Disclosure Schedules are a Waste of Money

This article is the sequel to the author’s previous article entitled Merger Agreements are Too Long.

In public company M&A deals, the target’s disclosure schedules typically consist of lists of facts about the target and its businesses.  Most of the listed items are either exceptions to detailed representations and warranties (the “reps”) or information specifically required by the reps to be listed out.  For example, disclosure schedules might include lists of all of the target’s registered trademarks or descriptions of all of the target’s pending litigation matters.  The resulting schedules can be hundreds of pages long and add little value from a risk allocation perspective for either buyers or targets.  Dealmakers should eliminate this burdensome “tree-killer” from the public company M&A playbook.

The Information Included in Disclosure Schedules is Often Immaterial or Uncertain

Public company merger agreements typically qualify almost all of the target’s reps by reference to the target’s recent SEC filings.  In other words, information that is already disclosed in the target’s SEC filings does not need to be duplicated in the disclosure schedules.  Under the ’34 Act and U.S. GAAP accounting rules, any material historical information about the target ought to be captured in the target’s SEC filings already.  So what information would be added by the disclosure schedules?  Lists of immaterial information and contingent matters that are not probable and estimable, are not required to be disclosed in the proxy statement or registration statement for the deal, and do not constitute material non-public information that would trigger a trading black-out.

In Public Company Deals, Disclosure Schedules Serve a Limited Purpose

Public company deals almost never involve reps and warranties insurance, post-closing indemnities or purchase price adjustments.  As a contractual matter, the disclosure schedules associated with reps primarily serve only one function: they limit what information can be taken into account in assessing whether closing conditions are satisfied.  The non-fundamental reps themselves are typically already “brought down” to a “material adverse effect” standard for purposes of the closing conditions.  Therefore, by definition, the associated disclosure schedules are only “additive” if they contain information that would otherwise have a “material adverse effect” – i.e., the very same kind of information that one would expect to see disclosed in the target’s SEC filings.  Even in contracts that lack fulsome fraud disclaimers, disclosure schedules would only be meaningful as a contractual matter if the scheduled information is “material” within the meaning of typical contractual or common law definitions of fraud.

The Information in Disclosure Schedules is Duplicative of Information Already Provided to the Buyer in Due Diligence

No reasonable buyer would allow a target to make references to information in the disclosure schedules that had not already been disclosed to the buyer in the course of due diligence.  A common task for a junior member of a deal team (or potentially an artificial intelligence agent) is to assign data room index numbers to each item listed in the disclosure schedules to ensure alignment between the two sources.  While some buyers use disclosure schedules as a forcing function to push targets to put responsive information in a data room, the vast majority of the work goes in the other direction (taking information and insights from the data room and listing it in schedules).

Assembling Disclosure Schedules Requires a Lot of Target Employees to be Brought “Under the Tent”

Putting together hundreds of pages of disclosure schedules inevitably requires the involvement of a myriad of subject matter experts from the target’s management team, including HR, IP, facilities, IT, litigation, finance, commercial contracts and environmental specialists.  For the most part, these are individuals whose involvement is ancillary to the negotiation of key risk allocation provisions of the merger agreement and whose participation may not otherwise be needed for the kinds of high-level management due diligence sessions that are common in public company deals.  Moreover, it is often possible to get inputs for assembling a data room without disclosing the reason the information is needed (e.g., with a narrative that the information is needed for a corporate record-keeping clean up or ordinary course financing transaction).  It is harder to maintain that kind of ruse when you are asking employees to review drafts of schedules.  Hence, the disclosure schedules are the primary catalyst for bringing a lot of additional people under the tent.

Obviously the more people you have to bring under the tent on a deal, the higher the risk of a leak.  Bringing in additional people also increases the administrative burden on the project leads.  For example, the additional people may need to sign internal NDAs; get added to a restricted list for purposes of administering the company’s insider trading policy; and, if they are new to M&A, get some basic training on how merger agreements and disclosure schedules work.  All of those people have busy day jobs, and getting involved in the deal process can be a huge distraction.  Moreover, involving large teams early in the weeds of the transaction may force the target’s board to put retention arrangements in place pre-announcement.

Disclosure Schedules Slow Down Deal Announcements

Merger agreements for public company deals can be drafted and negotiated in a matter of days.  Disclosure schedules and the associated reps, in contrast, can take weeks to put together.  Disclosure schedules can be even more cumbersome in deals when they include clean team information such that two versions of the schedules (a regular version and a clean-team only version) must be maintained separately.  The disclosure schedules are almost always the workstream that causes the deal team to pull an all-nighter on the eve of signing.  They so often lag all the other elements needed to sign a deal that they may only be capable of being finalized after the target’s board has already approved the deal, a sequencing issue that has been a subject of judicial scrutiny in Delaware courts.

Disclosure Schedules are Costly to Prepare

Because disclosure schedules are so unwieldy, they run up costly legal fees.  Most information provided in due diligence can typically be sourced without much external legal counsel involvement, whereas producing disclosure schedules can burn a lot of outside counsel calories.  Buyers ultimately bear this cost and really ought to ask themselves if the juice is worth the squeeze when it comes to getting granular information at signing, as opposed to getting it as part of orderly integration discussions between signing and closing.  It is possible that AI will eventually help targets to streamline the disclosure schedule preparation process, but even if the AI were well-prompted to extract information relevant to the reps, the AI tool would still need to have access to all of the target’s IT systems and other repositories of institutional knowledge in order to access the underlying responsive information.  In addition, the resulting data dump would need to be reviewed for accuracy, responsiveness to the reps and common sense.

Potential Alternative Approaches

There are several approaches dealmakers could use to eliminate the need for lengthy, detailed disclosure schedules.  Here are a few examples:

1. Some non-U.S. business combination agreements allow the target to “incorporate by reference” the data room as disclosure against the reps.  In other words, the target automatically “gets credit” for anything in the data room and does not have to list the details out in the schedules.
2. Twenty years ago, it was common for merger agreements to include a “10b-5” or “full disclosure” rep – in other words, a rep that there are no material misstatements or omissions in the agreement.  This kind of rep operates as a gap filler to sweep in concepts that otherwise would have to be addressed by more detailed reps that, in turn, might call for detailed disclosure schedules.
3. Most merger agreements strictly limit the buyer’s ability to rely on information provided outside the four corners of the merger agreement, but one could imagine a world in which buyers are expressly entitled to rely on the accuracy and completeness of information provided to them in a data room, thereby obviating the need for detailed reps and disclosure schedules.

These approaches, if administered thoughtfully, would not unfairly disadvantage either party in a deal.  In general, targets will have to get more comfortable standing behind their public disclosures (and potentially their due diligence production depending on the alternative approach adopted). At the same time, buyers will need to stop asking for granular reps on immaterial aspects of the target’s business.

Of course, none of these approaches will necessarily eliminate disclosure schedules entirely.  It may still be necessary, for example, to have a schedule of exceptions to the interim operating covenants or a list of required regulatory filings.

Conclusion

In many public company deals, once the transaction is signed, nobody ever looks at the schedules to the reps again.  Eliminating or paring back disclosure schedules is an obvious path to try to streamline deals, eliminate costly distractions and reduce leak risk.