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This article is written by Parul Shanker. Parul is a corporate lawyer based in Bangalore. She graduated from Campus Law Centre, University of Delhi in 2014. The article discusses How and Why to Make a Disclosure Schedule in M&A Transactions.

The Context

When investors make an investment (whether financial or strategic) in a company, they seek to minimise their exposure with regard to liabilities which may arise as a result of the past conduct of such company. One of the ways in which they do so is by seeking representations and warranties regarding certain key matters from the investee company and its promoters as part of the Share Subscription Agreement (‘SSA’) or the Share Purchase Agreement (‘SPA’), as the case may be. An SSA or an SPA is the document in which the parties put together the terms on which shares are subscribed or purchased respectively by investors in the current round. Most lawyers prefer to group together the warranties made by the investee company in a separate schedule (known as the ‘Warranties Schedule’) to the SSA for the purposes of ease of reference and clarity. Accordingly, various clauses in the SSA which depend on the warranties sought from the investee company in turn reference the above Schedule.

The investee company is required to provide these warranties even though the investors conduct separate due diligence exercises on the company to assess the risk associated with the particular investment. This practice of seeking warranties which are independent of the investors’ own findings assumes that the board members and promoters, being insiders in the investee company, are the persons who possess complete knowledge about its affairs and dealings, including issues which the investors’ due diligence fails to unearth.

In fact, in most cases, an investee company would not even receive the full due diligence report from the investors, because such a report is meant for the internal use of the investors and aids their decision making. However, in some, especially smaller transactions, investors do share their due diligence report with the investee company – which may serve as the starting point for the investee company’s lawyers to begin working on the Disclosure Schedule.

So, what is a Disclosure Schedule?

A Disclosure Schedule, as the name indicates, is a list of disclosures, generally in the form of a schedule to the SSA. These disclosures are exceptions to the representations and warranties made by the investee company in the transaction documents.

What is the purpose of a Disclosure Schedule?

A Disclosure Schedule provides the investee company the opportunity to disclose exceptions to the representations and warranties made by it under the Warranties Schedule.

Usually, an introduction to the Warranties Schedule in an SSA reads like this:

The Parties hereby agree that the Warranties hereunder shall be read and interpreted in conjunction with the relevant statements made in the Disclosure Schedule, and to the extent an exception to a specific Warranty is disclosed in the Disclosure Schedule, such exception shall not constitute a breach of the particular Warranty.

As is evident from the above sample wording, the aim of the Disclosure Schedule is to avoid a breach of warranty claim by the investors at a later date. In the absence of such disclosures, there exists a likelihood that the investors may claim a breach of warranty against as well as trigger an exit from the investee company. However, such a claim would fail if the facts that gave rise to the breach were disclosed as part of the Disclosure Schedule drafted and accepted by the parties during the relevant transaction.

Here I would like to clarify that disclosures under a Disclosure Schedule only help an investee company avoid breach of warranty claims – investors may, and in all probability will, ask the company and its promoters for indemnity protection regarding liabilities which may arise as a result of items listed in the Disclosure Schedule.

What to disclose under a Disclosure Schedule?

In order to minimise the risk of a breach of warranty claim, an investee company’s lawyers will seek to disclose as many exceptions to warranties as possible without making the disclosures vague or ambiguous. On the other hand, the investors’ lawyers would prefer to narrow down both the number and scope of such disclosures to protect their clients’ investments against liabilities which may be imposed on the investee company as a result of its past conduct.  

In my experience, warranties related to the following subject matters are most likely to require disclosures under the Disclosure Schedule:

  • Payment of taxes
  • Statutory filings
  • No loans due
  • No pending litigation
  • Exit of key employees
  • Absolute ownership of intellectual property
  • Rights of existing investors

Here are a few examples of warranties and probable exceptions/ disclosures which may be made against each of such warranties:

  • Sample Warranty 1: “The Company has not executed any prior agreements creating any special rights in favour of any other Person.”

Possible Disclosure: An agreement executed with an existing investor providing special rights to such investor. [Note: Followed by details of the relevant agreement and the specific rights provided to the existing investor.]

  • Sample Warranty 2: “All filings required to be made with the relevant Registrar of Companies have been made within the statutory time limit prescribed for the relevant filings.”

Possible disclosure: In the past, some forms may have been filed by payment of additional filing fee after the statutorily permitted timelines. There are no future financial liabilities that the Company may incur due to the aforementioned late filings.

  • Sample Warranty 3: Neither the Company nor the Promoter has given or agreed to give any guarantees or indemnities.

Possible disclosure: The Promoter has given a personal guarantee as a collateral to avail certain loans for the Company. [Note: Followed by details of the relevant loans and the agreement under which the guarantee was provided.]

Do lawyers use a Disclosure Schedule template?

No, lawyers do not use a template when drafting a Disclosure Schedule because disclosures in respect of each organisation are specific to its business and history and therefore cannot be standardized. In fact, because the parties face significant risks due to an incomplete or inaccurate Disclosure Schedule in any transaction, they negotiate and share multiple iterations of the Disclosure Schedule. More often than not, the final draft is significantly different from the version the parties began their discussions with.

What formats may be used to make the disclosures?

Disclosures may be listed either in a schedule attached to the SSA or in a separate letter from the company or the promoter to the investors. In both of the above formats, each disclosure must be mapped to a specific warranty in the SSA in order to fortify such exception against that particular warranty. Sometimes the same disclosure may be required to be made in respect of multiple warranties.

Disclosures must also be supported by copies of relevant documents. These documents together with the Disclosure Schedule constitute the Disclosure Bundle.

Avoid these common mistakes

The mistakes which a party may make when drafting and negotiating a Disclosure Schedule depends on whether it is the investee company or an investor.

In the event the party is the investee company, the company should be wary of making the following mistakes:

  • Not taking note of all warranties in the transaction documents

When an investee company’s lawyers go through the transaction documents, they must mark all warranties sought from the company in these documents and include them in the Warranties Schedule. This makes it easier to refer and disclose exceptions against such warranties in the Disclosure Schedule. It also reduces the chances of missing a necessary disclosure.

  • Not disclosing all exceptions

The investee company must ensure that disclosures against each such warranty which has an exception are included in the Disclosure Schedule. The above holds true even if: (a) a particular disclosure is required to be made in respect of multiple warranties; or (b) the investor is aware of the relevant exception.

  • Making vague disclosures

There is a high chance that courts will hesitate to throw out a breach of warranty claim made by the investors if a disclosure is too vague or ambiguous.

  • Failure to involve the employees with the required knowledge

While it is neither possible not advisable to involve each employee in the investment process, when the senior management of a company fails to seek comments from those employees who have the necessary knowledge regarding the subject matter of warranties sought by the investors, the company faces a significant risk of missing out on making a required disclosure.

On the other hand, an investor should:

  • Avoid accepting wide disclosures

An investor must resist wide disclosures in the Disclosure Schedule because such disclosures may end up diluting the strength of a breach of warranty claim if such a need arises in the future.

  • Raise enquiries about disclosures

An investor must raise enquiries about and discuss the disclosures made by the investee company in the Disclosure Schedule in order to fully understand and negotiate the scope of such disclosures.

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