Post-M&A Disputes Series: Disclosure

In Part 3 of this series, we consider disclosure and buyer’s knowledge (and the impact this has on a buyer’s ability to claim under warranties). In particular, the court in Learning Curve considered the concepts of “fair disclosure” and what is meant by actual (as opposed to imputed or constructive) knowledge.  In short:

• Warranties are usually qualified with reference to documents and information “fairly disclosed” in the “Disclosure Documents” (this typically includes the disclosure letter(s) including information incorporated by reference (e.g.: information on public registers) or appended (e.g.: information contained in the diligence Q&A) and a general disclosure of the entire contents of the dataroom, as well as specific disclosures about facts, matters or circumstances that expressly make a warranty untrue).
• The standard for “fair disclosure” (unless defined otherwise in the SPA) is reasonably high and to qualify the warranties effectively, a disclosure would need to make a positive statement as to the true position.  Raw data that provides only the opportunity for a buyer to identify the issue is unlikely to qualify the warranty.
• A limitation that a seller will not be liable for matters that make a warranty untrue and that are within the prior knowledge of a buyer (sometimes referred to as an “anti-sandbagging” clause) is likely to be interpreted strictly by a court.  If the limitation only applies to matters in the “actual” knowledge of a buyer, “constructive” or “imputed” knowledge will not limit a seller’s liability.

Background

The facts of the case are summarised in Part 1.  The Buyer made claims under a number of warranties including that the Company “during the last four years has complied, and continues to comply, in all material respects with the Funding Rules”.  After completion, it had transpired that the Company had not complied with the Funding Rules and was liable to return certain funding that it had received before completion.  Amongst the defences run by the Sellers, was an allegation that there was “fair disclosure” against this warranty, or that the Buyer had knowledge that the Company was in breach of the Funding Rules.

These are conceptually two different issues:

• As is very common, the SPA stated that the warranties were given “subject to matters Disclosed”.  That wording meant that if a matter was “Disclosed” there is no breach of warranty (the disclosure acts as a qualification to the warranty).
• The SPA also stated that the warranties were given “subject to…the limitations” set out in a schedule to the SPA.  The limitations operate to provide a defence to liability even if there is a breach of warranty.  In this case, the limitations included that:

• “12.1 The Vendors shall not be liable in respect of any Warranty Claim to the extent that the facts, matters or circumstances giving rise to a Warranty Claim:
• 12.1.1  are Disclosed in the Disclosure Letter or Disclosure Documents; and
• 12.1.2  were within the actual (and not, for the avoidance of doubt, imputed, constructive, implied or deemed) knowledge of the Purchaser at the date of this Agreement.” (Emphasis added.)

“Disclosed” was defined in the SPA as “fairly disclosed with sufficient detail to identify the nature and scope of the fact, matter or information concerned in the Disclosure Letter, the Disclosure Documents or the Additional Disclosure Documents."  As is very common, the “Disclosure Documents” included documents provided in the dataroom.

SPA interpretation issues

An initial issue of contractual interpretation arose: the Buyer’s position was that, on the wording of the relevant clause in the SPA, an effective limitation of liability would require the issue to both be “Disclosed” and within the actual knowledge of the Buyer as seems to be the literal meaning of paragraph 12.

The Sellers’ position was that the parties meant for these to be two separate ‘defences’ to a warranty claim, rather than cumulative (i.e.: why should it matter that a matter was not fairly disclosed if it is in the actual knowledge of the buyer?), and that the court should rectify the SPA accordingly (by replacing the “and” with an “or”).  The court rejected this interpretation of the contract.

What is meant by ‘fair disclosure’?

The SPA provisions therefore provided an interesting context for the court to consider the issue of “fair disclosure”.  The court considered recent authorities, noting the generally understood position that that the “fair disclosure” language “imposes an obligation to bring a matter to [the Buyer’s] attention, through a positive statement about the true position, rather than leaving [the Buyer] to work things out for itself”.

The court put it another way when considering the issue in the context of the SPA language; it considered that in the context of the drafting agreed in this SPA, “fair disclosure” should lead to actual knowledge on the part of the Buyer. That is, for disclosure to constitute “fair disclosure”, the end result being constructive or imputed knowledge of the Buyer is not sufficient.  Nor was it sufficient, on the wording of the SPA, for the Buyer to have obtained its knowledge from a source other than the Sellers’ disclosure, or for information in the dataroom to have raised mere question marks for further investigation.

This adds a further example of “fair disclosure” and the specific negotiated limitations can set a high threshold; a seller could not in this instance put raw data (even potentially, clearly sign-posted data) into a dataroom and be confident that it would constitute “fair disclosure” against what otherwise would be a breach of the warranties.  A seller is best served making clear, specific disclosures in the disclosure letter against known breaches of warranties especially where the particular SPA drafting places such an importance on the actual knowledge of the buyer. 

Anti-sandbagging - Buyer’s knowledge

Paragraph 12.1.2 of the limitation schedule (in isolation and not in conjunction with clause 12.1.1) amounts to what is sometimes referred to as an “anti-sandbagging” clause, that the Sellers would not be liable for matters that are within the actual knowledge of the Buyer.

Warranty claims are contractual, and not tortious, and as a result, a buyer does not have to prove reliance to establish liability. The fact that a buyer knew a warranty was untrue will not bar it bringing a claim for breach of warranty, unless the SPA expressly precludes it, with such an anti-sandbagging clause.  Where such a clause is not included in the SPA, a buyer would nevertheless face a significant challenge in its damages claim, if it should claim that it overpaid for the company despite having knowledge that the warranties were not true.

As it is common practice in the United States for pro-sandbagging clauses to be included in SPAs (i.e.: the SPA will give a buyer an express right to bring a claim even if it is aware it is untrue at the time it is given), where US acquirors enter into English law governed SPAs they will often negotiate pro-sandbagging clauses.

The courts have recently emphasised the primacy of the agreed wording in professionally drafted SPAs, and restated that commercial common sense arguments cannot be used to “rescue” poor drafting or to reallocate risk that the words, when read in context, did not allocate. Where such anti-sandbagging clauses are included, parties should consider carefully whether the Buyer’s knowledge must be “actual”, “imputed” and/or “constructive”.  For corporate buyers, consideration should be given to the persons within the buyer whose knowledge is to be attributed to the buyer.  In Learning Curve it was clear that only “actual” knowledge of the Buyer would be sufficient.

The court’s findings on “fair disclosure” and “Buyer’s knowledge”

On the facts, it was considered that the Buyer could not have discovered the issue from the documents in the dataroom.  In order to discover the issue, the Buyer would have needed access to other documents and information which were not in the dataroom.

Furthermore, the court noted that (i) the dataroom was only available to be reviewed by the Buyer for one week; (ii) the documents which were in the dataroom (said by the Sellers to give the Buyer knowledge) were huge spreadsheets of some 5000+ rows; and (iii) the pseudonymisation carried out was inconsistent between documents (i.e.: one document used learner reference numbers where another used acronyms), meaning it was not possible to cross-check documents in the dataroom against each other.

However, crucially, the court considered that even if all the necessary documents had been in the dataroom and/or the Buyer could have been prompted by the documents in the Data Room to make further enquiries, the SPA was “clear in putting the burden squarely on the [Sellers] to inform [the Buyer] about the relevant matters rather than leave it to [the Buyer] to make appropriate inquiries once put on notice of a potential issue”.

Accordingly, the court found that the Company’s historic breaches of the Funding Rules were not disclosed and the Buyer did not have actual knowledge of them prior to completion.

Conclusion

The Learning Curve decision is a useful reminder on the obligations of ‘fair disclosure’, and the scope of the meaning of actual knowledge on the part of the Buyer.

The key learning points from this judgment include:

1. If the SPA qualifies warranties with reference to a formulation involving ‘fair disclosure’, this is likely to require a seller positively to bring matters to the buyer’s attention. It is unlikely to be sufficient to bury information within a lengthy document, or within multiple documents, particularly in transactions where access to the dataroom is only for a short period of time.
2. Similarly, if an SPA provides that a seller will not be liable for matters that are within the “actual” knowledge of a buyer, a seller should take care that issues they are aware of are drawn to the attention of the buyer and that there is a good evidential record of this (ideally a document), or contained in specific disclosures in a disclosure letter countersigned by the buyer.
3. The specific drafting of the definitions of “Disclosed” or “Fair Disclosure”, and the agreed wording in the applicable limitations, should be carefully considered against the disclosure process that has actually taken place.
4. There is a balance to be struck by a seller in selecting which documents should be included in the dataroom (and which are to be omitted). It is important to interrogate why a document should be omitted, to assess whether it is reasonable to exclude it. On the other hand, over-including documents in the dataroom is likely to increase timescales and increase costs in completing the transaction; this also risks criticism in the event of a warranty claim.