Disclosure is a key part of the business sale process. The consequences of failing to disclose critical incidents before the date of completion can lead to serious repercussions for both sides of the transaction. Before the sale of any business is completed, the Vendor will be asked to warrant numerous circumstances (such as no outstanding health and safety claims, all taxes paid up to date and are correct). As part of this process, a disclosure letter and bundle will be prepared by the Vendor’s solicitors.
What is a ‘Disclosure’?
Disclosure is a defence against a warranty. If there have been any significant incidents up to and including the day of completion – for example, a health and safety breach, changes to a customer contract, or a product recall - this needs to be covered in the disclosure letter.
Below is a real example of an incident that was not disclosed to the Buyer, and which led to major costs for both the previous and new owners of a food packing business:
The company packed powdered food supplements for major retailers. Six weeks prior to completion, a blue plastic bag became shredded in the food processing machinery. As a result, tiny plastic particles were dispersed into the powdered food and the contaminated products were then sent out to distributors. After the business was sold, the plastic particles were discovered by a leading pharmaceutical company and there was a product recall. The failure to disclose such a major incident led to enormous costs for the Vendor including a warranty claim for compensation not covered by insurance.
Another example of a real-life scenario is where a cardboard box manufacturer lost a major customer contract prior to completion but failed to disclose this to the Buyer:
Sometime after completion, the new owner (Buyer) found a letter sat in a drawer that was dated over a month prior to the completion date. The letter was from a major customer stating that a large contract would be cancelled. Due to this discovery, the business became unviable, and the Buyer successfully issued a warranty claim receiving the full purchase price back for the business.
As a Vendor, you may be asked to warrant that, for example, your health & safety/accident book is up to date and there are no issues (to the best of your knowledge). However, if there has been a non-disclosed health & safety breach just before completion, this could cause big problems. Below is another real-life example of a non-disclosed incident - this time, it was for a business specialising in food ingredients:
The day prior to completion, the Factory Manager was counting stock in the warehouse and got concentrated liquid in his eyes, which temporarily blinded him. This was a health & safety incident and the Factory Manager ended up in hospital which potentially meant an employer’s liability. Due to the close timing of the imminent sale (the next day) the warranty had already been completed to say that the accident book was up to date.
We added a last-minute section to the disclosure letter, which stated exactly what had occurred including the current condition of Factory Manager. As the incident had been disclosed to the Buyer, they had to accept this as a fair disclosure; even though the information was brief and provided at very short notice. Had the Vendor not told the Buyer about the incident, they could potentially have had a warranty claim brought against them.
When a Vendor fails to disclose important points during a completion, this can expose the Vendor to subsequent warranty claims, sale falling through, or the Vendor being subsequently approached for a breach of warranty and possibly sued at a later date.
If you are selling your business, you should always submit a full disclosure with your legal bundle – don’t take the risk!
If you would like advice on disclosure and any aspect of business sale, please call 01455 244444.
Please note that any information provided in this article cannot be considered as tax or legal advice. Always consult a solicitor for legal advice, or a specialist adviser for surveys and reports.
Posted on 29th January 2019 by George Seward | Permalink
Our principal, George Seward, has enviable expertise and experience in the field of food business sales and mergers.
The news presented in our blog is all written by George. Should you wish to speak to him about any of the issues discussed, please call our office directly on:
01455 244 444