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Getting the Skeletons out of the Closet: Disclosure Letters on Sales of Businesses and Companies

11 January 2016 #Corporate

The general position for someone buying a business or a company is summed up by that dusty but succinct old phrase, “Caveat Emptor”, which the stern Victorian novelist, Trollope, once described as “the worst proverb that ever came from the dishonest stony-hearted Rome” (he had probably just bought something that didn’t work and found himself without effective comeback, as there was a distinct lack of consumer protection law in the 19th century). There is, essentially, no obligation on the seller to tell the buyer anything, and the buyer thus needs to “beware”. Buyers typically shift some risk onto the seller by putting a number of warranties in the sale contract, these being statements, typically of fact, about the business or company at a particular time, normally the date of signing. If any of these are found to be untrue or inaccurate, the seller may be in breach of contract, and so the buyer then may be able to seek damages for loss they suffer as a result.

What does a seller do to redress the balance, other than striking all the warranties out, which may, of course, prove fatal to the sale? It is very common for warranties to be qualified by reference to matters disclosed in a disclosure letter which is generally given by the seller to the buyer at the time of signing of the sale contract. The effect of disclosure in relation to a particular matter, if such disclosure is accepted by the buyer, is to prevent the buyer from making a warranty claim in relation to that matter to the extent of the disclosure.  The letter is usually in two parts, containing, first, items of general disclosure against all of the warranties and then specific disclosures against particular warranties. The interests, and approach, of each of the parties in respect of the disclosure exercise will clearly be very different.

For the seller, the disclosure letter is an effective way of watering down the warranties which they have agreed to give to the buyer. The general principle for a seller should be that as much information as possible is given to the buyer, in the disclosure letter and, typically, in documents annexed to it, so as to put the buyer, so far as possible, in the same state of knowledge as the seller at the date the warranties are given. It is really important for the seller, when preparing the letter, to work systematically through each warranty, very often in the presence of advisors and with those who are aware of the financial and trading position of the target company or business, to set out all possible exceptions to the warranties. As a matter of law, disclosure, to work as a defence to a potential warranty claim, must be specific, and it may not be enough for the seller if the buyer is expected to work out what the position is and come to a conclusion by inference from facts presented to it.

When making "general disclosures", the seller is, in effect, telling the buyer what preparatory work it should have done by way of due diligence, even if they have not done this. This is why general disclosures contain references to matters which either were or "could have been" disclosed by things such as property searches and enquiries, Companies House searches and so on. 

The buyer’s ideal approach to the disclosure letter should be that every matter disclosed in it should be sufficiently meaningful and detailed to be capable of forming a specific exception as if it were actually set out in the text of the relevant warranty - so, "except in respect of the action against John Smith instituted on 25 October 2014, there is no outstanding litigation affecting the company" or "except in respect of the contract with X Limited dated 4th July 2013 relating to the supply of widgets for a period of four years by the company, there are no supply or distributorship agreements to which the company is a party".  Applying this approach, it is very unlikely that some of the general disclosures that sellers try out (or maybe try on!) sometimes (a common example is "all matters which are in the public domain") are acceptable if viewed as a qualification in the text of a warranty.

What if the buyer is confronted with some disclosure “skeletons”? If they come across a disclosure which causes concern and which, for example, goes to the value of the business or company being acquired, then they may seek a specific indemnity in respect of that matter in the contract (ie an ability to recover pound-for-pound from the seller any loss or liability relating to that matter). Another approach may be to insist that the disclosure is simply struck out of the disclosure letter, so that the warranty bites without there being a disclosure to reduce or limit its ambit. Case law, however, seems to suggest that a buyer may not be able to claim they had no knowledge of a particular matter giving rise to a warranty claim, if they had actual knowledge of certain facts, even if these were not disclosed by the seller. Sometimes, there may even be a nuclear option as a result of disclosure by a seller – the buyer deciding to seek a price reduction, or even not to proceed.

So, for business and company sales, “Caveat Emptor” is a rarity, and the norm is a process of buyers apportioning risk and seeking disclosure through warranties, with the seller reaction being a carefully executed process culminating in the disclosure process. Trollope can rest easy!


Clarkslegal, specialist Corporate lawyers in London, Reading and throughout the Thames Valley.
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Jon Chapman

Jon Chapman
Senior Consultant

T: 0118 960 4683
M: 07979 591 627


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