So what exactly is a disclosure letter or
disclosure schedule (US)?
In simple terms, it's a formal document where the seller discloses all relevant information about their company's operations before a deal closes. Think of it as a detailed confession letter: the seller from future lawsuits and the buyer from nasty surprises. These letters qualify the warranties and representations made in the main sale agreement by disclosing exceptions, potential problems, and anything that might affect the deal's value.
Sounds simple, right? But, as with most things in M&A, it goes a little more in-depth.
Why is a Disclosure Letter Important?
Here's the thing about M&A deals: they're built on trust, but verified through paperwork. The disclosure letter is the verification system.
Buyers want comfort that what they’re buying is exactly what they think it is. Sellers want to avoid future lawsuits if things turn out to be less shiny than they looked at first glance.
When a seller makes warranties in a sale agreement, saying things like "we have no pending lawsuits" or "all our contracts are valid", they're essentially making promises about their business. But what happens when there are exceptions to these promises? That's where disclosure letters come in.
The disclosure letter serves three critical functions:First, it protects the seller from breach of warranty claims. By disclosing known issues upfront, sellers can't be sued later for misrepresentation.
Second, it gives buyers a complete picture of what they're actually purchasing - warts and all.
Third, it creates a clear record of what both parties knew at the time of signing, reducing disputes down the road.
Think of it this way: if buying a company is like buying a house, the disclosure letter is your inspection report. You wouldn't buy a house without knowing about the leaky roof, right?
The Anatomy of a Disclosure Letter
Let's break down what actually goes into these documents. A typical disclosure letter includes several key components that work together to paint a complete picture.
The introduction sets out which agreement the letter relates to and identifies the parties involved. It confirms that the disclosures are being made against specific warranties in the main agreement.
The general disclosures section covers information that's publicly available or already known to the buyer. This might include:
- Information available from public records (like Companies House filings in the UK)
- Laws and regulations that apply generally to the business
- Documents already seen by the buyer during due diligence
- Details from annual reports
The specific disclosures form the meat of the document. These are organised to match the warranties in the
sale agreement, making it easy to see which promises have exceptions. Each disclosure should be clear, specific, and detailed enough to give the buyer fair notice of the issue. They include:
- Listing ongoing litigation
- Highlighting key customer contracts that are due to expire soon
- Mentioning known environmental issues at a factory site
Here's what makes a good specific disclosure: it identifies the exact warranty being qualified, describes the issue completely, and provides enough detail for the buyer to assess its impact. Vague statements like "there may be some disputes" won't cut it—you need specifics.
Example 1: The Hidden Litigation Surprise
Let's share a fictitious situation that demonstrates why disclosure letters are critical.
A technology company was being acquired for $50 million by a larger competitor. During negotiations, the seller warranted that there was "no litigation pending or threatened" against the company.
Sounds simple enough, right?
But here's where it got interesting.
Three weeks before closing, the seller's legal team discovered that a former employee had sent a letter threatening to sue for patent infringement. The letter had been sitting in the HR department's files, and nobody had connected the dots.
The seller faced a choice: stay silent and risk a massive breach of warranty claim later, or disclose it in the disclosure letter and potentially kill the deal.
They disclosed it.
The disclosure letter specifically stated: "On [date], the Company received correspondence from [former employee] alleging infringement of patent [number] and indicating intention to commence legal proceedings. No formal claim has been filed. The Company's legal advisors believe the claim has no merit."
The result? The buyer's lawyers investigated, agreed the claim was weak, and the deal proceeded, but with a $500,000 holdback from the purchase price to cover potential legal costs. Without the disclosure letter, the buyer could have sued for breach of warranty and potentially unwound the entire deal or claimed the full $50 million purchase price should be adjusted.
This example shows the disclosure letter doing exactly what it's supposed to do: creating transparency that allows deals to move forward despite imperfections.
Real-World Example 2: The Tax Problem That Wasn't
Here's another scenario that highlights the strategic importance of disclosure letters.
A mid-sized manufacturing company was being sold to a private equity firm for $75 million. During final due diligence, the seller's accountants identified a potential tax issue related to certain R&D tax credits claimed in previous years. The tax authority hadn't challenged these credits, but there was a possibility - maybe 20% - that they could be disputed.
The financial impact, if challenged? Approximately $2 million in back taxes plus penalties.
The seller disclosed this in the disclosure letter with full supporting documentation (the need for supporting documents/bundles attached to the disclosure letter is routine in the UK): "The Company has claimed R&D tax credits totalling $[X] in fiscal years [dates]. While management believes these claims are valid based on [technical justification], there is no advance clearance from tax authorities, and the statutory review period remains open."
What happened next was interesting.
Rather than walking away or demanding a huge price reduction, the private equity buyer negotiated a specific indemnity for this exact issue. The purchase price remained at $75 million, but the sale agreement included a clause where the seller would cover any liability if the tax credits were successfully challenged, up to $2.5 million.
Everyone walked away happy. The seller got their full price, the buyer got protection, and the disclosure letter made it all possible by facilitating an honest conversation about risk.
Common Mistakes That Could Cost You the Deal
Let's talk about what not to do, because these mistakes have blown up deals more times than we can count.
Mistake 1: The "Kitchen Sink" Approach
Some sellers think they should disclose everything to protect themselves. They dump hundreds of pages of irrelevant information into the disclosure letter, hoping to hide important issues in the noise.
Bad idea. Buyers and their lawyers aren't stupid. When you bury important disclosures in a mountain of trivial ones, you're not protecting yourself, but creating grounds for a claim that you failed to make "fair disclosure." Courts have repeatedly held that disclosure must bring matters fairly to the buyer's attention.
Mistake 2: Vague Language
If disclosures are too vague (“some supplier disputes exist”), they may not protect the seller. Specifics matter.
Writing something like "There may be issues with some customer contracts" is essentially worthless. Which contracts? What issues? How serious are they?
Effective disclosure requires specificity. If there's a problem, spell it out clearly: "The contract with [Customer Name] dated [date] contains a change of control clause that may allow termination upon completion of the transaction."
Mistake 3: Last-Minute Bombshells
Dropping major disclosures on buyers 24 hours before closing is a recipe for disaster. Yes, you're technically making disclosure, but you're also destroying trust and potentially giving the buyer grounds to walk away or renegotiate.
Smart business sellers conduct thorough due diligence on themselves early in the process and make disclosures progressively. This gives everyone time to address issues constructively.
Here are a couple more common pitfalls worth mentioning:
- Inconsistency: If disclosures contradict information in the due diligence documents, it raises red flags and could derail trust. Courts can intervene and rectify a disclosure letter that fails to reflect the parties’ genuine intention - see Persimmon Homes Ltd v Hillier EWCA Civ 800, where the Court of Appeal upheld rectification of both the SPA and disclosure letter.
- Late Delivery: A rushed disclosure letter, delivered right before signing, leaves little time for buyers to properly review.
The Buyer's Perspective: What to Look For
If you're on the
buy-side of an M&A deal, the disclosure letter is one of your most important tools for understanding what you're actually purchasing.
Read it carefully- twice. First, read through the entire letter to get a sense of the types and magnitude of issues disclosed. Then, go through it systematically, checking each disclosure against the corresponding warranty in the sale agreement.
Pay special attention to these red flags:
Volume discrepancies: If one warranty has dozens of disclosures while others have none, ask why. Is the seller being selective about what they investigate and disclose?
Vague or incomplete disclosures: Any disclosure that raises more questions than it answers requires further investigation. Don't let sellers get away with half-disclosures.
Cross-referencing to masses of documents: When a disclosure says "see attached 500-page document," that's not proper disclosure. You need clear signposting to the specific issues that matter.
Financial disclosures that don't match the numbers: If it mentions liabilities or commitments that don't appear in the financial statements you've reviewed, dig deeper.
Buyer vs Seller: Who Benefits More?
It’s a balancing act. The seller benefits by limiting their liability. The buyer benefits by knowing exactly what they’re getting into. If done properly, a disclosure letter creates transparency and reduces post-deal disputes.
But buyers should stay sharp. Just because something is disclosed doesn’t mean it’s no big deal. For example, a disclosed dispute with a key supplier might mean the buyer needs to renegotiate the purchase price or add indemnities to cover the risk.
Negotiating Disclosure Letters: The Art of the Possible
Here's where things get really interesting. The disclosure letter is a key negotiation point that can significantly impact deal dynamics.
Timing matters. Buyers often request the first draft of the disclosure letter early in due diligence. This makes sense as it helps identify issues while there's still time to address them. Sellers sometimes resist, preferring to wait until closer to signing. Understanding both perspectives helps you negotiate more effectively.
Scope is negotiable. Some buyers push for "full and fair disclosure" standards that require sellers to disclose anything that might be relevant. Others accept that disclosure is limited to what the seller "actually knows." This difference can be huge in terms of the seller's disclosure burden and potential liability.
The "general disclosures" debate: Buyers often try to limit what can be included in general disclosures, arguing that only specific, flagged issues should count. Sellers want broader general disclosure buckets. Where you land on this affects how much work the seller must do and how much protection they get.
Best Practices for Creating Effective Disclosure Letters
Whether you're a buyer, seller, or advisor, following
M&A practices will help you navigate disclosure letters.
Start early and be thorough. As previously mentioned, don't wait until the last minute to identify issues requiring disclosure. Conduct internal due diligence early in the process to give yourself time to craft proper disclosures and address any concerns.
Be specific and clear. Every disclosure should identify the exact warranty being qualified, describe the issue completely, and provide sufficient detail for a reasonable buyer to understand the potential impact.
Organise logically. Structure your disclosure letter to match the warranties in the sale agreement. Use clear headings, numbering systems, and cross-references that make it easy to navigate.
Include supporting documents wisely. When you need to attach supporting documents, make sure to clearly reference the specific relevant portions. Don't just dump 300 pages of contracts and expect the buyer to figure it out.
Keep updating. Disclosure letters should be updated right up until closing if new issues arise. A disclosure made at signing might not protect the seller if they learned about an issue weeks earlier but failed to disclose it.
Get legal advice. This probably goes without saying, but disclosure letters have significant legal implications. Work with experienced M&A lawyers who understand the nuances of what constitutes effective disclosure in your jurisdiction.
Why Disclosure Letters Protect Deals & Moving Forward
If you're working in finance or legal roles at major corporations, understanding disclosure letters is essential. These documents sit at the intersection of law, finance, business strategy, and negotiation.
Master them, and you'll stand out.
For legal professionals, expertise in crafting and reviewing disclosure letters is a valuable skill that can accelerate your career in corporate law, particularly in M&A practices.
For finance professionals, understanding how disclosure letters affect deal valuation, risk allocation, and post-closing adjustments is crucial for anyone involved in corporate development, private equity, or investment banking.
For business executives, knowing how disclosure letters work helps you better manage M&A processes, whether you're buying, selling, or advising on transactions.
The technical knowledge you gain from understanding disclosure letters and M&A processes more broadly directly translates to career advancement opportunities. It's the kind of specialised expertise that opens doors to senior roles and higher compensation.
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FAQ
What is the role of lawyers in disclosure letters?
Lawyers are critical here. They draft, negotiate, and review disclosure letters with a fine-tooth comb. A poorly drafted disclosure letter can leave sellers exposed and buyers misinformed. Both sides need advisors who know the market standards and can push back on overreach.
For instance, buyers’ lawyers might insist that disclosures be clearly cross-referenced to warranties in the SPA. Sellers’ lawyers, on the other hand, push for broader general disclosures to minimise liability.