DUE DILIGENCE IN MERGERS AND ACQUISITIONS: THE SYNERGY BETWEEN NO-CONFLICT REPRESENTATIONS AND DISCLOSURE SCHEDULES

ABSTRACT

Due diligence in Mergers and Acquisitions (M&A) is as fundamental to the transaction as jurisdiction is to a court. Just as a court’s decision is void if rendered without proper jurisdiction, an M&A transaction is likely to unravel without adequate due diligence. This article focuses on a critical aspect of due diligence: representations—specifically, no-conflict representations and disclosure schedules. This research reveals that certain deficiencies, for instance poorly drafted disclosure UT schedules by the seller, can negate the assurances provided in no-conflict representations. This misalignment may lead to breaches of the acquisition agreement and expose the selling company or its shareholders to significant liability. On the buyer’s side, inadequate review of these schedules can mean missed opportunities to identify and address potential risks. This article explores these challenges and recommends best practices and tools to ensure disclosure schedules align accurately with no-conflict representations, thereby safeguarding the integrity of the M&A process.

INTRODUCTION

Businesses around the world today thrive on company restructuring processes to enhance productivity, expand their market share and improve competitiveness, among other benefits. M&A has proven to be one of the most effective means of corporate restructuring, which allows companies to have their stocks acquired by another company or merge with them completely for increased efficiency. An M&A process typically begins with a document from the seller that provides potential buyers with a general overview of the company, without revealing confidential information. Interested parties usually sign a confidential agreement to protect sensitive details. Thereafter, discussions may begin to address key legal, financial, and regulatory considerations. This is followed by a due diligence process, where the buyer examines the business to identify any potential risks. If the findings are satisfactory, both parties negotiate the final terms, such as the purchase price and responsibilities, then sign a formal agreement.[1]

The due diligence process involves an investigation of representations and warranties provided by the seller to the buyer. This serves as a risk allocation mechanism, enabling claims in the event of any loss arising from false or inaccurate representations and warranties.[2] Among the key representations is the no-conflict clause, which is a fundamental warranty by the seller confirming that entering into the agreement will not conflict with any existing contracts and laws.[3]  However to be on a safer side, when it is conceivable that such conflicts may come up, this representation is usually qualified with certain limitations included in a supplemental document known as the disclosure schedules. The purpose of qualifying this warranty with a disclosure is to prevent the buyer from making claims for any breach that had already been communicated. An incomplete or inaccurate disclosure schedules materially undermines the no-conflict representation, potentially resulting in the disclosing party’s liability for breach under the M&A agreement. Therefore, it is important that disclosure schedules are carefully prepared and reviewed for accuracy.[4] This article will examine the no-conflict representation clause and the role of disclosure schedules, then explain the legal consequences for inadequate disclosure and conclude with suggestions on best practices for drafting disclosure schedules to improve efficiency in the process.

UNDERSTANDING NO-CONFLICT REPRESENTATIONS

A no-conflict representation also known as a non-contravention representation, typically assures that the transaction will not conflict with any of its legal and contractual obligations. The clause serves two purposes: (1) to affirm that the transaction will not conflict with or result in a violation of the representing party’s governing documents, legal obligations or contractual obligations; and (2) does not require the consent of a third party or governmental authority, in each case other than as identified on the disclosure schedule.[5] The buyer will want the seller to disclose all possible conflicts, including violations of laws or any of its contracts, imposition of a tax or lien on the selling company, the ability  of any shareholder of the selling company to  exercise dissenters’ appraisal rights and any rights of termination under existing contracts.[6] However, a no-conflict representation clause stands as an assurance that none of such exists save for the exceptions.

A typical example of a no-conflict representation clause from the seller will read:

“Subject to obtaining all required consents, approvals, and authorizations outlined in Section 3.07, the execution, fulfillment, and performance of this Agreement by the Seller will not (a) breach any provisions in the Seller or the Company’s Organizational Document, (b) conflict with or violate any applicable Laws or Government Orders concerning the Seller, the Company, or their assets, properties, or operations, or (c) result in contractual breaches, defaults, termination rights, or the creation of any encumbrances on the Shares or Assets under any agreements involving the Company, except as indicated in Section 3.06(c) of the  Disclosure Schedule.”[7]

The Delaware Supreme Court case of City of Fort Myers General Employees’s Pension Fund v. Haley[8] is an example of how conflict in legal obligations can undermine a merger transaction. The court reinstated claims against John Haley, the CEO of Tower Watson & Co., for failing to disclose to his board a lucrative compensation package offered to him during merger negotiation with Willis Group Holdings PLC. The court held that Haley’s omission of this material conflict breached his fiduciary duty of candor and loyalty and invalidated the informed stockholder vote that would have protected him from liability. This is a clear case of a mismatch between fiduciary obligations and contractual representations in a merger. Haley’s undisclosed compensation discussions gave rise to a suit because they rendered inaccurate any representation that the seller has fulfilled their legal and contractual obligations and that negotiations have been conducted fairly.

Functions of a No-Conflict Representation

No-conflict representation like every other representations and warranty in M&A deals, serve multiple key functions;

1. They provide an avenue to disclose detailed information, particularly from seller to buyer about the target business or assets.
2. They enable “walk rights,” allowing a party to exit the deal if the representation becomes inaccurate before closing.
3. In private M&A deals, they facilitate risk shifting by enabling indemnification, ensuring the seller bears responsibility for inaccuracies.
4. They promote discipline, encouraging parties to ensure their statements are accurate to avoid deal failure or liability.[9]

Therefore, both the seller and the buyer in M&A deals have a duty of due diligence, to ensure that no issues arise that might create conflicts.

THE ROLE OF DISCLOSURE SCHEDULES

Disclosure schedules are documents that supplement the representations and warranties in an M&A agreement. They are used to communicate exceptions to the assertions made in the representations and warranties. For example, if a representation states that there is no ongoing litigation, the disclosure schedule may list any pending lawsuit.[10] The City of Fort Myers case[11]  emphasizes the need for full disclosure of conflicts in M&A negotiations.

In the context of a no-conflict representation, disclosure schedules not only qualify the statements, but also help sellers limit a buyer’s ability to claim a breach of the representation. It is an important step in the process, that exceptions listed in the disclosure schedules correspond directly to particular representations or warranties. The case of Williams Companies v. Energy Transfer Equity highlights the importance of clear drafting to avoid unintended cross-application of disclosures. In this failed merger, Williams argued that ETE’s $1 billion preferred unit offering violated multiple securities issuance, dividend limitations, and amendments to organizational documents. ETE relied on a section in the disclosure schedule that allowed the issuance but claimed it also applied to the other related covenants. The court concluded that exceptions in disclosure schedules apply cross-sectionally only when it is “reasonably apparent on [the] face” that they are relevant to multiple covenants.[12] The court has consistently emphasized the need for clarity and consistency in drafting disclosure schedules to avoid ambiguities that could lead to litigation.[13]

Legal Implications of Inadequate Disclosure Schedules

Given the scope of the no-conflict representations, it is imperative to disclose all material issues in the disclosure schedules to prevent future claims for breach. Failure to do so can lead to the termination of the deal. In cases where there are issues involving non-compliance with regulations especially where such compliance is mandatory, the court can permit the lawful termination of merger agreement.[14]

During the negotiation stage, the seller and the buyer must ensure that representations and accompanying disclosure schedules accurately reflect the agreed terms. However, in a transaction where the contents of the disclosure schedules misrepresent the parties’ mutual intentions, the UK court in the case of Persimmon Homes Ltd v. Hillier,[15] held that the document may be rectified to reflect the parties’ true agreement.

BEST PRACTICES FOR DRAFTING DISCLOSURE SCHEDULES

Involve Key Personnel

To ensure that the disclosure schedules are accurate and complete, involve legal counsel, financial accountants, auditors, and other relevant personnel who understand the company’s operations and have access to necessary information.[16] The role of the lawyer is to ensure that disclosure schedules align with the representations made in the agreement and to identify areas where exceptions need to be disclosed. While the accountant and other financial officers verify the accuracy of financial data.

Identify Key Documents to Review

Map out key documents that must be reviewed in line with the transaction, including Organizational documents (articles of incorporation, bylaws, etc.), Material contracts (customer agreements, supplier contracts, loan agreements, etc.), Legal and regulatory filings, Governmental approvals and permits, Previous M&A agreements, Shareholder agreements, Joint venture agreements, etc. [17] Do not leave any stone unturned.

Leverage Technology to Streamline the process

Using technology can streamline the process. Tools that automate document analysis help highlight potential conflicts, improve efficiency, and increase accuracy.[18]  M&A experts can leverage on AI-powered platforms like Kira systems or Luminance to extract and compare terms among multiple documents. This is not to undermine the role of professionals but to enhance the due diligence process

Utilize Checklists and Templates

With every document that must be reviewed to highlight conflicts, utilize checklists to ensure that all paragraphs are duly reviewed. Templates provide a structured format for organizing disclosures to avoid overlooking critical information.[19]

Ensure Clarity and Consistency

Ensure that disclosures are clearly worded and directly tied to specific representations. When cross-sectional application is intended, state it explicitly to avoid ambiguity.[20]

Constant Exchange of Information

The buyer and seller must create a room to allow for constant exchange of information between professionals from both sides. This exchange allows professionals to seek clarifications and collaboratively refine disclosures. [21]

CONCLUSION

Due diligence process is not merely one step in M&A transactions, it is a critical component that must be conducted with precision. The success or failure of an M&A transaction often depends on a number of factors including the accuracy of representations and warranties. When exceptions to representations and warranties exist, they must be clearly documented in the disclosure schedules. Failure to do such, incurs legal consequences for the seller, and robs the buyer of an opportunity to address potential risks. M&A professionals should exercise utmost care, and employ the use of AI-powered tools for improved efficiency in the process, and ultimately, to ensure transparency and minimize legal risk.

REFERENCE(S)

1. ‘Mergers & Acquisitions: The 5 Stages of an M&A Transaction’ (PwC, October 2022). Available at: https://www.pwc.com/mt/en/publications/tax-legal/mergers-and-acquisitions-5-stages-of-MA-transaction.html accessed 7 May 2025.
2. ‘The Critical Role of Disclosure Schedules in M&A Transactions’ (Raetzar, 21 March 2024). Available at: https://raetzer.com/the-critical-role-of-disclosure-schedules-in-ma-transactions/ accessed 8 May 2025.
3. ‘The Importance of Disclosure schedules in M&A Transactions’ (Hchlawyers, 4 September 2020). Available at: https://www.hchlawyers.com/blogg/2020/september/the-importance-of-disclosure-schedules-in-m-a-tr/ accessed 10 may 2025.
4. American Bar Association, Model Asset Purchase Agreement with commentary § 3.2 & cmt. (2001).
5. Asola et al., ‘Private Mergers and Acquisitions in Nigeria: Overview’ (1 May, 2024). Available at: https://www.aluko-oyebode.com/wp-content/uploads/2024/09/Private-Mergers-and-Acquisitions-in-Nigeria-Overview.pdf accessed 7 May 2025.
6. ‘Intro to M&A Representations and Warranties’ (Aigbe law, 8 January 2024). Available at: https://www.aigbelaw.com/securitiesinvestinglawblog/2024/1/8/into-to-mampa-representations-and-warranties accessed 8 May 2025.
7. Ip, S. Amyot & M. Smith, ‘M&A Transactions Involving AI Companies: Representations And Warranties’ (27 January 2025). Available at: https://www.mondaq.com/canada/corporate-and-company-law/1574410/ma-transactions-involving-ai-companies-representations-and-warranties accessed 10 may 2025.
8. Conway & T. Belton, ‘Tips on Drafting, Negotiating Disclosure Schedules In M&A’, (7 December, 2015). Available at: https://www.mondaq.com/unitedstates/maprivate-equity/449698/tips-on-drafting-negotiating-disclosure-schedules-in-ma accessed 7 May 2025.
9. Khindaria, ‘Due Diligence in M&A Transactions’ (3 July 2016). Available at: https://blog.ipleaders.in/due-diligence-ma-transactions/ accessed 10 may 2025.
10. ‘The Complete M&A Due Diligence Checklist’ (Dfinsolutions, 30 September 2024). Available at: https://www.dfinsolutions.com/knowledge-hub/thought-leadership/knowledge-resources/m-a-due-diligence-checklist accessed 10 May 2025.

[1] ‘Mergers & Acquisitions: The 5 Stages of an M&A Transaction’ (PwC, October 2022). Available at: https://www.pwc.com/mt/en/publications/tax-legal/mergers-and-acquisitions-5-stages-of-MA-transaction.html accessed 7 May 2025.

[2] S. Ip, S. Amyot & M. Smith, ‘M&A Transactions Involving AI Companies: Representations And Warranties’ ( 27 January 2025). Available at: https://www.mondaq.com/canada/corporate-and-company-law/1574410/ma-transactions-involving-ai-companies-representations-and-warranties accessed 10 May 2025.

[3] A. Asola, M et al., ‘Private Mergers and Acquisitions in Nigeria: Overview’ (1 May, 2024). Available at: https://www.aluko-oyebode.com/wp-content/uploads/2024/09/Private-Mergers-and-Acquisitions-in-Nigeria-Overview.pdf accessed 7 May 2025.

[4] T. Conway & T. Belton, ‘Tips on Drafting, Negotiating Disclosure Schedules In M&A’, (7 December, 2015). Available at: https://www.mondaq.com/unitedstates/maprivate-equity/449698/tips-on-drafting-negotiating-disclosure-schedules-in-ma accessed 7 May 2025.

[5] American Bar Association, Model Asset Purchase Agreement with commentary § 3.2 & cmt. (2001

[6] Ibid.

[7] ‘Intro to M&A Representations and Warranties’ (Aigbe law, 8 January 2024). Available at: https://www.aigbelaw.com/securitiesinvestinglawblog/2024/1/8/into-to-mampa-representations-and-warranties accessed 8 May 2025.

[8] City of Fort Myers General Employees’s Pension Fund v. Haley [2019] Del 234 A.3d 702.

[9] ‘Intro to M&A Representations and Warranties’ (n 7)

[10] ‘The Critical Role of Disclosure Schedules in M&A Transactions’ (Raetzar, 21 March 2024). Available at: https://raetzer.com/the-critical-role-of-disclosure-schedules-in-ma-transactions/ accessed 8 May 2025.

[11] City of Fort Myers case (n 8)

[12] Williams Companies v. Energy Transfer Equity, L.P., [2017] CA Nos. 12168 & 12337.

[13] Aldrich Capital Partners Fund, LP v. Bray, C.A. No. 2023-1253-PRW (Del. Ch. May 17, 2024; Wallace, J.) (letter opinion and order)

[14] Akorn, Inc. v. Fresenius Kabi AG, [2018] CA. No. 2018-0300-JTL

[15] Persimmon Homes Ltd v. Hillier & anor [2019] ECWA, Civ 800

[16] ‘The Importance of Disclosurechedules in M&A Transactions’ (Hchlawyers, 4 September 2020). Available at: https://www.hchlawyers.com/blogg/2020/september/the-importance-of-disclosure-schedules-in-m-a-tr/ accessed 10 may 2025.

[17] ‘The Complete M&A Due Diligence Checklist’ (Dfinsolutions, 30 September 2024). Available at: https://www.dfinsolutions.com/knowledge-hub/thought-leadership/knowledge-resources/m-a-due-diligence-checklist accessed 10 May 2025

[18] S. Khindaria, ‘Due Diligence in M&A Transactions’ (3 July 2016). Available at: https://blog.ipleaders.in/due-diligence-ma-transactions/ accessed 10 may 2025.

[19] ‘The Complete M&A Due Diligence Checklist’ (n 17)

[20] Aldrich Capital Partners Fund, LP (n 13)

[21] ‘Due Diligence in M&A Transactions’ (n 18)