United States: Tips On Drafting, Negotiating Disclosure Schedules In M&A

One of the most time-consuming (and arguably one of the most important) aspects of an acquisition transaction is preparing the seller's disclosure schedules.1 Disclosure schedules are basically an extension of the acquisition agreement, containing supplemental disclosure information that would be too cumbersome to include in the main document. If the disclosure schedules contain inaccurate or incomplete information, the disclosing party could be liable for breach under the acquisition agreement. Because of this, it is important that disclosure schedules are carefully prepared and reviewed for accuracy. What makes preparing disclosure schedules particularly difficult is that often, information is needed from individuals who have little to no experience with acquisition transactions. For people unfamiliar with acquisition documents, the disclosure schedule process can seem daunting and confusing.

This article sets forth general information about disclosure schedules, what they are and how they are prepared, as well as common missteps and pitfalls. It is meant to serve as an introductory guide to assist individuals unfamiliar with the disclosure schedule process, as well as provide tips to deal lawyers managing the disclosure schedule process.

Types of Disclosure Schedules

There are two categories of information presented in disclosure schedules: lists and exceptions. A "list" schedule occurs when the seller makes a representation to the buyer that the schedule contains a complete and comprehensive record of certain aspects of its business. For example, a representation might state that the disclosure schedule lists all registered intellectual property owned by the seller. A "list" schedule is important for buyers because it ensures that they have a full picture of certain aspects of the buyer's business and, very often, they will then ask for additional representations for the items on such list (for example, the seller owns the registered intellectual property listed on such schedule free and clear of all liens). Common "list" schedules include lists of stockholders and subsidiaries, employee benefit plans, registered intellectual property, permits, insurance plans, indebtedness, and leased and owned real property.

The second type of disclosure schedule is an "exception" schedule. An "exception" schedule occurs when the seller is qualifying a representation or warranty made by it in the acquisition agreement. These disclosures limit the scope of the seller's representation or warranty and has the effect of limiting the seller's potential liability.

For example, the acquisition agreement may include a representation that the seller is not a defendant in any material litigation claims. If the seller is a defendant in a material litigation claim, it will need to revise the representation to state that: "Other than as indicated on the Disclosure Schedules, the Company is not a defendant in any material litigation claims." The disclosure schedules would then contain a list of material litigation claims where the seller is a party.

A very common, and very important, "exception" schedule is the non-contravention schedule. A non-contravention schedule sets forth any potential roadblocks to consummating the deal, such as required government or shareholder consents, and identifies negative business consequences as a result of the transaction, such as resulting termination rights in the seller's customer or supplier contracts.

The Drafting and Negotiation Process

The Initial Draft

Preparing the disclosure schedules is an iterative process occurring concurrently with the negotiation of the acquisition agreement. Sellers will prepare the first draft of the disclosure document, generally based on their initial draft of the acquisition agreement.2 Since the disclosure schedules will call for information from all aspects of a seller's business, including tax, employee benefits, accounting, finance, legal, etc., sellers will need to rely on employees in each unit of its organization to help identify the items that need to be listed or excepted out of the representation. Particularly in larger organizations, careful planning is needed in order to balance the demands of performing such a comprehensive review while also containing the number of people with knowledge of the transaction to a minimum. The seller's counsel can serve a valuable role of coordinating the process among all parties and assisting with the review.

Sellers generally will want to keep the existence of a potential sale transaction a carefully guarded secret, with only certain employees allowed "under the tent," because rumors of a sale process could have negative business repercussions (for example, employees getting nervous and quitting and vendors/customers ending their relationships with the seller). As additional company employees are added to the deal team, it is important to emphasize to each the importance of keeping the sale process confidential. Many companies will require that each new deal team member sign a short confidentiality agreement. In addition, if either the buyer or seller is publicly traded, company employees must be informed of the need to forego trading in securities of the relevant companies.

Negotiating the Schedules

Buyers will review the sellers' initial draft of the disclosure schedules, examining them against the information gained from their due diligence review and provide comments. Typical comments include asking the seller to add items the buyer believes should be listed or disagreeing with the seller that certain items qualify for listing. Buyers will also request any items listed on the schedules that were not previously provided during the due diligence process and follow-up information based on items included in the schedules (e.g., an amendment referenced in the title of an agreement listed on a disclosure schedule). Sellers should carefully check any data rooms they have set up to ensure, to the extent possible, these items have been provided prior to submitting the initial draft of the disclosure schedules. As the buyer and seller continue to engage in this back-and-forth, the schedules will be continuously updated with each round of discussion. Also, as the acquisition agreement gets negotiated, the disclosure schedules often have to be revised. For example, as part of the negotiation, a new representation may be added that requires a "list" or "exception" schedule, or an existing representation may be expanded that requires new items to be disclosed on an existing disclosure schedule.

Drafting Concerns


Sellers often face a tension between protecting themselves by overdisclosing items on the schedules and alarming the buyer with an overpopulated schedule. Overdisclosure can be useful to a seller because it reduces the risk of liability for breaching its representations and warranties for failure to disclose an item. Since many of the schedules provide exceptions to representations made in the acquisition agreement, more disclosure limits the scope of the representation and therefore limits the seller's potential liability.

On the other hand, pages and pages of disclosure might make the buyer concerned over the level of risk it is taking from the seller, or concerned that the seller is trying to hide an issue by burying it within voluminous lists. For the seller's counsel, it is often helpful to tell the person drafting the disclosure schedule to lean more on the side of overdisclosure and then, upon review of the schedule, decide whether it should be dialed back.

Materiality Qualifiers

An important, and sometimes contentious, point of discussion when preparing the disclosure schedules is the materiality standards used to qualify which items will need to be listed. Let's say a representation in the acquisition agreement asks the seller to list all contracts to which it is a party. Seller would be required to produce an extremely long and unwieldy list of contracts, ranging from its most important agreements to purchase orders for sugar packets in its kitchen. This representation is dangerous for sellers because an inadvertent omission would result in a breach of the acquisition agreement, and not particularly helpful to the buyer from a diligence perspective because a full list of all contracts would not help it identify which contracts are material to the seller's business.

A materiality standard, such as limiting the list to contracts whose potential liabilities exceed $500,000, serves to reduce the chance that the seller will inadvertently miss listing an agreement (because the list itself will be shorter) and will limit listed items to those that are useful to a buyer's understanding and valuation of the business.

Setting a disclosure qualifier at a set dollar amount (or a set time period — i.e., only actions that took place in the last three years) serves as a bright-line materiality test. The parties are agreeing that anything over that dollar amount, or within that time period, is material and should be disclosed on the schedule. Another, less clear, standard is items that occur outside of the seller's ordinary course of business. While less clear, generally, disclosure schedule drafters have a good sense of disclosure items that are not ordinary course and do not have a difficult time making the determination regarding whether something should be listed on the schedule.

A more difficult (and, unfortunately, very common) formulation is the vague "materiality" standard. This occurs when the acquisition agreement calls for a schedule to list or except out "material" items. What constitutes "material" is often undefined and is a question of fact. "Materiality" qualifiers often drive the people compiling the disclosure schedules crazy because it is not an easy threshold to identify. When faced with an undefined "materiality" qualifier, it is important for the seller's legal team to discuss the effected disclosure schedule with the schedule drafters to discuss what "materiality" may mean and whether specific disclosures may meet the threshold. Preparing a disclosure schedule for a representation that has a "materiality' standard is a good example of where overdisclosure would be the preferred drafting strategy.

Sellers in particular should keep in mind that materiality thresholds are subject to change as negotiation of the acquisition agreement progresses. When the thresholds are lowered, items that originally may have been disregarded as not applicable in prior drafts will then become subject to disclosure. For this reason, a good practice is to anticipate these changes by keeping an internal list of items that will likely become disclosable should the thresholds be lowered. For instance, if an initial draft of the acquisition agreement sets a $500,000 threshold, the seller should undergo its review as if the threshold was some lower amount. This will avoid the extra time and expense of having to review the same set of materials multiple times after every alteration to the materiality standards.

The seller should also identify early on in the process what thresholds will make a disclosure schedule unwieldy and difficult to compile in the allotted time frame and convey that to the negotiation team. For example, if a threshold of $250,000 results in 50 contracts being listed, but a threshold of $200,000 results in 1,500 contracts being listed, the negotiation team should be alerted so they do not agree to such reduced thresholds. If the deal lawyers are unsure during the acquisition agreement negotiation process whether a requested lower threshold will result in an unwieldy disclosure schedule, the deal lawyers may reserve response on the lower threshold until they have a chance to discuss it with their disclosure schedule drafters.

Disclosing Bad News

One issue that might come up in the disclosure schedule drafting process is how a seller handles disclosing a particularly negative piece of information. For issues such as a potentially expensive litigation claim or an upcoming expiration of a key piece of intellectual property, the disclosure schedules should not be considered the proper forum in which to first inform the buyer. In practice, these issues are more commonly conveyed to the buyer prior to appearing on the disclosure schedules, as otherwise it might give the impression that the seller is attempting to sneak such disclosure into the deal documentation without the buyer noticing. A good practice is to have a businessperson-to-businessperson conversation about the issue early on in the sale process, so that it can be referenced later by the seller.

Depending on the level of materiality of the issue, the seller might also remind the buyer of these conversations at the time the disclosure schedules are distributed. Careful communication of these issues is crucial in order to avoid surprises and the tainting, or even destruction, of the trust between the parties. Sensitive matters, such as the status of pending litigation or claims, may benefit input from counsel.

A Common Mistake — "Why Do I Need to Put This on the Disclosure schedules? I've Already Disclosed It to the Buyer During the Due Diligence Process"

Providing an item to the buyer separately from the disclosure schedules generally does not relieve the seller of its obligation to also list such item on the schedules. A seller will often have uploaded all relevant documents and other information relating to a disclosable item in a virtual data room to which the buyer has access. The seller may have also verbally informed the buyer of certain disclosure matters during due diligence sessions. These items will nonetheless still need to be included in the disclosure schedules.

For schedule drafters without experience in acquisition transactions, they will often (understandably) view disclosure schedules as a way to disclose items that the buyer doesn't already know about. It is imperative that, at the start of the disclosure schedule process, the seller's counsel makes sure none of its disclosure schedule drafters are operating under this mistaken assumption. Indeed, as noted above, the data room disclosures offer a good check to make sure everything is disclosed in the schedules.

Parting Comments

Disclosure schedules are an integral part of the acquisition process and the process of preparing and negotiating these schedules must be carefully managed by members of the seller's deal team, working hand in hand with the seller's employees. Input from the seller's employees is critical, as they are often the only ones with the information required to complete their assigned sections of the schedules. While acquisitions are often fast-paced, with deal lawyers pulled in many different directions, it is imperative that they take the time to ensure that these employees understand the purpose of the schedules and precisely what information needs to be included. This can be accomplished by implementing a well-organized system with the deal lawyers as facilitators and open and frequent communication between all parties. Without such a system, the process becomes chaotic and the chance that something is mistakenly omitted from the schedule increases dramatically, along with the seller's liability for such omissions.


1 While buyers may also prepare disclosure schedules, seller disclosure schedules generally are more extensive and will be the focus of this article.

2 While generally, sellers will try to prepare the first draft of the disclosure schedules based on their initial draft of the acquisition agreement, in deals where there is no auction process, the buyer may have prepared the initial draft. In any case, the parties will likely negotiate the agreement, including representations and warranties to which the schedules relate, while the disclosure schedules are being prepared. Sellers should keep in mind that there will likely be some issues that are pending negotiation at the time the initial draft of the disclosure schedules are submitted. For instance, a seller may object to the buyer's inclusion of certain representations in the acquisition agreement or propose to include certain qualifications. As a consequence, there will likely be sections in the initial draft of the disclosure schedules that are reserved until these negotiations conclude.

Read the full article on Law360.

Appeared in Law360 on December 4, 2015. Originally appeared in the Kaye Scholer M&A and Corporate Governance Newsletter, Fall 2015.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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