A disclosure letter is a key document in many transactions, particularly business, asset and share sales. The seller provides this letter to assist with the buyer’s due diligence. It does this by outlining specific information which the buyer should know about the business, which will help inform their decision about whether they wish to proceed with the purchase. This article will explore common situations you may use a disclosure letter and what content it typically contains.
What is a Disclosure Letter Used For?
A disclosure letter is commonly used in business, share and asset sales to assist buyers with their due diligence. In these transactions, disclosure letters serve two main purposes.
1. Information Provision
A disclosure letter will provide the buyer with specific information that will inform their decision about whether they proceed with the purchase. This information can include background to the transaction and often supplements other documents the purchaser may have received. These other documents can include:
- profit and loss statements;
- key business contracts, including leases and employment agreements; and
- ASIC extracts.
Disclosure letters also provide the seller with an opportunity to update the purchaser. For example, the seller may want to disclose any changes to documents or previous information that requires updating.
2. Limitation of Warranties
A disclosure letter also serves the essential purpose of minimising the seller’s liability in the transaction. Accordingly, it can limit any warranties that the seller provides in the main sale contract. Examples of warranties that disclosures can impact are:
- share ownership in the company, including plans to issue options under an Employee Share Scheme;
- contracts that the business is a party to which may impact the buyer;
- employment obligations and employee entitlements for existing staff;
- loans that the company may be the guarantor of; and
- whether the entity is the only company in a group or if there are subsidiaries.
These are typical examples, and the disclosures made will vary greatly depending on the circumstances of the transaction. Accordingly, disclosure letters should set out any information about the sale asset that is inconsistent with warranties in the sale agreement. Therefore, if a seller’s warranty is incorrect or untrue, the purchaser will not be able to make a claim against the seller.
Form of a Disclosure Letter
Disclosure letters typically take the form of a letter which comprises of four main parts:
- introduction;
- general disclosures;
- specific disclosures; and
- annexures (if applicable).
However, each transaction is different, meaning the seller can draft disclosure letters in several ways.
1. Introduction
The introduction of the disclosure letter will clarify the letter’s purpose and identify the relevant sale agreement and the parties involved. It will also provide any necessary background information to the transaction and terms which need to be defined. Likewise, it is common to include a clause in the introduction which states that if there is any inconsistency between the disclosure letter and master sale agreement, the disclosure letter will prevail.
2. General Disclosures
Additionally, general disclosures are usually standard disclosures that could apply to any transaction. An example of one such disclosure is the assumption that the purchaser has knowledge of all available matters if they had conducted searches of public records. Thus, a seller assumes that the purchaser has performed a Personal Property Securities Register search or obtained an ASIC extract.
The parties’ lawyers will generally ensure that matters included in the general disclosures section do not overlap with matters already included in the sale agreement to prevent inconsistency and avoid confusion.
3. Specific Disclosures
The selling party usually provides specific disclosures that they tailor to the relevant transaction. For example, they may disclose specific warranties in the sale agreement by outlining how the disclosures relate to the warranties. This ensures that the buyer is aware of inconsistencies between disclosures in the disclosure letter and warranties in the sale agreement. The result is that the seller cannot claim a breach later on. Likewise, it is common to include these disclosures in a tabular form.
4. Annexure
Sometimes (but not always), a seller may want to refer to certain documents when making a specific disclosure. They can do this by annexing those documents, referred to as the disclosure bundle, to the disclosure letter. Doing so ensures the seller has provided full and frank disclosure. Likewise, the buyer is aware of any relevant documentation associated with the disclosures. Again, this helps avoid disputes later.
Once both parties finalise the form and content of their letter, they will attach it to the sale agreement. The seller must sign the letter and provide it to the buyer at completion. The buyer must also sign to acknowledge receipt of the letter and its disclosures.
Before buying a business, it is important to undertake due diligence, to verify the information supplied by the seller. This guide will walk you through the due diligence process.
Key Takeaways
Disclosure letters are a crucial document in business, asset and share sales. Likewise, it is an essential part of a buyer’s due diligence and is also important for the seller. It limits the warranties found in the master sale agreement, as the letter will usually prevail if there are inconsistencies between the two documents. Whilst there is no prescribed format of the letter, it will usually contain an introduction, general and specific disclosures and annexures if necessary.
For more information on using a disclosure letter or assistance with your business or share sale, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
Frequently Asked Questions
A disclosure letter is a key document in business, asset and share sales. It provides vital information to the buyer about the sale and limits the warranties of the seller.
Whilst there is no prescribed form of a disclosure letter, it usually contains an introduction and background information of the transaction, general and specific disclosures by the seller, and an annexure of any ancillary documents mentioned in the letter.
The seller will attach the letter to the master sale agreement. The parties then sign the full agreement (including the letter) upon completion.
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