Improving the M&A process and transaction performance

How corporate M&A teams ensure there are no undisclosed liabilities

Foundations for Corporate M&A Teams

Negotiate the no undisclosed liabilities

When a public company acquirer negotiates the no undisclosed liabilities representation for a private company target, several key structural, accounting, and risk-allocation dynamics come into play.

Because the seller knows more about unknown, unrecorded, or contingent liabilities, a number of deal protection mechanisms should be considered.

As the no undisclosed liabilities representation can act as a broad "catch-all" to sweep up risks that fall through the cracks of other specific representations, it is often fiercely negotiated. 

According to the 2026 Deal Terms Study by SRS Acquiom, most deals contain a seller favorable representation.

GAAP Compliance over "Past Practice"

Sellers frequently attempt to qualify the no undisclosed liabilities representation by stating that liabilities are disclosed "in accordance with past practice" or the "ordinary course".

Sellers will argue that a business incurs new, undisclosed liabilities every day just by operating (e.g., vendor bills, payroll, etc.) between the date of the last financial statement and the closing date. They will ask to exclude liabilities incurred in the "ordinary course of business".

While accepting this carve-out for routine vendor bills is standard market practice, it becomes a problem for the buyer if left undefined. 

Corporate development should work with corporate counsel to strictly define "ordinary course of business". The definition must explicitly state that the ordinary course exception does not excuse liabilities arising from breaches of contract, torts, IP infringements, or violations of law. 

Grab the Footnotes

GAAP mandates formal recognition or footnote disclosure of unrecorded liabilities, accrued expenses, and off-balance sheet commitments, providing a legal benchmark that opens up recourse if unrecorded liabilities emerge post-close. 

Disclosures in the footnotes are generally required if a loss is at least reasonably possible, or if it is probable but not reasonably estimable.

Sophisticated buyers will negotiate to include the footnotes in the financial statements.

Going beyond GAAP

By definition, truly "unknown" or contingent liabilities do not meet the threshold to be recorded on a balance sheet under accounting standards. Accordingly, buyers should generally push for the representation to cover all liabilities, "whether absolute, accrued, contingent, or otherwise," regardless of GAAP requirements. Examples include:

  • Unasserted Legal Claims and Pending Litigation: A target company may be engaged in early-stage litigation where the outcome is still highly uncertain, meaning no liability is recorded. Even more dangerous are unasserted claims—situations where the target company knows it breached a contract, infringed on a patent, or wronged a third party, but the injured party has not yet discovered the issue or filed a lawsuit.

  • Sales and Use Tax "Nexus" Exposures: Many private companies fail to realize they have triggered a tax obligation (a "nexus") in states where they make sales or have remote employees, resulting in years of uncollected sales taxes and unfiled returns. Because the company is unaware of the obligation or believes it has strong arguments against it, no liability is accrued on the balance sheet.

  • Worker Misclassification and Wage Violations: Companies at times misclassify actual employees as independent contractors to save on payroll taxes and benefits, or they fail to properly pay overtime to non-exempt employees. Until an employment audit occurs or a lawsuit is filed by the employees, these historical liabilities for back pay and penalties remain entirely off the books.

  • Environmental Remediation: Although a target company could have historical environmental contamination on its properties, unless a regulatory agency (like the EPA) has mandated a cleanup and the costs have been scoped by environmental engineers, these potentially cleanup costs will not meet the threshold for balance sheet recognition.

  • Product Liability and Latent Defects: A target may have sold products containing a latent design defect that has not yet caused injury or failure. While a company might have a standard reserve for routine warranty returns, product liability claims, future class actions, or the cost of a future product recall cannot be reasonably estimated before the failures begin occurring at scale.

  • Data Privacy Breaches and Regulatory Fines: A target company may have suffered a silent data breach or may be operating in continuous violation of data privacy laws (like GDPR or CCPA), OSHA safety standards, or FDA regulations. Until a regulator formally investigates and assesses a specific penalty, these compliance failures may represent a contingent liability that is invisible on the financial statements.

The "Present Obligation" Requirement

To have a liability, a target company must have a present obligation that exists at the financial statement date (per FASB Statement #8 (2021) Paragraph E45).

If a historical action or event has not yet triggered a present, binding obligation by the closing date, the seller is not required to record it as a liability or disclose it under a GAAP-qualified representation.

Sellers may try to use E45 to strictly limit the scope of the "no undisclosed liabilities" representation. 

Risks are Not Actually Liabilities

Although the daily operations of a business carry inherent risks, which might eventually crystallize into a liability, the mere existence of that risk today does not meet the definition of a liability (per FASB Statement #8 (2021) Paragraph E47).

If a buyer discovers a major operational vulnerability post-closing—say, new industry regulations, a destabilized supplier, or the threat of a competitor's new technology—the buyer cannot claim a breach of the "no undisclosed liabilities" representation.

Because E47 excludes business risks from the GAAP definition of a liability, buyers cannot rely on the "no undisclosed liabilities" representation as a catch-all safety net for negative operational developments. 

Blame the Transactional Insurance Underwriter

Buyers want protections against future, contingent, indirect, unmatured, or potential obligations or liabilities.

Without protections from audited SEC filing, acquirers need to be sure they are not buying "skeletons in the closet".

In fact, 'skeletons' in the financial statement and the associated undisclosed liabilities are among the most frequent drivers of Representations and Warranties Insurance (RWI) claims.

Because RWI policies exclude known risks or items explicitly listed on disclosure schedules, a broad undisclosed liabilities representation should push private sellers—who face potential fraud or indemnity exposure—to "pick up every rock" and populate the disclosure schedules thoroughly. 

Distinguishing Working Capital Adjustments from Undisclosed Liabilities

Sellers may argue that the no undisclosed liabilities representation is overly broad and should not apply to topics that have their own dedicated representations (e.g., arguing that all tax matters are covered in the tax representation, so the no undisclosed liabilities representation shouldn't apply to taxes). 

In addition, short-term operational variations (such as unrecorded bills or minor trade payables) are typically addressed through the Net Working Capital (NWC) post-close true-up. 

However, major unrecorded commitments should be addressed as direct breaches of the undisclosed liabilities representation rather than diluted within the working capital peg, including:

  • Un-reflected debt, shadow stock or bonus promises made to target employees
  • Tax exposures outside of the ordinary course
  • Off-balance sheet guarantees

Preserving Fraud Recourse and Non-Reliance Discipline

Public buyers should ensure that the purchase agreement contains an explicit, un-capped fraud carve-out so that intentional concealment or reckless omission of liabilities during diligence remains fully actionable, regardless of the transactional insurance policy limits or no-recourse provisions.

Sellers often push for broad non-reliance provisions or "no other representations" clauses to cut off extra-contractual claims.

Not that I’m aware of….

Sellers often try to soften the representation by stating there are no undisclosed liabilities "to the seller's knowledge". 

They will also represent there are no "material" undisclosed liabilities.

A knowledge qualifier fundamentally defeats the purpose of the no undisclosed liabilities representation. 

Generally buyers will argue that, if an unknown liability surfaces post-closing, the seller should bear the cost, even if they were genuinely unaware of it.

However, a knowledge-qualified version of this representation appears in less than 2% of agreements, according to the 2026 Deal Terms Study by SRS Acquiom.

Exclusively for Members of the Transaction Advisors Institute

Advanced Playbooks, Templates, and Negotiation Frameworks
on the No Undisclosed Liabilities Representation

Available with an All Access Account

Apply Filters
Load More

Notable M&A litigation on the
no undisclosed liabilities representation

CBS Inc. v. Ziff-Davis Publishing Co. (New York, 1990)

The New York Court of Appeals established that a buyer can sue a seller for breach of an express warranty—such as a "no undisclosed liabilities" representation or financial accuracy guarantee—even if the buyer doubted the truth of the warranted information prior to closing. The court ruled that contractual warranties are bargained-for promises intended to indemnify the buyer if facts prove untrue, removing the need to prove tort-like reliance. 

Following CBS v. Ziff-Davis, M&A practitioners frequently negotiate explicit "pro-sandbagging" or "anti-sandbagging" clauses in purchase agreements to definitively address whether a buyer can seek indemnification for a breach of representation if they had prior knowledge of the undisclosed liability before closing.


ABRY Partners V, L.P. v. F&W Acquisition LLC (Delaware, 2006)

The Delaware Chancery Court ruled that standard M&A exclusive remedy provisions and indemnification caps cannot shield a seller from liability for intentional fraud or deliberate misrepresentations regarding financials and undisclosed liabilities. The court held that Delaware public policy forbids a party from contractually capping damages or blocking rescission when they knowingly make false representations within the agreement itself. 

Following ABRY Partners, transaction attorneys strictly carve out "fraud" from indemnification caps and survival periods. M&A teams meticulously define fraud in purchase agreements to limit it to intentional misrepresentations found within the four corners of the contract, ensuring sellers are not exposed to uncapped liability for equitable or reckless fraud.


Cobalt Operating, LLC v. James Crystal Enterprises, LLC (Delaware, 2007)

The Delaware Chancery Court reinforced the state's "pro-sandbagging" default rule, awarding the buyer damages for breach of contract and fraud after the seller concealed liabilities and manipulated financial records. The court held that a buyer's extensive due diligence does not preclude its right to a remedy against the seller for false representations and undisclosed liabilities, as the breach of contract claim does not depend on a showing of justifiable reliance. 

Following Cobalt Operating, sellers in Delaware-governed transactions are highly motivated to negotiate express "anti-sandbagging" provisions if they wish to block buyers from claiming indemnification for undisclosed liabilities that the buyer actually discovered during the due diligence phase.


Akorn, Inc. v. Fresenius Kabi AG (Delaware, 2018)

The Delaware Chancery Court issued a landmark ruling allowing a buyer to terminate a $4.75 billion merger agreement prior to closing due to the target company's pervasive, undisclosed regulatory liabilities that constituted a Material Adverse Effect (MAE) and breached the ordinary course covenant. The court found that the target had concealed severe data integrity issues, rendering its representations materially inaccurate. 

Following Akorn, M&A dealmakers are drafting regulatory representations and covenants regarding the ordinary course of business with significantly heightened scrutiny. Buyers now aggressively leverage the discovery of severe undisclosed liabilities between signing and closing as a valid legal mechanism to establish an MAE and terminate transactions.

FAQ on Interim Operating Covenants

Conduct of Business: Sellers are required to conduct the business in the ordinary course, maintaining consistent management and decision-making without significant operational changes. This ensures the value of the company doesn't diminish and the buyer receives the business as agreed.

Financial Practices: Sellers must maintain current levels of working capital, adhere to accounting principles, and not take on additional debt without consent. These covenants ensure that the target’s financial health remains stable.

Asset Maintenance: Sellers must maintain both physical and intangible assets, preserving the business's value.

No Material Adverse Changes: Sellers are obligated to avoid actions that could materially and adversely impact the business.

Compliance with Laws: Ensuring ongoing compliance with all relevant laws and regulations.

Notification and Consent: Sellers often must notify buyers of key events and seek consent before taking specific actions like entering new contracts or changing employment terms for key personnel.

Employee and Management Retention: Sellers may covenant to retain key employees, often offering retention bonuses, to ensure talent stays through the transition.

Efforts-based qualifiers, like "commercially reasonable efforts," are designed to soften the strictness of operating covenants by indicating that a party is only required to attempt, rather than fully guarantee compliance.

In the context of AB Stable, the lack of such qualifiers played a key role in the court's interpretation of the contract as creating an absolute obligation to operate in the ordinary course.

Interestingly, post-AB Stable, some legal observers believe having an efforts-based qualifier would be more analogous to permitting parties to look at the actions of other industry participants for purposes of determining what constitutes ordinary course, and that they would impact the standard of compliance. This is a shift from the previous belief that efforts-based qualifiers only address whether absolute compliance is needed, or whether a party just needs to make reasonable attempts at compliance.

Representations and warranties are factual assertions that sellers make about the business being sold as of the signing date, and interim operating covenants act to ensure that those representations and warranties remain true at closing.

Breaches of these covenants can trigger various remedies, including:

Indemnification: The seller may have to compensate the buyer for losses caused by a breach.

Purchase Price Adjustments: If a breach causes a financial issue, the purchase price may be adjusted.

Escrow Funds: A portion of the purchase price is sometimes held in escrow to cover potential breaches.

Termination of the Agreement: A material breach can give the buyer the right to walk away from the deal, though this is not always a buyer's first remedy.

Specific Performance: The non-breaching party may seek a court order to compel the breaching party to fulfill their obligations, though that is a less common remedy.

AB Stable established a strict interpretation, stating that "ordinary course" means adhering to the company's past practices and not allowing for deviations, even when responding to extraordinary events like the COVID-19 pandemic.

The court found that the seller breached the covenant by making significant operational changes, such as closing hotels, reducing staff, and limiting services, even though these actions were responses to the pandemic and in line with industry trends.

This ruling emphasized that the "ordinary course" obligation is "flat, absolute, and unqualified," especially when accompanied by the phrase "consistent with past practice."

Thus, past practices -- and not the actions of industry peers -- are the yardstick for what constitutes an "ordinary course".