Disclosure letter: Overview, definition, and example
What is a disclosure letter?
A disclosure letter is a document used in legal and business transactions, particularly in mergers, acquisitions, and financing agreements, to disclose important information that may affect the deal or agreement. The letter is typically prepared by the seller, party offering the service, or other involved entity to provide full disclosure of any material facts, risks, or liabilities that could impact the transaction. The purpose of the disclosure letter is to ensure transparency between parties and protect the disclosing party from future claims related to undisclosed information.
The disclosure letter often includes a series of detailed disclosures regarding the status of assets, liabilities, intellectual property, contracts, or pending litigation, which are then referenced in the main transaction agreement.
Why is a disclosure letter important?
A disclosure letter is important because it serves as a vital tool for ensuring that both parties in a transaction are fully informed about the relevant details of the deal. For the buyer or receiving party, the disclosure letter provides insight into any risks or issues that could impact the transaction’s value or the future operation of the business or assets being acquired. For the seller, it serves as a defense mechanism, limiting potential liability by clearly listing any known risks or exceptions to the representations made in the primary contract.
By including a disclosure letter in the agreement, parties can negotiate the terms more effectively and ensure that the transaction proceeds with a full understanding of any potential challenges or risks.
Understanding a disclosure letter through an example
Imagine a company, Company A, is in the process of acquiring another company, Company B. Before the deal is finalized, Company B’s legal team prepares a disclosure letter to accompany the acquisition agreement. In the letter, Company B discloses pending litigation against the company, outstanding debts, and an intellectual property dispute with a supplier. By providing this information, Company B ensures that the buyer, Company A, is fully aware of the potential risks associated with the acquisition and can adjust the terms of the agreement accordingly, perhaps negotiating a lower purchase price or requiring indemnification clauses.
In another example, a lender asks a borrower to provide a disclosure letter regarding any potential environmental liabilities associated with a property being used as collateral. The borrower’s disclosure letter would outline any ongoing environmental cleanup obligations, regulatory issues, or contamination risks related to the property.
An example of a disclosure letter clause
Here’s how a clause related to the disclosure letter might appear in a contract:
"The Seller shall provide a disclosure letter to the Buyer, detailing any material facts, liabilities, or risks that may affect the Transaction. The disclosures made in the letter shall form part of the representations and warranties under this Agreement, and the Buyer acknowledges the receipt of such disclosures as satisfactory and complete."
Conclusion
A disclosure letter is an essential document in many types of legal and business transactions, particularly those involving the transfer of assets or business interests. It ensures that all relevant facts and risks are fully disclosed, protecting both parties and helping to avoid future disputes. For the disclosing party, it serves as a way to manage potential liability, while for the receiving party, it ensures that they are informed of any material risks before finalizing the deal. By using a disclosure letter, transparency is maintained, and both parties can proceed with the transaction with a clearer understanding of the situation.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.