No Undisclosed Liability Representation Clause
(M&A Transaction)

Summary

This clause is a "no undisclosed liability" representation, also known as an "absence of liabilities" representation. In this representation, the seller represents, subject to the optional qualifications, that all of the target's liabilities have been disclosed. This clause includes practical guidance, drafting notes, alternate clauses, and optional clauses. A no undisclosed liability representation (also known as an absence of liabilities representation) is a representation that the target company in an M&A acquisition has no undisclosed liabilities. This representation serves the same purpose as any other representation or warranty in an M&A acquisition agreement, namely: (1) to shift risk from one party to another and/or (2) to solicit information from the representing party for the benefit of the non-representing. A no undisclosed liability representation is particularly effective at achieving the risk-shifting function of representations, as it is capable of allocating the risk from any undisclosed or unknown liability from the buyer to the seller. For this reason, buyers will generally (successfully) demand inclusion of such a representation in the acquisition agreement. Where the representation is included in an acquisition agreement, buyers will attempt to lessen the scope and impact of the representation through qualifiers and limitations. As a result, there are multiple variations of a no undisclosed liability representation, each of which represents a negotiated compromise between buyer and seller. Uses of a "No Undisclosed Liability" Representation "No undisclosed liability" representations are used in both public and private M&A acquisition agreements. This representation is one of many ways parties can shift risk. Unknown (or known but undisclosed) liabilities of a target in an M&A transaction can be allocated by means of other representations in which a seller represents that it did or did not perform specific actions (e.g., paid all taxes, complied with environmental laws, etc.). So long as those representations are not qualified by the seller's knowledge, the seller has already assumed the risk of any unknown liabilities that arise from the subject matter of those representations. Types of "No Undisclosed Liability" Representation As a seller representation requested by buyers, the baseline no undisclosed liability representation is pro-buyer, by virtue of having first been drafted by the requesting buyer. The baseline representation requires that every single seller liability has been disclosed in the disclosure schedule or the target's latest balance sheet (and if applicable, an interim balance sheet prepared by the seller). This pro-buyer baseline variation of the no undisclosed liability representation is entirely without qualification or limitation. The target's latest balance sheet will be as of a date-certain (usually the close of the target's most recent fiscal quarter), as a result of which it may not cover a significant period of time and any liability that arose during this time period would breach the no undisclosed liability representation. As a result, a seller might prepare an interim balance sheet dated as close to (or as of) the closing date as possible. If prepared and referenced in a no undisclosed liability representation, an interim balance sheet would address having to list ordinary course liabilities since the date of the latest balance sheet. Pro-Seller Variations to the Baseline "No Undisclosed Liability" Representation In practice, an entirely pro-buyer variation of the no undisclosed liability representation is rarely, if ever, agreed to in transactions. A seller will negotiate to include qualifiers and exceptions. The limitations and exceptions set out below are listed in rough order of frequency of use and importance (i.e., how pro-seller each such variation is). Ordinary course exceptions. A seller will almost always ask that ordinary course liabilities incurred since the date of the target's latest balance sheet be excepted from the no undisclosed liability representation. This carve-out is standard because without it, even immaterial ordinary course liabilities (i.e., those necessary in the everyday conduct of the target's business) would breach the no undisclosed liability representation, as there would generally be no practical way to disclose them absent a balance sheet. Limiting the subject liabilities to GAAP balance sheet liabilities. This variation of the no undisclosed liability representation modifies the representation such that only liabilities that are undisclosed but which are required to have been disclosed on a balance sheet prepared in accordance with generally accepted accounting practices (GAAP) are considered undisclosed. As a general rule, GAAP calls for an accrual (i.e., an entry on a balance sheet, and thus, disclosure) for a contingent liability if it is probable that (1) an asset has been impaired or (2) a liability has been incurred. A probable event is one that is defined as being more than likely. As a result, limiting the subject liabilities of a no undisclosed liability representation to those which would be required to be disclosed on a balance sheet prepared in accordance with GAAP as liabilities eliminates the need to disclose immaterial, unforeseen or improbable contingent liabilities. In addition, unknown liabilities cannot be disclosed as they cannot have been expected to be disclosed on a GAAP-prepared balance sheet. This variation also eliminates the need to disclose many ordinary course business liabilities (e.g., ordinary course contract liabilities) because these are not considered liabilities under GAAP standards. Materiality or knowledge qualifiers. As with any representation or warranty, a no undisclosed liability representation may be limited by the seller's knowledge (which may be actual knowledge or assumed knowledge) or be subject to a materiality threshold which may take the form of a dollar threshold below which a liability can be disregarded. See Representations and Warranties in Acquisition Agreements — Knowledge Qualifiers for more regarding knowledge qualifiers. Excluding liabilities which are the subject of other representations. Another pro-seller variation to the no undisclosed liability representation is to carve-out subject matters that are covered by other representations and warranties. For example, a representation may require disclosure in a corresponding disclosure schedule of liabilities only if they are in excess of $[x] and relate to a particular subject matter. Without this optional clause, a liability may be carved out from having to be disclosed by a relevant representation by virtue of the manner in which it is drafted but would nonetheless need to be disclosed pursuant to the no undisclosed liability representation if no corresponding carve-out were included in it. Liabilities incurred in connection with a transaction. A seller may wish to carve-out liabilities incurred in connection the acquisition agreement and the transactions contemplated thereby. For example, a seller might incur legitimate costs associated with legal counsel, environmental experts, or IT consultants in connection with the proposed sale. Arguments For and Against a "No Undisclosed Liability" Representation Each of the buyer and seller have principled arguments to make in negotiating for (in the case of a buyer) or against (in the case of the seller) the inclusion of a no undisclosed liability representation. Pro-Buyer Arguments • First and foremost, a buyer may correctly point out that the seller is better positioned to assess the risk of there being an unknown liability. Fairness would also dictate that a known but undisclosed liability be borne by the seller. • A buyer usually does bear some of the risk of an undisclosed liability by virtue of the fact that a no undisclosed liability representation is generally subject to the limits imposed by indemnity caps and baskets. The buyer is thus responsible for any undisclosed liability that falls below the basket amount and above the cap amount of an indemnity provision. For further discussion, see Indemnification Provisions in Private Acquisition Agreements. Pro-Seller Arguments • A seller may push back against the inclusion of a no undisclosed liability representation by arguing that it operates as a wide-ranging catch-all which should be the buyer's responsibility to flesh out by way of specific representations and warranties from the seller. Indeed, a seller could argue that the absence of a representation which address a particular subject matter or aspect of such a subject matter reflects the bargain struck by the parties and that the inclusion of a no undisclosed liability representation would defeat the parties' intent. • A seller may also point to the general material adverse change or material adverse effect definition in an acquisition agreement and argue that these provisions should provide the buyer with sufficient comfort that no material undisclosed liability has arisen since the date of the last balance sheet. A standard representation regarding the accuracy of financial statements would provide the buyer with comfort that there were no undisclosed liabilities prior to the date of the last balance sheet. In conjunction, these two provisions might obviate the need for a no undisclosed liability representation. • A seller might also point to the interim period covenants by which it has covenanted to run the target's business in a particular way. These covenants typically require the seller to run the business consistent with past practice and in the ordinary course. For further discussion of representations and warranties generally, see Representations and Warranties in Acquisition Agreements. No Undisclosed Liability Precedents Click here to see recent examples of no undisclosed liability representations in Market Standards, the searchable database of publicly filed M&A deals from Practical Guidance that enables users to search, compare, and analyze its comprehensive database of transactions using over 150 detailed deal points to filter search results. You can customize this search to your needs by adding filters or modifying the search criteria.