Carey on Disclosure Requirements and Private Transactions

Carey on Disclosure Requirements and Private Transactions


In a loan transaction, the full disclosure representation is either revered or reviled depending on your side of the transaction. Counsel to sellers and borrowers need to know why this representation should be narrowed or eliminated from private deals. In this Commentary, Professor James L. Carey discusses Rule 10b-5 under the Securities Exchange Act of 1934 and examines full disclosure representations in the context of loan agreements. He writes:
 
     Some commentators argue that the representations and warranties section is the most important part of an agreement. Many consider it the section where over-reaching requirements are imposed upon sellers. According to multiple reports, the most common claims filed by buyers against sellers are for the breach of a representation. Whether these assertions are accurate or inflated, the representations in any deal will rightly generate a great deal of debate, negotiation and concern. This time-honored struggle pits buyers seeking many broad representations against sellers desiring few and more narrow provisions. In loan documents, we see the same struggle of lenders against borrowers.
 
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     The inclusion of a full disclosure representation should not be automatic even if the transaction is covered by the federal securities laws (including Rule 10b-5 under the Securities Exchange Act of 1934). There are very different standards for plaintiffs who seek to prove a violation of Rule 10b-5 as opposed to collecting for a breach of a representation. At a minimum, Plaintiffs must prove scienter and reliance in order to prevail in a Rule 10b-5 action. However, these requirements do not normally apply to breach of contract claims. The inclusion of this representation in the deal documents removes important hurdles that a plaintiff must address to collect on a claim. Rick Climan, partner at Cooley Godward LLP, summarized this issue well when he wrote that a purely innocent breach of a representation can give rise to a contractual indemnification obligation , but a purely innocent misrepresentation normally won’t give rise to civil liability under Rule 10b-5. The inclusion of this representation greatly expands the potential liability of your seller/borrower by giving the buyer/lender many more ways to argue a breach.
 
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     In light of these concerns, counsel to the seller/borrower may be well advised to eliminate, or at least to limit, the 10b-5 approach to a full disclosure representation. By no means are such full disclosure representations market in negotiated transactions among private parties. The Mergers & Acquisitions Market Trends Subcommittee of the Committee on Negotiated Acquisitions of the American Bar Associations Section of Business Law now periodically publishes a Deal Points Study. This study details how often various provisions appear in selected deals involving middle market, private company transactions (generally $24 million to $150 million). Over the years, this study has found that the Full Disclosure (10b-5) Representation is present in as few as 1 percent of the deals (2007 Private Equity Buyer/Public Target Study) to a seeming high of 64 percent of the deals (2004 Public Company Buyer/Private Company Target Study).
 

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