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?

A disclosure schedule is a legal document used in M&A transactions. Disclosure schedules provide supplemental documentation that support each of the representations (assertions of facts) and warranties (promises about the future) made by the buyer or seller in the purchase agreement. They are typically attached to the end of an agreement document and incorporated by reference.

“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. “The seller may not be able to truthfully guarantee everything about the business. The disclosure schedule allows them to disclose exceptions to these representations and warranties.”

Disclosure schedules 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.

Who Drafts Disclosure Schedules?

Drafting disclosure schedules in M&A deals is usually a collaborative effort between a few parties:

Seller: The seller possesses the most intimate knowledge of their business and has the best resources to gather the necessary information. They'll likely be the ones compiling the bulk of the data based on the specific requirements outlined in the main agreement.
Seller's Attorney: The seller’s attorney helps decipher requests from the buyer’s team and organize information so that disclosure schedules align with the representations and warranties made in the agreement. They may also help identify areas where exceptions need to be disclosed.
Seller's Accountant: An accountant's involvement is particularly important for sections dealing with financial information. They can help ensure the accuracy of financial data presented in the schedules.

Erroneous or incomplete disclosure schedules can cause the entire transaction to fall apart so choosing an experienced, efficient team is critical.

What Is Included In A Disclosure Schedule?

The specific content of a disclosure schedule will vary depending on the transaction, but here are some common categories of information you'll find:

Contracts: This section details all material contracts the company has entered into, such as leases, employment agreements, non-disclosure agreements (NDAs), and contracts with key suppliers or customers.
Employees and Benefits: This section provides information about the company's workforce, including employee headcount, benefit plans, any existing labor disputes, and potential liabilities.
Financial Statements and Accounting Matters: This section dives into the company's financial health, including historical financial statements, accounting policies, and any known contingent liabilities (potential future obligations).
Customers and Suppliers: This section identifies the company's key customers and suppliers, including information about their importance to the business and the terms of any existing agreements.
Intellectual Property: This section details the company's intellectual property (IP) assets, such as patents, trademarks, copyrights, and trade secrets.
Litigation and Regulatory Issues: This section discloses any pending lawsuits, government investigations, or potential environmental liabilities the company is facing.
Tax Information: This section provides details about the company's tax filings, any outstanding tax liabilities, and tax strategies.
Insurance Policies: This section details the company's insurance coverage, including types of policies, coverage limits, and any exclusions.

When Is A Disclosure Schedule Due?

The due date for a disclosure schedule in an M&A transaction typically falls before the closing date. (However, they are exchanged and discussed throughout the due diligence process.)

The exact timing can vary depending on the specific agreement, but it usually aligns with one of these two scenarios:

Simultaneous signing and closing: If the purchase agreement is signed and the deal closes on the same day, the disclosure schedules are typically due as part of the signing process.
Signing with later closing: In most M&A deals, there's a period of time between signing the purchase agreement and closing the deal. In this case, the disclosure schedules are often due shortly after the signing, allowing the buyer time to review the information before finalizing the purchase.

Here are some additional points to consider:

The exact due date for the disclosure schedules will be clearly spelled out in the purchase agreement.
The seller may be obligated to update the disclosure schedules closer to the closing date to reflect any material changes in the business.
There may be consequences for missing the deadline for disclosure schedules, such as delays in closing the deal or potential adjustments to the purchase price.

Your attorney will help ensure you understand and adhere to the specific deadlines and requirements for your transaction.

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

Don’t procrastinate! Sellers should not wait until the last minute to begin compiling the disclosure schedules or providing the information to attorneys.
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.”
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.
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.
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.