SPA Series Part 11: Negotiating M&A Deals in Finland - On Disclosures and Disclosure Letters

As promised now we talk about disclosure letters, documents that are very critical in many respects. First, we must understand the relationship between disclosures and warranties. As we discussed in part 5 of this blog series in connection with the disclosure material, if an issue is described in the disclosure materials, then the purchaser cannot claim that there be a breach of warranty unless the parties have agreed on specific indemnity to cover a known risk. Although this document is critical, the parties often invest much more time and effort in the wording of the warranties than the disclosure letter. These kinds of “formal disclosure letters” are typically more common in the cross-border context, while, in domestic deals, the same end-result may be achieved by disclosure material definition and adjustments to the specific sections of the agreement (and this way avoiding the need to have a specific annex titled “disclosure schedule”).

Disclosure letters are typically drafted by the sellers and in UK models divided into three parts: general disclosures, specific disclosures and disclosed documents.

General disclosures refer to matters, e.g., in public registers and so forth, which are not necessarily included in the due diligence material otherwise BUT are still publicly available information. One has to bear in mind that even in cross-border deals there is no strict one-size fits all approach. In fact, for example, it might be conceivable to argue that general disclosures are actually not very typical in US deals while they are so in UK deals. Also, by way of comparison according to some study, in US deals there is more often a requirement that a disclosure must be cross-referenced to warranties (as opposed to automatically qualifying all warranties). 

Specific disclosures, on the other hand, refer to actual warranties and may be deemed to complement disclosures (if a risk is not for example otherwise sufficiently disclosed in the due diligence material). Or, alternatively, there are typically warranties that require additional information to be given and listed in the disclosure letter. 

Moreover, as a third element, this disclosure letter document contains a reference to or copies of the documentation bundle being disclosed. The answer to the question often asked from us, whether something should be included in the letter or not, is that if you are a seller and you wonder whether a risk, fact or matter is worth disclosing, just disclose it. Even if you consider that something is already disclosed, just verify it by disclosing it again.

There are, however, two schools, and some do not like the idea that one has to make specific disclosures in the first place but rather they want to ensure that disclosure material included in the data room generally is sufficiently clear. Of course, even in this case there might be listings of facts or matters (such as in connection with a specific warranty, “Except for the facts, matters and circumstances outlined in Annex X, the Sellers represent and warrant that there are no additional…”). From the enforcement perspective, one could argue that, say, if a risk is not disclosed in the disclosure schedule expressly as a specific disclosure but only in the disclosure material, in one of the many Board’s minutes in the data room, such risk is not “fairly disclosed” to the buyer (see also Part 5 of this blog series). So in other words when evaluating the seller’s liability in case of a breach of a warranty, this means that it could be easier for the buyer to establish that this disclosure was insufficient to qualify the seller’s warranties and therefore the seller should be held liable for the breach and therefore there is resistance against using disclosure letter in general. 

Another argument for resisting disclosure letters is that disclosures can act as a double-edged sword if the buyer opens price negotiations or walks away as mentioned above and therefore, sellers may attempt to solve this dilemma by making information available without expressly drawing the buyer’s attention to it, like, in one of the many Board minutes included in the data room material. This way they could still argue that the buyer was aware of the risk prior to the execution of the deal and therefore the seller should be exempted from the breach of warranty.

There are so many questions still to consider: what constitutes "fair disclosure"? What is the connection of materiality and specific disclosure? What warranties can be given regarding disclosures? When to disclose? And so forth. Some standard questions are also answered in the disclosure letter's introductory text which might say something like this:

"GENERAL 

This is the Disclosure Schedule referred to in Article X of the Share Purchase Agreement (the Agreement).

All capitalised terms used and not defined in this Disclosure Schedule shall have the meanings given to them in the Agreement, unless the contrary intention appears.

This Disclosure Schedule shall have the effect set out in the Agreement. Accordingly, we shall not be deemed to be in breach of the warranties or other terms of the Agreement: i) if such facts or circumstances are specifically disclosed herein; or ii) if the disclosure is made in the disclosure material if such facts or circumstances should have been apparent based on such investigation or otherwise to a person reasonably knowledgeable having experience in business similar to the Business. 

Specific disclosures set out in this Disclosure Schedule mark out the section or subsection to which they apply for the ease of reading only but also qualify other sections or subsections in Section of the Agreement. All representations and warranties are further qualified by information available from public sources including, without limitation, press releases, publications and trade registers.

Where any representation or warranty contained in the Agreement is limited or is qualified by the materiality of the matters to which the warranty relates, the inclusion of any matter in this Disclosure Schedule does not constitute a determination by the Seller that such matters are material. 

The inclusion of any matter in this Disclosure Schedule does not constitute a determination by the Seller that such matters need to be disclosed in order for the Seller to avoid liability under the Agreement.

Opinions expressed by independent advisors and consultants are to be read as containing their professional opinion with any assumptions and limitations pertaining thereto...."

So to conclude, these are the main principles to help you get started but we have tried to point out that there are many more open issues if you wish to go deeper into this topic. We will continue from here next time and in the meantime, let’s enjoy the last summer days of our beautiful country!

August Greetings, Security Interests over Patents and M&A Blog News

Splendid August to everyone!

I’m back at the office and full of energy after a relaxing summer break. As my one of the first things on the agenda, I thought it would be a good time to continue our M&A blog. We have had several interesting projects after our last posting, so these blogs have been slightly on hold and, as some of you might have heard, we, for example, represented management and investors in the acquisition of Suomivalimo from Componenta, as well as represented Patria Plc in the acquisition of a stake in Silverskin (Press release can be read from here). Also in the IT sector things are moving forward, and in addition to transactional work we are currently involved in a facility management outsourcing project for a banking sector client and another outsourcing for one of the leading Finnish companies in its field is also in the process—so a magnificent autumn is ahead of us!

Anyways, new M&A Blog is coming next week and this time we talk about disclosure letters. These documents and disclosure strategies are very critical in many respects. We start by focusing on basics and the relationship between disclosures and warranties. As we discussed in part 5 of the blog series in connection with the disclosure material, if an issue is described in the disclosure materials, then the purchaser cannot claim that there be a breach of warranty unless the parties have agreed on specific indemnity to cover a known risk. Then we go deeper into the exact interplay between different provisions, different disclosure types and discuss questions what, how and when to disclose as the seller.

Another matter is that as the European Commission has recently asked organizations to submit comments to the Commission consultation on an effective insolvency framework within the EU (“Consultation”) and as the issue is also discussed in the forthcoming AIPPI conference to be held in Milan in September, we wrote a few words on the security interests over patents under Finnish law and some modest proposals for improvement.For all of you who are interested in this topic, please read Kluwer Patent Law Blog from here!

We will continue from here next time and, in the meantime, let’s enjoy the last summer days of our beautiful country!

SPA Series Part 5: How To Negotiate M&A Deals In Finland - Some Words on Definitions

Dear All,

After relaxing summer and some of the spring's corporate transactions it is time to start this autumn and what would be a better way to do this than to publish a new chapter in our SPA blog series. The total reader amount of the blog has exceeded the respectable 5.000 of which I am very grateful and special thanks for everyone who has visited my site!

During the spring we managed to close some interesting deals at TRUST including, e.g., financing rounds of Sportsetter Oy (of the deal see more from here) or sale of Alkali Oy to Alma Mediapartners (part of Alma group, of the deal see more from here) not forgetting our IP & Technology practise. There we advised, e.g., in one IP infringement for a listed Finnish forestry sector company and in business-critical ERP project in Norway negotiating plenty of IT procurement agreements in a multivendor environment. So just the kind of case we love doing! Unfortunately, it also meant that I had to postpone my blogging in this SPA series, but I try to be more active during these coming few months although I must say a warning word that we are also contributing to some other publications on cleantech sector investments, private equity and M&A so we'll see.

Regarding our actual topic, next in this SPA our blog we’ll go forward and move to definitions. I will not comment on some of the definitions that are more self-evident, such as “Parties” (or group companies and subsidiaries) or similar, but the most critical ones should be here. This is not to say that definitions not included in this blog would be irrelevant. As an example, if the deal involves minority ownerships or a joint venture, it is very important to have a sufficiently wide subsidiary definition. Another point is that these group company and subsidiary definitions should be drafted with care to ensure that obligations of the agreement document are allocated to the right companies and that, say, warranties are given by appropriate parties.

First, let me show you some of the main principles behind definitions:

- One should really pay effort to draft definitions, as these are the core terms of the agreement and in its interpretation.

- Always maintain consistency. So if you have a capitalized term, do not use it without capital letter or don’t use a different word to describe the same thing you have already defined.

- Understand the rules of interpretation in the applicable jurisdiction; if these are modified in the definitions section, check how you change the situation in case of dispute, e.g., to the allocation of burden of proof, in dubio contra stipulatorem or similar.

Let’s go through some more detailed definitions and comments to these. So, in very simple transactions these definitions could take the following form. This is actually a kind of a negotiation result of an earlier deal, so please note that this is not optimized for either the buyer or the seller as a starting position of the negotiation.

Term                   .	Meaning                                                                        .
Accounting Principles	The accounting records kept by the Company have been kept on a proper and consistent basis and contain all matters required by applicable law to be entered in them.
Agreement	This Agreement and all appendices hereto including the Disclosure Letter.
Completion	The consummation of the Agreement as described in section X.
Disclosure Material	All information on or related to the Company that has been made available during the Due Diligence Review to the Purchaser or its advisors, the negotiation process or otherwise, whether orally or in writing, as well as all information on the Company in the public domain.
Due Diligence Review	The meaning set forth in section X.
Financial Statements	The profit and loss statement and balance sheet of the Company for the financial period ended on 31 December 2013 together with the auditors' statement thereon.
Material Adverse Effect	Any material adverse change on the assets or financial condition of the Company, exceeding EUR X other than any change or effect (a) relating to the economy of the world or any geographic area in general, (b) relating to the industry in which the Company operate in general, (c) arising out of the announcement or pendency of the transaction contemplated by this Agreement, (d) arising out of compliance by the Seller with the terms of this Agreement or (e) arising out of any action taken or announced by the Purchaser or taken or announced by the Seller, the Company at the request or direction of the Purchaser or any inaction or failure to act by the Seller, the Company at the request or direction of the Purchaser.
Purchase Price	The meaning set forth in section X.
Seller's Knowledge	The actual knowledge of any of the following individuals: XXX and YYY. No duty of investigation shall be implied on the persons referred to above for the purpose of the transaction contemplated by the Agreement and the giving of the representations, warranties and undertakings thereunder.
Shares	All of the issued and outstanding shares of the Company.

Then, few words about some of the most critical definitions and additional points:

“Accounting Principles” & “Financial Statements”

First an organisational point which relates to the group structure of the target. If the target is a group, then accounting principles could be defined, e.g., as follows: “…the financial statements of the Company and the Subsidiaries as at and to the Balance Date, comprising the individual accounts of the Company and the Subsidiaries, and in the case of the Company, the consolidated group accounts of the Company and the Subsidiaries…”. In the above model, the target was merely a single entity.

Why, then, are these definitions critical? Well, the answer is simple: in almost all transactions the purchase price will be based on the target’s (or its group’s) accounts. Of course, goodwill and similar “assets” are excluded for the previous statement to be valid as these are not visible from the accounts. Consequently, it is very important to understand what the standards applied are when these where drafted, what the latest financial documents available are and how much reliance can be posed to these. From the seller’s point of view, the other side of the coin is that it needs to provide a warranty for the accounts so that these are accurate so if there are any shortfalls or inaccuracies, then it might result a warranty claim afterwards.

If the target is a group, the definition should refer to consolidated accounts. It is also advisable to include individual accounts as some items like intra-group transactions might not be included in the consolidated accounts.

When are these accounts too old? As everyone can guess, there is no standard rule for this. In any case, we could speak about a period of three months, and information older than these might quite surely be outdated. Management accounts, on the other hand, are a completely different story and these will be typically drafted on a monthly basis. If these accounts are too old, then naturally there might be a need to produce new ones for the closing or completion date, but taking into account that these naturally might take some additional time. In any case, there is always a relationship to the warranties as said above and every share purchase agreement should contain warranties not only as to the accuracy of the financial statements but also management accounts and financial position thereafter. We will return to these warranties later.

“Disclosure Material”

This definition relates to the core mechanics of the share purchase. If an issue is described in the disclosure materials, then the purchaser cannot claim that there would be a breach of warranty unless the parties have agreed on specific indemnity to cover a known risk.

More limited versions of this could be, e.g., “…shall refer to all written material listed in Schedule X made available by the Sellers to the Purchaser or its Advisors in connection with the Due Diligence Review.

“Material Adverse Change”

Also one of the key definitions. This definition may be used in connection with the conditions to closing or in connection with the warranties. If we look at the former, in practise if there is “no material change” clause used as a condition for closing and such an event is realized, then the buyer may walk out of the deal.

One alternative wording to the above mentioned quite detailed text is naturally to use a more general definition such as the following:

“..shall refer to any occurrence, event or change which materially and adversely affects or could reasonably be expected to materially and adversely affect the  Business, assets, liabilities, financial conditions, financial results of operations or prospects of any Group Company”.

The usage slightly depends on the how the definition is used in the documentation. As a seller, one does not want to permit an “easy exit” for the buyer to walk out of the deal and as a condition for closing this kind of express wording with reference to, say, political and other more general-level financial risks could be appropriate. There can also be a monetary limit that could be expressly specified or it could be defined quite freely. One possibility is to define it as percentage of the consolidated revenue, EBITDA or net worth levels.

“Seller’s Knowledge”

As discussed earlier, representations and warranties are often heavily negotiated between the parties. These clauses serve for several purposes but one is to allocate risks and force the seller to share information on the possible risks associated with the target business. When negotiating an SPA, the seller has an incentive to keep its representations and warranties as narrowly drafted as possible. On the other hand, the buyer, naturally, wants those representations and warranties to cast as wide net as possible.

One way for a seller to achieve its objectives is to qualify the representations and warranties to its “knowledge.” Let’s take an example that there is a security arrangement over the assets that the seller’s CEO failed to disclose and which is not recorded. Even if this item is covered by a warranty and the seller might be “on the hook” in this respect, the seller might escape liability if such defined person making disclosures did not have “actual knowledge” about the security. Similarly, the buyer, on the other hand, wants the seller’s representations and warranties to be unqualified. In connection with the specific warranties, we look at specific representations and warranties and how and when to qualify warranties.

If we once again provide an alternative from the other end of the negotiation spectrum:

“…shall refer to the actual knowledge of the individuals listed in Schedule 3.46 or the knowledge of such persons, had they acted diligently in view of their positions.”

So next we go to purchase price mechanisms, a very interesting topic, and I try to provide that within the next few weeks.

I wish you all an energetic autumn on behalf of TRUST's M&A team and looking forward to being in touch with you after these relaxing vacation weeks! Another matter before I forget, I was elected as the Co-Chair of ITechLaw's IP Committee and let me know if someone is going to European conference to be held in Paris as it would be my pleasure to meet there. Or alternatively, if you are going to IBA in Tokyo, that would be another alternative (send an e-mail jan.lindberg@thetrust.fi or call +358408236031) - hope to see you there!

Regards,

Jan