and most frequently underestimated — documents in any M&A transaction. They are the mechanism by which the seller qualifies its representations and warranties, setting out specific exceptions, facts, and circumstances that modify the general statements made in the purchase agreement. A well-crafted set of disclosure schedules protects the seller from post-closing indemnification claims; a poorly crafted set exposes the seller to liability for items that should have been disclosed. Understanding the strategy and mechanics of disclosure schedule preparation is essential for any business owner selling a company.
The Function of Disclosure Schedules
The purchase agreement contains a series of representations and warranties in which the seller makes statements about the business: that the financial statements are accurate, that all material contracts are listed and are in good standing, that the company is in compliance with applicable law, that there is no pending or threatened litigation, that the company has all required permits and licenses, that its intellectual property is owned free and clear, and so on. Each of these representations is a general statement that cannot literally be true without qualification — there will be contracts with unusual terms, compliance issues that are being addressed, litigation that has been threatened, permits that are pending renewal.
Disclosure schedules allow the seller to qualify these general statements with specific exceptions and facts. If the representation states that the company is in compliance with all applicable laws, the disclosure schedule can list any known instances of non-compliance that the seller wants to disclose. If the representation states that no litigation is pending, the schedule can list any pending or threatened litigation. The legal effect of a proper disclosure is that the buyer cannot claim the seller breached the representation with respect to a matter that was properly disclosed on the schedule.
The protection afforded by the disclosure schedule is fundamental to the seller’s indemnification risk management. If an issue is properly disclosed, it does not give the buyer grounds for an indemnification claim. If an issue is not disclosed but should have been, the seller faces potential liability for the resulting losses. For sellers with representations and warranties insurance, the disclosure schedule interacts with the insurance policy as well — disclosed matters are generally excluded from coverage (because the buyer knew about them), but undisclosed matters that breach a representation may be covered.
What Constitutes Adequate Disclosure
Not all disclosure is equal. Adequate disclosure requires that the facts disclosed are described with sufficient specificity to give the buyer a fair understanding of the nature and scope of the disclosed matter. A cryptic or incomplete disclosure — one that identifies a general issue without providing the details a buyer would need to assess it — may not constitute effective disclosure of all the information it was intended to cover. Sellers should err on the side of more detail rather than less, while being careful not to include information that creates new problems rather than resolving existing ones.
The applicable standard for disclosure varies by jurisdiction and by contract. Some purchase agreements provide that disclosure on one schedule qualifies all representations in the agreement (a “cross-reference” standard), regardless of whether the disclosed item would logically apply to the specific representation it qualifies. Other agreements provide that disclosure on one schedule only qualifies the specific representation to which that schedule relates (a more restrictive standard). The drafting of the disclosure qualification provision in the purchase agreement is itself an important negotiating point.
Bring-Down Conditions and Disclosure Updates
Most M&A purchase agreements include a bring-down condition that requires the seller’s representations and warranties to be accurate at closing (as well as at signing) as a condition to the buyer’s obligation to close. If a representation is accurate at signing but becomes inaccurate between signing and closing, the buyer may have grounds to refuse to close. This creates a question about the seller’s ability to update the disclosure schedules between signing and closing to reflect new developments.
Most purchase agreements include a mechanism for the seller to supplement or update the disclosure schedules between signing and closing to reflect new developments that arise after signing. The key question is whether a disclosure update can cure a bring-down failure. Different purchase agreements handle this differently: some allow updates only for matters that arise after signing (not to remedy pre-signing omissions discovered after signing), some allow updates but give the buyer a right to terminate if the updated matter is material, and some do not allow updates to cure bring-down failures at all.
Sellers should negotiate for a meaningful ability to update disclosure schedules between signing and closing, particularly in transactions with a long pre-closing period during which the business continues to operate and new matters arise. Buyers resist broad update rights because they create uncertainty about what they are acquiring. The negotiated outcome typically allows updates for matters arising after signing, with a materiality threshold and a buyer termination right for material updates.
The Strategic Decision: What to Disclose
The strategic question in disclosure schedule preparation is not just what must be disclosed to avoid a breach of representation, but also what should be disclosed as a matter of strategy. Sellers sometimes resist disclosing issues because they fear that disclosure will give the buyer ammunition to demand a price reduction or will signal a weakness in the business. This calculation is typically misguided: a buyer who discovers an undisclosed issue during post-closing operations (or during the due diligence process) is far more likely to react negatively than a buyer who encountered the same issue in a properly disclosed and contextualized disclosure schedule.
The risk of under-disclosure is also greater than many sellers appreciate. In addition to creating direct indemnification exposure, under-disclosure can constitute misrepresentation that gives the buyer grounds to rescind the transaction or to seek damages beyond the contractual indemnification cap (in cases of fraud or intentional misrepresentation). Sellers and their counsel should approach disclosure schedule preparation with a clear-eyed and comprehensive view of the company’s risk landscape, with the goal of producing schedules that are accurate, complete, and sufficiently specific to provide genuine protection.
Over-Disclosure: A Different Risk
While under-disclosure is the more commonly discussed risk, over-disclosure has its own problems. Including too many items in disclosure schedules — particularly items that are trivial, speculative, or unrelated to the representations they purport to qualify — can muddy the disclosure with noise that makes it difficult for the buyer to identify the genuinely important issues. It can also create unexpected problems: disclosing a matter against one representation may have unintended consequences for the seller’s position under a different representation if the cross-reference standard applies.
Additionally, disclosure schedules are complex documents that are reviewed and relied upon by buyers, their counsel, and their due diligence teams. A disclosure schedule that is disorganized, incomplete, or internally inconsistent creates an impression of disorganization that can undermine the buyer’s confidence and lead to heightened scrutiny. The most effective disclosure schedules are those that are well-organized, clearly cross-referenced to the relevant representations, and prepared with the assistance of experienced M&A counsel who can help the seller identify what must be disclosed, how it should be framed, and what level of detail is appropriate.