A Practical Guide to Private Equity Transactions

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Disclosure and the disclosure letter

3.2 The acquisition disclosure letter

Generally, disclosure letters come in three parts. The rst section sets out

some general principles, recitals and interpretation provisions concerning the

disclosure letter; the second sets out general disclosures intended to qualify all

of the warranties; and the third sets out disclosures of specic issues, cross-

referencing the specic disclosure against the particular warranty to which it

is relevant.

(a) General principles/interpretation

The introductory part of the letter will identify the document and its attach-

ments as the disclosure letter, and may set out some context as to how it should

be construed (for example, by borrowing dened terms from the acquisition

agreement). There is a tendency for advisers to the seller(s) to seek to explain

its purpose in some detail: for example, to include wording such as: ‘This let-

ter sets out the disclosures for the purposes of the acquisition agreement and

no claim may be made against the seller(s) for any matter disclosed in it.’ Such

expansive attempts to dene the legal effect of the disclosure letter should

generally be resisted – its purpose should be set out in the agreement not in

the letter, and such additional wording can undermine the carefully consid-

ered denition of the adverbial hurdle, such as fair disclosure, in the agree-

ment itself. Less objectionable to the buyer are provisions such as ‘Nothing in

this letter shall be taken as extending the meaning of any warranty or as an

acknowledgment that the disclosure needs to be made to qualify the warranty’,

which simply claries that the disclosure letter should not, in itself, increase

the liability of the seller(s).

(b) General disclosures

General disclosures represent an attempt by the seller(s) to disclose to the buyer

information which is available outside the text of the specic disclosures in the

disclosure letter itself. Typical examples include:

the contents of the statutory books of Target;•

information appearing in respect of Target at Companies House;•

contents of an agreed bundle of documents, documents from any data •

room, or any other written diligence information handed over (for exam-

ple, any information memorandum or other ‘selling’ document produced

by the seller(s) as part of the sale process);

the contents of Target’s accounts;•

matters that could be obtained from any public search or registry in •

respect of Target, its properties or intellectual property;

anything set out in the buyer’s due diligence reports;•

anything said or communicated between the parties’ advisers in respect •

of the transaction; and

anything in the public domain.•

Acquisition issues

As a general guide, the above list sets out an order of likely palatability – that

is to say that the lower a matter is in the list, the less likely it is that the buyer

will accept the general disclosure. However, there are some exceptions to this.

For example, some buyers take a particularly robust stance in resisting the

disclosure of any data room contents or a large bundle of disclosed documents,

irrespective of how tightly the concept of ‘fair disclosure’ (or similar wording)

has been dened.

There is some area of overlap between certain limitations and certain gen-

eral disclosures – for example, should the buyer be precluded by a limitation

from claiming to the extent that any matter is set out in Target’s accounts, or

should the contents of Target’s accounts be generally disclosed. It is in part a

matter of taste, but, generally speaking, the seller(s) should usually prefer a

limitation to a general disclosure, as in the former case it is possible that the

adverbial hurdle set for a disclosure to qualify the warranties can be avoided

or mitigated. In any event, it is important to ensure consistency – for example,

a buyer who insists that a limitation which seeks to prevent claims in respect

of any matters revealed by the buyer’s due diligence investigations cannot be

accepted should not then allow the content of any due diligence reports to

reappear as a general disclosure.

The essence of a general disclosure is that it does not in particular seek to

pull out from that information source exactly what is relevant to the Target, or

explain how the disclosure is relevant in the context of any particular warranty.

The effect of a general disclosure is that a claim cannot be brought for a matter

which is within that particular source of information. As a general disclosure

can have the effect of limiting warranty claims without necessarily identifying

any particular problem (which the buyer can then take into account in price

negotiation or other contractual protections), buyers will often resist extensive

general disclosures. However, custom and practice has allowed certain general

disclosures to be made in UK deals at least. Some general disclosures are

generally accepted to be beyond the pale – for example, seeking generally to

disclose everything in the public domain, or anything available in any register

in any part of the world. Such broad disclosures are not really telling the buyer

anything about the Target or the business but are instead seeking to create

‘after the event’ defences for the seller in the event of a warranty claim.

The majority of the disclosure letter will take the form of specic disclosures,

which are far more useful (from the buyer’s point of view at least) in the con-

text of the role of the warranties in eliciting disclosure. Specic disclosures

are usually made by reference to each numbered paragraph in the warranty

schedule, and set out the details of any facts, matters or circumstances which

constitute (or may constitute) a breach of that warranty. The disclosure is sup-

ported by reference to attached copies of any relevant documents. For example,

against a warranty that there are no claims under Target’s insurances policies,

Competition matters

the seller(s) should disclose details of any actual claims including their current

status, whether the insurers are accepting the liability, and the size and nature

of the claim – and may then make reference to any relevant policy wording

or correspondence with the insurers, which would be attached to the letter or

included in a separate bundle.

Precisely what is said, and in how much detail, depends in part on the

wording of the precise warranty, and in part on the adverbial hurdle which

must be overcome for the disclosure to be valid. It is for this reason that the

precise wording of key warranties, and the denition of ‘fair disclosure’ (or

whatever other concept is agreed), are so keenly negotiated. The buyer will

want to elicit as much information as possible from the disclosure exercise,

in order to understand the relevance of any disclosed matters to the busi-

ness, and the likely quantum of any liability. Seller(s) will be more cautious,

in that they will want to ensure that the disclosure will satisfy the relevant

adverbial hurdle, but will not want to alarm the buyer unduly, or to make any

statement that could be viewed to be misleading or which may prove to be

inaccurate.

One issue that can arise in the context of disclosure is the question of

whether the specic disclosures should qualify more than just the specic war-

ranty by reference to which they are made. The seller(s) will be anxious not

to have to repeat the same disclosure against multiple warranties where it may

be relevant, for fear of missing one and allow a claim to be made for a matter

already disclosed against another warranty. The buyer will not want all the

specic disclosures simply to become, in effect, general disclosures, and may

be concerned that the relevance of a disclosure made against one warr anty may

not be as clear or obvious in the context of another. A compromise wording is

usually found to the effect that a specic disclosure made against a specied

warranty also qualies any other warranty in respect of which it constitutes a

fair (or whatever other hurdle is used) disclosure.

4 Competition matters

4.1 Introduction

As with any acquisition of a business, the main competition issue to be con-

sidered in a private equity transaction is whether merger control legislation

applies. Such legislation typically provides for:

(a) a procedure for the notication of a merger to a competition authority

and the suspension of completion until approval has been given; the noti-

cation and suspension obligation is voluntary in the UK, but is often

mandatory in other countries;

(b) the investigation of the merger by a competition authority which will

seek to establish whether it may have a harmful effect on competition in

any market;

100

Acquisition issues

between four and eight weeks) and a longer ‘phase 2’ period for cases

which raise substantive issues (typically, around six months);

(d) the prohibition of anti-competitive mergers;

(e) penalties for failing to notify and ‘gun-jumping’ before approval is

granted (again, where notication and suspension is mandatory).

Not all mergers are subject to such control. Merger control legislation will have

a series of jurisdictional tests and so typically will apply only where:

one party acquires control or inuence over another party (the ‘control •

test’); and

the relevant jurisdictional or size tests are met (the ‘threshold tests’).•

There are now over seventy countries worldwide with merger control legisla-

tion each with their own set of control and threshold tests, often based on the

turnover or market share of the parties. In the vast majority of these countries,

where the jurisdictional test is met notication is mandatory, although, again,

the vast majority of notied mergers are cleared as they do not raise a substan-

tive competition or market issue.

4.2 Typical issues for private equity transactions

Private equity transactions will often not raise any substantive competition

concerns but, because of the way in which the control and threshold tests oper-

ate in practice, many transactions may be caught. Some of the issues that arise

are the following:

(a) ‘Control’ is not a Companies Act concept, and can arise even on the

acquisition of a minority interest where the acquirer will have a suf-

cient level of inuence (see further below).

(b) The turnover of the acquirer for the purposes of the threshold tests is the

turnover not just of the acquiring private equity vehicle but also that of

the group to which it belongs and that of all portfolio companies control-

led by the group. This will often greatly increase not just the level of the

turnover but also its geographic spread.

take account of the activities of all portfolio companies.

In most jurisdictions, as referred to in section 2.5 above, contracts can be

exchanged conditionally on clearance being granted but the delays and com-

plexities caused will still be of concern to the parties. For that reason, sell-

ers will often require competing buyers to conrm the likelihood of any such

18 In some countries (for example, within Europe, Germany, Ireland and Norway), the threshold

tests are very low triggering a need for mandatory local competition clearance where the

Target and the private equity investor (or more likely its other investee companies) have rela-

tively low sales.

101

Competition matters

clearance being necessary at an early stage in the process. Accordingly, the

competition review, including the identication of all relevant turnover of

portfolio companies, the geographic location of sales and whether there are

any overlaps between portfolio companies and the Target, must be conducted

early.

4.3 Which rules apply?

In the European Economic Area (EEA), large transactions require prior noti-

cation to, and clearance by, the European Commission. In this case, the merger

control rules of the individual EEA Member States do not apply (i.e. the trans-

action requires only one competition clearance in the EEA, as opposed to

multiple national clearances in different EEA Member States: see section 4.6

below).

In the event that the transaction does not trigger the EU rules on merger

control, parties to a proposed merger must look to see whether any relevant

national merger control rules apply. The next section describes the main sub-

stantive and procedural elements of the system for reviewing and investigating

mergers in the UK.

4.4 UK merger control legislation

The UK merger control rules are contained in Part 3 of the Enterprise Act

2002 (EA02). EA02 applies to transactions that lead to a ‘relevant merger situ-

ation’. A relevant merger situation arises where:

(a) two or more enterprises (companies or businesses, or parts of businesses)

cease to be distinct; and

(b) either a turnover or market share threshold test is met.

(a) Ceasing to be distinct (control)

Broadly, two or more enterprises cease to be distinct when they are brought

under common ownership or control. Enterprises are brought under common

ownership or control through the acquisition in another enterprise of:

(a) a controlling interest (legal control, e.g. more than 50 per cent of the vot-

ing rights); or

(b) the ability to control its policy (de facto control); or

or more of the voting rights enabling that shareholder to block special

resolutions, or a lesser holding which gives the acquirer inuence).

19 Section 23 of the Enterprise Act 2002.

20 Section 26 of the Enterprise Act 2002.

102

Acquisition issues

Control can, therefore, be acquired where a private equity buyer acquires a

minority stake in a business. The Ofce of Fair Trading (OFT) will consider

stakes as low as 15 per cent as potentially conferring material inuence par-

ticularly when combined with board representation and, invariably, when com-

bined with veto rights over strategic commercial decisions (e.g. approval of

budgets or business plans).

(b) Threshold tests

For EA02 to apply, the transaction must also meet at least one of these two

alternative size thresholds, namely, either:

(a) where the value of the turnover in the UK of the enterprise being acquired

exceeds £70 million; or

(b) where, as a result of the merger, at least 25 per cent of any goods (or

services) supplied (or acquired) in the UK (or a substantial part of the

UK) are supplied (or acquired) by one and the same person.

For the 25 per cent share of supply test to be met, both parties must supply

(or acquire) the relevant goods (or services) before the merger. For a private

equity investor, this means evaluating whether any of the portfolio companies

over which it or its group has material inuence is active in the same market

as Target.

4.5 Notiﬁcation: voluntary system

The UK merger rules operate a voluntary scheme of notication; there is no

obligation in UK law to notify a relevant merger situation to the OFT for prior

competition clearance. In practice, in private equity transactions, unless the

acquirer’s group has an interest in an existing portfolio company which is

active in the same market as Target (or upstream or downstream), notications

are rare.

There are two principal ways to ask the OFT to reach a decision on a rel-

evant merger situation:

(a) statutory voluntary pre-notication (by way of a so-called ‘Merger

Notice’); or

(b) informal submission.

When an anticipated (i.e. uncompleted) merger is in the public domain, a

party to the merger may submit a statutory pre-notication of the merger

21 See generally OFT, Mergers: Jurisdiction and Procedural Guidance (June 2009), chapter 3.

22 See, for example, Case ME/1591–05, Completed acquisition by the Blackstone Group of

UGC Cinema Holdings Ltd, OFT decision dated 28 April 2005, illustrated in Figure 4.1.

103

Competition matters

Blackstone Group's acquisition of

UGC cinemas

The Blackstone Group acquired the Cineworld cinema chain in October 2004. The

Cineworld acquisition did not raise any competition issues. Two months later in

December 2004, it acquired the UGC cinema chain. The OFT investigated the

acquisition post completion. The OFT took the following steps:

it conducted a phase I investigation of the merger and concluded that the

merger may be expected to result in a substantial lessening of competition in 6

locations (where there were both UGC and Cineworld cinemas);

•

it accepted hold separate undertakings from Blackstone LR Associates

(Cayman) IV Ltd and Cineworld UK Limited to ensure that Cineworld and

UGC were not integrated and that UGC was maintained as a going concern

while the OFT could conduct an investigation;

•

it accepted undertakings in lieu of a reference from Blackstone LR Associates

(Cayman) IV Ltd and Cineworld UK Limited to divest one cinema in each of

the identified locations to a purchaser approved by the OFT.

Figure 4.1 An example of a non-notiﬁed investment: Blackstone Group’s acquisition

of UGC cinemas

to the OFT using a Merger Notice. On submission of a Merger Notice, the

OFT is subject to strict time limits for reaching a decision. The OFT must

decide, within twenty working days of receipt of a completed notication,

whether to refer it to the Competition Commission (CC) (see below). The

OFT may extend the period for decision-making by a maximum of ten work-

ing days.

The parties may prefer to ask the OFT to review the transaction by way

of informal submission. The advantage of this route is to give time to resolve

any competition concerns, for example by giving undertakings in lieu of a

reference. The OFT’s administrative guidelines set forty working days as the

normal time limit for reaching a decision where parties notify the OFT by

way of informal submission.

The informal submission can be used for both

anticipated and completed mergers. See Figure 4.1.

If the parties do not notify a relevant merger situation, the OFT has

the power to investigate (before or after completion) whether the transac-

tion raises competition concerns and, if it does, to refer it to the CC for an

23 Sections 96–102 of the Enterprise Act 2002; and Enterprise Act 2002 (Mergers Prenotication)

Reg u l a t i o n s 2 0 0 3 ( S I 2 00 3 / 1 3 6 9 ) .

24 See OFT, Mergers: Jurisdiction and Procedural Guidance (June 2009), chapter 4, para-

graphs 4.63–4.70.

104

Acquisition issues

in-depth investigation. The OFT must do this within four months of com-

pletion or of the transaction becoming public knowledge.

Where there are

market overlaps, the OFT (and CC) has the power under EA02 to require

the acquirer to ‘hold separate’ the acquired business until approval has been

given.

The OFT is under an obligation to refer a relevant merger situation to

the CC for an in-depth investigation where it believes that the transaction

may result (anticipated mergers) or has resulted (completed mergers) in a

‘substantial lessening of competition’ in any market in the UK for goods or

services (the ‘SLC test’).

The OFT does not have to make a reference to the

CC where the market is of insufcient importance (or de minimis) or where

there are relevant customer benets which outweigh the SLC.

There are

provisions which allow the OFT to accept an undertaking in lieu of a refer-

ence where the parties offer commitments to remedy the SLC identied by

the OFT.

The CC must report on its determination within twenty-four weeks of the

reference. This period may be extended by eight weeks.

The CC also applies

the SLC test in coming to its conclusion. The CC may clear the transaction

or may take remedial action to resolve any competition concerns, including

clearing the transaction only subject to conditions, prohibiting it and/or order-

ing divestiture.

The Competition Appeal Tribunal (CAT) hears appeals in respect of any

merger decisions taken by the OFT or the CC (and exceptionally the Secretary

of State).

The CAT is able to review the detail of the OFT’s (and the CC’s)

investigation and supporting material in order to ascertain whether the OFT/

CC’s decisions are reasonable and demonstrate sufcient grounds for the con-

clusions reached.

4.6 EC merger control legislation

The EC merger control rules are set out in Council Regulation (EC) No. 139/2004

of 20 January 2004 on the control of concentrations between undertakings

25 Section 24 of the Enterprise Act 2002.

26 Sections 71 and 72 of the Enterprise Act 2002.

27 Sections 22 and 33 of the Enterprise Act 2002; and, as to the nature of the duty, see the Court

of Appeal’s judgment in OFT v. IBA Health [2004] EWCA Civ 142.

28 Sections 22(2) and 33(2) of the Enterprise Act 2002. For de minimis mergers, see OFT,

Exception to the Duty to Refer: Markets of Insufcient Importance (OFT516b, November

2007); and, for ‘relevant customer benets’, see section 23 of the Enterprise Act 2002.

29 Section 73 of the Enterprise Act 2002.

30 Section 51 of the Enterprise Act 2002.

31 Section 82 of, and Schedule 8 to, the Enterprise Act 2002; and Competition Commission,

Merger Remedies: Competition Commission Guidelines (November 2008).

32 Section 120 of the Enterprise Act 2002.

105

Competition matters

(also known as the ECMR or the Merger Regulation).

It is enforced by the

Directorate-General for Competition of the European Commission in Brussels

(DG COMP). It applies to all countries comprising the European Economic

Area (EEA), that is, the twenty-seven EU Member States, together with

Iceland, Liechtenstein and Norway.

The ECMR is based on the principle of the ‘one-stop shop’; once a transac-

tion falls within the jurisdiction of the ECMR, the national authorities of the

Member States are precluded from applying their own merger control laws to

the transaction in question (except in certain limited circumstances).

A transaction will fall within the ECMR if it amounts to a ‘concentration

with a Community dimension’.

(a) What is a concentration?

Broadly, a concentration occurs where the transaction brings about a lasting

change in control in the companies concerned, whether by the acquisition of

sole control, the acquisition of joint control or a change from joint control to

sole control. It covers a merger of two or more previously independent compa-

nies (where two previously independent companies cease to exist as such), the

acquisition of direct or indirect control of another company, and certain types

of joint venture.

The following should be noted and are often relevant in private equity

transactions:

(a) ‘Control’ means having the possibility of exercising decisive inuence

over a company or undertaking on a lasting basis. This includes the

acquisition of a majority of the equity of an undertaking or the acqui-

sition of a minority shareholding to which special voting rights are

attached which allow the minority shareholder to determine the stra-

tegic behaviour of Target. The right to block decisions on management

appointments, budget or business plan would also typically confer (neg-

ative) control.

(b) A concentration may also arise where two or more companies have the

possibility of exercising decisive inuence jointly over another company.

Joint control generally arises where two (or more) shareholders are able

to veto strategic proposals (for example, through equal voting rights

or special decision-making rights attaching to a minority sharehold-

ing), ensuring that there is joint agreement on a company’s commercial

policy.

33 OJ L24, 29.1.2004, p. 1.

34 Article 1(1) ECMR.

35 Article 3 ECMR; and, generally, the Commission Consolidated Jurisdictional Notice under

Council Regulation (EC) No. 139/2004 on the control of concentrations between undertak-

ings (‘Commission Jurisdictional Notice’), Part B.

106

Acquisition issues

The EU merger control rules apply to concentrations where:

EITHER (1)

•

the combined worldwide turnover of all parties exceeds €5 billion, and

• the turnover in the EU/EEA of each of at least 2 of the parties exceeds €250

million,

unless

• two-thirds of the EU/EEA turnover of each of the parties is in one and the

same Member State

OR (2)

• the combined worldwide turnover of all parties exceeds €2.5 billion, and

• the turnover in the EU/EEA of each of at least two of the parties exceeds

€100 million, and

•

in each of at least three Member States, the combined turnover of all parties

exceeds €100 million, and

•

in those three Member States, the turnover of each of at least two parties

exceeds €25 million,

unless

• two-thirds of the EU/EEA turnover of each of the parties is in one and the

same Member State.

Figure 4.2 EU merger control thresholds

acquired through share purchases, but also where the assets comprising

a business or some of the assets of a legal entity are acquired (for exam-

ple, brands or licences), provided that market turnover can be attributed

to such assets.

(b) A Community dimension: the turnover threshold

Whether there is a Community dimension depends on the respective turnovers

of the parties concerned. In applying the turnover tests, it is irrelevant whether

or not the parties are domiciled in the EEA or the transaction will be imple-

mented in the EEA. The turnover thresholds are set out in Figure 4.2.

36 Articles 1(2) and 1(3) ECMR.