Anatomy of an Asset Purchase Agreement

Like the classic game Operation,^® asset purchase transactions require parties to take great care in extracting just what they want. However, successful asset sales require quite a bit more than a pair of tweezers and steady hands. Among other things, they require a well-crafted Asset Purchase Agreement (APA). These agreements, at their most basic level, provide for the sale of tangible and intangible assets and liabilities of a seller to a buyer in return for cash or some other form of consideration (i.e., something of value). However, M&A transactions are anything but basic. They’re riddled with substantial risk and potential rewards for both parties, and APAs often become even more complex than Stock Purchase Agreements (SPAs), which govern stock sales, as asset purchase transactions lack the relative simplicity afforded by a transfer of all of the shares of a distinct legal entity.

I discussed SPAs in a prior post. Today, I’ll turn my focus to Asset Purchase Agreements. I’ll introduce you to the key provisions of an APA and explain their purposes. You may notice that much of my discussion below is substantively identical to my SPA post. That is because, as you would expect, the terms of each type of agreement are in many cases the same.  However, they do differ in many material respects.  For example:

• In APAs, acquired assets, assumed liabilities and retained liabilities and assets are all specifically enumerated, while in SPAs the contract simply references the shares being transferred.
• APAs provide for use of legal instruments necessary to transfer ownership, such as bills of sale (for personal property), assignment and assumption agreements (for contracts and permits), intellectual property assignments, real property transfer documents and so on.  SPAs don’t require these because assets and liabilities generally transfer indirectly by operation of law along with ownership of the target’s stock.
• APA representations and warranties obviously don’t describe any acquired shares. Instead, they include a special representation that the assets being acquired are sufficient to operate the acquired business after closing, and you’ll often encounter a provision designed to ensure compliance with any bulk transfer and fraudulent conveyance rules, which may be relevant if the seller is, or could become, insolvent.
• Because asset transactions often involve the extraction of one business from another, there will more likely be assets that are used in both the business of the seller and the acquired business. These are usually referred to as “Shared Assets,” and they require special provisions for their treatment in the deal.

In later posts, I’ll also examine each of the sections of an APA more closely and provide a more detailed and nuanced discussion of their contents.

If you’d like to compare my discussion below with a sample Asset Purchase Agreement, here‘s the APA that governed the 2013 acquisition by MSC Industrial Direct Co., Inc. of Barnes Group Inc.’s distribution services business assets in the U.S. and Canada for $550 million. You’ll notice some discrepancies between my references to Articles of the APA and the Articles of the MSC / Barnes Group agreement. Although agreements like these do conform to customary standards and structure, variations do exist. Please keep that in mind as you read on.

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Preamble and Recitals

The first paragraph of an APA is known as the Preamble. It usually names the agreement, introduces the parties and sets forth the effective date of the contract. More often than not, it will also create defined terms for each of these, such as the “Seller” and the “Purchaser.”

Immediately after the Preamble, the Asset Purchase Agreement often contains a series of statements beginning with the word “WHEREAS”. These are known as the Recitals. Unlike most of the rest of the agreement, the Recitals are not generally meant to be binding on the parties. Instead, they lay out the intentions of the transacting parties and provide context to anyone later attempting to interpret the APA.

Article 1: Definitions

Article 1 of most APAs provides an alphabetical list of definitions of important (usually capitalized) terms used throughout the agreement.  These definitions do not function as stand-alone terms and conditions but are instead incorporated into other operative provisions throughout the contract.  For example, Article I might provide definitions for the terms “Affiliate,” “Law” and “Person.”

Although you may be tempted to gloss over these definitions thinking they are immaterial boilerplate or difficult to make sense of devoid of context, they are critically important and may substantially alter the effect of the provisions in which they are used. Some, such as “Liabilities,” “Material Adverse Effect” or “Seller’s Knowledge” (or their equivalents) are used throughout the contract and may be the subject of extensive negotiations.  Others, such as “Acquired Assets,” “Acquired Business,” “Assumed Liabilities,” “Retained Assets” and “Retained Liabilities”  are central to the terms of the transaction, as they determine exactly what each party is and is not getting in the deal.

In addition to the list of definitions, this Article will frequently also contain cross-references to terms that are defined elsewhere in the Asset Purchase Agreement and a section devoted to rules of construction applicable to the contract.

Article 2: The Transaction

Article 2 of a standard APA usually provides the specific terms of the sale. It contains language to the effect of:

“In accordance with the provisions of this Agreement and except as set forth in Section 2.2 [governing Excluded Assets], at the Closing, the Seller will sell, convey, assign, transfer and deliver to the Purchaser, and the Purchaser will purchase and acquire from the Seller, free and clear of all Encumbrances other than Permitted Encumbrances, all of the Seller’s right, title and interest in and to all of the Seller’s properties and assets of every kind and description, whether real, personal or mixed, tangible or intangible, and wherever located, used [exclusively] in the Acquired Business.”

There will be similar provisions relating to Excluded Assets to be retained by the seller, Assumed Liabilities to be taken by the buyer and Excluded Liabilities, which remain with the seller. In addition, Article 2 sets forth the purchase price, any purchase price adjustments (such as an adjustment to account for variations in target net working capital at closing) and documents and other things that must be exchanged between the parties at closing. These will include the purchase price, of course, and bills of sale, assignment and assumption agreements, intellectual property assignments, real property transfer documents and so on, as well as any legal opinions, employment agreements, escrow agreement and other ancillary documents.

Article 3: Seller Representations and Warranties

Article 3 of most Asset Purchase Agreements contains representations and warranties from the seller about the target business. As discussed in a prior post, representations and warranties are statements of past or present fact relating to the business, assets, liabilities, properties, condition, operating results, operations and prospects of the acquired assets made by one party to an M&A transaction to another. Inaccurate representations and warranties may result in the incurrence of liability by the party that made the statements.

Here’s a long list of subjects that may be addressed by seller representations and warranties:

• organization and good standing
• authority and enforceability
• absence of conflicts
• capitalization and ownership
• financial statements
• books and records
• accounts receivable and accounts payable
• inventories
• absence of undisclosed liabilities
• absence of certain changes and events
• assets (including sufficiency of assets)
• real property
• intellectual property
• material contracts
• tax matters
• employee benefits
• employment and labor
• environmental, health and safety
• compliance with law
• legal proceedings
• customers and suppliers
• product warranties
• product liability
• insurance
• related-party transactions
• guarantees
• brokers and finders fees
• solvency and
• full disclosure.

Few, if any, transactions will include all of these representations and warranties, and many of them overlap at least in part.

Article 4: Buyer Representations and Warranties

Article 4 usually contains reciprocal representations and warranties from the buyer to the seller. (Occasionally, these are included within another section of Article 3 along with the seller representations and warranties.)  If the buyer is issuing shares as all or part of the purchase price, then its representations and warranties will mirror those of the seller fairly closely. More often, though, the buyer is paying cash and its representations and warranties are consequently significantly more limited in scope. After all, cash is cash.

Buyer representations and warranties frequently cover some combination of the following topics:

• organization and good standing
• authority and enforceability
• absence of conflicts
• governmental consents
• legal proceedings
• financing
• brokers and finders fees and
• independent investigation.

Article 5: Covenants

Assuming your deal has a gap period between signing and closing, as most do, Article 5 of the APA will contain covenants (i.e., promises to do or refrain from doing something) from the parties governing their activities during this time as well as after closing.

There’s usually an “Access and Investigation” covenant through which the seller promises to permit the buyer to access the acquired business and its books and records prior to closing.  Among other things, this enables the buyer to continue planning for and implementing its integration of the acquired business during the gap period.

This Article will also require the seller to operate the acquired business prior to closing in the ordinary course consistent with past practices. Such provisions sometimes include long lists of specific actions required to be taken (or prohibited from being taken) by the seller. Generally speaking, the more comprehensive and specific the list, the more favorable it is to the buyer. These conduct of business provisions help preserve the business in the form expected by the buyer and maintain it in a condition that is similar to what it investigated through due diligence.

In addition, Article 5 usually requires the seller to notify the buyer of certain material developments impacting the acquired business or the transaction. The goal here is not only to ensure real-time information flow to the buyer about its soon-to-be-owned business, but, depending on how the provision is written, to enable the buyer to declare a material breach of the APA or failure of a closing condition if it has been notified of a breach or failed condition.

Article 5 will generally also contain a covenant requiring the parties to exercise certain efforts to consummate the transaction, including obtaining regulatory approvals and securing third part consents. Such approvals and consents are particularly important in asset transactions, given the requirement to convey ownership of each asset individually from one entity to another, which is significantly more likely to be prohibited by, or require approval under, applicable law and contracts than an indirect transfer via sale of stock.

Other covenants you may encounter in Article 5 include provisions governing:

• confidentiality
• no-shops
• public announcements
• preparation of interim financial statements
• seller cooperation with financing
• customer communications
• employee matters
• fraudulent conveyance law and satisfaction of seller obligations to creditors
• indemnification and insurance
• non-competition
• non-solicitation
• treatment of shared assets and intercompany arrangements
• use of the seller’s retained names and marks
• handling of mail and other communications and
• production of witnesses and attorney-client privilege.

Article 6: Closing Conditions

Again assuming the deal has a gap period between signing and closing, the Asset Purchase Agreement will include conditions precedent that must be satisfied or waived before each party will be required to consummate the transaction. Among other things, these will generally require that the other party’s representations and warranties will have been true when made and remain true at closing, and they will require that the other party will have complied with its pre-closing covenants. As you might expect, all required regulatory approvals and third party consents will need to have been secured, as well. Frequently, a buyer will also require as a condition precedent that the acquired business will not have experienced a material adverse change—an adverse change in the acquired business that is consequential to its long-term earnings power. Occasionally, a buyer may be able to negotiate for a requirement that it will have secured financing or satisfactorily completed its due diligence examination of the target, too.

Article 7: Indemnification

Another APA Article will provide for indemnification rights, which entitle each party to be compensated by the other for losses suffered on account of a breach of any of the other party’s representations, warranties and covenants. Indemnification may also be extended to losses arising from specific causes, such as an identified environmental condition. The seller will usually provide indemnity for losses incurred by the buyer as a result of “Retained Liabilities,” as well, and the buyer will offer a reciprocal indemnity with respect to “Assumed Liabilities.”

This Article will not only outline each party’s basic rights to indemnity. It also typically:

• establishes a survival period for representations and warranties after which claims for breach cannot be brought,
• sets limits on indemnification, including a threshold or deductible and a cap,
• if applicable, outlines the use of any funds deposited in escrow for indemnification,
• lays out procedures to be followed to make indemnification claims and to handle third party claims,
• indicates the extent to which indemnification is a party’s exclusive remedy for breaches and
• clarifies how losses should be calculated for purposes of any recovery.

Article 8: Termination

The conditions to closing contained in Article 6 would be pointless without an associated right to terminate the APA and the transaction if any of those conditions aren’t satisfied or waived. Every APA thus contains an Article describing each party’s termination rights, which often include not only termination due to failure of a condition but also termination by mutual consent, termination by the buyer if the acquired business has suffered a material adverse effect, termination by either party if the transaction is enjoined or fails to obtain necessary governmental or third party consents or termination by either party if the deal hasn’t closed by a specified deadline.

In addition, this Article explains the effect of termination, usually that some provisions of the APA will survive termination (e.g., governing confidentiality and miscellaneous provisions), that one party may owe a termination fee or expense reimbursement to the other and that the parties will remain responsible for any pre-termination breaches.

Article 9: General Provisions

Finally, virtually every APA will contain an Article dedicated to miscellaneous provisions governing a variety of subjects, including expenses, governing law, notice, dispute resolution, expenses, severability, counterparts, assignment, amendment and more.

Other Articles

Aside from the more common sections described above, many Asset Purchase Agreements contain Articles devoted exclusively to other topics, including taxes, employment and labor and environmental matters. Such additional Articles will usually only appear in an APA if their subject matter is particularly important and requires a more fulsome approach than it would otherwise receive.

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