Delaware Law Alert: Avoiding Ambiguities in M&A Disclosure Schedules

A notable Delaware Chancery Court opinion offers important insights for M&A deal parties into how courts interpret disclosure schedules. In Aldrich Capital Partners Fund, LP v. Bray,¹ the stock purchase agreement and the disclosure schedules had contradictory provisions on the treatment of items listed in the disclosure schedules. Although the opinion arises from a motion to dismiss and does not resolve the issues over the conflicting language, it does provide a close reading of the disclosure schedules that illustrates how relying on common assumptions and drafting practices might lead to unexpected outcomes.  

Background

The case involved a target company that was a defendant in intellectual property infringement litigation, which the company disclosed in some parts of the disclosure schedules to the stock purchase agreement. The disclosure schedules were structured to correspond with the representations in the purchase agreement, and below is a summary of the statements made with respect to the representations at issue in the case:

The buyer brought fraud claims, alleging that the company’s founder had knowingly made misrepresentations in the purchase agreement that were not modified by the disclosure of the litigation in the schedules. Specifically, the buyer claimed that, although the litigation was disclosed in sections 4.16(b) and 4.18 of the schedules, it was not specifically disclosed with reference to the representations in sections 4.16(a) and 4.25, rendering those representations fraudulent.

To complicate matters, the effect of the disclosure schedule information was unclear because the agreement and the disclosure schedules had starkly different provisions relating to how information disclosed in one section of the schedules would apply to other sections:

• On the one hand, the purchase agreement employed a fairly liberal approach to cross-references in the disclosure schedules. It provided that disclosure of an item in one section of the schedules would apply to other sections “to the extent the applicability of such disclosure is readily apparent on its face.” Relying on this provision, the company disclosed the litigation with respect to certain representations and seems to have expected this disclosure to apply by implicit cross reference to all other relevant representations.
• On the other hand, the introductory language to the disclosure schedules purported to employ a restrictive approach to cross-references, stating that disclosure with respect to one section of the schedules would apply to other sections only if “specified under such other section number.” This meant that the company’s disclosure of the litigation only applied to the sections where the disclosure appeared and other sections that explicitly referenced the disclosure.

The founder moved to dismiss the claims, which the court denied, holding that the conflicting language in the agreement and schedules resulted in ambiguity.

Key Takeaways

In ruling on a motion to dismiss, the court did not resolve the clash between the purchase agreement and the disclosure schedules. However, the court’s reasoning offers helpful considerations for sellers preparing disclosure schedules, whether they are operating under a “readily apparent” standard or a more restrictive standard:

• Draft for clarity. Perhaps it goes without saying, but sellers should make sure that disclaimers and other language included in the disclosure schedules do not conflict with the purchase agreement or create ambiguities as to how the disclosure schedules are to be interpreted.

Beyond avoiding such drafting errors, sellers are best served when the agreement is clear about how the disclosure schedules are to be interpreted, possibly by specifically addressing some of the interpretive issues raised in the opinion that are outlined below (such as the use of explicit cross references and the meaning of “none” and “readily apparent”). For important disclosures where the seller desires certainty, the best approach is to either repeat the disclosure in all relevant sections of the schedules or use clear cross-references to the section(s) with disclosure.

• Use “none” with caution. In one relevant section of the schedules, the company wrote “none,” and the court held it would be reasonable to read the term literally to mean that no disclosure applied to that section, even if disclosure made elsewhere in the schedules might apply. Unless the agreement expressly provides otherwise, sellers should expect that any schedule that states “none” may be understood to block implicit cross-references.
• Adverse inferences may come from inconsistent disclosure. The court noted that, although the company claimed that explicit cross-references were not needed, the company still used them in some sections. The court held that under Delaware principles of contract interpretation, the use of explicit cross-references weighs against reading implicit cross-references into the schedules.

Similarly, the company had described the litigation specifically in the section of the schedules modifying the non-infringement representation (§4.16(b)) and, in addition, modified the no-litigation representation (§4.18) by including a cross-reference to the specific disclosure. The court, relying on the presumption against meaningless contractual language, interpreted the separate cross-reference to the specific disclosure as evidence that the specific disclosure alone was not broad enough to apply to other representations.
With these interpretations in mind, sellers should take care to be consistent in how they reference information in the disclosure schedules.

• There are limits to “readily apparent” disclosure. Finally, the court indicates that even under a “readily apparent” test, it would be reasonable to conclude that a disclosure implicitly modifies only those representations that directly conflict with such disclosure. Specifically, the court suggests that the disclosure of the litigation would be a readily apparent modification of the representations relating to the absence of litigation (i.e., the no-litigation and non-infringement representations) but might not be a readily apparent modification of other representations, such as those relating to intellectual property ownership and the validity of material contracts. Sellers should take care in assessing what might be “readily apparent” from disclosure and either clearly specify in the agreement that disclosure in one section applies to all others or err on the side of using explicit disclosures or references.

¹ C.A. No. 2023-1253-PRW (Del. Ch. May 17, 2024; Wallace, J.) (letter opinion and order).