M+A: Fair disclosure & sale agreements

Disclosure

It is not uncommon for sellers and their advisors to make extensive disclosures prior to a sale contract being signed.  This process is referred to as due diligence and is typically undertaken by uploading information to a secure server (referred to colloquially as the data room) that only certain people associated with the transaction have access to. Inspections are carried out on-line and information about the target/transaction can be downloaded and/or printed as required. This process of uploading documents is often complemented with a Q+A process whereby the buyer and its advisers ask question of the seller and its advisers who reply by uploading answers to the secure server.

Reliance

If as a result of this due diligence process a buyer and/or its advisers become aware of facts that have been fairly and accurately disclosed in the data room (or possibly in discussions that occur concurrently with the due diligence process) and the buyer/its advisers fail to address the concern raised by the disclosure and proceed to complete the transaction they may encounter significant legal obstacles to bringing a claim for breach of warranty or misrepresentation if subsequently that disclosed fact/problem results in the buyer suffering loss or damage.  This is because the seller is put in a positon where it can often successfully argue that the buyer did not rely upon the truth of the warranty/representation and is therefore not liable for any losses or damages that the buyer may subsequently suffer. The court in the case of Australian Receivables Ltd v Tekitu Pty Ltd (Subject to Deed of Company Arrangement) (Deed Administrators Appointed) & Ors [2011] NSWSC 1306 at [305] explained the positon this way:

“Common law damages for breach of a contractual warranty will not be awarded to a party who has not relied on the alleged truth of the warranty because in those circumstances the breach of warranty is not causative of any loss. In Accounting Systems 2000 (Developments) Pty Ltd v CCH Australia Ltd (1993) 114 ALR 355, where a majority of the Full Court of the Federal Court (Northrop J dissenting) held that because warranties in the copyright assignment agreement were false there was misleading or deceptive conduct, Lockhart and Gummow JJ made it clear that the representee must be able to establish loss or damage suffered through reliance on the truth of that warranty in order to be granted relief. It followed that if there was no reliance on the truth of the warranty (i.e. if the representee had knowledge that the information warranted was not, in fact, true) then relief could not be obtained.”

What constitutes fair disclosure?

It is not uncommon in a well drafted sale agreement for a formulation of words to appear in that document that has the effect of limiting the seller’s liability under the sale agreement when there has been fair disclosure of a fact/problem.  When acting for a seller we would typically seek the inclusion of a provision in these terms:

“Each Warranty is qualified by, and the Purchaser and any related body corporate of the Purchaser may not make any Claim for, anything:

  • fairly disclosed in the Disclosure Materials; or
  • of which the Purchaser has actual knowledge prior to entering into this document.”

In another part of the share sale agreement we would require it to state:

“For the purposes of this clause x1, a fact, matter or circumstance is ‘fairly disclosed’ if sufficient information has been disclosed that a reasonable investor, experienced in transactions of the nature of this sale of shares would be aware of the substance and significance of the information and would be aware of the nature and extent of the breach of the Vendors’ Warranty. “

Conclusion

These clauses (including the procedures which underlie them namely the due diligence process) when coupled with common law concepts of causation and reliance operate to exculpate sellers who have made fair disclosure and highlight the need for buyers and their advisers to pay careful attention to the due diligence process.