The Function and Significance of the Disclosure Letter in Mergers and Acquisitions

In merger and acquisition (M&A) transactions, the disclosure letter is one of the key documents in the deal process, serving as an exception to the representations and warranties provided by the seller. Fundamentally, the disclosure letter exempts the seller from liability for matters disclosed therein and functions to limit the scope of the seller’s liability under the share purchase agreement (SPA).

Scope and Function of the Disclosure Letter

The disclosure letter essentially discloses matters that fall outside the scope of legal, financial, tax, or technical due diligence reports or that are not otherwise covered therein, and thereby carve out exceptions to the seller’s representations and warranties under the SPA. By disclosing such matters to the buyer, the seller is released from liability regarding those specific items.

The parties typically negotiate which matters constitute exceptions within the SPA itself. A narrower scope benefits the buyer, while a broader scope favors the seller.

Especially in transactions where a closing account or closing adjustment mechanism is used to determine the purchase price, findings from due diligence reports are taken into account in the purchase price calculation. These findings are also reiterated in the disclosure letter to serve as exceptions to the seller’s representations and warranties.

Implementation and Acceptance Requirement

While disclosure letters are a common feature in many M&A transactions, they are not always used—particularly in transactions where the buyer holds a stronger bargaining position or where the target company’s operations are relatively limited. Therefore, there is no general rule requiring a disclosure letter in every transaction.

Whether the buyer is obligated to accept the disclosure letter is determined in the SPA. If the SPA stipulates that the buyer must accept the disclosure letter, the buyer cannot later reject it. However, the buyer may negotiate for a “material adverse change” (MAC) clause, allowing the buyer to refuse to close the transaction if significant adverse changes are disclosed. In this case, the absence of a MAC becomes a condition precedent.

Conversely, the SPA may grant the buyer the right to reject the disclosure letter. Although this is less common, in such cases, acceptance of the disclosure letter becomes a separate condition precedent.

Timing of the Disclosure Letter

Since the primary purpose of the disclosure letter is to relieve the seller of liability for disclosed matters, it is prepared during the period between signing and closing of the SPA. Typically, it is delivered to the buyer in a certain period prior to closing.

The buyer may request further clarifications on any items in the disclosure letter that are not sufficiently clear.

Legal Consequences of Providing a Disclosure Letter

Once the disclosure letter is provided, the matters disclosed therein operate as exceptions to the seller’s representations and warranties, and the seller is no longer liable to the buyer for those issues.

However, pursuant to Article 115(1) of the Turkish Code of Obligations, any advance agreement attempting to waive liability for gross negligence is null and void. Therefore, even if a matter is disclosed in the letter, a clause stating that the seller is not liable for grossly negligent misrepresentation or breach of warranty would be legally invalid.

Similarly, in SPAs governed by English law, it is standard to include provisions excluding gross negligence or willful misconduct from the protection afforded by the disclosure letter.

Summary

The disclosure letter outlines exceptions to the seller’s representations and warranties in an M&A transaction, effectively removing the seller’s indemnification obligations for disclosed matters. As a result, the buyer cannot claim damages from the seller for items listed in the disclosure letter.

The letter is typically prepared by the seller during the interim period and submitted to the buyer ahead of the closing date. Buyers generally retain the right to request further detail where necessary.

It must be noted that while the disclosure letter limits the seller’s liability, it does not protect the seller from claims arising from gross negligence or willful misrepresentation of warranty.