Undisclosed liabilities: Overview, definition, and example
What are undisclosed liabilities?
Undisclosed liabilities refer to financial obligations, debts, or liabilities that are not revealed or made known to another party, typically during a business transaction such as a merger, acquisition, or the sale of a company. These liabilities may exist but are not disclosed in financial statements or during the due diligence process, potentially leaving the acquiring party or stakeholders unaware of them until later. Undisclosed liabilities can include unpaid taxes, outstanding debts, legal claims, or contingent liabilities that were either overlooked or intentionally withheld.
In a business transaction, it is critical for the seller to disclose all liabilities, as failure to do so can result in legal consequences, financial penalties, or disputes down the line. Ensuring that all liabilities are disclosed allows both parties to understand the full scope of financial obligations and negotiate terms accordingly.
Why are undisclosed liabilities important?
Undisclosed liabilities are important because they can significantly impact the financial stability and risk profile of a company. When these liabilities are not disclosed, the buyer or another party may unknowingly assume financial risks that they did not account for, which can lead to unexpected costs, lawsuits, or bankruptcy.
For businesses, disclosing liabilities upfront is essential for transparency, maintaining trust, and complying with legal and regulatory requirements. For investors or buyers, ensuring that all liabilities are disclosed is crucial for accurately assessing the value and risks associated with the business or investment.
Understanding undisclosed liabilities through an example
Imagine a company selling its assets to another business. During the due diligence process, the seller provides financial statements showing its assets and liabilities. However, the seller fails to disclose an outstanding tax obligation from the previous year, which amounts to $500,000. After the sale is complete, the buyer learns about the undisclosed liability and is forced to bear the cost, potentially affecting the value of the acquisition.
In another example, a business is acquired by a larger corporation, and the smaller business’s financial statements do not account for pending litigation regarding a patent dispute. The acquiring company was unaware of the potential legal costs and settlement fees, leading to a financial strain after the acquisition is completed.
An example of an undisclosed liabilities clause
Here’s how an undisclosed liabilities clause might look in a contract:
“The Seller represents and warrants that all liabilities, whether known or unknown, contingent or otherwise, have been fully disclosed in the financial statements provided to the Buyer. The Seller agrees to indemnify and hold the Buyer harmless against any undisclosed liabilities that arise after the closing date of this transaction. Any liabilities not disclosed shall be the responsibility of the Seller.”
Conclusion
Undisclosed liabilities can pose significant risks to both buyers and sellers in business transactions. These hidden debts or financial obligations may affect the value and viability of the business being acquired or invested in. To protect all parties involved, it is essential to disclose all liabilities fully and transparently. This not only ensures legal compliance but also fosters trust, mitigates financial risks, and helps in making informed decisions about transactions.
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.