So you are looking to sell the business that you've spent the last 20 years building up from scratch. You've engaged a financial adviser, signed up interested parties to a confidentiality agreement and gone through the due diligence process. You've received indicative offers, and selected a preferred bidder. Next thing you know, you get an email from the preferred bidder attaching a 100 page sale agreement. So what are the most critical provisions to which you need to pay the most attention?
The disclosure/information warranty
It is usual for a seller in a sale transaction to warrant the quality of the due diligence materials provided to the buyer. Small differences in the wording of this warranty can make an enormous difference to the content of the seller's promise regarding the quality of the due diligence materials and hence the allocation of risk between the parties.
Consider the following warranty:
"The Seller warrants that:
all information contained in the Due Diligence Materials is true, accurate and not misleading (including by way of omission); and
the Due Diligence Materials include all information relating to the Business which is material to a purchaser of the Business in assessing or in entering into the transactions contemplated by this agreement."
This is an extremely buyer-friendly warranty because the seller is making two promises to the buyer.
First, the seller is promising every single piece of information in the Due Diligence Materials is correct and not misleading. It won't matter if:
- it is historical or factual in nature or is instead in the nature of a forecast, prediction or projection;
- the seller didn't know facts or circumstances which made the information incorrect or misleading;
- it was correct at the time of its preparation, but is now, some time later, no longer correct; or
- the information was prepared by a third party, not the seller.
Secondly, the seller is promising the Due Diligence Materials contain all information that would be relevant to the buyer's decision to purchase the business and what price to pay for it, regardless of whether the seller was aware that any information was missing.
A well advised seller would probably have resisted giving such a warranty, and instead pushed for a more seller-friendly warranty under which the seller:
only gives the warranty to the extent of its awareness. Unlike the buyer-friendly version, here the buyer assumes the risk of the unknowns (whether or not the seller could be aware of those matters);
only warrants that the due diligence materials overall are not misleading or deceptive, as opposed to every single piece of information;
gives a promise as to the quality of the due diligence materials which does not extend to forecasts, predictions or projections (so it's restricted to historical or factual matters), or third party information; and
is not promising that the due diligence materials are comprehensive, in that they include all material which is relevant to a purchaser of the business or the price to pay for the business.
Additionally, it may be appropriate for a seller to specify that certain information contained in the due diligence materials is correct only at the time it was prepared, and also to have a separate warranty for financial accounts (ie. to carve out financial accounts from the due diligence materials warranty).
Even if a seller is successful in negotiating something closer to the seller-friendly version of this warranty, it will most likely still face some level of risk in agreeing to it. The most effective way to address that risk (and thereby reduce the likelihood of sale proceeds being clawed back or reduced) is for the seller to:
commence collecting proposed data room materials some time ahead of the sale process kicking off;
review materials collected for errors and gaps, then proceed to rectify these;
closer to finalisation of the sale, when senior staff are aware of proposed transaction, undertake a verification exercise involving senior staff to test correctness and adequacy of the due diligence materials.
Qualification of warranties by disclosure
It is fairly standard practice for the warranties given by a seller in a sale agreement to be qualified by matters which are "fairly disclosed" in the due diligence materials (ie. the data room) or the disclosure letter given by the seller.
This means that not every single fact, matter or circumstance that is disclosed in the due diligence materials or the disclosure letter will qualify the warranties given by the seller. For example, a single line reference to a particular business contract buried in a 200 page report will in all likelihood not constitute fair disclosure of that business contract.
What this means is that where a matter is not plainly self-evident on the face of the due diligence materials (ie. it would require some deduction or inference on the part of the reader), then a well advised seller would expressly refer to that matter in the disclosure letter. This avoids the risk that the matter will be taken to have not been fairly disclosed in the due diligence materials.
While this will put the matter front of mind for the buyer, this is probably better for the seller than worrying if it has fairly disclosed the matter and thereby passed on the risk to the buyer.
A seller who has carefully compiled (and has a thorough understanding of) the due diligence materials, and verified the matters proposed to be disclosed in the disclosure letter with relevant senior management at the appropriate stage of the sale process, will be much better placed to know what matters should be highlighted in the disclosure letter and to reduce its risks accordingly.
What else should be considered?
In the next part of this article we'll look at what might seem straightforward issues, but can really give rise to significant headaches for sellers: what are you selling or transferring to the buyer, how much money are you getting – and how many risks remain after the transaction?
Thanks to Adrian Quah for his help in writing this article
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