The M&A Lawyer Blog

Anatomy of a Stock Purchase Agreement

Most private M&A transactions are structured as acquisitions of stock, rather than mergers or asset purchases. The principal agreement governing such a transaction is typically a Stock Purchase Agreement (SPA), sometimes styled a Securities Purchase Agreement or simply a Purchase Agreement. At their most basic level, these agreements provide for the sale of shares in a target company 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 are riddled with substantial risk and potential rewards for both parties, and SPAs often become quite complex in an effort to address the many ways M&A deals might go wrong.

In this post, I’ll introduce you to the key provisions of an SPA and explain their purposes. In later posts on The M&A Lawyer Blog, I will examine each of these sections more closely and provide a more detailed and nuanced discussion of their contents.

If you’d like to compare my discussion with a sample Stock Purchase Agreement, here‘s the SPA that governed AT&T’s attempted (and ultimately abandoned) acquisition of T-Mobile from Deutsche Telekom for $39 billion in 2001. You’ll notice some discrepancies between my references to Articles of the SPA and the Articles of the AT&T / Deutsche Telekom agreement. Although agreements like these do conform to customary standards and structure, variations do exist. Please keep that in mind as you read on.

Want to buy a stock purchase agreement?

Preamble and Recitals

The first paragraph of an SPA 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 Stock 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 SPA.

Article 1: Definitions

Article 1 of most SPAs 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 “Acquired Shares,” “Encumbrance” and “Environmental Law.”

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.

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

Article 2: The Transaction

Article 2 of a standard SPA will usually provide the specific terms of the sale of the stock. It contains language to the effect of “the Seller will sell and transfer to the Purchaser, and the Purchaser will purchase and acquire from the Seller, all of the Shares.” It also 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 and share certificates, of course, as well as legal opinions, any employment agreements, any escrow agreement and other ancillary documents.

Article 3: Seller Representations and Warranties

Article 3 of most Stock Purchase Agreements contains representations and warranties from the seller about itself and the target company. 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 a subject company or set of 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
subsidiaries
financial statements
books and records
accounts receivable and accounts payable
inventories
absence of undisclosed liabilities
absence of certain changes and events
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 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
investment intent
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 SPA 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 SPA 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.

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 and indemnification and insurance.

Article 6: Closing Conditions

Again assuming the deal has a gap period between signing and closing, the Stock 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 target’s business that is consequential to the company’s long-term earnings power. Occasionally, a buyer may be able to negotiate for a requirement that it will have satisfactorily completed its due diligence examination of the target, too.

Article 7: Indemnification

Another SPA 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.

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

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 a corresponding right to terminate the SPA and the transaction if any of those conditions aren’t satisfied or waived. Every SPA 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 target company 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 SPA 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 SPA 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 Stock 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 SPA if their subject matter is particularly important and requires a more fulsome approach than it would otherwise receive.

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The M&A Lawyer Blog Publishes Forms Database

Mergers & Acquisitions practice relies heavily on the use of forms and precedent. They are the very foundation of what we do. Absent an eidetic memory, even the most accomplished M&A attorneys need precedent consents, agreements, certificates, checklists, filings and other documents to consummate a transaction, and the quality of the forms used directly impacts the allocation of rights and obligations of the parties and, ultimately, the success or failure of the deal. In this light, The M&A Lawyer Blog has created an M&A forms database consisting of carefully curated, high quality forms and precedent created by top law firm attorneys, including purchase agreements, merger agreements, escrow agreements, closing certificates, consents and more.

Each document in our M&A forms database is available for purchase in Microsoft Word format and reflects what is, in my opinion, a reasonable starting point for drafting and negotiation. That is not to say that each document is ideally suited to every circumstance or to your specific transaction. On the contrary, each document will almost certainly need to be customized for your deal, and you are strongly encouraged to engage a qualified M&A attorney in connection with doing so.

Our M&A forms database is set forth below.

M&A Forms Database

Ancillary Documents

Form of Term Sheet – Private M&A Transaction – Asset Purchase for Cash

Provides for (1) purchase price adjustments, (2) restrictions on the seller's pre-closing sales practices, (3) obtaining landlord estoppels for transferred real property leases, (4) treatment of expected insurance proceeds, (5) treatment of transfer taxes, (6) closing conditions, (7) treatment of retail facilities that cannot be transferred at closing on account of a failure to obtain third party consents, (8) an indemnity escrow and (9) seller indemnification. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Legal Due Diligence Request – M&A

Medium length form. Heavy requests associated with intellectual property and environmental risks. Length: 17 pages | Format: Microsoft Word

$50 - Purchase View Sample

Form of Legal Due Diligence Memo, Including Short Due Diligence Request – Private Transaction

Appropriate for small to medium size transaction. Contains interesting disclaimers and identifies assumptions. Length: 17 pages | Format: Microsoft Word

$50 - Purchase View Sample

Form of Exclusivity Agreement Extension – Short

Simple one-page letter agreement amending expiration date of exclusivity period. Length: 2 pages | Format: Microsoft Word

$15 - Purchase View Sample

Form of Exclusivity Agreement – Short

Short form does not include provisions with respect to due diligence access, expenses or confidentiality. Includes abbreviated governing law, specific performance and other miscellaneous provisions. Length: 2 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Exclusivity Agreement – Private Company Acquisition

Medium-length form does not include provisions with respect to due diligence access or expenses. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Definitive Bid Letter

Form of letter typically delivered by a prospective buyer to a target company or its representatives stating the buyer's interest in acquiring the target company. Includes a summary of terms of the offer, including the proposed transaction structure, form and amount of consideration (purchase price), financing sources, remaining due diligence to be conducted, required consents, the timing to closing of the deal and confidentiality. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of M&A Auction Process Letter – Public M&A

Letter from a target company financial advisor to prospective acquiror setting forth guidelines for submitting an acquisition proposal. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Escrow Agreement for Public Buyer, Private Target Merger – Cash Escrow Property – Fully Negotiated

Involves multiple seller parties, necessitating coordination with seller representatives. Provides for (1) an environmental remediation set-aside, (2) distributions upon written agreement or pursuant to a court order and (3) USA Patriot Act disclosures. Length: 14 pages | Format: Microsoft Word

$50 - Purchase View Sample

Form of Certificate of Formation of LLC

Single member, manager managed. Length: 2 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of M&A Closing Checklist – Private Asset Purchase

Detailed M&A closing checklist of more than 50 actions that need to be taken and documents that must be delivered for a complete asset purchase transaction, from signing to post-closing. Includes all transaction agreements, resolutions and closing deliverables. No gap period between signing and closing. Length: 5 pages | Format: Microsoft Word

$100 - Purchase View Sample

Form of M&A Closing Checklist – Private Stock Purchase

Detailed M&A closing checklist of more than 60 actions that need to be taken and documents that must be delivered for a complete stock purchase transaction, from signing to post-closing. Includes all transaction agreements, resolutions, closing deliverables, CFIUS and HSR filings, escrow, gap period between signing and closing and third party consents. Length: 8 pages | Format: Microsoft Word

$100 - Purchase View Sample

Form of M&A Transition Services Agreement

A customary agreement effective at closing of an M&A transaction pursuant to which the seller agrees to provide certain ongoing services to the buyer and target company for a period of time to assist with the transition. Transition Services Agreements like this are typically used when the seller is an operating company selling a subsidiary, division or other portion (but not all) of its operations. Length: 7 pages | Format: Microsoft Word

$50 - Purchase View Sample

Form of Escrow Agreement – Private M&A Transaction – Initial Escrow Agent Draft

An example Escrow Agreement to govern the deposit, maintenance and distribution of cash and other assets to be used for post-closing indemnification. Draft prepared by bulge bracket financial institution. Reflects agent-friendly provisions. Contemplates seller stockholder representative. Length: 12 pages | Format: Microsoft Word

$50 - Purchase View Sample

Closing Deliverables

Form of M&A Closing Certificate – Fully Negotiated

Buyer's certificate bringing down reps and warranties and confirming compliance with covenants. Length: 1 page | Format: Microsoft Word

$25 - Purchase View Sample

Form of Assignment & Assumption Agreement – LLC Interests

A short, simple instrument effecting conveyance of limited liability company ownership interests. Contains very limited representations and warranties. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Officer’s Closing Certificate

A model officer's certificate delivered at closing and certifying the buyer's compliance with representations, warranties and covenants required to have been complied with prior to closing. Length: 1 page | Format: Microsoft Word

$25 - Purchase View Sample

Form of Bill of Sale – Attachment to Asset Purchase Agreement

Instrument through which title to tangible personal property and certain other assets may be transferred at closing of an asset sale. Includes a further assurances covenant and grant of power of attorney to buyer. Length: 2 pages | Format: Microsoft Word

$25 - Purchase View Sample

Confidentiality Agreements

Form of Short, One-Way Confidentiality Agreement – Individual Recipient

Extremely simple, pro-discloser, one-way non-disclosure agreement containing optional, bracketed language. Intended for early-stage discussions with a potential employee or individual service provider. Length: 1 page | Format: Microsoft Word

$25 - Purchase View Sample

Form of Short, One-Way Confidentiality Agreement – Entity Recipient

Extremely simple, pro-discloser, one-way non-disclosure agreement containing optional, bracketed language. Intended for early-stage discussions with a potential commercial service provider. Length: 1 page | Format: Microsoft Word

$25 - Purchase View Sample

Form of Confidentiality Agreement Between Potential Parties to Unsolicited Public M&A Transaction – Fully Negotiated

Governs the treatment of existence of, and information exchanged at, a preliminary meeting between parties to discuss a potential transaction. Does not contain a standstill but does contain a broad indemnity and entitlement to injunctive relief. Length: 2 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Confidentiality Agreement – One-Way; Public Company Discloser – Very Short

A bare-bones form of confidentiality agreement. Length: 1 page | Format: Microsoft Word

$25 - Purchase View Sample

Form of Confidentiality Agreement – One-Way; Public Company Discloser

Reasonable one-way non-disclosure agreement. Includes an employee non-solicitation provision and submission to jurisdiction in California. Appropriate for use by private companies or by companies outside of California with minor modifications. Length: 4 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Confidentiality Agreement – Mutual; Public Company Parties

Reasonable mutual non-disclosure agreement containing optional, bracketed language. Includes an employee non-solicitation provision. Appropriate for use by private companies or by companies outside of New York with minor modifications. Length: 5 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Confidentiality Agreement – Mutual; Public Companies

Reasonable mutual non-disclosure agreement containing optional, bracketed language. Includes an employee non-solicitation provision and submission to jurisdiction in California. Appropriate for use by private companies or by companies outside of California with minor modifications. Length: 4 pages | Format: Microsoft Word

$25 - Purchase View Sample

Consents & Resolutions

Form of Written Consent of Sole Stockholder Approving Merger

Simple consent approving M&A transaction. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Unanimous Written Consent of a Board of Directors – Approving Merger & Issuing Shares

Appropriate for a private transaction. Includes HSR filing threshold determination. Must be updated to reflect subsequent increase in HSF filing threshold. Length: 4 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Board Resolutions Approving M&A Transaction – Buyside

Includes approval of financing documents and ancillary agreements. Deal involved cash consideration. Length: 2 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Lender Consent to M&A Transaction

To be used to obtain buyer lender consent to an acquisition. Contemplates secured and guaranteed debt. Length: 7 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Written Consent of LLC Members – Approval of Purchase Agreement – Sale of Assets

Subsidiary approval of an asset sale effected via a two-step transaction involving an initial transfer of assets to a holding company and the subsequent sale of the holding company LLC interests to a third party buyer. Length: 2 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Written Consent of LLC Members – Approval of Board Size

Approves an increase in the size of the board of directors of the LLC in connection with the company's issuance of additional interests to a new member. Length: 2 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Written Consent of LLC Manager – Approval of Sale of LLC Interests & Admission of New Member

Approves an assignment of a member's limited liability company interest to an unaffiliated third party, admission of the assignee to as a member of the LLC and waiver of the company's right of first refusal relating to the assignment. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Written Consent of the Board of Directors of LLC – Approval of Units Issuance, Repurchase and Related Transactions

Provides for (1) issuance of new membership interests to investors, (2) repurchase of employee membership interests and (3) the admission of new investors as members of the LLC. Length: 4 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Written Consent of the Board of Directors of LLC – Approval of Distribution of Members

Complex set of recitals and resolutions relating to compliance with the LLC operating agreement and applicable credit agreement covenants and approval of a distribution to members. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Written Consent of the Board of Managers of LLC – Approval of Acquisition

Buy-side approval of stock purchase and intellectual property license. Includes a power of attorney through which managers may act on behalf of the board. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Written Consent of the Board of Directors of LLC – Approval of Sale of LLC Interests & Admission of New Member

Approves the transfer of existing members' membership interests to unaffiliated third parties, the withdrawal of the transferors from the LLC and the admission of the transferees to the LLC as members. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Written Consent of the Board of Directors – Approval of Asset Acquisition Transaction

Provides for approval by a corporation's Board of an asset purchase and the related transaction documents, including a transition services agreement, waiver agreement and guaranty agreement. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Written Consent of Sole Member of LLC Approving Merger

A simple consent needed for the sole member of a limited liability company to approve an M&A transaction. Length: 2 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Written Consent of Board Appointing Officers & Amending Bylaws

Adopts amended and restated bylaws, establishes corporate offices, appoints officers and grants banking authority to specified officers. Length: 3 pages | Format: Microsoft Word

$25 - Purchase View Sample

Form of Written Consent of Sole Stockholder – Approval of Purchase Agreement – Sale of Assets

Parent company approval of an asset sale effected via a two-step transaction involving an initial transfer of assets to a holding company and the subsequent sale of the holding company LLC interests to a third party buyer. Length: 2 pages | Format: Microsoft Word

$25 - Purchase View Sample

Principal Transaction Agreements

Form of Bill of Sale Conveying Supplies, Inventory, Fixed Assets, Leases, Other Contracts and Permits – Buyer First Draft

A complex bill of sale conveying multiple asset types. Includes excluded assets, assumed liabilities, reps and warranties, post-closing covenants and indemnity. Can serve as a stand-alone instrument without an asset purchase agreement. Length: 7 pages | Format: Microsoft Word

$50 - Purchase View Sample

Merger Agreement – Public Company Acquisition of Private Company with Large Stockholder Base

A fully-negotiated model Merger Agreement appropriate for a public company's acquisition of a private company with a broad stockholder base. The transaction involved (1) a combination of cash and stock consideration, (2) an earnout, (3) public M&A deal protections and share exchange mechanics, (4) a stockholder representative, (5) post-closing indemnification (with basket and cap) and escrow, (6) a working capital adjustment, (7) a 19.9% cap on purchaser share issuance to comply with Nasdaq listing rule 5635, (8) a target stockholder lockup, (9) a California Section 3(a)(10) fairness hearing, (10) purchaser board representation, (11) assumption of target stock options and (12) a special foreign tax indemnity. Length: 123 pages | Format: Microsoft Word

$100 - Purchase View Sample

Form of Stock Purchase Agreement – Sellside Auction Draft

A pro-seller form of stock purchase agreement for a private M&A transaction. Includes a purchase price adjustment, gap period between signing and closing (during which closing conditions will be satisfied), a Section 338(h)(10) election provision and limits on indemnification. Length: 44 pages | Format: Microsoft Word

$100 - Purchase View Sample

Form of Asset Purchase Agreement – Pro-Buyer First Draft

Draft APA for a private sale of a chemical business. Includes inventory purchase price adjustment, non-compete, dollar-one basket, right of setoff, specific environmental indemnity and seller parent indemnity. Length: 70 pages | Format: Microsoft Word

$100 - Purchase View Sample

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The New Role of Private Equity Firms

The following is a guest post from Nate Nead, an investment banking Director at Merit Harbor Group, LLC. Nate’s practice focuses on software, technology, energy and manufacturing. He and the Merit Harbor team work with middle-market business owners looking to grow, acquire or sell companies in the $10mm to $100mm valuation range. He works out of the company’s Seattle office.

It wasn’t too long ago when private equity firms had the power – and ability – to do very little heavy lifting in order to enjoy a substantial growth on their return in a short period of time.

But times are surely changing. With recent high company valuations and other general macro-economic factors, investors need to get far more involved with a company in order to expect any type of fast growth. Earning returns from investments is harder than ever before, forcing private equity firms to prove that they have something to offer companies. That’s why, in recent years, we’ve seen more and more private equity firms create a post-acquisition value for their portfolio companies.

Today’s private equity firms need the skills and strategies in place to grow revenue and cash flow, in order to maximize the investment exit.

Increasing Competition for Deals

Private equity firms are finding themselves outbid as valuations are increasing to all-time highs, including at 10x cash flow. These PEGs find it difficult to compete with what multiple strategic buyers can afford, and with these increasing valuations, are finding it more challenging to get the return they need to rationalize the investment.

As a result, private equity firms have had to step up their game in order to offer something unique. It seems they’re doing just that. More and more firms are choosing to stay involved, according to GF Data. In fact, 90% of the buyouts GF Data tracks included a post-management solution or continuity in 2015, much higher than in previous years.

Less is More

Generally speaking, private equity firms want to acquire between 51% and 100% of a business. In order to stay involved, management is typically asked to roll over equity. As a result, a PE firm might own around 85% of the company, and will likely retain some control over board seats. In addition, the private equity firm might also include operating partners as board members. Day-to-day operations are often times left to the company’s existing management team.

So why would a company want this type of more-involved arrangement? Well, think of the alternative. If a company is sold to a strategic partner, then chances are that the management team will lose control of the business.

On the other hand, a company with a strong management team that sells to a private equity firm is in better position to bring that company to the next level, as a result of gaining access to:

Additional capital
Operational and professional expertise

One of the shifts we’ve seen in recent years is the decline of the private equity firm that brings in an operation team after acquiring a company. This shift falls in line, perfectly, with the PE’s increasing role. As private equity gets more involved post-acquisition, it’s important that a company grow familiar with the private equity fund’s management team. A rapport should be built so that everyone remains clear and focused on the growth goals outlined.

So long as the PE firm has the expertise to be heavily involved (and typically that means that the investing principals have operating experience) then this evolution can result in great returns in the future.

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M&A Disclosure – Annotated Form 8-K

Public companies that participate in M&A transactions are subject to a myriad of potential disclosure obligations throughout the transaction process. These may arise under applicable stock exchange listing rules, federal securities laws, state fiduciary duty and proxy requirements as well as antitrust law and other regulatory regimes. The federal securities laws alone may require various disclosures through an astonishingly long list of possible forms, schedules and registration statements, including, among others, Form 8-K, Form 10-K, Form 10-Q, Schedule 14A, Schedule 14C, Schedule TO, Schedule 14D-9, Schedule 13D, Schedule 13G, Schedule 13E-3, Form 3, Form 4, Form 5, Form S-1, Form S-3, Form S-4 and, of course, several types of prospectuses.

Today, we’ll address the most common of these disclosure obligations: those arising under the Form 8-K Current Report. This Form is used to make prompt disclosure of specified material events or circumstances affecting issuers of securities registered under the Securities Exchange Act of 1934. It is generally required to be filed or furnished within four business days of the occurrence of the triggering event or circumstance. In the M&A context, these may include any or all of the following:

signing a material transaction agreement (Item 1.01),
terminating a transaction agreement (Item 1.02),
closing the deal (Item 2.01),
borrowing money to finance the transaction (Item 2.03),
incurring costs in connection with selling assets or subsidiaries (Item 2.05),
delisting from a stock exchange at closing (Item 3.01),
issuing unregistered shares as consideration (Item 3.02),
adopting charter or bylaws amendments (Items 3.03 and 5.03),
experiencing a change of control (Item 5.01),
departure of directors and officers (Item 5.02),
holding a stockholder meeting to approve the transaction (Item 5.07) and
making selective disclosures of material information (Item 7.01).

For those without a great deal of experience with these requirements, navigating them may be intimidating if not impossible. Frankly, complying with the requirements of Form 8-K is tricky even for those of us who have been doing it for years. Not only must one comply with the facial requirements of the Form and its instructions, the Securities and Exchange Commission (SEC) has issued a patchwork of nigh-inscrutable supplemental guidance and requirements in the form of Exchange Act and Securities Act Rules, adopting releases, Compliance and Disclosure Interpretations, telephone interpretations, no-action letters, informal guidance and the Financial Reporting Manual.

Frustrated by this state of affairs, I created a unified source for nearly all SEC Rules and guidance applicable to Form 8-K. I call it The Ultimate Annotated Form 8-K. It includes references (and hyperlinks) to all Rules and guidance needed to comply with Form 8-K’s requirements on an Item-by-Item basis. I guaranty it will make your Form 8-K disclosure compliance much easier in the future. Let me know what you think!

The Ultimate Annotated Current Report on Form 8-K

Form-8-K-Full-Form-with-Instructions-Links-100315

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Material Adverse Effect Clauses

Things rarely go according to plan. Earnings are missed. Commercial relationships end. Regulatory approvals don’t materialize. Lawsuits get filed. And disasters happen. Such are the vicissitudes of business. But what happens when they transpire during the gap period between signing and closing an M&A transaction? Most sellers would argue that little if anything should happen—the deal should still close at the previously agreed-upon purchase price. Buyers, on the other hand, would counter that they shouldn’t bear the risk of adverse developments, particularly because sellers remain responsible for day-to-day operations of the target throughout the gap period.

Usually, the parties find a middle ground, where at least some of the risk is allocated to the seller. This is achieved through indemnification and termination provisions in principal transaction agreements, one important component of which is the concept of Material Adverse Effect (MAE), sometimes called Material Adverse Change (MAC).

In this post on The M&A Lawyer Blog, I will:

introduce the concept of Material Adverse Effect and explain its principal functions,
present pro-buyer and pro-seller versions of MAE definitions and explain how, and why, they differ, including with respect to forward-looking language and common qualifications, and
describe key cases that provide important context for the preparation of MAE clauses.

Functions of Material Adverse Effect Clauses

MAE serves two primary functions in a transaction agreement. First, it qualifies (i.e., limits) various seller representations, warranties and covenants, establishing a relatively high threshold for disclosure or compliance relating to risks associated with changes in the target’s business. For example, a representation may provide that all liabilities of the target have been disclosed, “except for liabilities that would not have a Material Adverse Effect.” Thus, the MAE qualification renders some adverse events irrelevant and non-actionable under the agreement. Note that, in this context, the inclusion of the MAE concept is favorable to the seller because it reduces the disclosure obligations and risk of breach by the seller.

Second, MAE is operative in the conditions to be satisfied or waived before the buyer is required to consummate the deal. Specifically, an MAE must not have occurred during the gap period. Otherwise, the buyer may terminate the acquisition agreement. This is often referred to as a MAC out. Some 95% of M&A deals include a MAC out. In contrast with its use in reps, warranties and covenants, this application of the MAE concept favors the buyer by presenting it with the option to walk from a deal after its anticipated value has changed.

In both contexts, however, the seller will want to minimize the likelihood of occurrence of an MAE by narrowing which events and circumstances will satisfy the definition, and the buyer will seek to achieve the opposite.

Material Adverse Effect Definition

Virtually all acquisition agreements include a formal definition of Material Adverse Effect in the Definitions section. Here’s a pro-buyer example, intended to cast a wide net:

“Material Adverse Effect” means any event, change, circumstance, effect or other matter that has, or could reasonably be expected to have, either individually or in the aggregate with all other events, changes, circumstances, effects or other matters, with or without notice, lapse of time or both, a material adverse effect on (a) the business, assets, Liabilities, properties, condition (financial or otherwise), operating results, operations or prospects of the Acquired Companies, taken as a whole, or (b) the ability of the Company or the Seller to perform its obligations under this Agreement or to consummate timely the transactions contemplated by this Agreement.

By contrast, a relatively pro-seller definition intended to be difficult to satisfy might provide:

“Material Adverse Effect” means any event, change, circumstance, effect or other matter that has a material adverse effect on (a) the business, financial condition or results of operations of the Acquired Companies, taken as a whole, or (b) the ability of the Seller to consummate timely the transactions contemplated by this Agreement; provided, however, that none of the following, either alone or in combination, will constitute, or be considered in determining whether there has been, a Material Adverse Effect: any event, change, circumstance, effect or other matter resulting from or related to (i) any outbreak or escalation of war or major hostilities or any act of terrorism, (ii) changes in Laws, GAAP or enforcement or interpretation thereof, (iii) changes that generally affect the industries and markets in which any Acquired Company operates, (iv) changes in financial markets, general economic conditions (including prevailing interest rates, exchange rates, commodity prices and fuel costs) or political conditions, (v) any failure, in and of itself, of any Acquired Company to meet any published or internally prepared projections, budgets, plans or forecasts of revenues, earnings or other financial performance measures or operating statistics (it being understood that the facts and circumstances underlying any such failure that are not otherwise excluded from the definition of a “Material Adverse Effect” may be considered in determining whether there has been a Material Adverse Effect), (vi) any action taken or failed to be taken pursuant to or in accordance with this Agreement or at the request of, or consented to by, the Purchaser, or (vii) the execution or delivery of this Agreement, the consummation of the transactions contemplated by this Agreement or the public announcement or other publicity with respect to any of the foregoing.

And here’s how the two definitions differ:

“Material Adverse Effect” means any event, change, circumstance, effect or other matter that has, or could reasonably be expected to have, either individually or in the aggregate with all other events, changes, circumstances, effects or other matters, with or without notice, lapse of time or both, a material adverse effect on (a) the business, assets, Liabilities, properties, financial condition (financial or otherwise), operating or results, of operations or prospects of the Acquired Companies, taken as a whole, or (b) the ability of the Company or the Seller to perform its obligations under this Agreement orSeller to consummate timely the transactions contemplated by this Agreement; provided, however, that none of the following, either alone or in combination, will constitute, or be considered in determining whether there has been, a Material Adverse Effect: any event, change, circumstance, effect or other matter resulting from or related to (i) any outbreak or escalation of war or major hostilities or any act of terrorism, (ii) changes in Laws, GAAP or enforcement or interpretation thereof, (iii) changes that generally affect the industries and markets in which any Acquired Company operates, (iv) changes in financial markets, general economic conditions (including prevailing interest rates, exchange rates, commodity prices and fuel costs) or political conditions, (v) any failure, in and of itself, of any Acquired Company to meet any published or internally prepared projections, budgets, plans or forecasts of revenues, earnings or other financial performance measures or operating statistics (it being understood that the facts and circumstances underlying any such failure that are not otherwise excluded from the definition of a “Material Adverse Effect” may be considered in determining whether there has been a Material Adverse Effect), (vi) any action taken or failed to be taken pursuant to or in accordance with this Agreement or at the request of, or consented to by, the Purchaser, or (vii) the execution or delivery of this Agreement, the consummation of the transactions contemplated by this Agreement or the public announcement or other publicity with respect to any of the foregoing.

Broadly speaking, there are three differences between the definitions. First, the pro-buyer version includes forward-looking language, such as the phrase “could reasonably be expected to have” and the word “prospects.” Second, the list of direct objects on which effects will be measured in the buyer definition includes narrower categories, e.g., “assets” and “Liabilities,” and, third, the pro-seller definition includes a long list of exceptions.

Let’s consider each of these in turn.

Forward-Looking Language

The forward-looking language sought by buyers is intended to capture events or circumstances that have not yet, but may in the future, result in a materially adverse effect. Without this language, it’s conceivable that an eventuality that would certainly reduce a target company’s future value without having any impact on its current operations and earnings would not qualify as an MAE. An example would be a failure to obtain FDA approval for a new drug.

Interestingly, while M&A lawyers often get fairly animated in negotiating whether to include the word “prospects” in the MAE definition, they do not similarly struggle with inclusion of the “could reasonably be expected to have” language, which should be viewed by a court as having the same effect. The result is that less than 5% of deals include the word “prospects” while more than half include the “could reasonably be expected to have” language, reflecting a slightly buyer-favorable outcome here in most deals.

Material Adverse Effect on What?

The second difference between the pro-buyer and pro-seller versions of MAE relates to the object of the effect. The buyer version looks to include assets, liabilities, properties and non-financial condition, all of which were omitted from the seller version. The buyer’s objective in this case is to reduce the size of the denominator in assessing materiality. What may qualify as a material adverse effect on, say, a company’s liabilities or properties alone may not be material to the company as a whole, particularly where the target company didn’t have a lot of liabilities or properties to begin with. Once again, the buyer looks to make a given event or circumstance more likely to constitute an MAE.

MAE Exceptions

The final material variation between the two MAE definitions is the seller’s proposed inclusion of a long list of exceptions. Despite being omitted from the buyer favorable draft, virtually all MAE definitions include such lists in one form or another, though they may differ in their specifics. Some of the more common exceptions are those relating to:

changes in the economy or business in general,
changes in general conditions of the specific industry,
changes in the securities markets,
changes in the trading price or trading volume of a target’s stock (in public deals),
acts of war or major hostilities,
acts of terrorism,
Acts of God,
changes in political conditions,
changes in laws or regulations,
changes in interpretations of laws by courts or government entities,
effects of announcement of the transaction,
changes caused by the taking of any action required or permitted or in any way resulting from or arising in connection with the agreement,
changes in Generally Accepted Accounting Principles (GAAP) and
failure by the target to meet revenue or earnings projections.

Less frequently, you may encounter exceptions relating to:

changes in interest rates,
changes in exchange rates,
national calamities,
international calamities directly or indirectly involving the U.S.,
changes resulting from bankruptcy or actions of a bankruptcy court,
changes in applicable taxes or tax law,
employee attrition,
changes in the target’s relationship with any labor organization or union,
reduction of the target’s customers or decline in its business,
seasonal reductions in revenues,
delays or cancellations of orders for services or products,
developments arising from any facts that were expressly disclosed to the buyer or the public,
expenses incurred in connection with the transaction,
actions required to be taken under any law or existing contract by which the target is bound and
litigation resulting from any law relating to the agreement or the transactions.

The particular configuration of exceptions depends on the specifics of the transaction and the parties’ expectations of areas of risk. Importantly, though, the example MAE definitions I provided above have omitted an important feature that is today found in virtually all such lists of exceptions—that is, disproportionately impact language, which carves out exceptions from the MAE clause to assure that buyers have the protections of the provision if the target suffers more greatly than similarly-situated companies from a specified event or circumstance.

Such language is often appended to the end of the exceptions list and may provide as follows:

“except, in the case of clauses (i) through (iv), to the extent that such event, change, circumstance, effect or other matter adversely affects the Acquired Companies in a substantially disproportionate manner relative to other participants in the their industry and markets.”

This has a moderating effect on the pro-seller list of exceptions and makes the inclusion of exceptions less objectionable to the buyer.

Key Material Adverse Effect Case Law

Unfortunately, case law interpreting MAE provisions is meager. However, three Delaware cases stand out as particularly important. They are:

A quick Google search will reveal numerous articles about each of these cases, so I won’t retread old ground here. Instead, I’ll offer you the key takeaways from each case.

IBP vs. Tyson

After signing a merger agreement to acquire IBP for about $1.6 billion, Tyson asserted that IBP’s decline in performance (including a 64% drop in same quarter sales over the prior year) and a $60.4 million impairment charge arising from improper accounting each constituted an MAE.

In rendering its opinion, the court stressed that MAE must be interpreted in the larger context in which the parties were transacting. In particular, IBP’s past performance revealed strong swings in annual EBIT and net earnings. In addition, for a buyer that seeks to purchase a company as part of a long-term strategy, the impact of changes in the target’s earnings power must be considered over a “commercially reasonable period,” which the court stated should be measured in years rather than months.

The court stressed that a buyer must make a strong showing to invoke a MAC out, explaining:

Merger contracts are heavily negotiated and cover a large number of specific risks explicitly. As a result, even where a Material Adverse Effect condition is as broadly written as the one in the Merger Agreement, that provision is best read as a backstop protecting the acquiror from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally significant manner. A short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror.

The court thus concluded that an MAE had not occurred and granted IBP’s request for specific performance to enforce the merger agreement.

Hexion v. Huntsman

Prior to this litigation, Hexion Specialty Chemicals attempted to exercise a MAC out under its agreement with Huntsman on the basis of a deterioration in Huntsman’s business during the gap period. Hexion focused its arguments on Huntsman’s repeated failure to achieve its forecasts as well as an increase in Huntsman’s net debt as compared to its projected decrease and the underperformance of two of Huntsman’s operating divisions.

The court concluded that, because Huntsman had specifically disclaimed any representations regarding projections, the failure to achieve targets could not be the basis of an MAE. The court also concluded that the proper way to determine the existence of an MAE is to compare current results against the prior historical period and found only a small decline (3-6%) over annual periods. In addition, the increase in net debt had been small (5%), and the Huntsman business units affected by the downturn contributed only 25% of overall EBITDA. Thus, all considered, no MAE had occurred.

The court then ruled that Hexion was obligated to consummate the acquisition, a transaction for which financing was no longer available.

Key takeaways from the decision include:

It reaffirms the holding in IBP v. Tyson that parties seeking to invoke MAC outs bear a “heavy burden” to demonstrate that an MAE has occurred.
Parties can reallocate the burden of proof in their agreement.
The court noted that, as of the date of the opinion (2008), Delaware courts had never found a material adverse effect to have occurred in the context of a merger agreement.
An MAE ordinarily will be “measured in years rather than months” and, thus, an MAE will not be found unless an adverse change is “consequential” to the target’s long-term earning power, rather than a “short-term hiccup.”
The case suggests that buyers may wish to include specific metrics and benchmarks in their agreements because reliance on generalized MAE definitions to terminate will be difficult.
MAE clauses will not be read in isolation, but will be viewed in the context of the entire agreement and the overall transaction.

Osram Sylvania

Unlike in IBP v. Tyson and Hexion v. Huntsman, here the court ruled in favor of the buyer. This case, though, involved a post-closing indemnity claim based on a purported MAE, rather than exercise of a MAC out. Specifically, Osram Sylvania Inc. (OSI) was a shareholder of Encelium Holdings that bought out the other shareholders. OSI sought indemnity for an MAE based on Encelium’s failure to meet sales forecasts and manipulation of financial results.

In considering the sellers’ motion to dismiss OSI’s contract and tort-based claims, the court held that:

Acts of financial manipulation prior to execution of the agreement could lead to an MAE.
Failure to meet sales forecasts could be an MAE.
Failure to notify a buyer of missed forecasts usually will not constitute fraud.
“Materiality scrapes” should generally not apply to “absence of MAE” representations.

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If you’d like more information about current practice in drafting Material Adverse Effect clauses, a terrific resource is Nixon Peabody’s Annual MAC Survey. The 2020 Survey is available here.

Intro to M&A Representations and Warranties

The primary transaction agreement in every M&A deal contains representations and warranties, colloquially referred to as “reps and warranties” or simply “reps,” from each party to the other. These are statements of past, present and sometimes future fact relating to the status, business, assets, liabilities, properties, condition, operating results, operations and prospects of the party making the statements, one or more companies under the party’s control or a group of assets and liabilities. Reps and warranties as a whole can be quite lengthy, often comprising from 15 to 30 pages of a transaction agreement and more still when you include the text incorporated by reference from the agreement’s Definitions section. A substantial amount of the time and energy involved in papering and negotiating the deal is usually devoted to reps and warranties.

Why do representations and warranties get so much attention?

Reps serve four primary functions.

Disclosure

First, they provide important disclosures from one party with an informational advantage to the other about the disclosing party and, in the case of the seller, the target company or assets. As you might expect, except in the relatively rare circumstance in which a portion of the purchase price is paid in buyer stock, most of this information relates to the target company or assets and flows from the seller to the buyer.

Reps and warranties may thus be thought of as an extension of the due diligence process—they ameliorate informational asymmetries between the parties. Frequently, parties will make meaningful discoveries through the process of drafting reps and warranties (and the associated disclosure schedules) that may materially alter the deal’s value proposition.

Walk rights

Second, representations and warranties may form the basis of a party’s right to terminate the deal prior to closing. Assuming a deal has a gap period between signing and closing, as most do, the principal transaction 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. Otherwise, the non-breaching party will usually have the right to terminate the transaction agreements and walk from the deal. Thus, reps and warranties effectively enable a party to continue its due diligence during the gap period and also protect a buyer (or a seller receiving shares as consideration) from many intervening events or conditions that adversely impact the other party or the target.

Risk-shifting

Third, together with the parties’ indemnification rights, representations and warranties serve as a risk-shifting mechanism—inaccuracies may entitle the other party to monetary compensation for associated losses. (This applies only in private, rather than public, M&A transactions, where post-closing indemnities are exceedingly rare.) In many respects, this is the primary purpose of representations and warranties in private deals, as the buyer’s expectation that the seller, and not the buyer, will bear much if not most or all of the risk of losses resulting from false statements provides a great deal of comfort and increased certainty for the buyer, enabling it to price the deal more accurately and plan for post-closing operations.

Parties are well-served to remember this risk-shifting function during negotiations. It is not uncommon for one party to voice an objection to a proposed representation or warranty on the basis that “it just isn’t true,” “we can’t confirm this” or words to that effect, to which a well-trained M&A lawyer may quickly retort, “So what? My client shouldn’t bear this risk.” After all, the reasoning goes, reps and warranties are not only about what is and is not. They reflect the parties’ understanding of which party will bear the burden of losses that arise from certain events or circumstances.

Discipline

The final key function of M&A representations and warranties is derivative of the prior two. The possibility that a counterparty may terminate the transaction or seek compensation from the disclosing party for breaches strongly incentivizes the party giving the reps to make sure they are in fact true (or will be when deemed made). By way of example, this means a party providing representations as to good standing, due authorization and absence of conflicts will in endeavor to ensure it or the target company is in good standing, has the authority to enter into the transaction and is not a party to any conflicting contracts. Thus, the desire to avoid the costs associated with a broken deal or breached reps often has salutary effects on the underlying substance of the deal.

What do representations and warranties say?

Reps and warranties may address a broad variety of subjects, from the target’s legal existence, good standing and financial statements to the buyer’s ability to finance the transaction and comply with its obligations under the agreement.

Here’s an example of a typical seller “absence of conflicts” rep:

“Assuming that all consents, approvals, authorizations and other actions described in Section 3.07 have been obtained, the execution, delivery and performance of this Agreement by Seller do not and will not (a) violate, conflict with or result in the breach of any provision of the Organizational Documents of Seller or the Company, (b) conflict with or violate (or cause an event which could have a Material Adverse Effect as a result of) any Law or Governmental Order applicable to Seller, the Company or any of their respective assets, properties or businesses, or (c) except as set forth in Section 3.06(c) of the Disclosure Schedule, conflict with, result in any breach of, constitute a default (or event which with the giving of notice or lapse of time, or both, would become a default) under, require any consent under, or give to others any rights of termination, amendment, acceleration, suspension, revocation or cancellation of, or result in the creation of any Encumbrance on any of the Shares or any of the Assets pursuant to, any Contract to which the Company is a party or by which any of the Shares or any of the Assets is bound or affected.”

Other reps like this one you may encounter in a typical private company stock purchase agreement would address all or some combination of the following subjects:

organization and good standing
authority and enforceability
capitalization and ownership
subsidiaries
financial statements
books and records
accounts receivable and accounts payable
inventories
absence of undisclosed liabilities
absence of certain changes and events
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 and
full disclosure.

The transaction agreement usually contains reciprocal representations and warranties from the buyer to the seller. 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 because the seller in that case would effectively be making an investment in buyer securities. 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.

Accordingly, in deals without stock consideration, buyer representations and warranties usually address some combination of the following topics:

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

What determines which representations and warranties are given in a deal

The precise configuration of representations and warranties in a particular deal is a function of a number of factors in addition to whether part of the purchase price will be paid in buyer shares. These include:

transaction structure – each transaction structure requires some differences in reps (e.g., valid issuance in stock purchases and sufficiency of assets in asset deals),
whether the transaction is a public or private deal – public deals usually involve representations about a company’s Securities and Exchange Commission filings and afford buyers some additional comfort stemming from the requirements imposed on public companies by the federal securities laws and stock exchange listing standards,
how thoroughly each party is able to conduct due diligence – generally, there is an inverse relationship between the amount of due diligence a party conducts and the scope of reps and warranties it will demand from the other side,
specific issues identified during due diligence – if problems are discovered during diligence, such as a third party intellectual property infringement claim or an environmental hazard, enhanced representations in that area may be sought,
the target company’s industry – areas of focus differ based on industry (e.g., technology deals are IP-centric and chemicals transactions require more environmental coverage),
current market practice – norms evolve over time; what was standard 10 years ago may be unusual today,
past practices of the parties and their lawyers – occasionally, a party can obtain example transaction agreements from prior deals and see what concessions may have been made in the past,
the parties’ (and their lawyers’) respective preferences and priorities as informed by their past experience with other transactions – as with individuals, company preferences vary, especially if a party has suffered losses in prior deals,
the parties’ desired allocation of post-closing risk in light of the expected impact of indemnification rights – indemnification rights may be more or less protective, depending on applicable baskets, caps, materiality scrapes, survival periods, credit-worthiness, guarantees, holdback, escrow, earnouts, rights of offset and other terms, and the greater a party’s exposure is to a potential indemnification claim the more likely the party is to resist broad representations,
whether the parties will be obtaining representations and warranties insurance – such insurance can shift risk from parties to insurance providers, and insurance providers may themselves comment on the contents of representations and warranties,
a buyer’s interest in maintaining optionality on the deal – more fulsome seller representations and warranties make it easier for a buyer to exercise walk rights,
the parties’ relative bargaining power – where competition is high for a particular target, sellers usually enjoy greater success in resisting rigorous reps,
definitions of pervasive qualifiers – terms like “knowledge,” “material” and “Material Adverse Effect” are used throughout representations and warranties to limit them, and how they are defined will determine where and how frequently each is used,
the parties’ receptiveness to additional complexity and cost – longer representations and warranties generally require more time and legal fees to draft and negotiate,
whether the seller has agreed to any broad “catch-all” type representations, such as so-called “full disclosure” or “10b-5” reps or open-ended compliance with law or absence of changes representations – if a seller has agreed to include broad representations that may form the basis of a variety of different claims, buyers will often be less insistent on other, more specific representations, and
whether the buyer’s or the seller’s M&A lawyer prepares the first draft of the agreement – usually, a buyer-prepared first draft will have more extensive seller representations and warranties than a seller-prepared draft.

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In subsequent posts on The M&A Lawyer Blog, we’ll examine some of these topics more closely, including discussing the actual language of key representations and warranties, the definitions of pervasive qualifiers, the interplay with disclosure schedules, the significance of sandbagging and more.

How to take control of a Board through written consents

On August 19, 2015, the Delaware Court of Chancery issued an opinion in Kerbawy v. McDonnell that addressed how holders of a majority of a company’s shares should take control of a board of directors by executing written consents. The case involved interpretation of Section 228 of the Delaware General Corporation Law, which provides that, unless otherwise set forth in a corporation’s certificate of incorporation, shareholders may act by written consent upon any action that may be taken at any annual or special meeting of shareholders, “without a meeting, without prior notice and without a vote.”

Kerbawy offers several important reminders and other interesting takeaways relating to Section 228, including:

Written consents delivered pursuant to Section 228 are required to bear the date of signature of each shareholder who signs the consent.
Action by written consent is effective under the statute only if a number of consents sufficient to take the action are delivered to the corporation within sixty days of the earliest dated consent.
A duty of disclosure does not generally apply to the solicitation of Board consents by non-controlling shareholders. Any duty of disclosure would derive solely from the fiduciary duties of care and loyalty.
Generally, non-controlling shareholders do not owe any fiduciary duties, even if they are attempting to become directors, and, just as Delaware law does not require directors-to-be to comply with their fiduciary duties, former directors owe no fiduciary duties.
If a majority of shareholder consents were procured at least in part by materially misleading disclosures, that could support such a finding of inequity that would warrant a court’s intervention. A statement, omission or partial disclosure is considered material “if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote,” or if, “under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder[,] . . . [or] would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”
Incumbent directors that have been purportedly removed by consent of a majority of shareholders, “have a heavy burden in asking the Court potentially to disenfranchise a majority of the stockholders, and a breach of the duty of disclosure . . . only supports that result if it ‘inequitably taints the electoral process.'”
Disclosure by a fiduciary of confidential information of the corporation in connection with a consent solicitation may have been actionable conduct, particularly in the absence of a confidentiality agreement intended to protect the information. However, a plaintiff would have to demonstrate harm to persuade a court to set aside written consents on an equitable basis.
Section 228 permits shareholders to act independently of the Board and without prior notice or discussion. In other words, they can engage in a “secret compilation of consents” and surprise the Board if they so choose.

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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.

Want to buy an asset purchase agreement?

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.

* * *

Dole CEO and GC Fraud Liability for Otherwise Proper Going-Private Deal

On August 28, 2015, the Delaware Court of Chancery found the controlling shareholder-CEO and General Counsel of Dole Food Co. Inc. liable to investors for $148 million for fraudulently driving down the company’s share price in anticipation of a going-private transaction. What’s particularly noteworthy here is that the controlling shareholder appears to have structured the transaction with all of the protections required for minority shareholders (see In Re MFW Shareholders Litigation), including approval by a committee comprised of independent directors, approval by a majority of minority shareholders and even a fair price.

In the words of the court:

“But what the Committee could not overcome, what the stockholder vote could not cleanse, and what even an arguably fair price does not immunize, is fraud. Before Murdock [the CEO] made his proposal, Carter [the GC] made false disclosures about the savings Dole could realize after selling approximately half of its business in 2012. He also cancelled a recently adopted stock repurchase program for pretextual reasons. These actions primed the market for the freeze-out by driving down Dole‘s stock price and undermining its validity as a measure of value. Then, after Murdock made his proposal, Carter provided the Committee with lowball management projections. The next day, in a secret meeting that violated the procedures established by the Committee, Carter gave Murdock‘s advisors and financing banks more positive and accurate data. To their credit, the Committee and Lazard recognized that Carter‘s projections were unreliable and engaged in Herculean efforts to overcome the informational deficit, but they could not do so fully. Critically for purposes of the outcome of this litigation, the Committee never obtained accurate information about Dole‘s ability to improve its income by cutting costs and acquiring farms.

By taking these actions, Murdock and Carter deprived the Committee of the ability to negotiate on a fully informed basis and potentially say no to the Merger. Murdock and Carter likewise deprived the stockholders of their ability to consider the Merger on a fully informed basis and potentially vote it down. Murdock and Carter‘s conduct throughout the Committee process, as well as their credibility problems at trial, demonstrated that their actions were not innocent or inadvertent, but rather intentional and in bad faith.”

You can read the full opinion here.

* * *

What does an M&A lawyer do?

An M&A lawyer runs the deal. She is the hub in the hub-and-spoke system of deal parties and their advisers. The M&A lawyer serves as the primary point of contact for the rest of the deal team and has principal responsibility for shepherding the transaction to closing.

She may be an in-house attorney but is more often an M&A specialist practicing with an outside law firm. In many respects, an M&A lawyer is a legal jack of all trades. Core competencies include:

strategic thinking,
negotiation,
multitasking,
delegation,
organization,
complex drafting,
attention to detail and
critically, the ability to work quickly.

Substantive legal knowledge is focused on state corporate, contract and fiduciary duties law as well as federal securities law. An M&A lawyer must also have at least a working knowledge of corporate finance, secured lending, tax, environmental law, employment and labor law, executive compensation and benefits, real estate, antitrust, intellectual property, anti-corruption, commercial law and more.

An M&A lawyer is involved in virtually every aspect of a transaction, from initial conception to consummation, though she rarely participates in setting purchase price and post-closing integration. Her specific functions include:

preparing the target company for sale by, for example, ensuring that corporate formalities have been duly adhered to, third party vendor and supplier relationships are appropriately formalized and identifying, and if possible taking steps to mitigate, areas of potential risk,
drafting and negotiating a financial adviser engagement letter, a letter of intent and a confidentiality agreement,
working with tax and financial advisers to structure the transaction,
conducting or facilitating legal due diligence (i.e., the review of contracts, permits, organizational documents and other materials relating to the target company, the subject assets or, occasionally, the buyer, to develop an understanding of the scope, value and risks of the transaction),
preparing a due diligence memorandum or other summary of due diligence findings for the buyer,
creating a comprehensive implementation checklist identifying all actions that must be taken and documents to be delivered in connection with the transaction,
drafting and negotiating the principal transaction agreement, including crafting appropriate representations, warranties, covenants and disclosure schedules in light of issues identified during due diligence and conditions to closing,
advising buyer and target boards of directors and management on fiduciary duties and minority shareholder rights, such as dissenters’ rights, including identifying conflicts of interest or other factors that may result in higher standards of scrutiny,
reviewing and commenting on the financial adviser’s fairness opinion and board presentation in light of the board’s fiduciary duties, any disclosure obligations and the financial adviser’s engagement letter,
advising as to disclosure obligations under applicable federal securities laws, securities exchange listing standards and fiduciary duties as well as drafting any Form 13Ds, press releases, proxy or information statements, Form 8-Ks, tender offer documentation and registration statements,
providing tactical advice during negotiations,
managing specialist attorneys and integrating their comments, as well as comments from client personnel, into transaction agreements,
drafting and negotiating ancillary documents, including any exclusivity agreement, legal opinion, bill of sale, assignment and assumption agreement, escrow agreement or transition services agreement,
coordinating with proxy solicitors,
preparing, or working with antitrust counsel to prepare, an HSR filing,
advising on and implementing defensive measures to deter or thwart hostile takeover attempts or activist shareholder destabilization campaigns, including advising on proxy contests and preparing shareholder rights plans (poison pills), and
identifying requirements for third party consents and coordinating with client personnel to obtain them.

* * *

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