The Importance of Disclosure Schedules in M&A Transactions

Mergers and acquisitions have many moving parts, and while all M&A transactions require their share of due diligence, disclosure schedules—the documents that support and supplement a seller’s representations and warranties—are among the most important.

A poorly prepared disclosure schedule can create significant exposure to liability for sellers and stockholders. That’s why business owners and their potential buyers need to be aware of their importance, how and why they are prepared, as well as some common pitfalls in preparing schedules.

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“Many times, with these transactions, the buyer will pay a significant portion of the sales price at closing and the balance will be held in escrow for a period of time—one year, two years, whatever has been negotiated,” says business law expert and Managing Shareholder Trey Hendershot. “As a seller, if your disclosure schedules fail to list a liability, and that liability raises its head—whether it’s a lawsuit, an employee claim, OSHA issue, failure to pay taxes, vendor claim, IT security breach, etc.—the buyer will take your money out of escrow. The buyer has no reason to contest claims—they’ll just take your money.”

“The bottom line is this: If you don’t get everything fully disclosed in the disclosure schedules, it can create problems after closing,” he adds. “It may cause you to get sued, be involved in arbitration, or you may lose your escrow funds.”

By compiling carefully curated disclosures, sellers greatly limit unnecessary risk from leaking into their transaction, facilitate a swift and successful sale, and gain protection from post-closing liability claims.

What Are Disclosure Schedules?

“Disclosure schedules are a common component of a purchase agreement in an M&A transaction, whether that transaction is facilitated by a stock purchase agreement, asset purchase agreement, or merger agreement,” says transactional law attorney Trey Hendershot. They are typically attached to the end of an agreement document and incorporated by reference.

Disclosure schedules provide supplemental, factual information that support each of the representations (an assertion of facts) and warranties (a promise about the future) made by the seller, such as lists of stockholders, important contracts, intellectual property, employee benefit plans, outstanding debts, and other material matters of the selling company.

Disclosure schedules also provide detail on any exceptions to a warranty made in a merger or acquisition agreement. For example, an M&A agreement may state that the business is not involved in any litigation or court cases, except as set forth on the disclosure schedules. Details of the exception—in this example, an outstanding court case—would then be disclosed in the disclosure schedules.

Common Mistakes in Preparing Disclosure Schedules

Preparing the disclosure schedules can be time-consuming and arduous, but it is an important part of the process. An experienced attorney will counsel the seller to start preparing schedules early, even before the acquisition agreement is finalized. “Hastily prepared disclosures are more likely to be incomplete or inadequate. This can create unnecessary risk, delay the closing of a transaction, or even tank the deal,” warns Hendershot.

Besides procrastinating, there are other potential pitfalls to avoid in assembling your disclosure schedules. “Many times, the seller may not understand what the buyer is requesting and, instead of asking for clarification, will simply state that the document doesn’t exist,” says Hendershot. “These are the types of lapses and liabilities I want to avoid for my clients.”

Common mistakes to avoid when preparing disclosure schedules include:

• Providing an incomplete list of important contracts
• Using out-of-date employee rosters that do not contain all current employees, or do not list salaries, bonuses, and other key information
• Schedules for leases are missing required information, such as the landlord, lease terms, security deposits, etc.
• An incomplete list of software and information technology used in the business
• Failing to list all required disclosures regarding litigation, arbitration, investigations, or other governmental proceedings
• Incomplete financial statements
• Missing information for bank accounts or insurance policies, including account or policy numbers, fees, premiums, etc.

Tips For Preparing Disclosure Schedules

1. Don’t procrastinate! Sellers should not wait until the last minute to begin compiling the disclosure schedules or providing the information to attorneys.
2. Understand the purpose: Many sellers don’t understand that the due diligence process and the disclosure schedules in the purchase agreement are two separate parts of the transaction, especially since some information provided during due diligence will likely need to be documented again in the disclosure schedules. “Even if information has been provided during the due diligence process, the seller is still obligated to specifically list the information on each of the schedules,” warns Nash, “as the seller is making representations and warranties specific to each of the listed items and will be liable if any of the information is incomplete or inaccurate.”
3. Involve key management and employees: The seller should include the right employees in the preparation of the disclosure schedules—key personnel with the necessary knowledge and access to information. This will facilitate the exchange of information between the selling party and its attorney.
4. Stay organized: It is not uncommon for acquisition agreements to go through several rounds of revisions. Make sure you have an internal process to share each new redlined draft with the parties involved in preparing the disclosure schedules so there are no surprises down the line that could derail the closing process..
5. Work with experienced legal counsel. Many problems inherent to disclosure schedules arise from selling parties lacking a necessary understanding of what is being requested, lack of organization, or failing to ask for assistance when deciphering requests or formulating responses. Working with attorneys experienced in transactional law and mergers & acquisitions can ensure you have the insight and foresight to plan ahead, be prepared, and anticipate potential problems.

Speak with a Texas Attorney About Your M&A Deal & Disclosure Schedules

In matters as important and as encumbered with risk as purchase agreements, preparation and prevention are key to a successful transaction. At Hendershot Cowart P.C., our Houston-based attorneys counsel start-ups and companies of all sizes in a range of business transactions, including mergers and acquisitions.

From drafting and negotiating key agreements and disclosure schedules to mitigating risk and liability, enforcing contracts, and defending against contractual claims, our business law team provides the comprehensive service and support business owners need to effectively protect their rights at all phases of a major transaction, or the structuring of a successful and sustainable new venture.

To speak with a Texas business attorney, call (713) 909-7323 or contact us online.