Disclosure letters to share purchase agreements - Basics of the procedure and outline of Luxembourg market practice

A sale of shares and the related share purchase agreement commonly provide for warranties given by the sellers to the buyers. The warranties are statements of fact on which the buyers rely in making their decision on the acquisition. In the case of a sale of shares, these statements are about the shares being sold, the target company to which they relate and, as applicable, to the subsidiaries of the target company. The selling shareholders can incur liability for a breach if the warranties they have given to the buyers are incorrect or not true. 

As an initial step, it is necessary to specify which entities and/or persons are responsible for which warranties (e.g. title warranties, capacity warranties, business warranties). Among the deciding factors in allocating these responsibilities are the knowledge, information, belief and/or awareness in respect of such different warranty objects. Even though in the end it is the sellers who will actually give the warranties, the disclosure process itself might often include a wider group of individuals – e.g. persons with some particular relevant expertise - to ensure that all the relevant information is captured.

Usually, warranties set out an abstract state of affairs relating to the target company. This could be an absolute statement that there is “no litigation” or “no encumbrance” when in fact there is/are some. This is deliberate and designed to force disclosure of all matters and/or issues that should qualify the warranty concerned and to make these matters/issues known to the buyers. On this basis, the sellers will draw up a disclosure letter divided into ‘general disclosures’ and ‘specific disclosures’, which will set out these matters/issues. Such a set of disclosures will then constitute the qualification of and exceptions to the warranties.  

In turn, the disclosures in their entirety are supposed to take on the function of a ‘shield’ against potential warranty claims. This function can be realised to the extent the relevant matters/issues are disclosed fairly in the disclosure letter. If all the disclosures are fair, no breach of the warranties will occur.               

A disclosure is ‘fair’ as long as it is made in such manner and in such detail as to put the buyers in a position where they are able to recognise, identify or assess the matter/issue concerned. 

1. general disclosures

The general disclosures are placed in the initial part of the disclosure letter. Their content is publicly available information and searches that reasonable buyers would be expected to review/undertake as part of their due diligence. For example, although a matter for negotiation, the parties to the share purchase agreement (“SPA”) might agree to the general disclosure of: 

  • all matters described expressly with a reasonable level of detail in the vendor due diligence reports;
  • all information provided in publicly available approved annual accounts; and
  • all information provided in the data room.

2. specific disclosures

The specific disclosures can feature in an attached schedule. They are intended to draw out those statements, facts or documents that “qualify” the warranties in the SPA. The specific disclosures are tailored to the exact statements in the SPA and thus differ from the sweeping exceptions contained in the general disclosures.

In the run-up to the drafting of the specific disclosures against the warranties as well as other parts of the disclosure letter, the sellers should read the warranties carefully and note in respect of each of them if they consider that there is any matter/issue that should be disclosed against that warranty. This includes anything that the seller side considers make the warranty untrue and/or inaccurate in any way. If something is neither inaccurate nor untrue but may still make the statement misleading, or if the sellers are unsure about any matter/issue, they should nevertheless refer to it so that it can be analysed further. The rule is: if in doubt, disclose it. This is because disclosures to the warranties are protections from future claims being brought against the sellers and because they help the buyers to properly understand the business that they are investing in. 

If the sellers do not make a comment against a particular warranty, it will be assumed that they are not aware about anything that may need to be disclosed against the warranties contained in the respective section of the SPA.

Understandably, certain warranties will fall outside of the seller-side’s area of expertise or knowledge. For the sake of completeness, however, it is advisable that the sellers consider all of the warranties (at least at high-level) as this may trigger a thought about a potentially relevant disclosure. Going from there, input can be requested from relevant internal team leads and any third party advisors advising the target company in respect of the specialist areas in question on any potential disclosures, which may need to be made against the warranties. Such input is of vital importance and ought to be brought in.  

Warranties will differ from one another in terms of the depth of detail and exactness. A broader warranty might be one stating that there are no encumbrances on shares, whereas a more specific one might say that there are no encumbrances on shares stemming from share pledge agreements. Certain circumstances will qualify more than one of the warranties. If a more specific warranty is introduced about a topic where there is a general warranty, it is important to qualify the general warranty as broadly as possible. In the above example, the “no encumbrances on shares” warranty would cover encumbrances on shares stemming from share pledge agreements but it would also cover any other existing encumbrances on shares. In such cases where a disclosure would be relevant to more than one warranty, it is advisable to cross-refer in the disclosure to the other related warranties. 

Some of the warranties might be qualified by the expression “so far as the sellers are aware”, or similar. Such warranties should be considered in at least just as much – or more – detail. Anything within the knowledge or expertise of the person in charge of commenting on such a warranty that may or should qualify the warranty concerned should be thoroughly discussed, at least internally, before finalising the disclosure letter.  

By way of a final hint as to the workflow, it is common practice for the sellers’ lawyers to draft and circulate an internal procedure on preparing the disclosures, laying out the necessary steps and allocating responsibilities for research, checks and updates. With such a work schedule, it is much easier to correctly assess all the issues both from the sellers’ own business perspective as well as from the legal one. 

Torsten Sauer, Partner
William Tanguy, Counsel