THE MERGERS & ACQUISITIONS HANDBOOK First Edition
SecuritiesConnect™ WWW.SECURITIESCONNECT.COM
THE MERGERS & ACQUISITIONS HANDBOOK A Practical Guide to Negotiated Transactions First Edition
Printed in Canada
DLA PIPER LLP
BC-BFP-PG-217
>
DIANE HOLT FRANKLE STEPHEN A. LANDSMAN JEFFREY J. GREENE DLA PIPER
Print Date: November, 2007
This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is published with the understanding that the publisher is not engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. — From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers. This guidebook is part of Bowne’s SecuritiesConnectTM Library.
FIRST EDITION
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About the Editors DIANE HOLT FRANKLE is a partner in the Silicon Valley, California office of DLA Piper and Co-Chair of the firm’s global Mergers & Acquisitions Group. Ms. Frankle specializes in mergers and acquisitions, corporate governance, and antitakeover counseling. She has represented numerous companies, both buyers and sellers, in asset deals, stock and cash mergers, tender offers, management buyouts and other complex acquisitions, and in implementing defensive strategies. Ms. Frankle is a member of the American Bar Association’s Committee on Negotiated Acquisitions and Co-Chairs the Committee’s Task Force on Public Company Acquisitions. She speaks and writes regularly in programs for both clients and practicing lawyers on mergers and acquisitions, corporate governance, the fiduciary duties of directors, and federal and state securities laws. She is listed in the Best Lawyers in America, Who’s Who Legal: The International Who’s Who of Business Lawyers, Chambers Global Guide and as one of Northern California’s Super Lawyers, for her mergers and acquisitions practice. Ms. Frankle received her J.D. magna cum laude from Georgetown University Law Center in 1979. After law school, she served as law clerk to Senior District Judge R. Dorsey Watkins, Senior District Judge of the United State District Court for the District of Maryland from 1979 to 1981. STEPHEN A. LANDSMAN is a partner in the Chicago office of DLA Piper and is Co-Chair of the firm’s global Mergers & Acquisitions Group. He engages in a general corporate, business counselling, and tax practice, with special emphasis in the area of mergers and acquisitions. Mr. Landsman has extensive in-depth experience in numerous industries as lead counsel representing both purchasers and sellers in a wide variety of transactions including public to public, private to public, private to private, leveraged recapitalization, divisional or asset sales and joint venture/strategic alliance transactions. Mr. Landsman has been a speaker on various corporate law matters and has been the author of several published articles in his field. In 2007 the respected English research firm Chambers & Partners cites Mr. Landsman in Chambers USA: America’s Leading Lawyers for Business. He has been designated an Illinois Super Lawyer in both 2005 and 2006 and is also listed in Who’s Who in America and Who’s Who in American Law. JEFFREY J. GREENE is a partner in the Shanghai office of DLA Piper. He concentrates his practice in the areas of cross-border mergers and acquisitions, corporate and securities law. Mr. Greene regularly advises clients in a wide variety of mergers, acquisitions and change of control transactions, and has led cross-border M&A deals in Australia, China, Finland, Germany, India, South Korea and the United Kingdom, among others. Mr. Greene frequently presents to practicing attorneys on the areas of mergers and acquisitions. Before relocating to the firm’s Shanghai office, Mr. Greene practiced in the firm’s Seattle, Washington office where he was named a “Rising Star” by Washington Law and Politics magazine from 2001 to 2006. iii
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Acknowledgements Editorial: Diane Holt Frankle Steven A. Landsman Jeffrey J. Greene Contributing Authors: William H. Bromfield Sulee J. Clay Stephanie M. Decker Trenton C. Dykes Francis J. Feeney, Jr. Danielle S. Fitzpatrick Diane Holt Frankle Jeffrey J. Greene David M. Hryck Purnima N. King Paolo Morante Kathryn H. Ness Michelle D. Paterniti Thomas B. Reems Robb Scott Jeffrey M. Shohet Christian Waage Eric H. Wang
Silicon Valley, California Chicago, Illinois Shanghai, China Seattle, Washington Washington, DC Shanghai, China Seattle, Washington Boston, Massachusetts Seattle, Washington Silicon Valley, California Shanghai, China New York, New York San Francisco, California Baltimore, Maryland New York, New York Boston, Massachusetts Washington, DC San Francisco, California San Diego, California San Diego, California Silicon Valley, California
Numerous partners, associates and other colleagues have contributed to this handbook. Our special thanks to Edward Batts, Joel Ginsberg, Lawrence Gold, Mark Hoffman, W. Michael Hutchings, Peter Lawrence, Albert Li, Laura Puckett and David Reitz.
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PLEASE READ THIS DISCLAIMER: This handbook is intended to provide a general, informational overview to non-lawyers and is not intended to provide legal advice as to any particular situation. The laws, regulations and other rules applicable to each specific variation of the deals discussed in this handbook are complex and subject to change. Experienced counsel should be involved in every aspect of the planning, structuring and negotiation of any M&A transaction, including the drafting and execution of all transaction documentation. Without limiting the generality of the preceeding disclaimer, the discussion of the basic Internal Revenue Service rules and regulations relating to the taxation of business combinations is intended to be a summary only. Such rules and regulations are extremely complex and evolving, and by definition are dependent on the specific facts of each particular case. Participants to business combinations must consult their tax advisors early and often when structuring M&A deals. The views in this handbook are those of the editorial staff and the contributing authors only and do not necessarily reflect the views of DLA Piper.
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TABLE OF CONTENTS Chapter 1 The Mergers and Acquisitions Process . . . . . . . . . . Why Buyers Buy and Sellers Sell. . . . . . . . . . . . . . . . . . . . . . Elements of Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Players . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisition Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time and Responsibility Checklist . . . . . . . . . . . . . . . . . . . . . Leveraging The Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 2 Letters of Intent & Term Sheets . . . . . . . . . . . . . . . . Letter of Intent Pros and Cons . . . . . . . . . . . . . . . . . . . . . . . . Binding or Non-Binding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Elements of the Letter of Intent . . . . . . . . . . . . . . . . . . . . . . . Chapter 3 The Nondisclosure Agreement . . . . . . . . . . . . . . . . . Understanding the Scope of Confidential Information . . . . . . . Use of Confidential Information . . . . . . . . . . . . . . . . . . . . . . . Non-Disclosure of Discussions. . . . . . . . . . . . . . . . . . . . . . . . Legally Required Disclosures. . . . . . . . . . . . . . . . . . . . . . . . . Return or Destruction of Materials . . . . . . . . . . . . . . . . . . . . . Non-Solicitation/Employment . . . . . . . . . . . . . . . . . . . . . . . . . Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Choice of Law/Forum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 4 Legal Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . What Is Due Diligence and When Is It Performed? . . . . . . . . What Are the Objectives of Due Diligence? . . . . . . . . . . . . . . Overview of the Due Diligence Process . . . . . . . . . . . . . . . . . Who Is Involved and the Necessity of a Diverse Team of Experts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due Diligence Request List . . . . . . . . . . . . . . . . . . . . . . . . . . Response to Due Diligence Request List . . . . . . . . . . . . . . . . Scope and Process of Review . . . . . . . . . . . . . . . . . . . . . . . . Results of Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 5 Deal Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Principal Deal Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock Purchase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Asset Acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mergers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Considerations in Choosing a Structure . . . . . . . . . . . . . . . . . Chapter 6 Definitive Acquisition Agreement. . . . . . . . . . . . . . . Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Economic and Structural Provisions . . . . . . . . . . . . . . . . . . . . Representations and Warranties . . . . . . . . . . . . . . . . . . . . . . Interim and Post-Closing Covenants . . . . . . . . . . . . . . . . . . .
1 2 2 4 5 6 7 9 10 10 11 13 14 15 15 16 17 17 18 18 18 21 21 21 22 24 25 27 29 30 33 33 33 34 35 39 47 48 48 52 59 vii
Employee Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deal Protection Devices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Conditions to Closing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Miscellaneous Provisions. . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 7 Indemnification & Contribution . . . . . . . . . . . . . . . . Why Indemnification? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisitions of Publicly-Traded Targets . . . . . . . . . . . . . . . . . Types of Indemnified Matters . . . . . . . . . . . . . . . . . . . . . . . . . Definitional Limitations on Indemnification . . . . . . . . . . . . . . . Monetary Limitations on Indemnification . . . . . . . . . . . . . . . . Other Limitations on Indemnification . . . . . . . . . . . . . . . . . . . Sole and Exclusive Remedy. . . . . . . . . . . . . . . . . . . . . . . . . . Indemnification Procedures; Dispute Resolution. . . . . . . . . . . Hold-Backs of the Purchase Price . . . . . . . . . . . . . . . . . . . . . Contribution Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 8 Fiduciary Duties of Board of Directors . . . . . . . . . . Overview of Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . Heightened Fiduciary Duty . . . . . . . . . . . . . . . . . . . . . . . . . . . Fiduciary Duty Implications of Certain M&A Transaction Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Voting Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 9 Stockholder Approvals and Securities Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obtaining Stockholder Approvals . . . . . . . . . . . . . . . . . . . . . . Registration Statements For Buyer’s Securities . . . . . . . . . . . Chapter 10 The Role of Investment Bankers in M&A Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Engagement Letter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fairness Opinions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 11 Hart-Scott-Rodino and Related Regulatory Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Brief History and Purpose of the Act . . . . . . . . . . . . . . . . . . . HSR Notification Requirements . . . . . . . . . . . . . . . . . . . . . . . Beyond Notification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Beyond the HSR Act — Government Challenges Outside the Statutory Context . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Beyond the HSR Act — International Pre-Merger Notification Requirements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 12 Tax Considerations . . . . . . . . . . . . . . . . . . . . . . . . . Taxable Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax-Free Reorganization . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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Annex Section . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Annex 3-A Mutual Nondisclosure Agreement . . . . . . . . . . . . . General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Use of Evaluation Material . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-Disclosure of Discussions. . . . . . . . . . . . . . . . . . . . . . . . Legally Required Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . Return or Destruction of Evaluation Material . . . . . . . . . . . . . No Solicitation/Employment . . . . . . . . . . . . . . . . . . . . . . . . . . Standstill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maintaining Privilege . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Compliance with Securities Laws . . . . . . . . . . . . . . . . . . . . . . Not a Transaction Agreement . . . . . . . . . . . . . . . . . . . . . . . . No Representations or Warranties; No Obligation to Disclose . . . Modifications and Waiver . . . . . . . . . . . . . . . . . . . . . . . . . . . . Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Governing Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Severability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Entire Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Counterparts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Annex 3-B Summary Checklist . . . . . . . . . . . . . . . . . . . . . . . Definition of Confidential Information . . . . . . . . . . . . . . . . . . . Use of Confidential Information . . . . . . . . . . . . . . . . . . . . . . . Non-Disclosure of Discussions. . . . . . . . . . . . . . . . . . . . . . . . Legally Required Disclosures. . . . . . . . . . . . . . . . . . . . . . . . . Return or Destruction of Materials . . . . . . . . . . . . . . . . . . . . . Non-Solicitation/Employment . . . . . . . . . . . . . . . . . . . . . . . . . Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Miscellaneous Provisions Applicable to Providers and Recipients . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Annex 4 Sample Due Diligence Checklist . . . . . . . . . . . . . . . Annex 11 Certain HSR Exempt Transactions . . . . . . . . . . . . .
A-1 A-1 A-1 A-1 A-2 A-2 A-2 A-3 A-3 A-3 A-5 A-5 A-5 A-5 A-6 A-6 A-6 A-6 A-6 A-7 A-7 A-7 A-7 A-9 A-9 A-10 A-10 A-11 A-11 A-12 A-12 A-13 A-13 A-15 A-41
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Preface The term mergers and acquisitions, or “M&A�, refers generally to a number of different types of transactions, including mergers, asset acquisitions and stock purchases. While there may be some degree of overlap among the various transaction types, each deal and each deal type is its own unique animal driven by certain practical and business considerations of the parties. For example, on the sell-side, a company may look to an M&A deal to provide liquidity to its founders or because it has reached the limits of its ability to grow organically. A would-be buyer, on the other hand, may be motivated by the prospect of acquiring strategic technology, expanding product offerings, adding distribution channels or increasing market share. Even under ideal circumstances, an M&A transaction will consume management resources of both the prospective buyer and would-be seller. Consequently, the parties must have realistic expectations of the timing, structuring, regulatory and other related considerations. Because every transaction is different, it must be approached from the vantage point of the specific facts and circumstances at hand. In putting this handbook together, we endeavored to focus on these practical matters and to use them as a backdrop for our discussion of the legal considerations associated with doing an M&A deal. This handbook addresses negotiated transactions only. As such, we do not consider hostile takeovers or other situations where the would-be buyer and would-be seller have not come together willingly to attempt to do a deal. With that said, a negotiated transaction is nevertheless an adversarial proceeding. While all parties to the deal may be keenly interested in getting the deal to closing, one should never lose sight of the fact that the parties have different, competing and, generally speaking, conflicting interests. While much of the information contained in this handbook regarding both deal structures and principal deal terms applies to transactions involving both public and private companies on the buy and sell side, certain structural considerations and deal terms may be significantly affected by whether the parties involved are publicly traded or privately held. Reference is made to these distinctions throughout the book only where relevant to a particular discussion. Finally, although Federal securities and anti-trust laws may come into play in certain transactions based on the type of deal consideration or the nature of the parties, an M&A transaction is for the most part driven by the laws of the particular state(s) in which the constituents are incorporated or domiciled. Accordingly, this handbook is intended to be agnostic with respect to particular state laws. However, because it is generally accepted among practitioners that Delaware law tends to offer the most comprehensive body of M&A and corporations law, and because a considerable number of the public companies in the United States are incorporated in Delaware, Delaware law is sometimes discussed for illustrative purposes. xi
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Chapter 1 The Mergers and Acquisitions Process As we use the term in this handbook, the mergers and acquisitions (“M&A”) process describes the methods and arrangements by which a prospective buyer and seller consummate the purchase and sale of a company. Through this process one party decides to buy and the other decides to sell at an agreed price and on agreed terms. To make such a decision, the parties have to reach some level of understanding of underlying information. This information almost always includes proprietary information which can be obtained only with the consent of the parties. Moreover, it is the kind of information which the parties will disclose only after they are relatively confident that a deal will follow. Accordingly, the part of the process by which the parties exchange information (referred to as “due diligence”) often parallels to some extent the part of the process by which the parties arrive at a conceptual price and deal structure (the “letter of intent” or “term sheet”) and by which the parties finally establish the price, the allocation of risk and other terms and conditions of the arrangement (the “definitive agreements”). The overall effort to bring about the transaction is coordinated with a master checklist (the “time and responsibility checklist”). This chapter provides an overview of the stages of the acquisition process with reference to some of the tools that have evolved to manage each stage. Mergers and acquisitions are generic terms that may refer to a variety of transactions, including asset purchases, stock purchases, mergers, share exchanges and the like. Except where the context indicates otherwise, the term “acquisition” is used in the broad sense to encompass acquisitions and dispositions. Entering the acquisition process is much like starting a marriage or a new job or other life altering event in that it involves a major commitment, and is best embarked upon after carefully considering the long-term goals of all parties involved. If you make a bad hire or match, you are likely to regret it for some time, and it is likely to be expensive. The acquisition process involves a large cast of insiders and consultants, some of whom may have conflicting interests. There are also regulatory considerations that are usually routine if addressed in a timely manner. There are different kinds of buyers/sellers and different kinds of deals, and the motivation for doing deals are equally plentiful and varied. 1
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
Why Buyers Buy and Sellers Sell Competitive Advantage. Although it is unusual, there are times when a buyer will acquire a company primarily to keep someone else from buying it. Strategic Considerations. Strategic buyers are the proverbial crown princes of buyers because, by definition, they pay more. Generally, a strategic buyer pays what the company is worth to the buyer rather than what it is worth on its own. Cheaper to Buy Than Make. There are buyers for whom buying other companies is an everyday part of their businesses. These include buyers doing “roll ups,” which are usually companies operating in an industry that is consolidating. Generally, these buyers intend to keep and operate the companies they buy. On the other hand, private equity funds (formerly referred to as leveraged buyout funds) and merchant banks typically buy companies with the intention of reselling them or taking them public within some predetermined period of time. These professional buyers may be opportunistic or strategic, depending on the circumstances. Generally, they are experienced buyers with experienced advisors. Historically, they do not overpay, but they also know what they are doing and do not waste the seller’s time. Risk Mitigation. There are times when the best way to resolve or avoid a lawsuit is to buy the other party.
Elements of Value It can be fairly inferred from the different kinds of buyers and different kinds of deals that the parties frequently go into the M&A process with different goals and expectations. These differences often center around the elements of value. The deal values of the party with the greatest negotiating strength generally dictate deal structure. • Price. In a cash deal, the price dynamic reflects common sense. Setting aside tax considerations, the higher the price, the better for the seller and the worse for the buyer. However, where the currency is the stock of a public company, this may not be true if the deal is large enough to be noticed by the market. Ironically, if the market thinks the price is too high (not accretive), the value of the market price of the stock received as the purchase price will fall after the transaction. Unless the seller has been able to sell or hedge the stock before this fall takes place, the seller will end up receiving less total value because the price was set too high at the outset. • Tax and accounting consequences. Tax and accounting consequences depend on the deal structure. In an acquisition, the buyer 2
Chapter 1 - The Mergers and Acquisitions Process
acquires either the seller’s assets or the seller itself. (To make matters complicated, there is one kind of deal — under Internal Revenue Code Section 338(h) — in which the buyer acquires the seller but the transaction is taxed as if the buyer had acquired assets.) Generally, the buyer pays for what is acquired either with its stock, cash, or a combination of both. It is often possible to structure an acquisition as a tax-free reorganization. If the transaction is taxable, the gain may be taxed as either capital gain rates or ordinary rates. In addition, there are some potentially scary tax complications, generally depending on how the seller has been formed and operated. For example, if the seller is an S corporation that converted from C corporation status, it may have “built in gain” that will be taxed. Or if the seller has issued stock options that vest, or bonuses that are earned upon a sale of the company, the “excess golden parachute” payment punitive excise tax must be considered. There may also be a punitive excise tax if stock options were granted at less than fair market value. The choices here are complicated and often binary (that is, what is good for one party is likely to be bad for the other). Just as the seller wants the highest cash price, the seller also wants to pay as little tax as possible. A tax-free deal sounds like it would be best for the seller, but cash is always taxed. If the proceeds are to be taxed, the seller does not want them double-taxed (at the corporate level and again at the stockholder level) and for this reason would prefer a stock sale over an asset sale. The seller would also prefer to be taxed at capital gain rates. If the buyer is a taxpayer and sensitive to tax consequences, the buyer may want a portion of the purchase price paid in respect of covenants not to compete, which can be expensed more quickly than purchase price, but which are taxed to the seller at ordinary income rates. If the seller is more sensitive to impact or earnings (e.g., a pre-IPO company), it will not want the more rapid amortization for non-compete payments. • Liabilities and the Allocation of Risk. If a buyer buys stock, it is buying the company rather than the company’s assets. The company brings with it all of the known and unknown liabilities arising from the operation of the business. The known liabilities are directly addressed, but most buyers prefer to buy assets in order to avoid, to the extent possible, the assumption of the seller’s contingent liabilities. • Liquidity. The seller’s primary motivation for the sale of a successful company is typically to convert an illiquid asset (the company) into a 3
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
liquid asset (cash or the buyer’s publicly traded stock). On the other hand, depending on the circumstances, many buyers using stock to make acquisitions are concerned about the potential impact of a big block of stock coming onto the market. As a consequence, if the acquisition is paid for with stock, the buyer often wants to restrict the subsequent transfer or hedging of that stock.
The Players There is a long list of players potentially involved in helping the parties reconcile the elements of value applicable to their particular type of deal. In general, the constituencies include some or all of the following: • Owners. One way or another, the owners/stockholders always get a voice in the disposition of a company. However, depending on the form of transaction, the owners may not get a direct voice in the decision to acquire a company. • Management. It is unusual to buy or sell a company without the cooperation of management. • Employees. If management and the owners are satisfied, employees as a group generally have only indirect, if any, influence. The exceptions are where the employees are unionized, where the buyer and seller are relying on the employees to perform during a transitional period, and where a large number of employees will lose their jobs (requiring compliance with state and federal plant closure laws). • Third parties. m Customers m Lenders m Creditors • Advisors. m Counsel (corporate, tax, regulatory, intellectual property, etc.) m Investment bankers m Valuation experts m Accountants m Escrow Agents m Financial Printers • Regulators. m Federal Trade Commission. The Hart-Scott-Rodino Act, administered by the FTC, applies only to large deals m
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Securities Exchange Commission and State Securities Regulators (in the event stock is part of the purchase price or one of the companies is publicly held)
Chapter 1 - The Mergers and Acquisitions Process m
Internal Revenue Service and State Tax Regulators
m
Industry Specific Regulators
Acquisition Process The big-picture goal of the acquisition process is to manage the players so as to allow the proposed transaction to be completed on time and on budget. Of course, this is easier said than done. In practice, a number of tools and devices have been developed to manage the constituencies as efficiently and effectively as possible toward the realization of this goal. For example, the due diligence (fact-finding) process is generally initiated and managed with a due diligence checklist. These tools and their purposes are as follows: Acquisition Tools
Purpose
Time and Responsibility Checklist
Manage the overall effort by coordinating the constituencies
Due Diligence Checklist
Manage the process by which the parties exchange information
Letter of Intent (‘‘LOI”) or Term Sheet
The part of the process by which the parties arrive at a conceptual price and deal structure
Definitive Agreement
The part of the process by which the parties finally establish the price, allocation of risk, and other terms and conditions of the arrangement
Earn-Out or Price Adjustment
Contingent purchase price
Representations and Warranties and Schedule of Exceptions
Allocation of risk as to underlying facts
Conditions to Closing
Allocation of risk as to supervening facts
Post-Closing Covenants
Obligations of the parties after closing
Indemnities
Financial consequence of risk allocation
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The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
Time and Responsibility Checklist The Time and Responsibility Checklist provides an overview of the M&A process. It breaks down the deal into component parts. Responsibility is then assigned and a schedule set for each part. A typical Time and Responsibility Checklist includes the following: • a list of each person who will have responsibility for some part of the deal (generally, the parties listed above in the discussion of constituencies); • a list of each document or action required to complete the transaction, organized as described below: m for each, an assignment of responsibility for drafting and reviewing that document or action; m for each, a status report; and m for each, a due date. Each document or action is further broken down with reference to the stage of the process, as follows: • Actions Taken Prior to Signing Definitive Agreement: m term sheet m board approvals m formation of newco (where an acquisition sub is formed) m business due diligence m legal due diligence • Agreements and Documents to be Delivered at Signing, e.g.: Asset Purchase Agreement (the Exhibits Differ for a Stock Purchase Agreement and Merger Agreement) m assumption agreement m bill of sale and assignment m buyer’s closing certificate m contract assignment m lease assignment m seller’s closing certificate m trademark and patent assignment m stockholder agreement m offer letters • Pre-Closing Actions: Company Stockholder Written Consent m Information Statement (provides disclosure to stockholders in connection with soliciting consent to the transaction) Third Parties Requiring Notice Third Parties Requiring Consent Allocation of Cash Consideration 6
Chapter 1 - The Mergers and Acquisitions Process
• Agreements and Documents to be Delivered at Closing: General m Governmental Approvals m Company Stockholder Approval for Asset Purchase Deliverables/Actions; Conditions to Closing m Assumption Agreement m Bill of Sale and Assignment m Contract Assignment m Lease Assignments m Buyer’s Closing Certificates m Seller’s Closing Certificates m Trademark and Patent Assignment m All Government Consents Obtained m Third Party Consents m Offer Letters m Good Standing Certificates The closing is the time when all documents, like consents and permits, must be delivered and proof of any necessary government filings, good standing certificates and approvals are required. All ancillary agreements and certificates must also be delivered at the closing. It is obviously “crunch time.”
Leveraging The Process While M&A transactions come in a variety of shapes and sizes, and vary from industry to industry, in negotiated transactions, the overall process by which the buyer and the seller look to consummate a transaction is fairly constant. Both the buyer and the seller should have a firm understanding of the process, as time, money and ultimately the deal itself may depend on it.
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The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
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Chapter 2 Letters of Intent & Term Sheets How does a deal begin? Parties known to one another may from time to time undertake discussions about a potential tie-up. Often these discussions do not end up amounting to much. However, on some occasions the parties are serious enough about their discussions to want to memorialize certain key understandings in writing. Such a writing is generally referred to as a letter of intent — i.e., the parties’ expressed desire to go forward in some manner. The terms “letter of intent,” “term sheet,” “memorandum of understanding” and “heads of terms” are generally synonymous in that they essentially make reference to the same type of document — i.e., an agreement in principal by a would-be buyer and would-be seller to further consider the propriety of doing a deal. In some circumstances, a letter of intent and term sheet will be combined, with the letter of intent portion setting forth a highlevel discussion of the transaction terms which are then set out with greater particularity in a term sheet (attached as an exhibit to the letter of intent). This is really a matter of personal preference as the substance of the document will be the same regardless of the form in which it is presented. For purposes of this chapter, the term “LOI” or “letter of intent” is used broadly to encompass all incarnations of such agreements in principal. In many deals the first statement of deal terms will be in an LOI or term sheet; however, in some cases the parties may move from a general discussion of proposed transaction terms straight to negotiation and documentation of the definitive acquisition agreement. While there may be compelling reasons for the parties’ decision to forego a letter of intent, in complex deals the parties are often better served by taking the extra time to negotiate an LOI. Among other things, a letter of intent provides the parties with a structure to their discussions and may set out the parties’ expectations as to how the deal negotiations will proceed. Moreover, a well-crafted LOI may streamline drafting and negotiation of the definitive acquisition agreement and as a result actually reduce transaction time and expense. While a letter of intent is not intended to function as the definitive acquisition agreement, to the extent the parties do have an LOI, it should not be so cursory or high level in nature that the parties move forward without having at least a general understanding of what the deal terms will ultimately look like. 9
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
Letter of Intent Pros and Cons Parties sometimes resist using letters of intent because, like the definitive acquisition agreement, the LOI is a negotiated document. Negotiating and drafting an LOI will invariably involve additional front-end time and expense for the parties. Often the parties are reluctant to want to take the “bloom off the rose” so to speak by having to undertake tough negotiations when they are just getting to know one another. Additionally, either party may be reluctant to enter into an LOI for fear of conceding a particular point that has not been fully vetted. This may be less of an issue for the buyer because in all likelihood the buyer will have only undertaken limited, if any, due diligence up to that point and will typically reserve its rights to modify certain deal terms based on the results of its due diligence review. Often the letter of intent will provide for a limited period of exclusive negotiation between the buyer and seller. This is disadvantageous for the seller, but it is one of the primary reasons why buyers often insist that the parties execute an LOI.
Binding or Non-Binding Generally, an LOI will be non-binding with respect to all but a few certain provisions. Typically, the binding provisions in an LOI will involve: • confidentiality obligations of the parties; • an exclusivity period (i.e., no shop) running to the benefit of the buyer; and • the right of the buyer to receive a termination or break-up fee in the event the seller walks away from the deal. If the parties have not previously entered into a confidentiality agreement, it would be prudent for them to do so at the time they undertake negotiation of an LOI. Once an LOI has been executed, the parties’ focus generally shifts to the due diligence investigation, timing considerations and negotiation of the definitive acquisition agreement. It is important not to let the confidentiality agreement slip through the cracks. Care should be taken to ensure that the LOI is truly non-binding, except as noted above, and does not inadvertently create a binding “agreement to negotiate” definitive terms. In some jurisdictions courts have prescribed so10
Chapter 2 - Letters of Intent & Term Sheets
called “magic” language that expressly removes any such implicit duty to negotiate.
Elements of the Letter of Intent To some extent, the terms of the LOI will mirror what one would expect to find in the definitive acquisition agreement, only with less specificity. A typical LOI will likely address at least the following: • Assets/Stock — description of the assets (which may simply be described as “all or substantially all” of the seller’s assets), or capital stock to be acquired • Acquisition Consideration — consideration to be paid by the buyer in respect of the assets or stock of the seller (e.g., cash, stock, earn-out, etc.) • Closing Conditions — specifies certain key closing conditions, such as voting agreements (and proxies), votes/consents required, required regulatory approvals, and required third party consents • Closing Date — general timetable for completing the transaction • Corporate Approvals — whether stockholder consents required or whether a stockholder meeting will be called
are
• Due Diligence — the parties’ respective access to the books and records of the other party • Escrow — amount of acquisition consideration to be escrowed or held-back to backstop indemnification or other post-closing obligations of the seller • Governing Law — legal jurisdiction governing the terms of the transaction, including the LOI • Representations & Warranties — scope of the seller’s representations and warranties (Note: because of the abbreviated nature of the typical LOI, parties often simply provide for “customary” representations and warranties, which may set the stage for disagreement during negotiation of the definitive acquisition agreement) • Structure — whether the transaction will be structured as a merger, asset acquisition or stock purchase • Survival — length of time after closing that the parties’ representations and warranties will survive 11
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
A more comprehensive LOI might also address other considerations, including: • Board Representation — whether the seller would retain any postclosing representation on the board of the acquired entity • Employment Agreements — if the buyer is to retain certain key members of management, the LOI may condition closing of the deal on the buyer’s ability to negotiate satisfactory employment agreements with such management members • Fees and Expenses — any special fee arrangements among the parties • Options — treatment of outstanding employee stock options upon consummation of the transaction (Note: terms of the option plan and applicable option agreements will need to be considered) • Publicity — whether either party is permitted to announce the transaction (typically the parties will agree to keep the LOI and proposed transaction confidential) • Registration Rights — buyer’s obligation to register any of its securities used as acquisition consideration • Tax Treatment — whether the parties intend for the transaction to receive a certain tax treatment (i.e., tax free reorganization) While there may be strategic or tactical considerations for the parties’ decision to forego an LOI, if thoughtfully considered, a letter of intent may provide the parties an early indicator of whether there is indeed a deal to be done.
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Chapter 3 The Nondisclosure Agreement The nondisclosure agreement, often referred to as the NDA or confidentiality agreement, is typically one of the first agreements to be entered into in an M&A transaction. The agreement is designed to protect the confidentiality of information exchanged in connection with the transaction and during the course of one party’s due diligence review of the other party. This chapter outlines a few of the more frequent issues encountered in negotiating a typical NDA for a merger or acquisition. Generally, the seller provides the buyer with confidential information. However, as noted above, the seller may also receive confidential information from the buyer. If the transaction involves significant equity being issued by the buyer, both parties may provide confidential information to each other. In such circumstances, the concepts discussed below should be considered accordingly. The NDA is usually prepared by the seller’s counsel or the seller’s financial advisor. Although the principal focus of the agreement is protecting confidential information that the seller provides the buyer, the buyer may also have an interest in maintaining the confidentiality of information provided during the course of negotiations. For example, the buyer may have provided confidential information to the seller in order to provide assurances of its ability to pay the consideration for the acquisition. If the buyer is issuing equity as consideration, the buyer may provide sensitive information to the seller related to future business plans in order to demonstrate to the seller that the buyer and the seller make a good business fit, to assure the seller of its ability to develop the seller’s combined businesses in the future, or, if the buyer is issuing a substantial percentage of its equity as consideration, to satisfy the seller’s due diligence investigation of the buyer. If both buyer and seller provide confidential information to each other, a “mutual” NDA will be needed. If the provision of confidential information is only contemplated to be from the seller to the buyer, a “unilateral” NDA may be used. In most instances, however, a mutual NDA will often still be used because the buyer’s confidential information may be disclosed to the seller at some point during the discussions, even if it was not originally contemplated.
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The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
Practical Tip: Tailoring the NDA to the Specific Deal Parties will often mistakenly start with an NDA that is designed for providing information to vendors or with a short-form NDA that is not tailored for M&A transactions. The parties should be careful to avoid this mistake, because the NDA for an M&A transaction will contain specific provisions addressing matters not necessarily present in other situations. For the same reasons, the parties should avoid the temptation to rely on an NDA previously used by the parties in a prior commercial arrangement.
Understanding the Scope of Confidential Information One of the preliminary matters to review in any NDA is the scope of the definition of “confidential information.” The seller should carefully examine whether the definition of confidential information sufficiently covers the information and materials it will provide to the buyer (and, to the extent applicable, confidential information that may have been provided to the buyer before the NDA was signed) to ensure that it does not inadvertently exclude information or materials intended to be confidential. In addition, the seller should be wary of “residual” clauses that allow the buyer, in its future products or services, to use confidential information retained in the “memory” of the buyer’s employees. On the other hand, the buyer typically attempts to limit the definition of confidential information so that it does not include information created or discovered by the buyer prior to, or independent of, the seller. If the buyer is a close competitor, the seller may have particular concerns about providing highly sensitive information to the buyer (e.g., pricing information, patent information or source code). Similarly, the buyer may not want to review such highly sensitive information because it might expose the buyer to future claims of misuse of proprietary information in violation of the NDA or pose regulatory concerns. Therefore the parties may want to consider carving out any subset of information that is extremely confidential to the seller. These items may be better addressed in a separate NDA containing careful controls and procedures to limit the distribution and access of information to those advisors or agreed-upon personnel of the buyer whom the seller reasonably believes will not exploit the information commercially. Another issue that may arise is how to determine whether information is confidential. The seller may want to remove any onerous legending 14
Chapter 3 - The Nondisclosure Agreement
requirements that would require the seller to mark written materials “confidential” or to reduce oral statements to writing. The potential pitfall of such requirements is that the seller may disclose confidential information assuming such information is protected when it is not in fact protected by the NDA because the seller inadvertently failed to legend the confidential information or to summarize oral confidential information in writing. The buyer may agree to waive these requirements, especially since such requirements often lead to a delay in receipt of due diligence materials due to the seller’s need to carefully legend each document delivered or desire to limit access to and control oral diligence discussions. For evidentiary purposes, the seller should maintain a list or copy of all the documents provided to the buyer and all persons to whom such documents were delivered. This will also help the parties to keep track of what was previously provided so that duplicative requests for information can be reduced.
Use of Confidential Information In addition to defining which information is confidential, it is important that the seller prevent the buyer from using the confidential information provided by the seller for any purpose other than evaluating the possible transaction at hand. The seller may want to insist on language in the NDA stating that the confidential information is to be used solely for the purpose of evaluating the transaction and that no implied license is being granted to any of the seller’s intellectual property. The seller may also want to protect its confidential information by limiting the distribution of confidential information to a select group of the buyer’s representatives. The seller may also consider a provision in the NDA that would allow the seller to hold the buyer liable for any improper use of confidential information by the buyer’s representatives. Alternatively, if there are heightened concerns about the sensitivity of the information, the seller may ask that confidential information be disclosed only to the buyer’s representatives listed on a separate schedule to the NDA and that such persons provide an acknowledgement, in writing, that they are bound by the obligations of the NDA.
Non-Disclosure of Discussions Both the seller and the buyer often want to keep confidential the fact that discussions are taking place. Disclosure of such information could create uncertainty among the seller’s suppliers, customers, vendors, and 15
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
employees, and if the seller is a publicly-traded company, result in a dramatic change in the seller’s stock price. The buyer typically has concerns about the confidentiality of discussions for similar reasons, and, in addition, will want to limit the seller from using the buyer’s interest in the seller to negotiate a potential sale to another party in order to avoid competitive bidding or to prevent disclosing the buyer’s potential business strategy to its competitors. However, in an auction context, the seller may attempt to retain its ability to disclose the fact that the buyer is a bidder, or, to the extent possible, to disclose the terms of any bid made by the buyer to other bidding parties. If the buyer needs financing to complete the transaction, the buyer may negotiate an exception allowing it to disclose information to its financiers.
Practical Tip: What it Means to Not Disclose Discussions • May not disclose that evaluation materials have been exchanged • May not disclose that discussions or negotiations are taking place • May not disclose the terms and conditions of such discussions
Legally Required Disclosures In some situations, the buyer may be legally required to disclose confidential information to third parties in connection with legal proceedings. To address this scenario, the seller should request either (i) the right to object to the disclosure of any confidential information, or (ii) at the very least, the ability to limit or control the scope of any court-ordered disclosure. The seller should also insist that the buyer and its representatives notify the seller within a certain period of time of any legal proceedings that would require the disclosure of confidential information. The notification period should give the seller enough time to seek injunctive relief or some other protective order from an appropriate court. The seller may also want to request that the buyer fully cooperate or use its reasonable best efforts to cooperate with the seller in obtaining such a court order. If the seller is unable to obtain such equitable relief, the seller will want language stating that the buyer will only disclose confidential information that is legally required to be disclosed, in the opinion of its legal counsel. 16
Chapter 3 - The Nondisclosure Agreement
Return or Destruction of Materials It is important to the seller that all written confidential information be returned or destroyed by the buyer, together with all copies and derivative materials, if the acquisition is not completed. However, the buyer may prefer to destroy the confidential information, or certify to the seller that it has destroyed the confidential information because its representatives may have made written notes on the documents or incorporated the content of those documents into internal memoranda or business presentations. If the seller accepts the buyer’s certification alternative, it should consider requesting that the buyer list the documents that have been destroyed. Some thought should be given to the destruction of electronic data on the buyer’s computer hard drives and servers, as well as the tangible copies of confidential information that the seller supplied. In some circumstances, the buyer may ask that a copy of what was received be retained for archival/evidentiary purposes to protect itself from being accused of using disclosed confidential information. If this is the case, a copy should be kept by outside counsel only.
Non-Solicitation/Employment A prospective buyer may seek to interview the seller’s employees as it “kicks the tires” on its potential acquisition. This raises two concerns for the seller: (i) it may alert the seller’s employees of a potential acquisition, making it difficult for the seller to continue its normal course of business, and (ii) it may result in a situation in which the potential buyer decides to solicit key employees rather than acquiring the entire company. The seller should request language in the NDA prohibiting the buyer from soliciting or hiring the seller’s employees for some period of time (typically 6 months to 2 years, one year being fairly common) and from soliciting or hiring former employees who may depart within some period of time (typically 3 to 6 months). The buyer may resist this prohibition by arguing that it is a large entity and that keeping track of the solicitation and hiring activities of its human resources department will be difficult, if not impossible. As a result, the buyer may ask to limit this provision to only “key” employees or employees that the seller identifies during the due diligence process. Furthermore, the buyer may argue that general solicitations not directed at the seller’s employees should be carved out because the buyer has no control over whether the seller’s employees receive or respond to general solicitations that may appear in newspaper publications or on the Internet. 17
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
Term The term of the NDA will depend on (i) the strategic value of the information to the seller, and (ii) how quickly such information may become obsolete. Some NDAs fail to include a “sunset� provision and are silent as to the duration of the confidentiality obligations under the NDA. In such cases, the seller may argue that the confidentiality obligations, especially those relating to core technology that will not become obsolete, should never terminate. However, the buyer should attempt to limit the NDA to a specific period of time (typically 1 to 5 years) because the seller’s proprietary knowhow may become obsolete in several years and the buyer will not want to be limited by the NDA in making new technological developments. The buyer may suggest that the NDA terminate upon the earlier of (i) completion of the transaction or (ii) within a period of time after signing or termination of negotiations if the transaction fails to close. If the seller is providing software source code, it should consider asking for a carve-out provision excluding source code from any time limits on protection.
Practical Tip: Avoiding Inadvertent Termination of the NDA Generally, a definitive agreement will have a provision that states that the definitive agreement sets forth the entire understanding of the parties relating to the subject matter thereof, that it supersedes all prior understandings, and that all prior agreements are terminated. Make sure that the NDA is carved out from this provision so that the NDA is not inadvertently terminated.
Remedies Another issue to consider in evaluating NDAs is the question of remedies. The seller will want to include some language from the buyer acknowledging and agreeing that monetary damages are insufficient to remedy a breach of the NDA and that the seller is entitled to injunctive relief in addition to any other remedies. The seller may also request that the buyer pay any legal fees resulting from a breach of the NDA, but a provision stating that the prevailing party will pay the legal fees may be a more reasonable compromise.
Choice of Law/Forum With respect to a one-way NDA, the law and courts of the domicile of the disclosing party is typically provided for. Where both parties are making 18
Chapter 3 - The Nondisclosure Agreement
disclosures, this issue is frequently contentious. A possible compromise is to provide that the law and forum of the domicile of the disclosing party will control with respect to disputes involving that party’s confidential information. While the NDA is typically one of the first agreements to be entered into in an M&A transaction, it is often the most overlooked. When negotiating and finalizing the NDA, the parties should carefully weigh the desire to proceed quickly with a transaction against the importance of assuring that the NDA adequately protects the parties’ interests. A sample form of a mutual NDA is attached as Annex 3-A and a checklist of items to look for when reviewing an NDA is attached as Annex 3-B for your reference.
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The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
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Chapter 4 Legal Due Diligence In the context of an M&A transaction, the term “due diligence” describes the process each of the parties undertakes to investigate the other before a final decision is made whether to proceed. It can be likened to dating (or maybe an engagement) before marriage. The parties are still finding out about each other, and either can back out, though that is likely to be unpleasant for one or both. Usually the buyer assures its investigation is critical to permit it to decide to spend its cash or issue its securities to buy the seller. However, a savvy seller will be equally concerned about the buyer if the consideration is stock in the buyer or there is some strategic combination contemplated.
What Is Due Diligence and When Is It Performed? Due diligence is not a formality. It is a critical part of any M&A transaction because it allows a buyer or a seller to examine the business, legal and financial affairs of the other to confirm that it is getting what it thought it was getting. The results should answer two important questions: (i) “Can or should we do the deal?” and (ii) “On what price/terms do we want to do the deal?” Due diligence may expose “deal breakers” (e.g., accounting issues, litigation, regulatory issues, tax issues, third party consent issues, etc.) that could materially change the anticipated benefits of the deal. At a minimum, discoveries can change the price/terms of the deal. At the worst, the discoveries may prevent the deal from getting done at all. Due diligence findings are also a critical concern in drafting the definitive transaction documents, in particular, the representations, warranties, covenants and disclosure schedules. Due diligence allows the parties to allocate the risks as they move forward.
What Are the Objectives of Due Diligence? The objectives of due diligence vary depending upon: • whether a party is the buyer or the seller; • the buyer’s business purpose for the transaction (i.e. does the buyer plan to integrate operations following the closing, or will it strip down the seller’s operations to assets); and • the proposed deal terms, including the type of consideration that the seller would receive. 21
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
For the buyer (or seller if the transaction contemplates a stock-forstock exchange, “merger of equals,” or strategic combination), the objectives of due diligence may include the following, among others: • accumulating sufficient information to validate the proposed valuation and to justify the business reasons for consummating the deal; • learning more about the seller’s business and operations; • uncovering and identifying the current and potential issues, problems, risks and liabilities posed by the transaction; • determining whether the seller’s business can effectively be integrated into that of the buyer; and • identifying unused capacity and determining how such capacity can be effectively utilized to produce synergies. For a seller receiving cash consideration in the transaction, its focus during due diligence will be on (i) what stockholder or third-party consents are required to consummate the transaction; (ii) corporate, business records, or contract clean-up issues; (iii) compensation, severance, or personnel matters; and (iv) arrangements where the consummation of the transaction would cause an undesirable effect on the seller, such as an event of default, a right of a third party to terminate a material obligation of the seller, or a trigger of a source code escrow obligation.
Overview of the Due Diligence Process Due diligence is routinely time consuming and often complex. However, the process can be manageable and cost-effective if a party spends time in advance creating a due diligence plan and forming a due diligence team. The first step in the due diligence process (after, of course, finding a deal) is for the parties to enter into an NDA or confidentiality agreement. This agreement protects the subsequent disclosure of information that will be provided to a buyer or seller in connection with the due diligence review of the other party. As discussed in greater detail in Chapter 3 (“The Nondisclosure Agreement”), a well-designed NDA accomplishes the following: • sets the ground rules concerning the disclosure and use of any provided information; • defines the scope of the documents and materials that will be reviewed (for example, certain competitive or sensitive information 22
Chapter 4 - Legal Due Diligence
may be initially excluded from the process until the parties progress further in the negotiations, or may be further subject to explicit screening procedures); • may include prohibitions on the solicitation of employees and other “standstill” provisions; and • addresses the processes and ongoing obligations of the parties (including the return or destruction of confidential information) in case the deal falls through during the due diligence stage. The next step in the due diligence process is assembling a due diligence team and assisting the individuals who will actually be performing the due diligence to understand the type of transaction, the context of the proposed investigation, and the type of company that is being reviewed. By developing a general understanding of key features of the deal including its scope, periods of review, and materiality thresholds common for deals of these types and in the applicable industry, as well as the expected timing of the transaction, the due diligence team can prioritize its review and structure the campaign accordingly. What information does the recipient need or want? In this step, the parties should broadly identify the scope of the documents they would like to review and prepare a list of the requested documents and information (“due diligence request list”). This list, which also creates a mechanism for identifying and cataloguing both the information requested and the information received, is usually very broad in the beginning of the due diligence process. Upon finalizing the list of initial documents that the reviewing party would like to receive, the due diligence request list is presented to the other side, which then begins to compile, copy, and index the requested materials. Because due diligence is an evolutionary process, the review of one document may prompt an additional line of inquiry or a need for additional documents on the same subject (e.g., supplemental due diligence requests concerning intellectual property, export, governmental contract, and environmental information matters). These supplemental due diligence requests are common and an important part of the process. Once the materials have been prepared and organized, the disclosing party distributes the documents and materials to the reviewing party’s due diligence team. Historically, this distribution was made in person by delivering the documents to a “data” or “war” room at the offices of the disclosing party’s counsel. In such cases, the reviewing party’s due diligence team 23
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
would perform its due diligence review in those offices. More recently, however, parties have begun to copy and mail (or email) due diligence documents to the reviewing party’s due diligence team and even post the materials to secure online data rooms. Once the diligence materials have been made available, the diligence teams may spend hours or days reviewing such materials and compiling appropriate work product to memorialize their findings.
Practical Tip: Online Data Rooms Online data rooms allow the reviewing party’s due diligence team to review the documents in the comfort of their own offices, which generally has the effect of decreasing the cost of the due diligence review (i.e., there is no need to travel to remote locations to carry out the review). However, convenience and potential cost reduction must be balanced against any issues that may result from the broader dissemination of sensitive information.
Who Is Involved and the Necessity of a Diverse Team of Experts Every deal is different, and one of the first priorities in the due diligence process is to assemble a diverse due diligence team. The team’s collective expertise should cover the various business, legal, technical, and financial matters unique to the seller and the deal at hand. This means not only assembling the appropriate legal team, but making sure that the buyer or seller has designated the appropriate in-house contacts to address questions that may arise concerning financial, customer, marketing, technical/ engineering, information technology/infrastructure, or personnel matters. Although the primary lawyers on the deal will conduct much of the legal diligence review, there are certain areas that will warrant a legal “specialist’s” review. These areas include antitrust, corporate and securities, debt facilities, environmental, executive compensation and employment, government contracts or regulatory agencies, import and export, intellectual property, litigation, privacy, real estate and real property, and tax. Each specialist should have an integral role in creating the contents of the due diligence request list (or responding to the request list), reviewing material related to the specialist’s subject matter, and drafting, reviewing and modifying the portions of the definitive transaction documents relevant to the specialist. In order to make the due diligence review by a specialist cost24
Chapter 4 - Legal Due Diligence
effective, the specialist should be briefed on the objectives of the parties as discussed above. The due diligence process is a collaborative effort and delegating responsibility will facilitate a more efficient and effective process, thereby producing a higher quality result and reducing the probability that key issues will be overlooked or improperly addressed or negotiated.
Practical Tip: Points of Contact Consider having one point person each for the seller, its counsel, the buyer, and its counsel, whose task is fielding and responding to all requests for additional due diligence material or information.
Due Diligence Request List The due diligence request list (as prepared by the investigating party) is an important step in formulating the scope of a due diligence review. Although some may believe that this list is generic or “boilerplate,” a detailed and targeted request list can make the due diligence process more efficient, which may also lead to a more thorough and cost-effective review. In general, a due diligence request will include all material agreements, stockholder agreements, capitalization records, financial information, customer and supplier information and contracts, employee records, and benefits plans. Despite the general nature of the types of information that will be requested, the list itself should be fairly specific, and tailored to the specific deal. It is better to make a targeted request for specific materials than it is to make a general request such as, “Provide us with all material information about the company.” For example, asking for “all charter documents” or “all financing documents” is not as helpful or efficient as asking for “the company’s certificate of incorporation, its bylaws, and all amendments as now in effect” or “all loan agreements, credit facility documents, security agreements, indentures, bonds, notes, and other evidences of short-term or long-term indebtedness, and all amendments, as now in effect.” This is particularly the case with parties that are not experienced in handling due diligence requests and may not be familiar with the information generally. 25
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
Practical Tip: When a Broad Diligence Request is Appropriate A broad diligence request list may be appropriate when: • the timeline is very tight (for example, a deal involving a public company in a competitive situation or a situation in which the risks of a leak are high); • the disclosing party has a large diligence team to respond to the entire request; • the recipient has sufficient resources and personnel to handle and review the information upon receipt; and • both parties have committed to completing the diligence process efficiently and expeditiously. Whether the request is global or targeted, generic or detailed, it should be tailored to the particular provider as much as possible. For example, if the provider is a public company, its SEC filings should be read before the request is submitted. This will enable the recipient to identify particular documents (or potential documents) it might not otherwise be in a position to ask for specifically. Although this kind of customization is more difficult when the provider is a private company, it is not impossible. The recipient will likely have some specific information about the provider (from firsthand knowledge or information from a website); and a modest amount of advance teamwork among those who have this information can help focus the request.
Practical Tip: When the Disclosing Party is Public Review SEC filings (e.g., forms 10-K, 10-Q and 8-K) before preparing a diligence request. Attached as Annex 4 is an example of what a comprehensive due diligence request list might look like. Please note that this form is merely a starting point. However, whether the form is used for a single global request or staged focused requests, it should provide an itemized list of material documents that are important in any due diligence review. The form may be used by provider and recipient alike as an inventory of documents requested and provided. 26
Chapter 4 - Legal Due Diligence
Response to Due Diligence Request List Once the team has been assembled, the due diligence request list items have been delegated among team members, and the seller and its counsel have had the chance to collect and review all of the items requested, the seller’s counsel typically prepares a formal written response to the due diligence request list. In an ideal world, the seller would be able to produce all of the items requested at once. In practice, however, and in order to keep the due diligence process moving forward, the seller will usually be unable to assemble all of the requested information and materials at once. In these situations, the parties will usually deliver a partial response and will follow up with additional information as it is assembled. All materials delivered by the seller should be accompanied by a written response and should be organized to correspond with the due diligence request list (e.g., a response that addresses each requested document item-by-item). This will allow the buyer and seller to more efficiently and effectively locate and review the desired information and will make subsequent supplements or updates easier. Typically, commencement of the due diligence process will require that a large amount of information be located, reviewed, and produced in a relatively short period of time. In most cases, the buyer will require that the seller, and the seller will wish to, keep the potential transaction confidential and not disclose its existence to the employee base. This reduces the number of people on the seller’s side available to help in the due diligence process. As a result, most of the information gathering is done by a handful of the seller’s personnel, who are oftentimes the high-level executives of the seller, or the seller’s legal counsel. Some of the information may need to be collected by or from employees who have yet to be informed of a potential transaction, and accordingly, production of such items may need to wait until the likelihood of consummating the transaction is higher. It is important that no due diligence material is produced to the other side until counsel to the disclosing party has had the opportunity to screen, if not complete its review of, and organize, such material. A provider of information should always memorialize what they send to the other side. Often, particularly in time-intensive situations, the provider responds to the due diligence request with an “information dump”, where armfuls of documents are grabbed from drawers and file cabinets, boxed up, and sent without first being inventoried. 27
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
Practical Tip: Information Dumps May Have Bad Results Among the unfortunate results of the “information dump” approach are • potential disputes down the road over what was and was not provided; • potential inadvertent privilege; and
waivers
of
the
attorney/client
• potential disclosure of sensitive documents. To minimize the risks of inadvertent disclosure, it is essential to establish a control mechanism with respect to the review, organization, and delivery of the documents by the provider and its evaluation by the recipient, and the creation of an accurate record of the documents so provided. The most common approach is to designate a single person or a very small group of people to act as a gatekeeper through which all documents must flow. In certain situations, this approach may produce internal resistance because of concerns that such coordination will slow down the review process. The due diligence process can be very disruptive to the operations of a seller. Because the buyer is trying to review a large portion of the seller’s books and records (and the information may not be readily organized and available), collection and review can be time-consuming and in turn divert the attention of company personnel to matters other than the seller’s core business objectives and operations.
Practical Tip: Source Code Protection and other Proprietary Information For protection of source code or other highly confidential proprietary information the seller may insist that the parties engage a thirdparty/independent organization tasked with evaluating the source code base or other highly confidential proprietary information rather than delivering it directly to the buyer. 28
Chapter 4 - Legal Due Diligence
Scope and Process of Review Once documents have been delivered, the reviewing party may wish to consider imposing some sort of control on the reviewing team as to the allocation and distribution of the documents. As discussed above, a fullscale due diligence review — particularly when the provider is a large company — will involve experts in many disciplines (for example, tax, accounting, intellectual property, employee benefits, environmental, and regulatory areas). Within each discipline, more than one reviewer will probably be necessary. For instance, different people may be needed to review federal and state tax issues, or patents and copyrights. In order to control this process and track the documents that are being reviewed by various team members (in case the documents must be returned or destroyed), a single individual responsible for each category of requested information should be established. This procedure helps ensure that there is a “closed loop” of identified individuals who know about the transaction and receive the documents for review. Once an NDA has been signed, the due diligence request has been submitted, coordination procedures have been put in place on both sides, and the information has begun to flow, the real due diligence work can begin: evaluating the information and its relevance to the potential transaction. In this part of the process, the due diligence team will begin to review all the documents and materials provided to date, paying particular attention to those issues that may impact the proposed terms in the definitive transaction documents or the likelihood of consummation of the deal. Much of the diligence review during this process is often performed by relatively junior team members. As such, it is important for junior team members to raise potential problems to the more senior members of the team as quickly as possible. Experience is the key to effectively analyzing and evaluating the results of a due diligence review. For example, an issue that may be deemed to be “interesting, but immaterial” to a junior member of the due diligence team may be extremely material to a more senior person who has firsthand knowledge of the problems associated with these situations. In fact, such information may ultimately be linked to another issue that, together, may be one of the most important issues to the buyer. Thus, coordination among reviewing team members is critical to success. An equally important mechanism in the due diligence process is the exchange of information orally through site visits, interviews with management, formal presentations, and informal discussions. This part of the due diligence review is often performed by the acquisition team and other principal employees or consultants of the reviewing party. Generally, attorneys are not 29
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
significantly involved in this process. In this step, members of management of the disclosing party may prepare and deliver detailed presentations that give an overview of the operations, prospects, and finances of the subject company. The acquisition team will then have the opportunity to talk to these individuals to “drill down” on the assumptions and statements made in the presentations. An important fact to remember in these situations is that presentation materials, statements made in these meetings, handouts, and other materials will directly affect the scope and substance of the representations and warranties and the extent of indemnification obligations (if any) in the definitive acquisition agreement. The buyer’s team will note any inconsistencies and inaccuracies in these statements and use these facts to shift any risks relating to the statements to the seller and its stockholders under the representations, warranties, and covenants contained in the definitive agreement.
Results of Review The results of the due diligence review will ripple through all aspects of a proposed M&A transaction. A detailed summary of the due diligence review, often called a due diligence memo, is usually prepared by counsel as a way to organize, track, and manage which documents have been reviewed, who reviewed them, and what issues or action items were identified. The due diligence memo may also become an important tool for both the business and legal aspects of negotiating the final deal terms. Once the parties have digested the results of their respective due diligence investigations, the last step in the due diligence process is making certain determinations: • Can or should we do the deal? • Do we still want to do the deal? • Is the seller worth the valuation as originally proposed or should there be a reduction in the purchase price? • Should an alternative form of consideration or payment be considered, such as an earn-out? • To what extent should the scope of the representations and warranties be expanded? • Is an adjustment to the indemnification and escrow term or amount necessary? • Should additional covenants or conditions to closing be added (e.g., third-party consents, employee retention targets, required terminations (of contracts, customers, or personnel)? 30
Chapter 4 - Legal Due Diligence
Practical Tip: Hot Issues in Due Diligence Following is a list of “hot” issues that may arise during the course of the diligence investigation, and which may impact the definitive transaction documents: • capitalization issues • nonassignability clauses • termination/default provisions • change of control provisions • employment/severance agreements • discovery of “hidden” liabilities (i.e., litigation, environmental) • discovery of provisions that conflict with the transaction or require consent/waiver • non-competition or non-solicitation restrictions on the seller • open source software • privacy issues • export control violations • source code escrow arrangements • acceleration of stock options • 280G parachute payments or 409A issues Assuming the parties wish to move forward with the deal, the due diligence memo and related documents are invaluable to the buyer in confirming the contents of the disclosure schedules to the definitive agreement. Moreover, by maintaining an accurate record of all documents disclosed pursuant to a due diligence request list, the seller may use this list in the preparation of the disclosure schedules. As mentioned above, the due diligence process continues until the transaction is closed. The parties will continue to request, deliver, and review information throughout this period. As such, the parties should recognize that due diligence is an evolving process that will require a significant time commitment on each of their parts. 31
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32
Chapter 5 Deal Structures Principal Deal Structures A business acquisition can take many forms. The optimal structure in any particular transaction will depend on a number of factors, such as the nature of the business, assets and liabilities being acquired, the economics of the business deal, tax considerations, required third-party consents, securities laws considerations, and similar issues. Determining the optimal structure for the acquisition is a critical step in every deal and must be addressed early on in the transaction process, ideally at the term sheet stage. The structure may affect the buyer and the seller very differently from an economic perspective and is therefore often an important part of early business negotiations. For example, a structure that is tax optimal to the seller may be less so for the buyer, and vice versa. The structure will also affect the scope of the due diligence and disclosure process. For example, structure may impact the scope and nature of the liabilities the buyer will assume, or the consents required for contract assignment. Setting structure will be a prerequisite to determining appropriate documentation for the transaction. Finally, the structure chosen will have a significant impact on the overall deal process. The three principal categories of negotiated acquisition structures are stock purchases, asset acquisitions, and mergers.
Stock Purchase In a stock purchase, the buyer negotiates directly with the target and its stockholders to acquire the target’s outstanding shares of capital stock directly from each of the target’s stockholders. As consideration for the acquisition of the stockholders’ shares, the buyer may pay cash, its own capital stock, debt, or other property. As with all acquisition structures, sometimes a combination of cash, stock, and/or other property may be used as consideration.
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The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
The following illustrates a typical stock purchase structure: STOCK PURCHASE Cash,Stock or Other Consideration
Before:
Stockholders of S
B Stock of S
S
After: (if stock consideration) B
Former Stockholders of S
Assuming B purchases 100% of S's stock
S
After the stock purchase has closed, the buyer will own whatever percentage of the target’s stock is represented by the shares the buyer acquired. Importantly, the buyer may not acquire 100% ownership if some stockholders do not sell their shares. After the closing, the target will continue as it existed prior to the acquisition with respect to the ownership of its assets and liabilities, its employees and the conduct of its business.
Asset Acquisition In an asset acquisition, the buyer acquires certain enumerated assets and liabilities of the seller in exchange for the buyer’s cash, stock, or other property. The buyer only acquires those assets that are specifically listed in the asset acquisition agreement and also only acquires those liabilities that are explicitly assumed. As a result, this structure can provide greater flexibility for the buyer if it seeks to limit its exposure to undesired or unknown liabilities or to acquire only those assets that are meaningful to it. 34
Chapter 5 - Principal Deal Structures
For example, a buyer that is not interested in the seller’s entire business can limit the purchase to a discrete set of assets, such as a single business line or division, or an intellectual property portfolio. Similarly, a buyer could negotiate to leave behind a lawsuit or other class of liabilities, although the seller might only be willing to keep such liabilities if the seller is retaining other assets or has a plan for handling such liabilities. When a buyer acquires all or substantially all of a seller’s assets, the seller will typically distribute the consideration that the buyer paid for those assets to its stockholders in advance of the seller’s liquidation. The following illustrates a typical asset acquisition structure: ASSET ACQUISITION B
Cash,Stock or Other Consideration
Assets
S
Distribution of Cash, Stock or other Consideration as part of or after asset sale
Stockholders of S
After the asset acquisition transaction has closed, the buyer will own only those assets of the seller, and be responsible for only those liabilities of the seller specifically enumerated under the asset acquisition agreement. Importantly, the seller will continue in place as it existed prior to the transaction — absent the business assets and liabilities sold to the buyer.
Mergers A business acquisition may also be structured as a direct or indirect merger, which is a creature of state statute and based on detailed statutory requirements that vary from state to state. As with stock purchases, mergers result in the buyer’s acquisition of the seller’s equity from the seller’s stockholders, and depending on the type of merger will often result in the continued existence of the seller as a separate legal entity. Unlike a typical stock purchase, however, a merger does not require approval by each of the seller’s stockholders in order for the buyer to acquire 100% of the seller’s equity interests. Once the requisite vote of the seller has been obtained — 35
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
e.g., a majority of the issued and outstanding shares of capital stock — a merger can be effected and the buyer will acquire 100% of the seller’s outstanding equity pursuant to the operation of the state’s merger statute.
Practical Tip: Appraisal Rights Most states’ laws provide appraisal rights to stockholders who do not vote to approve a merger and who decline the merger consideration. These rights typically enable the non-consenting stockholders to petition the court to cause the buyer to pay them a higher value for their shares than that offered in the merger. Direct Merger A direct merger occurs when the seller merges with and into the buyer, with the buyer continuing as the surviving entity. As demonstrated in the diagram below, the seller’s stockholders receive the merger consideration upon the consummation of the merger, which may be cash, stock, or other property. A direct merger will generally require the approval of both the seller’s and the buyer’s stockholders under state law, which is one of the reasons it is a less-favored structure. The seller does not survive after the closing as a separate entity, but is incorporated into the buyer.
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Chapter 5 - Principal Deal Structures
The following illustrates a typical direct merger structure: DIRECT MERGER Before: Cash, Stock or Other Consideration
StockholdersS
StockholdersB
S Stock
B Stock
B
S Merger
After:
StockholdersS
StockholdersB
B Stock (if stock consideration)
B Stock B
Surviving Corp = Buyer
Indirect Merger In an indirect, or “triangular” merger, the buyer establishes a merger subsidiary to effect the acquisition. In a forward triangular merger, the seller merges with and into the buyer’s merger subsidiary, with the merger subsidiary surviving the merger. The buyer pays the seller’s stockholders consideration in exchange for the cancellation of the shares of the seller’s stock. After giving effect to the merger, the merger subsidiary survives as the wholly-owned subsidiary of the buyer. All of the seller’s assets and liabilities are deemed to have been transferred from the seller to the merger subsidiary, which represents the continuing business post-merger.
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The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
The following illustrates a typical forward triangular merger structure: FORWARD TRIANGULAR MERGER Before: Cash, Stock or Other Consideration B
Stockholders
S
MS Merger Buyer forms merger subsidiary
After:
B Stock B
MS (combined with S)
Former S Stockholders (if stock consideration)
Surviving Corp = MS
In a reverse triangular merger, the buyer’s merger subsidiary merges with and into the seller, with the seller surviving the merger as a whollyowned subsidiary of the buyer. The buyer receives all of the seller’s outstanding stock in exchange for the merger consideration it pays the seller’s stockholders. This is often the favored acquisition structure for several reasons, including the fact that the seller continues to exist after the closing, minimizing the need for contract assignments and other special efforts to continue the business.
38
Chapter 5 - Principal Deal Structures
The following illustrates a typical reverse triangular merger structure: REVERSE TRIANGULAR MERGER Before: Cash, Stock or Other Consideration B
StockholdersS
MS
S Merger
Buyer forms merger subsidiary
After:
B
B Stock
Former S Stockholders (If Stock Deal)
S (combined with MS) Surviving Corp = Seller
Considerations in Choosing a Structure A number of considerations are involved in choosing a deal structure for a typical M&A transaction. Although these considerations vary greatly depending on context, they generally fall into five principal categories: • Business and economic considerations • Corporate and securities laws and mechanics • Allocation of liabilities • The need for third-party consents or approvals • Tax considerations It is important to recognize that the considerations driving a particular structure are dynamic and often overlapping, and in any given case the ultimate choice may depend on an analysis of a number of competing 39
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
factors. Moreover, as is discussed in more detail below, the buyer and the seller often have opposing interests in the choice of the structure, which can contribute to significant complexity in the negotiations. In addition, the structures are not rigid, and may be combined in a creative fashion to achieve a particular result. For example, a stock purchase in which the buyer acquires less than 100% of the seller’s outstanding stock may in some cases be followed by a “back-end” merger in order to “squeeze-out” minority stockholders who have not consented to sell their shares. If the buyer acquires a certain percentage of outstanding shares (typically 90%) in the stock purchase step of the transaction, stockholder approval may not be required to effect the back-end merger, which may allow the buyer to use a stock purchase to acquire a company even when it is not able to directly acquire every last share. Similarly, combinations of structures may be used in order to gain favorable tax treatment in a particular transaction, such as a “multi-step” merger implemented in an attempt to obtain favorable tax treatment while reducing some of the limitations inherent in a typical merger. Business and Economic Considerations The nature of the seller’s business and the economic reasons for the acquisition typically influence the choice of structure. The most obvious example is where the buyer is looking to acquire a line of business from the seller rather than the entire company. In this case, an asset acquisition is an obvious choice, because the buyer can enumerate which assets it is interested in acquiring and leave behind those it does not want. In contrast, a buyer with a number of independent business lines may be interested in acquiring the seller’s entire business, but intends to run the business separately as one of several standalone subsidiaries. In that case, a stock purchase or subsidiary merger are good choices. The type of consideration the parties would like to use is another important factor that drives deal structure. While some sellers prefer the immediacy, certainty, and liquidity of cash, others prefer taking an investment in buyer’s stock if they believe the upside potential of the stock is significant. On the buy-side of a transaction, a buyer may not have sufficient cash to use as consideration for the acquisition and may be unable to incur additional debt due to financial covenants and existing debt loads. In that case, using its stock will be the obvious alternative from the buyer’s perspective. As is described in more detail below, the type of consideration the parties choose will in turn influence the type of structure that can be used in a particular deal due to both legal and practical constraints, such as the 40
Chapter 5 - Principal Deal Structures
limitations inherent in using cash in the context of a tax-free merger, as well as securities law considerations. Corporate and Securities Laws and Mechanics • Corporate approvals Different deal structures may require different types of board and stockholder approvals for both the buyer and the seller, and the practicalities of obtaining such approvals in certain cases may dictate a specific structure. In the case of board approvals, while a merger or substantial asset acquisition typically requires approval by the seller’s board of directors as a matter of statute and corporate practice, and will require the approval of the buyer’s board if the transaction is material to the buyer, a stock purchase often does not require approval of the seller’s board because the shares are acquired directly from the stockholders themselves. If the buyer negotiates a contract with the seller in a stock purchase transaction, however, the seller’s board will need to approve the agreement. The need for target board approval is thus relatively universal, but stockholder approval is not always required. In the merger context, approval by the seller’s stockholders is required to consummate the deal, but the buyer will be able to acquire 100% ownership of the seller without first obtaining every stockholder’s consent. Because a merger is a creature of state statute, each state’s merger laws will dictate the baseline level of stockholder approval required in a merger in order for the buyer to consummate the transaction, and typically the affirmative vote of a majority of the outstanding shares is required for such approval. In the stock purchase transaction, in contrast, each stockholder must approve the sale of its stock in order for the buyer to obtain 100% control over the equity. For this reason, buyers typically only use a stock purchase structure with a purchase of a division or the acquisition of sellers with few stockholders, so that the buyer can be sure to acquire the desired control over the seller with minimal holdouts and cost. Approval by the seller’s stockholders may not be necessary for some asset acquisitions depending on the scope of the transaction. Typically, if the acquisition involves all or substantially all of the seller’s assets, stockholder approval is required. State law requirements vary as to what constitutes “substantially all of the assets” and the approval required, and these requirements should be reviewed carefully. 41
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
On the buyer side, subject to the requirements of public stock exchanges and national markets with respect to publicly-traded buyers (e.g., the requirement that buyer’s stockholders approve any issuance of shares in excess of a certain percentage of the buyer’s outstanding shares), the buyer’s stockholders would typically not need to approve an acquisition effected as a stock purchase, asset purchase, or indirect subsidiary merger. However, they would likely need to approve an acquisition effected by the direct merger of the seller into the buyer.
Practical Tip: Contract and Charter Approval Requirements May Be More Stringent than the Statute Attention must be paid to any applicable contracts or charter requirements that might require more stringent approvals than those dictated by statute. For example, investors’ rights agreements in the private company context often require approval of a discrete class or series of stockholders that would not otherwise be required by state law — such as approval rights on behalf of a series of preferred stock owned by a venture capital investor. • Appraisal rights Appraisal rights are another element of statutory corporate law that varies based on the nature of the transaction structure. For example, Delaware law provides that stockholders of unlisted companies who do not approve of a merger may exercise appraisal rights if they are dissatisfied with the consideration the stockholders are to receive in the merger. On the other hand, appraisal rights are not present in a stock purchase transaction because stockholders are required to agree to the sale of their shares in order for such a sale to take place. Some jurisdictions provide for appraisal rights in connection with certain asset sales as well, although state law varies. • Deal process and mechanics The process and mechanics of effecting the transaction vary depending on the deal structure, with mergers typically requiring more state mechanics because mergers are creatures of state law. The merger provisions of the various state corporation laws typically require the preparation and filing of detailed documentation (such as articles of merger) with 42
Chapter 5 - Principal Deal Structures
the Secretary of State or comparable state official in order to close the transaction. These procedures can become more complicated when multiple jurisdictions and state merger statutes are involved due to the location of the buyer and the seller. In contrast, parties to asset acquisitions need to clarify any required mechanics with respect to transferring title to the assets being sold, which can lead to some complexity depending on the assets and the laws of the states involved. Because a stock purchase is effected for equity at the stockholder level, the corporate law mechanics involved are typically the least onerous of the deal structures, at least where the target is a private company. • Securities laws and mechanics As discussed in Chapter 9, securities law considerations may impact the choice of acquisition structure significantly. For instance, if a seller’s stockholders are not all “accredited investors,” the buyer may not be able to take advantage of an appropriate exemption from the registration requirements under the Securities Act of 1933, as amended, in order to issue the seller’s stockholders shares of the buyer’s stock as consideration for acquiring their shares. In that case, the buyer may choose to pay cash at least to the non-accredited stockholders rather than go through the timeconsuming and expensive process of registering the buyer’s stock. Securities law requirements and mechanics could also make a cash deal faster to close than a deal involving the buyer’s stock. There are additional considerations if either the buyer or the seller are publicly traded.
Allocation and Assumption of Liabilities By structuring a deal as an asset acquisition, a buyer can specifically identify which of the seller’s liabilities it wishes to assume and which liabilities it wishes to leave behind. This determination is very important to both sides and therefore will likely have a very significant impact on the negotiation and valuation of the transaction. For example, a seller may be reluctant to retain a contingent liability once the business associated with the liability is sold. In contrast, a transaction structured as a stock purchase or merger, will result in the buyer acquiring the seller’s equity ownership, and thus the buyer will also assume responsibility for any and all liabilities inherent in the seller’s business. 43
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
Practical Tip: Liability Protection The buyer may look to certain mechanisms within the specific terms of the agreement to protect itself from the seller’s liabilities, even where the buyer is acquiring all the seller’s stock, and thus acquiring all the seller’s liabilities. For example, the buyer may seek indemnification from the seller and/or its stockholders, and it may insist on a holdback and escrow with respect to the deal consideration to ensure that funds are available should liabilities arise after closing. See Chapter 7 for more information on these techniques A distinction also exists with respect to the type of stock acquisition. In a stock purchase or indirect subsidiary merger, the seller continues after the closing as a subsidiary of the buyer. In contrast, in a direct merger, the seller and the buyer will become one entity, with their assets and liabilities pooled together in one enterprise. To the extent the buyer is concerned about liabilities from the seller’s business impacting its existing business and assets, it will likely prefer having the liabilities contained within a separate corporate subsidiary rather than merged with its own business. The buyer should not rely too heavily on the notion that it can simply walk away from the seller’s liabilities by structuring a deal as an asset acquisition in which it picks and chooses the liabilities it wishes to assume. In some jurisdictions, courts have applied the “de facto merger” doctrine to treat a deal the parties had originally structured as an acquisition as a merger instead. As a result, the buyer was required to assume all of the seller’s liabilities. Although uncommon, the risk that an asset acquisition will be recharacterized as a merger highlights the importance from the buyer’s perspective — even in the context of an asset acquisition — that the buyer conduct thorough due diligence and obtain appropriate representations and warranties and indemnification from the seller. There is also case law relating to liabilities associated with the business such as taxes, product liabilities and environmental claims that cannot be left behind in an asset acquisition Need for Third Party Consents In structuring transactions, parties seek to minimize the number of third party approvals required to consummate the deal. Having to obtain third party consents can delay and even prevent an acquisition from getting 44
Chapter 5 - Principal Deal Structures
done, so it is important that the parties address assignment issues early in the process. An asset acquisition by definition involves the assignment of assets between the seller and the buyer. Thus, parties to an asset acquisition must carefully review important commercial agreements the buyer is expecting to assume (such as license agreements, real estate leases, professional services agreements and the like) in order to confirm whether such agreements require the other party to consent to the assignment. Because the forward triangular merger structure results in the seller merging out of existence into the buyer’s acquisition subsidiary, such transactions also require special attention with respect to the need for third-party consents. In contrast, a reverse triangular merger and stock purchase are not likely to trigger anti-assignment provisions in third-party contracts because the seller continues in existence as the surviving entity after the transaction has closed and only the ownership of the seller changes hands. However, diligence must be conducted to determine if consents are required under specific agreements due to “change of ownership” or “change of control” contractual provisions.
Practical Tip: Contract Assignment Provisions In the absence of a specific provision in the contract explicitly defining a stock purchase or merger as an assignment for purposes of the contract, state law generally provides that an assignment of the agreement has not taken place. Tax Considerations Tax considerations may in some cases be the most significant factor in determining deal structure, and can also affect the overall economics of the deal. The interests of the buyer and the seller may not be aligned in terms of the optimal tax approach, which can lead to significant negotiations around this issue. The seller’s preferred result from a tax perspective is often to eliminate the payment of tax upon closing the transaction — preferably at both the entity and stockholder levels. Whether or not this is possible in a given transaction will generally be determined by the structure of the transaction, 45
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
the nature and amount of the consideration the seller will receive in the transaction, and the nature of the seller’s entity (e.g., whether the entity is a C corporation or S corporation for tax purposes). Different rules apply where sellers are LLCs or partnerships. The buyer, on the other hand, often seeks to obtain a “step-up” in the tax basis of the seller’s assets in order to claim larger tax deductions for depreciation later on. Generally, an asset basis step-up is only possible if the transaction is structured in such a way as to result in tax to both the target corporation itself and its stockholders. Chapter 12 contains a more in-depth discussion of some of the tax considerations inherent in an M&A transaction. While the buyer and seller’s preferences as to the best structure will often conflict at any given price, it is sometimes possible to choose a structure which, together with a price adjustment, results in everybody coming out ahead.
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Chapter 6 Definitive Acquisition Agreement Business acquisitions are typically documented by a comprehensive, definitive acquisition agreement, as well as a variety of ancillary agreements that cover a number of substantive areas and address different aspects of the deal. This chapter focuses on the key terms and provisions of the definitive acquisition agreement, particularly as they impact the negotiation and consummation of the transaction. The title, scope and overall substance of the definitive acquisition agreement will depend largely on the transaction structure. For instance, an M&A deal effected as a stock purchase will be governed by a “Stock Purchase Agreement,” whereas a deal effected as a merger will be governed by an agreement such as a “Merger Agreement” or “Reorganization Agreement”. Most of the principal substantive differences among the various types of definitive acquisition agreements relate to differences in the underlying transactions, such as the need in a Merger Agreement to have provisions that deal with the statutory merger requirements arising from applicable state law. Moreover, even within each type of transaction structure and agreement, there will always be substantive differences from agreement to agreement that reflect the particular terms and idiosyncrasies of the particular deal. Oftentimes these distinctions derive from differences in the basic facts of the deal, such as the nature of the consideration being paid (e.g., cash vs. stock) and the nature of the business agreement being struck (e.g., whether or not there will be an escrow). Moreover, even where the underlying substance of two agreements is generally comparable, there may be considerable variation in the order of presentation of the various provisions and the specific language relied upon to memorialize the business arrangement. Nonetheless, despite the many differences that exist among definitive acquisition agreements from one M&A deal to another, virtually all agreements in the negotiated acquisition context include the following basic components: • Definitions • Economic and structural terms (i.e., form of transaction, purchase and sale, pricing and related matters) • Representations and warranties • Covenants • Deal protection devices 47
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• Closing conditions and termination rights • Remedies and indemnification • Miscellaneous provisions
Definitions Given the complexity of M&A transactions and the resulting complexity of the definitive acquisition agreements themselves, most agreements contain a separate section setting forth the principal defined terms in the agreement. This is often useful from an organizational and structural standpoint with respect to readability of the document. It is worth noting that some of the defined terms that are used throughout the agreement are very much substantive in nature and can have a real impact on the underlying business deal. For instance, the definitions of “knowledge” and “material adverse change” can be critical to the parties’ basic risk allocation under the representations and warranties and indemnification sections. For this reason, the negotiation of key definitions like these can be critical to the ultimate resolution of the transaction.
Economic and Structural Provisions The first few sections of the definitive acquisition agreement generally cover the following key issues: Purchase price amount and form This section addresses the crucial issues of how much will be paid for the business and what form the consideration will take. The nature of the consideration to be paid will drive additional information and disclosure that will flow throughout the rest of the agreement. For instance, if the consideration includes buyer’s securities, the parties must address securities law ramifications — i.e., a seller receiving unregistered shares of buyer’s stock will likely demand registration rights, which will be reflected within the definitive acquisition agreement and in a separate registration rights agreement. Alternatively, if the issuance of the buyer’s stock to seller is being registered, the definitive acquisition agreement will include provisions dictating the timing and other details of necessary securities filings, including a Form S-4 registration statement. 48
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Closing and payment mechanics This section details such mechanics as how the payments will be made — e.g., wire transfer — as well as when and where the closing will take place. This section will also include descriptions of statutorily-driven requirements such as filing of articles of merger. Identification of assets and liabilities In the case of an asset acquisition, this section of the definitive asset purchase agreement will contain a precise description of the assets to be acquired and the liabilities to be assumed, which is of critical importance to the underlying substance of the deal. Timing of payments and earn-outs The parties may agree to pay consideration in installments, in which case the definitive acquisition agreement will detail the timing of ongoing payments. In many cases, installment payments will be tied to future performance. These so called “earn-out” provisions detail the negotiated performance goals the successor company must achieve after the closing to trigger additional payment obligations from buyer to seller. A seller might rely on an earn-out to maximize consideration where it believes the future performance of the business will be substantially better than its historical performance. The buyer may be able to lower its initial cash outlay, avoid overpaying for future revenues, and use earn-outs as an incentive to retain and motivate key personnel of the seller after the closing. Properly drafted, earn-outs may provide incentives to continuing management and maximize value for both parties. However, earn-outs are difficult to negotiate because of competing concerns of the seller and buyer. The seller will be concerned about its ability to track the financial performance of the business post-closing in a way that accurately reflects the seller’s contribution to the performance, whereas the buyer, particularly a strategic buyer, will seek the greatest flexibility in operating and integrating the acquired business. The parties should carefully consider how much time they will need to assess the seller’s performance while ensuring that they don’t motivate the seller’s management to maximize short term revenue at the expense of growth and sound long-term business planning. Earn-out provisions should include carefully drafted statements about who controls the successor entity, the method of operating the business after the closing and methods of accounting for revenues, profits, losses and/or expenses, or other milestone 49
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determinants. Although earnouts represent a possible way to bridge the gap between an optimistic seller and a conservative buyer, these provisions often lead to disputes post-closing. Purchase price adjustments Many definitive acquisition agreements contain provisions to adjust the purchase price upon review of final financial information about the performance of the business prior to closing, which is typically not available until after completion of the transaction. For example, parties may include purchase price adjustments to reflect changes in the seller’s working capital or stockholders’ equity in the period prior to closing that could not be verified in time to be reflected in the closing purchase price. This helps ensure that the actual performance of the seller through closing was appropriately captured in the purchase price. When purchase price adjustments are included, the definitive acquisition agreement will typically contain mechanics of delivery and review of financial statements covering the metrics relating to the purchase price adjustment, dispute resolution, time limits for bringing claims, payment of auditing fees, etc. The definitions of the key terms and applicable accounting methods for determining the purchase price adjustment are critically important. Holdbacks and escrows The parties may agree to hold-back and/or escrow a portion of the transaction consideration to cover the seller’s indemnification obligations, reductions in purchase price due to post-closing adjustments, or other liabilities. In certain circumstances, the buyer may agree to escrow a portion of the consideration payable upon achievement of earn-out targets. If the parties agree to an escrow arrangement, the definitive acquisition agreement will contain some basic details concerning the escrow arrangement and the parties often also will enter into a separate escrow agreement with a third party that will govern the management and release of escrowed funds. In some cases a well-financed seller, whose business will continue after the transaction, will not enter into an escrow arrangement and will have the direct obligation to make any payments. Exchange ratios caps and collars If the consideration being paid by the buyer is shares of its public stock, the parties will sometimes include provisions to adjust the number of shares being issued at closing based on fluctuations in the buyer’s stock price between signing and closing in order to ensure some limits on changes to 50
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the underlying deal value. Negotiations over such adjustments can be key to reaching agreement on the economics of the deal. The exchange ratio can be “fixed,” that is, a set number of shares will be delivered at closing based on a set ratio of shares of buyer stock to seller stock. This will produce deal consideration that fluctuates on the value of buyer stock. Alternatively the exchange ratio could be floating if the transaction is a certain fixed dollar value of buyer stock, with the number of shares based on the current market price typically measured over 5, 10 or 20 trading days prior to closing of the buyer’s stock. This could result in a larger number of shares being issued if the buyer’s stock price dips, resulting in potentially unattractive dilution to the buyer. The risks related to the two types of exchange ratios can be mitigated by a collar or cap, pursuant to which the transaction will either result in (i) a floating ratio becoming fixed or a number of shares becoming set at some agreed upon point, or (ii) providing walk away rights for the parties at such agreed upon value. The buyer and seller will need to negotiate these provisions carefully, often requiring consultation with each party’s financial advisors. Purchase price allocation The purchase and sale provisions in a definitive asset acquisition agreement may allocate the purchase price between the business acquired and the value of an agreement by the principals of the seller not to compete with the business. In some cases, courts are more likely to enforce a noncompetition agreement if the party seeking enforcement can demonstrate that sufficient consideration was delivered. Parties may also specify how much of the purchase price should be allocated to goodwill. This allocation is economically important and often the parties have opposite tax results from any particular allocation, making this a critical negotiation. Treatment of options and restricted stock Merger agreements will typically contain a provision detailing the treatment of the seller’s outstanding options to purchase seller’s stock in the transaction, as well as unvested restricted stock, if any. For instance, in many cases the buyer will assume the seller’s employee stock option plans such that any unexercised options after the closing will become exercisable for shares of the buyer’s common stock (after being adjusted for the applicable exchange ratio in the merger). In other cases, such as where the seller’s outstanding options permit the seller to cancel any unexercised 51
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options in advance of a merger, the buyer and seller may agree to terminate any options that have not been exercised as of the closing. Appraisal rights Where applicable, a merger agreement will contain a provision detailing stockholders’ rights to seek appraisal remedies under applicable state law. The buyer will often insist that its obligation to close the transaction be conditioned on there not being more than a de-minimus percentage of stockholders who pursue such appraisal remedies.
Representations and Warranties The principal purpose of the seller’s representations and warranties is to set forth, as of a certain point in time, key facts about the seller and its business that the buyer considers to be material to the value of the business and its decision to go forward with the transaction. For instance, the seller will be required to represent to the buyer that it has obtained all requisite corporate, contractual, and governmental consents necessary for the seller to sell its business to the buyer. Other representations will focus on the seller’s business, such as a representation stating that the seller has prepared its financial statements in accordance with generally accepted accounting principles, or a representation that the seller has paid all of its taxes on time. The drafting and negotiation of the representations and warranties must be considered in close conjunction with the seller’s preparation and delivery of schedules to the representations and warranties — known as “disclosure schedules” — that disclose any known exceptions to the statements being made by the seller in the representation and warranties. For example, if one of the representations requested by the buyer in the agreement is that the seller is not in breach of any material agreements involving the license of software, but the seller knows that in fact it is in breach under such an agreement, the seller would need to include in the disclosure schedules a description of the nature and scope of the breach. By doing so, the buyer is put on notice that there is a potential liability and the seller is complying with its obligation to disclose to the buyer all of the material facts about the seller and its business. Although the buyer will obtain much of the information it requires to determine whether to proceed with the transaction and on what terms through its due diligence review of the seller, the seller’s written representations serve as a critical backstop for the buyer’s diligence by confirming, in a formal and legally binding manner, the information provided to the buyer. 52
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Together with the disclosure schedules, the representations and warranties also serve as a critical mechanism for allocating risk between the parties and they can be a significant source of liability for the seller should any of the representations and warranties prove to be untrue after the deal has closed. In addition to (and sometimes in lieu of) a standard breach of contract action, the seller may be required to indemnify the buyer for breaches of the representations and warranties, which can be an especially powerful weapon for the buyer where there is an escrow in place to support the seller’s indemnification obligations. The representations and warranties may also impact the buyer’s obligation to close the transaction. The potential impact on the closing of the transaction and on the seller’s future liability to the buyer provides an important additional incentive to the seller in the diligence process, helping to ensure that the seller is motivated to disclose all material information to the buyer. Typical Seller representations and warranties Although the actual representations and warranties in the definitive acquisition agreement will vary from agreement to agreement, some of the more typical seller representations cover the following topics: Consummation of the deal, e.g.: • legal authority to complete the transaction, the nature of required consents and approvals and legal and contractual non-contravention • whether the seller owes any brokers’ or finders’ fees in connection with the transaction Legal matters, e.g.: • due organization, qualification • outstanding capitalization, rights to acquire securities and related matters • subsidiaries • litigation • intellectual property ownership and infringement issues, including with respect to patents, trademarks, material licenses, etc. • compliance with environmental laws and regulations • compliance with laws 53
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Financial matters, e.g.: • preparation of financial statements • undisclosed material liabilities • preparation and filing of tax returns, payment of taxes • accounts receivable/payable • inventory Composition and conduct of the seller’s business, e.g.: • title to and condition of assets • conduct of business and absence of material adverse change since last balance sheet date • material contracts and leases and absence of default relating to same • customers and suppliers • provisions relating to any government contracts • employee matters, including with respect to compensation, labor disputes, employee benefits, etc. • title to and condition of real property • real property leases • transactions with affiliates • insurance • permits • a “catch-all” 10b-5 representation certifying as to the completeness of the seller’s disclosure to the buyer If unregistered securities of the buyer constitute part of the consideration in a stock purchase or merger, the seller’s stockholders should also be required to make comprehensive investment representations that are drafted to ensure that the transaction will qualify for an exemption from registration. 54
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Key issues involved in negotiating the seller’s representations and warranties • Who is required to make the representations on behalf of the seller? The selling entity will almost always make representations and warranties to the buyer in the definitive acquisition agreement. In addition, the buyer may ask any significant stockholders of the seller to make comprehensive representations and warranties as well, particularly if they have a significant operating role with the seller. At a minimum, if the seller’s stockholders are parties to the definitive acquisition agreement, such as in the context of a direct stock purchase, they will be required to make representations relating to their ownership of their shares and their ability to enter into and perform the agreement. The issue of who is making the representations and warranties on the seller’s side is related to the question of purchase price adjustments, holdbacks, escrows and other terms impacting risk allocation. The buyer may be more comfortable proceeding without stockholder representations if a sufficient portion of the purchase price has been held back to satisfy any indemnification claims. • As of what date(s) are the representations and warranties made? The representations and warranties are typically made as of signing of the definitive acquisition agreement. Moreover, in a typical transaction in which the closing takes place some period of time after signing of the agreement, the representations and warranties will also be “brought down” to the closing. In most cases, the mechanism for ensuring that the representations are valid as of closing is the inclusion of a closing condition that the representations and warranties that were originally made at signing must also be true and correct as of the closing. In some cases, this “bringdown” may be qualified based on materiality, but that must be considered in the context of the specific materiality qualifiers that exist within the representations themselves (i.e., the buyer will want to ensure that the seller’s representations are not subject to a “double-materiality” standard, that is, a representation already qualified as to materiality should not typically be further qualified to be “deemed to be true in all material respects” or except where breach is not a “material adverse effect,” but instead is required to be true without further qualification). Additionally, a senior officer of the seller will be required to provide a closing certificate certifying, on behalf of the seller, that the representations and warranties are true and correct as of the closing. The seller may seek 55
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the right to qualify a representation or amend a corresponding schedule based on changes between signing and closing to account for intervening events or new information. If the buyer accepts the seller’s right to update the schedules, thus cutting off any indemnity claim for such updated schedules, the buyer may be given the right to terminate the deal due to such changes. • Materiality and knowledge qualifiers Much of the negotiation throughout the representations and warranties will focus on the extent to which the representations will be qualified by materiality considerations or considerations as to the seller’s knowledge. For example, most practitioners would agree that the seller should be entitled to rely upon a knowledge qualifier with respect to the typical representation as to “threatened” litigation — i.e., the seller will not be liable for failing to disclose any threatened litigation to the extent the seller did not know that litigation was in fact threatened against it. In a similar vein, most sellers would insist that they should not be liable to the buyer for failing to disclose liabilities that would not have a material impact on the seller’s business, such as a risk that the seller may lose its contract with the company that provides it with water coolers for its employee lounge. Negotiating the representations and warranties is in many ways an exercise in risk allocation, and the buyer will typically resist many of the seller’s requested qualifiers and insist on the seller bearing as much of the risk as possible. For example, while the seller would in all cases prefer to limit a representation it makes regarding its compliance with its contractual obligations so that it only makes representations as to “material breaches” of “material agreements,” the buyer has every incentive to want the seller to make a “flat” representation in which the seller represents that it is not in breach of any agreement to which it is a party. That is, the buyer wants the seller to assume the full risk of any violations instead of forcing the buyer to prove materiality. In addition to the broader issue of risk allocation that is reflected in the tension over the negotiation of materiality and knowledge qualifiers, significant negotiation can take place at the more granular level of what forms of knowledge and materiality qualifiers to use with respect to discrete representations. For instance, the parties may negotiate whether to use the phrase “to the knowledge of seller,” as compared with “to the best knowledge of seller,” or even “to seller’s best knowledge after due inquiry.” A related question is whose knowledge counts — while some agreements are silent on how to determine whether the seller should be deemed to have 56
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had knowledge of something, others specify that the actual knowledge of enumerated senior officers or employees of the seller must be used to determine whether the seller is deemed to have had knowledge in a given case or provide that knowledge of any employee is sufficient. Similarly, the definition of materiality is often sharply negotiated in various contexts throughout the agreement. Definitions of “material contracts” are often based upon a minimum dollar value. Another example is the definition of “material adverse change,” which is often critical to determining the import of various representations and warranties, including the standard representation that there has not occurred a material adverse change since the balance sheet date. A typical negotiation point in this definition is whether a material adverse change will be deemed to have occurred if the material change relates to the seller’s prospects, as opposed to its existing business. Forward-looking language like “prospects” injects an element of subjectivity into the test for harm from a breach of a representation. Sellers might also seek to negotiate a set of events that are not deemed material adverse effects, such as changes in the conditions in the economy or the industry or failures to meet internal projections. In each of these cases, the precise word or combination of words used may impact the eventual liability of the parties. • Relationship of representations and warranties to indemnification In most acquisition agreements, the representations and warranties are closely connected to the indemnification provisions, and the two sections must be negotiated in careful conjunction with one another. For instance, the indemnification provisions may apply differently to different representations. Different treatment may include different survival periods and different caps on liability. A brief overview of indemnification follows in this chapter, while a more in-depth discussion of this topic is set out in Chapter 7. • Double materiality The buyer should be wary of the effect of “materiality” qualifiers throughout the definitive acquisition agreement, which may create a “double materiality” standard. For example, if one of the conditions to the buyer’s obligation to close provides that the seller’s representations and warranties must be true and correct “in all material respects” as of the closing, the test with respect to any representations that are qualified by materiality within the body of the representation itself, such as a representation that there are no material liens on any of the buyer’s assets, would have to breach two materiality thresholds for the condition to fail. To avoid this issue, which 57
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creates an ambiguity, the definitive acquisition agreement is often drafted to make clear that the materiality qualifier on the closing condition does not apply to any representation that as written is already so qualified. Similar double-materiality issues can arise in connection with the indemnification provisions to the extent the Seller seeks to limit certain of its indemnification obligations to material breaches. • Public company sellers In the public company context, the seller’s representations may be more limited and will likely incorporate its filings with the Securities and Exchange Commission. Typical Buyer Representations The definitive acquisition agreement will also contain the buyer’s representations to the seller, however, except for deals involving a “merger-ofequals,” the buyer’s representations and warranties will typically be less detailed than those given by the seller. If the buyer is issuing stock as consideration in the acquisition, the buyer’s representations will be more complete regarding its business than if cash is the consideration. Practical Tip: Effect of Mergers of Equals and Stock Transactions on Diligence and Representations In a true merger-of-equals, the distinctions between buyer and seller are less relevant — e.g., in a merger-of-equals, each entity would likely be conducting the same basic level of diligence and be equally concerned about receiving comprehensive representations and warranties from the other party. In a stock transaction, the seller will also typically do some diligence on the buyer, with the level of diligence and scope of representations from the buyer growing as the percentage of the combined company represented by the transaction grows in significance. Typically, these representations will be limited to the basics, such as those ensuring that the buyer has all necessary corporate and legal approvals necessary to consummate the transaction, can do so without breaching its existing agreements, is not a party to litigation that would impact the transaction, and has not hired a broker in connection with the transaction. 58
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Depending upon the deal and the nature of the consideration being paid, the buyer also may be asked to make representations regarding its financial ability to complete the deal. If the buyer is issuing stock as part of the consideration, the definitive acquisition agreement should contain additional representations regarding the due authorization and issuance of the securities. In some stock transactions, the seller also may ask the buyer to make additional representations relating to its business, based on the notion that the acquisition will in effect constitute an ongoing investment by the seller’s stockholders in the buyer. The scope of the representations depends on the percentage of the combined company represented by the stock issued in the transaction.
Interim and Post-Closing Covenants In contrast to representations and warranties that essentially serve as a “snap-shot” of the seller and its business at a particular moment in time, covenants govern the relationship of the buyer and seller over a certain period of time both before and after the closing of the transaction. The majority of the key covenants cover the period between signing and closing, but some covenants continue in effect post-closing. Depending on the nature of the transaction, some covenants will be made by the buyer, some by the seller, and some by both parties. They take the form of agreements by a party either to do something or to refrain from doing something. Depending upon the nature of the covenant, the parties may spend time negotiating the extent of their obligation to perform certain undertakings — for example, the distinction between a party using its “best efforts” vs. its “reasonable commercial efforts” as compared to a flat obligation to do something. Interim covenants Interim — or pre-closing — covenants are undertakings by the buyer or seller to take or not take certain specified actions between the signing of the definitive acquisition agreement and the closing. Their principal function is to preserve the status quo such that the parties can be assured that the business the buyer is acquiring at closing will be substantially the same as the business the buyer agreed to acquire upon signing the definitive acquisition agreement. For instance, the seller will typically covenant not to sell a material amount of its assets. Another important purpose of interim covenants is to ensure that the parties will take the necessary steps to cause the transaction to be consummated, such as using their best efforts to obtain all required regulatory consents necessary to close. Of course, 59
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interim covenants are only necessary to the extent there is a delay between signing and closing, which is the case in most significant M&A transactions. The reasons for a delayed closing are discussed further below in the discussion of conditions. Although they will vary from deal to deal, typical interim covenants relate to the following types of issues: • Agreement by the seller to conduct business in the ordinary course, e.g., no capital expenditures in excess of a specified amount, no material pay increases or bonuses, no dividends, no new hires, no charter amendments or other transactions that would fundamentally alter the nature of the business to be purchased, no sale of a material amount of assets, etc. • Seller providing the buyer with ongoing access to the seller’s records, facilities and employees and the buyer’s ability to conduct due diligence • Agreement by parties to seek all necessary third party consents • Confidentiality obligations of the parties, as well as agreements relating to public announcements of the deal • Agreement by both parties to make Hart-Scott-Rodino anti-trust filings (to the extent applicable) • Agreement of the seller to deliver interim financial statements or copies of regulatory filings • Agreement of the seller to notify the buyer of certain events, such as the seller becoming involved in new litigation • Agreement of the seller to a no-shop or non-solicitation provision that prohibits the seller from shopping the deal once it has been announced Post-closing Covenants Whereas pre-closing covenants relate solely to the period between signing and closing, post-closing covenants are undertakings by a party that are to be performed after the closing has occurred. For example: • Agreement of the seller (and/or its former executives) not to compete with the acquired business • Allocation of deal expenses 60
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• Tax treatment and reporting • Licenses and related provisions concerning technology and corporate names • Continuing access to information and preservation of books and records • Registration rights where consideration includes unregistered securities (such provisions may also be contained in an ancillary agreement) • Continuing or transition support services, particularly in the context of an asset sale or the sale of a division or subsidiary • Covenant of the buyer to provide indemnification and/or directors and officers insurance to outgoing directors and officers
Employee Matters Most definitive acquisition agreements contain provisions that address the treatment of employees in connection with the transaction, including with respect to employee benefits issues. For instance, in a reverse triangular merger in which the seller will remain in existence as the surviving corporation after the merger, the agreement may require the buyer to continue the employee benefit plans in place prior to closing at the same levels for some period of time post-closing. In asset acquisitions where the buyer acquires all or substantially all of the assets of the seller, the employee-related provisions are often especially important given that the employees’ employment with the seller will terminate as of the closing and the parties may need to account for the hiring of the employees by the buyer. The seller may want assurances that the buyer will extend offers of employment to certain employees on certain terms and conditions, and the buyer may want assurances that the seller will assist the buyer in hiring employees that the buyer considers necessary to the ongoing business. Regardless of the form of transaction, either or both parties will often make the execution by the buyer of employment or consulting agreements with key members of the seller’s management team a condition to the parties’ respective obligations to close the transaction. The negotiation of these arrangements can be difficult and time-consuming, particularly around the issues of equity, change of control provisions, severance terms, and the like. In addition, the specifics of noncompete provisions requested by the buyer can be a sticking point in negotiations. 61
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Deal Protection Devices A critical aspect of many M&A transactions, particularly deals involving public company sellers, are the so-called “deal protection ” devices. Deal protection devices are essentially anti-takeover provisions imposed by the buyer to reduce the odds that a third party can come in and outbid the buyer after the deal has been announced but before the stockholders of the seller have approved the transaction and the deal has closed. There are many types of deal protection devices, including the following typical approaches: • No-shop/no-talk clauses seek to limit the ability of the seller to solicit, negotiate with, and in some cases provide information to, competing bidders once the definitive acquisition agreement has been executed. • Termination — or “break-up” — fees can be used to compensate the buyer with cash in the event the definitive agreement is terminated prior to closing for reasons such as the failure of the seller’s stockholders to approve the deal because the seller’s board receives and recommends a superior bid. • Voting Agreements obligate certain stockholders of the seller to vote their shares in favor of the consummation of the deal with the buyer, making it more likely that stockholder approval for the buyer’s deal will be obtained. • Commitment to call a stockholder meeting requires the seller’s board to submit the buyer’s deal to the seller’s stockholders, even if the seller’s board withdraws its recommendation to vote in favor of the deal. • Stock options give the buyer the right to acquire a large percentage of the seller’s stock — typically no more than 19.9% — under certain circumstances related to the emergence of a competitive bidder for the seller. A key element of the no-shop/no-talk provision mentioned above is the “fiduciary-out” provision, which serves to mitigate the impact of the no shop covenant by giving the seller’s board some flexibility in responding to and pursuing competing proposals, if it concludes that its fiduciary obligations require it to do so. There are many variants of fiduciary-out clauses providing for more or less discretion and flexibility for the seller’s board depending on their formulation: The fiduciary out might permit a seller’s 62
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board to break a “no-talk” restriction by providing information in response to unsolicited proposals. Another provision will typically allow the board to withdraw its recommendation to its stockholders under some conditions, including the determination that fiduciary duties are at issue. In some cases, a fiduciary-out termination right is drafted to permit the seller’s board to terminate the definitive agreement and walk away from the deal entirely. Even if the target board has a fiduciary-out clause, however, deal protection devices can form a substantial impediment to the efforts of a third party bidder to acquire the seller after it has announced a deal with the buyer. For this reason, courts have limited the ability of intended buyers and sellers to use these devices — i.e., they may not be “preclusive. It is important to note, that the appropriateness of protection devices in any given case must be considered based on the totality of the terms and the circumstances surrounding the transaction; there are many variables that can affect how a court in retrospect may view a given transaction, and many of them depend on the specific facts underlying the deal. Due to both the importance of deal protection devices to a given transaction and the complexity of the applicable law, both the buyer and the seller should very carefully consider their alternatives before agreeing to any package of deal-protection devices. Chapter 8 looks at deal-protection devices in more detail.
Conditions to Closing A closing condition is a condition that must be satisfied in order for one or both parties to be obligated to close the deal. The condition might take the form of either an affirmative action by either party to the agreement or by a third party, or the absence of an action or event. Failure or inability to satisfy a condition to a party’s obligation to close will give that party the right to terminate the transaction without any further obligation or liability. Most agreements contain separate conditions to each party’s obligation to close, as well as common conditions to both parties’ obligations. For instance, under almost all circumstances, the buyer will have as a condition to its obligation to close some variant of the conditions that the seller’s representations and warranties must be true and correct at closing. Alternatively, conditions to both parties’ obligation to close will likely include the requirement that there not be any court order enjoining the parties’ consummation of the deal. 63
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Of course, closing conditions are only necessary to the extent there is a gap in time between signing the definitive agreement and closing the deal. There are numerous reasons why transactions are effected through delayed closings, but they principally fall into three broad categories: the need for regulatory approvals, the need for stockholder approvals, and pragmatic deal considerations. • Regulatory: There are many possible regulatory causes for delayed closings. For example: • Depending upon the size of the transaction and the size of the parties involved, the parties may need to make antitrust notice filings under the Hart-Scott-Rodino Act, which typically requires a minimum 30-day waiting period before the transaction can be consummated (assuming no early termination). In some cases, the notice filing might trigger a more involved antitrust review, which could further delay the transaction. • In a stock-for-stock transaction that involves the issuance of registered shares by the buyer, the buyer will be required to file a registration statement with the SEC and will need to obtain SEC approval before the shares can be issued. • Stockholder approval: Where stockholder consent is required, one or both parties may need to convene a meeting of stockholders in order to approve the transaction. This is most typical where there are numerous stockholders and obtaining a written consent is not practical — or is not permitted by the applicable charter documents or state law. Where a meeting of stockholders is required, it cannot take place until sometime after the definitive agreement has been signed. • Deal considerations: Often business and legal issues related to the deal are the principal reasons behind a delayed closing. For example: • Buyer must complete aspects of its diligence investigation of the seller that it was not able to complete before the parties signed up the definitive agreement (but note that in most cases the buyer and seller are both well-advised not to enter into the definitive agreement until buyer has substantially completed its diligence review); • Parties must obtain certain contractual consents, such as a consent of the seller’s primary bank, landlord, principal customer, etc.; or • Buyer must obtain financing to fund the deal consideration. 64
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In transactions where a delayed closing is necessary, both parties must ensure first and foremost that the conditions that created the need for the delayed closing are satisfied before the closing can take place — for instance, if a Hart-Scott-Rodino notice filing is required, as further discussed in Chapter 11, the deal cannot close until the notice period has expired or been terminated, or Hart-Scott-Rodino approval has otherwise been obtained. Once a delayed closing is mandated, however, the parties also must ensure that the passage of time does not alter the deal that they agreed to when they signed the agreement. This latter necessity is of primary importance to the buyer, which will want to know that the seller’s business is substantially the same when they close the transaction as it was when they signed up the deal sometime earlier. As with most M&A deal terms, the nature of the closing conditions in a particular deal will by necessity depend upon both the structure of the transaction and the specific facts underlying that deal. For instance, contractual consents are less likely to be necessary in deals structured as reverse triangular mergers, so it is in turn less likely that obtaining contractual consents will be a material closing condition of either party in a reverse triangular merger. Similarly, issues unearthed in the due diligence process will often impact the drafting of the closing conditions in a particular deal. With that said, the following are typical conditions that appear regularly in a variety of different transactions: • performance or satisfaction of pre-closing covenants reflected in the definitive agreement; • continued truthfulness of representations and warranties; • satisfaction of regulatory requirements, such as HSR clearance; • there having been no law, regulation or court order seeking to enjoin the transaction; • obtaining governmental and third party contractual consents; • obtaining stockholder approval(s); • no material adverse change with respect to the seller or its business; • entering into any required ancillary agreements (e.g., escrow agreement, registration rights agreement, voting agreement, employment agreements and noncompetes, etc.); • delivery of requisite legal opinions; • delivery of other closing documents and certificates. 65
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It is also important to recognize the relationship between the closing conditions and the interim covenants discussed above. Whereas covenants of the seller contractually prohibit it from taking certain actions prior to closing — or require it to take certain actions — in order to protect the buyer’s interest in the transaction between the signing and closing, a closing condition with respect to the seller’s compliance with such covenants will enable the buyer to walk away from the deal if in fact the seller breaches a covenant. For instance, if the seller were to breach a covenant prohibiting it from selling a material portion of its assets before closing by selling an important product line that the buyer expected to acquire in the transaction, the buyer not only would have a possible claim against the seller for breach of contract (and likely indemnification as well), but also would have the right to terminate the agreement and walk away from the deal because it was no longer getting what it had bargained for. In some deals, the buyer might also be entitled to a break-up fee due to such breach and termination. Two types of conditions are worth some further discussion: the conditions that representations and warranties be true and correct; and the material adverse change condition. Each typically engender negotiation. The condition that the seller’s or buyer’s representations and warranties be true and correct is subject to negotiation over two significant issues: how significant a breach might result in failure of the condition, and when is the truth of representations measured? Representations must generally be true subject to some materiality standard. Thus representations must be true “in all material respects” or “except where inaccuracies in the aggregate do not result in a material adverse effect”. The difference between these standards can be significant. In addition, often the representations must be true both at signing and closing; while in some transactions the representations must simply be true at closing, or less frequently at signing (a so called “hell or high water” deal). These terms may affect the parties’ obligations to close the deal after a business setback has occurred. The seller’s representations can be considered many separate conditions for the buyer, all of which must typically be true or not materially false in any way that harms the seller’s business in order for buyer to be obligated to close. The “no material adverse change” condition is another condition on which buyer might argue no obligation to close on the occurrence of a negative event in seller’s business subsequent to the signing of the agreement. In some agreements buyers negotiate for a condition that there be no material adverse effect on seller’s prospects, a forward-looking condition that is difficult to measure. Sellers often negotiate carve outs to the 66
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definition of what is a material adverse effect, like effects arising from economic or industry conditions, effects arising from the agreement, such as loss of employees, customers or suppliers, or failures to meet projections or “street” estimates. In each case the buyer will seek to limit such carve outs, if accepted at all, by requiring that the effects not disproportionately affect the seller, that the effects be directly related to the agreement or that the underlying causes of a failure to meet a projection not be carved out of the definition. The importance of these two types of conditions, the truth of representations and the material adverse change condition, is that changes in the seller’s business between signing and closing will often trigger these conditions. Accordingly, these are the conditions most likely to be asserted if a buyer chooses to walk away from a transaction. The facts and circumstances surrounding the transaction and the parties’ intent may become material to the resolution of any dispute.
Indemnification Indemnification provides a post-closing remedy for losses sustained by a party after the closing of the transaction as a result of breaches of the parties’ representations, warranties and covenants. The indemnification provisions are crucial to understanding the real risk allocation between the buyer and seller under the agreement. We discuss indemnification at length in Chapter 7.
Termination In transactions with a delayed closing, the definitive agreement will contain termination provisions that set forth the terms by which either or both of the parties can terminate the agreement and walk away from the deal before closing. The termination section is closely related to both the covenants and the closing conditions and must be considered together with those provisions. For instance, a breach by a party of a covenant will typically allow the non-breaching party to terminate the agreement and walk away from the deal. An example of this would be when the buyer terminates the agreement because the seller failed to satisfy its covenant to obtain an important customer consent, the receipt of which was a condition to the buyer’s obligation to close. Note that, from the buyer’s perspective, a welldrafted agreement would also give the buyer the right to waive the breach and go through with the closing, while still preserving its right to recover from the seller for the breach. 67
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Although they differ from transaction to transaction based on the nature of the covenants, conditions, and other relevant deal points, the following are examples of occurrences that will typically give rise to the right of one or both parties to terminate the agreement: • if both parties agree to terminate; • if the transaction has not closed by a certain date (a “drop dead” date)(provided that a party that was responsible for the transaction not closing in time due to willful failure to perform a required covenant should not be entitled to terminate under such provision); • in the event of the inaccuracy of representations and warranties or a breach of covenants in a manner resulting in a failure of the condition, typically after some cure period; • if required stockholder approval has not been obtained; • if closing the transaction would violate any nonappealable final order, decree or judgment, or any law; or • by the buyer, if the seller has experienced a material adverse change in its business. As is the case with the relationship between the closing conditions and the representations and warranties, the parties must be careful to consider the possible impact of materiality qualifiers throughout the representations and warranties and covenants on the parties’ potential termination rights. For example, the buyer will likely resist a formulation that results in the seller having the benefit of a double-materiality standard, such as when a representation that is by its terms qualified by a materiality standard must also be materially breached in order for the buyer’s termination right to apply.
Miscellaneous Provisions As with the vast majority of corporate transactional documents, the definitive acquisition agreement will include a number of provisions under the heading of a “miscellaneous” section, such as provisions related to governing law, notices, methods of dispute resolution, successors and assigns, severability, payment of expenses, amendment and the like. Although many of the so-called miscellaneous provisions approach “legal boilerplate” and are not of real interest to the parties, some — such as provisions addressing governing law, dispute resolution, and expenses — can become of critical importance in the event the transaction does not close or otherwise results in a dispute between the parties. 68
Chapter 7 Indemnification & Contribution Chapter 6 discussed how the definitive acquisition agreement will include representations, warranties and covenants of the parties that serve as conditions to the parties’ respective obligations to close the transactions contemplated in the agreement and as risk allocation devices between the buyer and the seller. Generally, the indemnification obligations of the parties in the definitive agreement provide the mechanism through which the parties can recover damages in the event of a breach of a representation, warranty or covenant.
Why Indemnification? If a post-closing event occurs or a pre-closing fact or circumstance is discovered that causes damage to the seller, its business or the buyer (by virtue of its post-closing ownership of the seller or its business), the buyer will bear the risk of loss associated with this event, fact or circumstance unless it has a contractual right of indemnification or some other cause of action. To understand the need for indemnification rights it is helpful to know the alternative avenues of recovery. Breach of contract claims may be available to the buyer where the seller fails to comply with its obligations under the definitive agreement. One major drawback to breach of contract claims is the fact that parties to litigation generally bear their own legal fees and expenses. Thus, even if the buyer is successful on the merits of a breach of contract claim, it generally will not be “made whole� in light of the legal fees and expenses incurred to recover damages from the seller. Tort claims such as fraud may also be available to the buyer in certain circumstances. Major drawbacks to tort claims include the fact that proving the elements of a tort claim is often difficult and that the time involved in successfully concluding tort litigation is often considerable. Further, as with breach of contract claims, a buyer who brings a tort action generally will not be able to recover its legal fees and expenses incurred with respect to the litigation. To avoid the drawbacks associated with breach of contract and tort claims, the buyer generally relies on rights of indemnification in the definitive acquisition agreement. In most acquisition transactions other than acquisitions of public companies, the seller and/or its stockholders will provide at least some level of post-closing indemnification protection to the buyer. 69
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What Is Indemnification? A typical indemnification provision will require one party to “defend, indemnify and hold harmless” the other party from all “damages” that result from a breach of the agreement or some other event or circumstance. In other words, the indemnifying party will pay or reimburse the indemnified party for any damages that its suffers with respect to matters included within the scope of the indemnification provision. The definition of “damages” will generally include legal fees and expenses associated with pursuing the indemnification claim or defending the indemnified party against a thirdparty lawsuit. This is done to make the indemnified party whole from the losses it suffers. The indemnification obligations in the definitive agreement are contractual rights. As such they are defined and limited by the provisions of the definitive agreement. Indemnification rights are typically subject to numerous qualifications and limitations which are discussed below. Bear in mind that a culpable act of a party may not be a prerequisite for recovery under an indemnification provision. The parties to a definitive acquisition agreement are free to agree to indemnification for any event or circumstance, regardless of whether it is the subject of a representation, warranty or covenant. Thus indemnification is a highly effective means to allocate risk between the buyer and seller, without regard to the malfeasance of a party.
Acquisitions of Publicly-Traded Targets When the buyer acquires a publicly-traded target, it will rarely be able to negotiate for post-closing indemnification from the selling stockholders. The market’s resistance to post-closing indemnification rights in the public context and the difficulties involved with seeking damages from a large and disparate group of stockholders generally preclude the buyer from raising the issue with the seller. Nevertheless it may be possible for the buyer to negotiate for post-closing indemnification rights under certain circumstances. For instance, in a “going private” transaction where the seller’s stock is not widely held and a small group of controlling stockholders hold a significant majority of the outstanding shares, the buyer may be able to successfully negotiate indemnification rights. The logistics of dealing with contribution rights from selling stockholders may be manageable in this context. The question will ultimately be decided by the negotiating leverage of the buyer and the seller. 70
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Types of Indemnified Matters There are several types of matters for which indemnification rights are typically provided in a definitive agreement. Often the limitations and qualifications on the indemnification rights will vary depending on the type of matter in question. Representations and Warranties The representations and warranties in the definitive agreement serve both as conditions to the parties’ obligations and as a method for allocating risk among the parties. As discussed earlier, in addition to the parties’ other due diligence efforts, they will look to each other to reaffirm their understandings regarding the buyer, the seller and its business by making representations and warranties in the definitive agreement. If it turns out that any of the representations and warranties are not true as of the signing of the definitive agreement and/or as of the closing, the parties will generally have a right to walk away from the transaction. However, most agreements provide that immaterial breaches do not give rise to a walk away right, but do allow the aggrieved party to make an indemnification claim after the closing to the extent damages are suffered. If the parties close the acquisition and thereafter it is discovered that a representation or warranty was breached, and as a result of that breach the other party suffered damages, then the aggrieved party will generally be able to bring an indemnification claim. A typical definitive acquisition agreement will require the seller to make many representations and warranties regarding itself, its business and its legal ability to consummate the contemplated transaction. Particular attention may be paid to specialty areas such as tax, real property, environmental, intellectual property, employee benefits and labor matters. One area of negotiation is the time period after closing for which indemnification is available, or the “survival period.” Standard representations might survive for a period such as six months to three years, depending on the industry and specifics facts of the parties. Specialty representations such as tax, environmental, benefits, etc. might survive for longer periods, such as two to six years, or for the period of the statute of limitations for the particular type of claim. The buyer’s representations and warranties in the definitive agreement will generally be more limited. The seller will want to know the buyer has the legal and financial ability to close the contemplated transaction. As 71
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discussed, much of the legal negotiation with respect to the definitive agreement will center around the scope of the seller’s representations and warranties. Covenants and Agreements Besides the principal obligation of the parties to consummate the transactions contemplated by the definitive agreement, there will be several other covenants (or undertakings) among the parties in the definitive agreement. These agreements will generally be organized into pre-closing covenants and post-closing covenants. Pre-closing covenants will focus on the actions necessary to close the transaction, such as cooperation with the buyer’s due diligence efforts, coordination with respect to required third party consents, and perhaps deal protections for the buyer such as “no shops” and “break-up fees” for the period between signing and closing. Post-closing covenants will generally include agreements between the parties regarding information rights and the transition of benefit plans and employees to the buyer. The buyer will frequently obtain restrictive covenants as well such as non-competition, non-solicitation and non-disclosure provisions. Pre-Closing/Post-Closing Actions The buyer will often try to obtain indemnification for any action that was taken by or with respect to the seller and its business prior to the closing. This request is usually resisted by the seller as it in effect expands the scope of liability that was negotiated in the representations and warranties. If the seller is unsuccessful in resisting this demand, it will sometimes argue for a reciprocal right, i.e., indemnification for all actions taken by or with respect to the seller and its business after the closing. The buyer will generally resist this request as well as it can be used by a seller to circumvent the negotiated risk allocations in the representations and warranties. Specific Areas of Concern In addition to indemnification for representations, warranties and covenants, the buyer will generally require separate indemnification rights for certain areas of concern, regardless of whether a representation or warranty was breached. For instance, the buyer will almost always have indemnification rights with respect to the disclosed tax liabilities of the seller prior to the closing. The buyer also frequently obtains separate indemnification rights with respect to disclosed environmental and employee benefit plan liabilities of the seller prior to the closing. If during 72
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due diligence the buyer identifies any specific areas of concern, such as a threatened or existing litigation matter, the buyer will usually negotiate for a separate indemnification for such item as well. The buyer will also often seek indemnification for transaction expenses and dissenters’ rights claims. The buyer will frequently require that any negotiated limitations on indemnification, discussed below, will not apply to these special areas of concern.
Definitional Limitations on Indemnification The buyer and the seller generally negotiate several limitations and qualifications regarding their respective indemnification obligations. These limitations and qualifications are usually discussed with respect to the seller’s indemnification obligations, since the majority of the representations, warranties and post-closing covenants are obligations of the seller. Scope of the Indemnified Parties and Indemnifying Parties Perhaps the first limitation to negotiate is who will give indemnification rights under the definitive agreement. Usually all of the parties to the definitive agreement grant indemnification rights with respect to their respective representations, warranties and covenants. But if one party is uncomfortable with the credit risk associated with another party, it may negotiate for an indemnification right from a more credit worthy affiliate, such as the parent of the party to the agreement. Sometimes a minority stockholder may be able to negotiate for limited or no indemnification obligations if the buyer is satisfied with the credit risk of the majority, controlling stockholder. Another threshold limitation to negotiate is who will be a beneficiary of the indemnification rights under the definitive agreement. Usually all of the parties to the definitive agreement will be beneficiaries of the indemnification obligations of the other parties. But it is not uncommon for other, related parties to also be entitled to indemnification. The parents, subsidiaries, officers, directors and employees of the parties to the definitive agreement are frequently included within the scope of the indemnified parties. Sometimes the lawyers, accountants and lenders of the parties are also included. Some provisions provide that any affiliate of a party is included within the scope of the indemnified parties. Scope of the Indemnified Breaches Post-closing breaches of representations, warranties and covenants will be included within the scope of indemnified matters in most definitive 73
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agreements other than an acquisition of a publicly-traded entity. The treatment of pre-closing breaches is less uniform. The seller frequently is able to exclude breaches which are disclosed prior to signing and sometimes will be able to exclude breaches which occur after signing but before closing, so long as the breach does not rise to the level where a closing condition is unfulfilled. This type of arrangement sometimes calls for a hard decision by the buyer: either close the transaction and waive its ability to seek damages for the disclosed breach or walk away from the transaction. See the discussion below regarding prior knowledge or “anti-sandbagging.� Scope of Damages The scope of the damages recoverable for indemnified matters is a critical provision to negotiate. The seller will seek to put limitations on the types of damages available, and will frequently seek to negotiate a limitation that prohibits recovery of any type of damages other than actual damages suffered. The buyer, on the other hand, typically counters that if it is able to demonstrate to a judge that it is entitled to other types of damages, such as consequential, lost profits and punitive damages, it should be able to recover these damages as well. Many buyers will negotiate hard for consequential damages (such as lost profits) that are reasonably foreseeable, as these are frequently the only damages suffered due to breaches of representations and warranties related to the seller’s customers and material contracts. The parties will also negotiate the definition of damages and may exclude damages based on diminution in value, damages calculated as a multiple of earnings and punitive damages from the definitive agreement.
Monetary Limitations on Indemnification It is common for the seller to seek to impose monetary thresholds and limitations on its indemnification liabilities. Sometimes the buyer will also obtain the benefit of the negotiated limitations. Baskets, Deductibles and Mini-Baskets Baskets and deductibles are minimum thresholds that must be exceeded by the aggregate amount of all losses claimed by an indemnified party before it is entitled to indemnification. If the provision is expressed as a basket, then once the threshold has been met, the party entitled to indemnification will be able to recover all of its losses related to the indemnified matters, including the losses below the threshold. If the provision is 74
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expressed as a deductible, then the indemnified party will only be able to recover its losses in excess of the threshold. Baskets and deductibles have the effect of shifting some initial portion of the risk of loss from the indemnifying party to the indemnified party. A related concept is the mini-basket. With mini-baskets, if the damages claimed by an indemnified party do not exceed the negotiated threshold, then the indemnifying party does not have to indemnify for the loss, and the amount of the loss is disregarded for subsequent determinations of whether the basket or deductible has been reached. The theory behind mini-baskets is that there is some threshold level of losses that is de mininis, and that an indemnifying party should not be forced to investigate such claims because the time and costs greatly outweigh such “nuisance” claims. Most buyers resist mini-baskets and argue that their purpose is already served by the materiality thresholds negotiated in the representations and warranties. Caps Caps are maximum limitations on the obligations of an indemnifying party. If an indemnified party’s losses exceed the negotiated cap, then the indemnified party will only be able to recover its losses up to the cap (and subject to any baskets or deductibles). Carve-Outs It is common for buyers to negotiate to “carve-out” from the baskets, caps and other limitations certain types of indemnification obligations. However, indemnified parties generally do not want to create a situation where an indemnifying party has an economic incentive to breach a provision of the definitive agreement because its indemnification exposure is less than its anticipated economic gain by breaching the agreement. This is particularly important in the context of obligations like non-competition covenants. Where the parties end up is almost always impacted by the individual facts of the transaction, as well as the parties’ relative negotiating power. Materiality Qualifiers As noted, certain representations and warranties will have materiality and knowledge limitations within their text. These limitations may also affect whether a representation or warranty has been breached for purposes of indemnification obligations. The buyer may argue, however, that materiality and knowledge limitations should be disregarded for purposes of 75
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determining whether a breach giving rise to indemnification has occurred on the theory that the presence of a basket coupled with these limitations creates a “double materiality” limitation and is “unfair” to the indemnified party. If these limitations apply to the determination of the indemnification right, they nevertheless typically do not act as a limitation on damages once the breach has been established.
Other Limitations on Indemnification In addition to definitional and monetary thresholds and limitations, many definitive agreements contain one or more of the following limitations. Prior Knowledge (Anti-Sandbag) Anti-sandbag provisions provide that an indemnified party is not entitled to indemnification for any matters that it knew about prior to closing. The seller frequently negotiates for these provisions arguing that the contract should provide an incentive for the buyer to raise any such matters prior to closing so that the parties can negotiate a resolution of the issue before the deal is closed. Buyers object to these provisions as unnecessary to compel the buyer to discuss a problem with the seller — which naturally happens during the due diligence process — and because the real purpose of the provision seems to be to create a procedural hurdle for making indemnification claims. The buyer argues that the seller will always claim the buyer had prior knowledge of the matter if an indemnification claim is made, and that the buyer will be forced to spend time and money refuting this argument and will be forced to prove a negative (i.e., lack of knowledge). Prior Resolution (Purchase Price Adjustment) Purchase price adjustment provisions are intended to ensure that an indemnified party does not recover twice for the same indemnified matter. The problem arises where the matter in question is the subject of a balance sheet reserve and/or purchase price adjustment and an indemnification covenant. For instance, if there is a $100,000 reserve for doubtful accounts on the closing balance sheet which reduces the purchase price and a representation in the definitive agreement that the accounts receivable will be collected, and if it turns out that $100,000 of receivables are not collectible, the buyer arguably should not be entitled to any indemnification for losses because the purchase price delivered at the closing already 76
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compensated the buyer for this loss via the reserve. To allow the claim would effectively be a “double dip” in the seller’s eyes. Insurance Proceeds Another common provision that is requested by the seller and resisted by the buyer is the concept that the losses recoverable by an indemnified party should be reduced by the amount of any insurance proceeds actually received with respect to the indemnified matter. As with the purchase price adjustment, the indemnifying party’s concern is that the buyer should not recover more than the losses suffered on account of an indemnified matter. The buyer will typically agree to such provisions provided that they take into account any increases in the cost of insurance caused by the matter, such as premium increases or drop of coverage. Tax Benefits The seller may negotiate for a provision that provides that the losses recoverable by an indemnified party should be reduced by the amount of any tax benefits actually received or recognized with respect to the indemnified matter. As with the purchase price adjustment and the insurance proceeds provisions, the indemnifying party’s concern is that the buyer should not recover more than the losses suffered on account of an indemnified matter. However, measuring the tax benefits actually received on account of an indemnified matter can be quite difficult, at best.
Sole and Exclusive Remedy Many definitive acquisition agreements provide that indemnification under the escrow is the sole and exclusive remedy of a party with respect to an indemnified matter unless there is fraud, in which case the limitations are generally not applicable under the terms of the agreement.
Indemnification Procedures; Dispute Resolution In addition to defining the types of matters for which indemnification is available and the limitations on the damages recoverable through indemnification, definitive acquisition agreements typically provide the procedural mechanics for bringing and resolving an indemnification claim. 77
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Disputes Between the Parties Many definitive acquisition agreements distinguish between third-party claims and disputes between the parties to a contract when negotiating the indemnification procedures. If the dispute does not involve a third-party claim, then the ground rules established at the time of the signing of the definitive agreement regarding how the parties will resolve their disputes can be used to speed the negotiation and dispute resolution procedures in the agreement. Required periods of negotiation, mediation, arbitration and traditional litigation are all tools that are available to the parties to the agreement. Third Party Disputes Resolving indemnification claims regarding third party disputes are more problematic. Each of the parties will want to control the dispute resolution process with the third-party and use its own lawyers and other professionals. Each of the parties will want to have a say in the resolution of the dispute, particularly if any fault is admitted or if any precedent is established. The indemnifying party will many times negotiate to control the dispute and its resolution, subject to the indemnified party’s ability to participate at its own expense and to veto any settlement requiring it to admit fault or pay damages. Special Matters Certain substantive areas such as tax and compliance with environmental laws will frequently have additional procedures that govern indemnification claims. These tend to be fairly technical and are usually negotiated directly by the relevant experts.
Hold-Backs of the Purchase Price To secure the indemnification obligations of the seller and/or its stockholders under a definitive agreement, buyers frequently require a hold-back from the purchase price. The form of the hold-back may be an escrow of a portion of the purchase price, a contractual deferral of the obligation to pay a portion of the purchase price until some date in the future, a promissory note for a portion of the purchase price, or some combination of the forgoing. In order to secure the seller’s performance of its indemnification obligations, the hold-back usually will be coupled with a right of set-off that will allow the buyer to forgo payment of the deferred portion of the purchase price in the amount of the damages suffered. Sellers often resist the buyer’s 78
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efforts to obtain the right of set off, although hold backs are quite common. Another key question is whether the escrow is the exclusive remedy for indemnification. Sellers will often negotiate for the escrow to be the sole and exclusive remedy, while buyers will resist such term, which is effectively a cap.
Contribution Agreements Contribution agreements are entered into by parties who share joint and several liability for an obligation. When there are two or more sellers in a transaction, they will frequently enter into a contribution agreement to clarify how they will allocate responsibility for indemnification claims among the sellers for any liabilities that arise post-closing under the definitive agreement. Usually sellers will bear responsibility pro rata based upon their respective ownership interests with respect to representations, warranties and covenants that are made on a joint and several basis, while imposing all of the liability on the applicable seller with respect to representations, warranties and covenants that are made on an individual basis. The contribution rights of the sellers allow them to go against the assets of the other sellers to the extent that they are forced to pay the buyer for an amount under the definitive acquisition agreement in excess of their allocated responsibility under the contribution agreement. In order to secure the contribution obligations of the sellers, contribution agreements frequently require a portion of the deal proceeds be set aside in an escrow. Limitations on the parties’ indemnification rights and obligations on both the upside and the downside are typically one of the most heavily negotiated aspects of the indemnification section of the definitive acquisition agreement, with the parties often constructing complex and elaborate provisions in order to establish an overall risk allocation scheme that is satisfactory to them.
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Chapter 8 Fiduciary Duties of Board of Directors A board of directors considering whether to commit the corporation to an M&A transaction owes fiduciary duties, including duties of care and loyalty, to the corporation and its stockholders. It is essential, therefore, that directors considering M&A transactions understand and engage in strong corporate governance practices and ground their decision-making in a good-faith, disinterested, well-informed and well-documented process. In M&A transactions involving “interested” directors, directors must engage in a process to assure that the duty of loyalty is satisfied. In the event of the sale of control of a corporation or transactions with deal-protection devices, directors may have heightened fiduciary duties.
Overview of Fiduciary Duties The Business Judgment Rule The common law “business judgment rule” reflects the recognition by the courts that businessmen, not judges or stockholders, run corporations. The rule provides an important defense to sustain well reasoned, informed and good faith business decisions by the board. The Delaware Supreme Court has summarized the rule as follows: “The business judgment rule ‘is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.’ ...A hallmark of the business judgment rule is that a court will not substitute its judgment for that of the board if the latter’s decision can be ‘attributed to any rational business purpose’...” Unocal Corp. v. Mesa Petroleum Co., (Del. 1985). To have the benefit of the business judgment rule, directors must demonstrate that they have met the duty of care, the duty of loyalty and the duty to act in good faith. Duty of Care Generally, directors have a duty to act in good faith and with reasonable care. Directors must exercise the degree of care that a reasonable person in a like position would exercise under “similar circumstances.” The Delaware Supreme Court explained this duty in the context of mergers as the duty “to act in an informed and deliberate manner in determining whether to approve an agreement of merger before submitting the proposal to the stockholders.” Smith v. Van Gorkom (Del. 81
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1985)(emphasis added). In determining whether a board has met its duty of care, the legal test is whether a board availed itself of all reasonably available material information about the subject of the decision. The extent and nature of a board’s review and ultimate determination concerning a proposed M&A transaction may vary depending on, among other things, the nature of the deal, its importance to the corporation, the size of the corporation and certain timing considerations. The duty of care requires directors to observe a process to make an informed decision. Thus, a court’s review does not turn on whether a proposed transaction ultimately turns out to have been unwise, a mistake of judgment or detrimental to the corporation, but rather on whether the directors’ actions in reaching a decision on the proposed transaction evidence an appropriate degree of rationality, diligence, consideration and deliberation. Van Gorkom, however, has made it clear that the business judgment rule’s protection in the context of M&A transactions requires directors to prove that there was a decision making process that was designed to allow the directors to be informed and consider all reasonable alternatives. In that case, the court determined that a corporation’s directors were liable for breaches of their duty of care for making an uninformed decision even though there was no evidence of interested directors, personal gain, bad faith or fraud. The facts of Van Gorkom are illustrative: Jerome Van Gorkom, the Chairman of the Board of Trans Union Corporation, commenced discussions with a potential acquirer of Trans Union without consulting with his board. Only after reaching terms for the sale of Trans Union did Mr. Van Gorkom call a special board meeting to consider the transaction. The directors were not provided notice regarding the purpose of the meeting and were not provided materials, such as term sheets, proposed valuation reports or transaction documents to review in advance of the meeting. Since Mr. Van Gorkom had also negotiated the terms of the proposed transaction with only limited involvement from senior management, most senior management members first found out about the proposed sale during a meeting for senior management called an hour before the board meeting was to be held. During the meeting with management, the senior management team, with the exception of the two executives who had assisted Mr. Van Gorkom with negotiating the terms of the deal, expressed a strong negative reaction 82
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to the proposed transaction. Nonetheless, the board meeting went ahead as scheduled. During the board meeting Mr. Van Gorkom provided the board an overview of the transaction — which ran approximately twenty minutes. Trans Union’s Chief Financial Officer, who opposed the transaction at the management meeting, stated that he could not indicate if the price was fair but that the price per share offered was “at the beginning of the range” of a fair price (it was noteworthy that Mr. Van Gorkom had actually suggested the sale price to the potential buyer but did not disclose this fact to the board). After just two hours of meeting time, the board approved the transaction without ever reviewing the definitive acquisition agreement. Mr. Van Gorkom signed the definitive acquisition agreement later that evening. In total, the board • received little advance warning of the meeting, • held only brief deliberations and discussions of the proposed transaction, • did not consult with or consider the advice of experts, • did not review material transaction agreements, and • disregarded the obvious hesitancy of members of senior management regarding the proposed transaction. With these facts in hand, the court concluded that Trans Union’s directors had breached their fiduciary duty of care. Directors considering proposed M&A transactions must not presume that the business judgment rule will offer an absolute shield of protection. Rather, they should take reasonable efforts to ensure a process that demonstrates that they have reached a conclusion in a good-faith, wellinformed and well-documented manner. Practical Guidelines for Considering the Duty of Care While the determination as to whether a board has met its fiduciary duties in the context of an M&A transaction will always be made by a court vested with the benefit of 20/20 hindsight, practical guidelines on how a 83
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board may satisfy its duty of care can be distilled from case law and corporate statutes, and include the following: • Know Your Business — Directors should have a working knowledge of the business of the corporation as well as its products, plans and potential problems. • Haste Makes Waste — The board should avoid not only haste, but the appearance of haste, in approving an M&A transaction. • Decisions regarding M&A transactions should be made only after directors have had a full opportunity to digest all available material information. • Directors should receive information in sufficient time to review it adequately. • Important and complex transactions, such as a sale of the corporation, generally will require more than one board meeting. • No Substitute for Diligence — Directors should review and consider carefully all available material information, and the board should carefully review all relevant documents, including the definitive acquisition agreement, prior to authorizing their execution. • Obtain Expert Advice — Directors should consider the advice of advisors or experts, including outside legal counsel and/or the corporation’s investment banker, chosen with reasonable care (note that the board may not entirely delegate its responsibilities or the decision-making process to third parties). A board should consider whether persons providing information regarding a proposed acquisition are potentially biased due to severance arrangements, fee arrangements or otherwise. Directors should also be convinced that the advisors to the board are competent, were chosen with reasonable care and are providing sound advice. • Look Beyond the CEO — Directors should consider the advice of the corporation’s other officers and employees who would be expected to have relevant information on the subject. • Ask Questions — Directors should ask questions and actively probe and test all information presented to them, judging its reliability and accuracy and understanding it fully, and review all issues important to the directors’ conclusion. 84
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• Be Cognizant of Conflicts — The board should ensure that “interested” directors recuse themselves from the discussion and the decision. • Leave a Thoughtful Record — The record of the board’s deliberations should be documented carefully and completely. Neither the presence nor absence of any one of these factors is likely to be dispositive of a director’s compliance or breach of his or her duty of care. Instead, courts will consider whether a director has given thoughtful consideration to the issues, and will review methods of inquiry and sources of information available to and employed by the director. Courts have, however, been more likely to conclude that directors have failed to meet their duty of care when they have acted hastily or as passive participants without carefully examining information provided by management and experts. Duty of Loyalty In addition to the duty of care, directors have a fiduciary duty to make decisions based on the “best interests” of the corporation and its stockholders and not their own personal interests. This duty of loyalty is intended to prohibit “self-dealing” by directors and generally requires that directors have an absence of personal financial interest in the matters they approve. Directors are not viewed as “interested” simply because they may become directors of the combined entity, or because they are stockholders or option holders. In contrast, a director who also serves as an officer or employee of the corporation, or who is a member of a firm receiving substantial revenue from the corporation, whether or not in the particular transaction, may be viewed as having a self-interest not shared equally by all stockholders. There may be employment agreements with management directors which should be considered in determining if self-dealing transactions exist. A person who is a director of both the target corporation and a prospective buyer has a conflict of interest, as the director owes a duty of loyalty to each corporation. This director is required to keep information of each corporation confidential, but is also obligated to provide material information in his possession to each board on topics he knows are being considered. A director in this circumstance must recuse himself from any discussion about a potential transaction for either company, and cannot serve as an agent of either company without breaching his duty to one or the other corporation. 85
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All possible transactions or relationships that might influence a director’s decisions concerning an acquisition, including relationships with other prospective acquirers, should be fully disclosed to the board as a whole. Courts have found that a board has met the requirement of independence where a majority of the board consists of independent outside directors.
Practical Tip: Conflicts of Interest are Not Inherently Improper But Require Good Process Today, transactions that present conflicts of interest involving a director are not viewed as inherently improper. Courts will instead inquire as to the manner in which the board addressed the conflict of interest to determine if the board’s decision was improperly influenced by the interests of any interested directors or other corporate parties. When an interested director transaction has not been approved by a majority of informed and disinterested directors, courts may disregard the business judgment rule and instead apply the “entire fairness analysis” — which shifts the burden to the parties who entered into the transaction to prove that the transaction was fair to stockholders. As such, the entire fairness analysis is based not on whether directors acted in bad faith but whether, in the absence of arms-length negotiation and bargaining, the transaction, viewed objectively, is in fact fair and reasonable. In the M&A context, the parties to the transaction will be required to show that the transaction was the product of both fair dealing and fair price. Practical Guidelines for Considering the Duty of Loyalty The involvement of disinterested, independent directors in approving an M&A transaction can increase the likelihood that a board’s decision will receive deference under the business judgment rule or will survive the heightened scrutiny attendant in cases involving sale of control transactions. For boards comprised of a majority of disinterested, independent directors this protection can be found by having the interested minority abstain from approving or negotiating the deal. Care must be taken to ensure the special interest is fully disclosed to the board by the interested director(s). When a majority of the board is interested and/or not independent, or in cases where management is actively working with the buyer, 86
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however, the board may wish to form a special committee comprised of uninterested and independent directors and delegate to the committee the authority to review and negotiate the terms of the proposed transaction. Use of Special Committees An effective special committee must: • consist of members who are truly independent from the matters under consideration, • have the power to act independently, • have access to all relevant material information, and • engage in arms-length negotiation of the transaction terms. When a board creates a special committee it is important that the committee both be involved in the transaction and have the authority and power to negotiate and ultimately disapprove the transaction. The committee, moreover, should be involved throughout the entire process of the proposed transaction and not just at the initial or term sheet level or in the initial efforts to choose one suitor from a field. Critically, a special committee must also have a clear conception of its role in the deal negotiation and approval process and must be aware that its members have the authority to ultimately disapprove the deal. A special committee is not effective if it is used only as a “rubber stamp” for a transaction negotiated by the management or interested directors. To ensure that the committee members are fully informed regarding the transaction, and have independent advice on strategy and tactics for negotiations, the courts have held that special committees require their own set of financial and legal advisors separate from those advising the board. The special committee should have the power to select these advisors and the advisors should report directly to the committee.
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Practical Tip: An Effective Special Committee Takes Planning The use of a special committee may be an invaluable tool to address duty of loyalty concerns but requires advance planning, additional time to accommodate the special committee’s separate deliberations and the costs associated with retaining separate advisors for the committee. Alternatives to Special Committees When a board is comprised of a majority of disinterested directors, it may seek to address the potential influence of interested directors through the following means: • Approval by Disinterested Directors — When a director faces a possible conflict of interest, such director should: • submit such action or decision for approval by the disinterested members of the board, and • provide such disinterested directors or committee with full disclosure as to the nature of the conflict of interest. • Recusal from Board Discussions — Where a conflict of interest is inherent, the most prudent course of action for an interested director may be to withdraw from participation in both the voting upon the issue (in order to achieve disinterested board member approval) as well as the board’s discussion of the matter. • Stockholder Approval — The board may choose to: • submit the action or decision for approval by the stockholders of the corporation (excluding any shares that might be held by the interested director or affiliate), and • provide the stockholders with full disclosure as to the nature of the conflict of interest and the terms of the transaction in question. Such stockholder approval (with full disclosure) may also bring an interested director transaction within the scope of applicable statutory safe harbors for interested party transactions. In all cases, during the board meeting at which the potentially “interested” transaction is presented for approval, directors should thoroughly 88
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review and discuss the proposed transaction, analyze and question the internal and outside reports prepared in connection with the board review, ensure that open issue items are addressed, and reflect in the minutes the diligent deliberations in which the board members had been engaged.
Heightened Fiduciary Duties Directors have heightened duties and a restricted range of action in M&A transactions in two situations — those that will result in a sale of control of the corporation or in transactions involving deal-protection devices. In such instances, the conduct of the board with respect to a proposed transaction is judged under an “enhanced scrutiny” standard. Where the directors have determined that a sale of “control” or break up of the company is “inevitable,” their duty is “the maximization of the company’s value at a sale for the stockholders’ benefit.” Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., (Del. 1986) “In the sale of control context, the directors must focus on one primary objective — to secure the transaction offering the best value reasonably available for the stockholders.” Paramount Communications v. QVC Network, Inc., (Del. 1994). A cash merger or other business combination in which stockholders are cashed out, or in which a stockholder or affiliated group of stockholders of the buyer controls the continuing entity, is generally viewed as a “sale of control.” This is because such a transaction represents the stockholders’ only opportunity to receive a control premium. Thus, an acquisition transaction that is primarily a cash transaction is judged under the Revlon standard, and if the directors decide to pursue a sale of the company for cash the board’s obligation is to obtain the best available terms for the stockholders. Not every merger is a “sale of control.” Delaware courts have held that a “stock-for-stock” merger, where a majority of the shares in the combined entity will continue to be held after the merger by a “fluid aggregation of unaffiliated shareholders representing a voting majority,” is not a sale of control. Of course, even in a stock-for-stock merger, a board must continue to exercise due care, reviewing all reasonably available information concerning the transaction and other alternatives. Even when a board is subject to Revlon duties, no one method of obtaining the best value is required, and the board has reasonable latitude in determining the method of sale most likely to produce the highest value for all the stockholders. The clearest method to assure that the directors have obtained the “best” available price is to conduct a public auction of the company. Nevertheless, the courts have recognized that such an auction 89
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damages the company, perhaps irretrievably, in the event a deal cannot be made with potential buyers, and adversely affects the company’s ongoing operations during the auction process. Perhaps as important, the courts recognize that most bidders are unwilling to expend the time and effort on a possible acquisition merely to serve as a “stalking horse” for another bidder. Accordingly, Delaware courts have sometimes accepted as reasonable directors’ reliance on a “market check” in which private inquiries to the most likely bidders have been made, or where the transaction has been publicly announced far enough in advance so that competing bidders may have a reasonable opportunity to express interest. Moreover, Delaware courts have held that in determining the adequacy of the offer in a sale of control, directors may approve a transaction without employing an auction or a market check, so long as they are able to demonstrate that they possessed a “body of reliable evidence” on which to base their decision. QVC Network, Inc. v. Paramount Communications, Inc., (Del. Ch. 1993), citing Barkan v. Amsted Industries, (Del. 1989), affirmed (Del.1994). In Barkan, the court noted there is “no single blueprint” for obtaining the necessary evidence to satisfy Revlon duties. However, Delaware law is still developing as to what constitutes sufficient “reliable evidence” on comparative value. In one Chancery Court case, the judge explained that although a target “negotiated with a single bidder, it bargained hard and made sure the transaction was subject to a post-agreement market check...” In re Pennaco, Inc. Shareholders Litigation, (Del. Ch. 2001). In a recent case, however, the Chancery Court noted that “[a]lthough the directors have a choice of means they do not comply with their Revlon duties unless they undertake reasonable steps to get the best deal.” In re Netsmart Technologies, Inc. Shareholders Litigation, (Del. Ch. 2007). In the Netsmart case, the Chancery Court noted the obligation of the board or committee to control every aspect of the process, including the diligence process, to maximize value, and also criticized the special committee in that case for failing to consider seriously possible strategic buyers. The target company board developed a process with their banker seeking only private equity buyers, and relying on a post-signing market check as the means to determine if other interest, including interest from strategic buyers, existed. The Netsmart case signals the Delaware courts’ view that if a board decides to pursue a cash sale of the company, the directors are obligated to take “reasonable efforts to maximize the return to ... investors.” This recent case confirms earlier cases permitting the board to use a “market check” of likely buyers rather than a full-blown auction, but requires 90
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the board to use its business judgment to develop a process that will enable a market check for logical buyers, and notes that reliance on a post-signing market check is not per se reasonable. The Chancery Court noted the “potential utility of a sophisticated and targeted sales effort,” tailored to “a few logical buyers” and the use of a banker with industry connections to market the company. The Court further elaborated that a board can legitimately consider the risks to the company from going to a broad group of potential buyers, but that the risk must be real and weighed against the board’s duty to obtain the best available price and terms. The board must make a “genuine and reasonably-informed evaluation of whether a targeted search might bear fruit.” Exclusivity Agreement A prospective buyer will sometimes propose an exclusivity agreement to a target, arguing that the buyer does not want to be a stalking horse and is unwilling to undertake significant expense in diligence efforts and negotiation of an acquisition agreement without such an exclusivity agreement. These types of arrangements are subject to significant scrutiny by the courts, particularly in a cash transaction, given the board’s duty to maximize stockholder value, and should be evaluated with caution. These arrangements should not be entered into without board approval and only after considering all the factors relevant to the arrangement, including the likelihood of other bidders, the duration and extent of any market check undertaken, the amount of time requested for exclusivity, the status of negotiations relating to price and terms and the relative attractiveness of the offer compared to other alternatives reasonably available to the company, the risk of losing the transaction at hand in the event exclusivity is not granted and any other relevant factors.
Fiduciary Duty Implications of Certain of M&A Transaction Terms The board’s approval of certain transaction terms, no matter how well discussed or considered, may itself constitute a breach of the directors’ fiduciary duties. In particular, the board’s approval of certain types of noshops, termination fees, breakup fees and voting agreements, and other such deal-protection devices have been subject to scrutiny by courts. In a transaction involving these “deal protection” devices, the courts have applied a two prong test for determining whether a board has breached its fiduciary duty. The first prong of the test is that the directors must have had a reasonable belief that the takeover bid posed a danger to the 91
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corporation. The second prong of the test is that there must have been a reasonable relationship between the threat of takeover and the actual defensive tactics adopted by the board. No-Shop Provisions No-shop provisions are protective mechanisms used in M&A transactions that seek to reassure a prospective buyer that the seller will not accept a competing offer, by prohibiting the seller from soliciting other bids or negotiating with other potential buyers. No-shop provisions reduce the risk to the potential buyer that a proposed transaction in which it has invested substantial time, energy and costs will be used as a stalking horse. No-shop provisions may also benefit the prospective seller by inducing the prospective buyer to enter agreements for M&A transactions despite the risks that the deal may not get done. Directors have a fiduciary duty to carefully review and consider noshop provisions because the provisions may have the effect of precluding competing bids that might offer greater value to the stockholders. In sale of control transactions, no-shops provisions will generally only pass muster if they are: • found to be reasonably necessary to induce an offer that the board reasonably believes is the best available bid, and • drafted so as to contain a “fiduciary out” clause. Fiduciary out clauses permit boards to consider unsolicited offers, provide other unsolicited suitors with information, accept competing offers and withdraw recommendations to the stockholders if the failure to do so would result in a breach of the directors’ fiduciary duties. The buyer can seek to limit fiduciary outs in a number of ways. The most common way is to require that the seller’s board first conclude that the alternative transaction on which the board seeks to exercise its fiduciary out is a “superior proposal”. The seller can negotiate the definition of “superior proposal” so that it is only triggered by a bid that is financially or strategically better then the buyer’s offer or more likely to actually be consummated based upon on a good faith determination of the board and/or supported by the advice of a nationally recognized financial advisor that such offer is indeed a “superior proposal” as well as advice of legal counsel that failure to accept the new offer would result in a breach of the directors’ fiduciary duties. A prospective buyer can also negotiate the fiduciary out to include a provision that requires the seller to provide the buyer with advance notice of 92
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the competing offer and granting the original prospective buyer the right to match the new offer. Termination and Breakup Fees Termination and breakup fees are financial penalties that must be paid by one party to another party to a proposed M&A transaction upon the occurrence of certain events that result in the transaction failing to close. Such fees usually are triggered by: • the seller’s decision to exercise its fiduciary out under a no-shop clause and pursue a superior proposal; or • the seller’s board’s withdrawal of its recommendation or failure to reaffirm such recommendation upon the announcement of another acquisition proposal; or • an alternative transaction is announced and subsequently the target stockholders do not approve the transaction and within some period such as 6-18 months after termination of the merger agreement the target enters into a definitive agreement for an acquisition proposal or is acquired; or • breach of the no shop. Termination and breakup fees are generally permissible if required by the target to induce the buyer to enter into the agreement. A board’s decision to approve termination and breakup fees, however, is subject to heightened scrutiny and may lose the protection of the business judgment rule when the size of such fees becomes so large as to preclude bids which might offer substantially greater value to the stockholders. Directors determining whether to approve termination and breakup fees in an M&A transaction thus must carefully consider both the size of the fee and the events triggering its payment. There is no clear guideline as to how large is too large, but court approved fees have generally ranged between 1.0% to 4.5% of transaction value. Courts have said that there is no “one size fits all” percentage but the terms must be considered in the particular fact pattern to determine if the fees are preclusive to an alternative bidder. The timing and triggering events for termination and breakup fees also merit careful attention by directors. If a fee is triggered by a seller’s mere provision of information to a potential suitor who makes an acquisition proposal deemed by the target board to be reasonably likely to lead to a 93
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superior proposal, this would be of particular concern. The board should be able to discuss with a prospective buyer in that case whether the offer is in fact superior. The board generally should not fear losing the deal in hand and having to pay a termination fee in connection with exploratory discussions with a suitor who may offer greater value to the stockholders, so long as the offer is unsolicited. In a recent Chancery Court decision, the Vice Chancellor favorably commented on a termination fee structured to ensure that stockholders “would not cast their vote in fear that a “no” vote alone would trigger the fee; the fee would be payable only if the stockholders were to get a better deal.”
Voting Agreements A prospective buyer will often try to “lock-up” an M&A transaction by obtaining a commitment from the stockholders, typically holders of 5% or more of the voting stock and management stockholders, that the stockholders will • vote in favor of the proposed transaction, • vote against any proposal adverse to the buyer’s, and • agree to certain restrictions on transfers of their shares until the transaction is approved and consummated. The lockup typically takes the form of a voting agreement between the buyer and the seller’s stockholders and grants an irrevocable proxy. Voting agreements containing lockup provisions warrant particular scrutiny because they commit stockholders to vote in favor of a transaction even though a more favorable offer may arise and without regard to the fact that the board may have chosen to exercise a fiduciary out. Voting agreements may implicate directors’ fiduciary duties because directors are required to approve the agreements in certain instances. For example, the applicable corporate statute may require corporations and thus their boards to approve any lockup agreement in an M&A transaction to which the voting securities of the corporation are subject. Whether a voting agreement contains an unreasonable lockup, the approval of which by a director constitutes a breach of fiduciary duty, can hinge on the degree of the lockup and its preclusive effect on other offers. If the voting agreement locks up too many of the seller’s stockholders such that it creates a preclusive block on any other transaction, courts have held 94
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that the board’s approval of such a voting agreement will constitute a breach of fiduciary duties. Under Delaware law, if a merger agreement contains a “force the vote” provision (under which the seller’s directors are required to submit a proposed transaction to a stockholder vote even if the board subsequently changes its recommendation), then it is illegal under Delaware law to also have a voting agreement with a majority of the corporation’s stockholders to vote in favor of the transaction. Delaware courts have held that the coupling of a “force the vote” requirement and voting agreement that locks up a majority of the voting shares effectively precludes any competing bids for the seller and that by permitting the corporation to be subject to such provisions, the seller’s directors may be in breach of their fiduciary duties by not negotiating a fiduciary termination right. Directors must ensure that any board approved voting agreement containing a “force the vote” provision also provides for a fiduciary termination right or not govern so many shares as to preclude any other transactions. Exactly where this preclusive threshold lies is unclear (courts have found 33.5% of the outstanding voting stock to be sufficiently preclusive in certain circumstances while finding that a 40% lockup was not truly locked up). In summary, arrangements such as “no shop” clauses, “break up” fees, stockholder voting agreements, and “force the vote” provisions may be justified under Delaware law if the board determines that the defensive provision is necessary to obtain a favorable merger proposal, but only if the provisions, taken as a whole, do not preclude the board’s consideration of a more favorable transaction for the stockholders. Recent Delaware cases make it clear that these types of “lockup” provisions are not to be entered into without significant board scrutiny and a determination that the provisions are reasonably tailored and actively negotiated to protect the enhanced value inherent in the transaction and not to preclude all competing deals.
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Chapter 9 Stockholder Approvals and Securities Law Compliance The parties to an M&A transaction will have to determine whether either party will need to obtain stockholder approval for the completion of the transaction. This is most often an issue for the seller in the transaction, but depending on the deal structure and consideration to be paid in the transaction, the buyer may also need to seek stockholder approval. Stockholder consent requirements are usually driven by the laws of the state of incorporation of the subject corporation or its charter documents (i.e., certificate/articles of incorporation and/or bylaws). For example, Section 251 of the General Corporation Law of Delaware requires that a merger agreement between domestic stock corporations be submitted to the stockholders of the constituent corporations for approval at an annual or special meeting for such purpose. Note that in Delaware, if a buyer uses a subsidiary corporation to make the acquisition, the parent corporation is not a “constituent” corporation. In addition, the charter documents of the seller may require additional consents from a separate class or series of shares, e.g., from holders of a majority of the outstanding preferred stock (this type of requirement is most often found in the charter documents of privately held companies). Another source of a requirement for stockholder approval may be the listing agreement or governance requirements of a stock market or exchange such as the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) or the Nasdaq Global Market (Nasdaq). Even in an acquisition of a private company there might be a requirement on the buyer side in connection with the issuance of the buyer’s stock as consideration for the acquisition. The requirements under stock exchange rules for stockholder approval vary, but generally approval is necessary for transactions in which the buyer will issue, or has the potential to issue, 20% or more of its outstanding common stock, or if the issuance will for some other reason impact the control of the buyer. The NYSE, AMEX and Nasdaq each have specific rules in effect in this regard, and the rules need to be carefully reviewed to determine application to the particular transaction. The impact of these requirements and the determination of whether they are applicable to a deal can be especially tricky in a transaction where the acquisition consideration is based on a fluctuating per share price, or if the number of shares can increase as the function of an earn-out provision. The buyer may include a cap on the number of shares that may be issued in the transaction to eliminate a need for buyer stockholder approval. Even in a situation where 97
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the buyer first raises money in a financing transaction (in which the 20% limitation does not apply) in order to make a subsequent cash acquisition, if the number of shares sold in the financing transaction constitutes 20% or more of the outstanding common stock, Nasdaq generally takes the position that such transaction would require stockholder consent.
Obtaining Stockholder Approvals Timing Obtaining stockholder approval usually takes place after the parties sign the definitive acquisition agreement and should be a condition to the closing of the proposed transaction. The buyer and seller will want to be sure that they have a fully negotiated transaction before going to stockholders for consent. This is especially the case where the seller is a public company and the consent solicitation material, or proxy statement, is publicly filed with the SEC, as discussed below. The period of time required for the stockholder consent process can also vary greatly in length depending on whether the buyer and seller both need stockholder consent and whether the seller is a public or private company.
Practical Tip: Stockholder Approval Covenants The parties typically include covenants within the definitive acquisition agreement concerning the use of “commercially reasonable” or “best” efforts to obtain requisite stockholder consents and to prepare and file with the SEC any related materials as soon as practicable after the signing of the agreement. Voting Agreements To mitigate the risks of the parties not being able to deliver required stockholder consents, and therefore not being able to close the deal, the parties may use voting agreements. Voting agreements, if used, are typically required of the seller, but when both parties are required to obtain stockholder consents, they may be reciprocal. As discussed in Chapter 8, a voting agreement is used to contractually bind a stockholder to vote in favor of the proposed transaction and to vote against any alternative transaction. The stockholders asked to sign voting agreements are typically limited to those with a significant amount of stock. 98
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As noted in Chapter 8, the use of voting agreements is subject to judicial scrutiny because of the restrictions that voting agreements may impose on the ability of the board to fulfill its fiduciary duty to maximize value to stockholders. In a private company acquisition, buyers often avoid this issue by requiring the target to deliver consents of stockholders to approve the transaction at the signing of the definitive agreement, or require stockholder approval to be obtained prior to the buyer entering into the acquisition agreement. Note also that entry into voting agreements may also require the buyer and/or subject stockholder to file with the SEC a Form 13D with respect to changes in beneficial ownership of the seller’s stock. The Process The process by which the parties to an M&A transaction obtain required stockholder consents will depend in large part on their status as either a privately held or a publicly traded corporation and the nature of the consideration being paid in the transaction. In any case, the parties will want to be sure to provide to their stockholders information sufficient to make an informed decision as to whether to consent to the transaction. If the party seeking stockholder consent is a publicly traded corporation, it will include this information in a proxy statement that is filed with the SEC. If the party seeking consent is a privately held corporation, it may prepare an information statement that is not filed with the SEC, but which includes most, if not all, of the information that would be contained in a proxy statement filed with the SEC. If the buyer is issuing stock in the transaction, and is not registering the stock with the SEC under Form S-4, the buyer will need to find another exemption from registration, such as Regulation D or Rule 3(a)(10) and in these cases the buyer will need to comply with the information requirements of either Regulation D or of the state securities laws governing the fairness hearing under Rule 3(a)(10). The Proxy Statement Once the definitive acquisition agreement is signed by the parties, the preparation of the proxy statement begins in earnest. It is important to note that the securities laws define the term “solicitation” broadly, which creates problems for the constituent corporations trying to communicate about the proposed transaction after announcement of the transaction and prior to the filing of the proxy statement. Under Regulation MA, the SEC has permitted companies to speak about the transaction prior to the filing of the proxy statement, but the trade-off is that the corporation must file all “solicitation” materials with the SEC on the date of first use with a legend 99
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indicating that they are additional soliciting materials. The judgment call as to whether press releases, investor presentations or employee presentations are additional material required to be filed requires careful analysis and should be considered with the assistance of legal counsel. Schedule 14A under the Securities Exchange Act of 1934 outlines the information to be disclosed in a proxy statement concerning a transaction being submitted for stockholder consent. This information may include: • Description of the Transaction — A description of the basic mechanics and effects on the constituent corporations of the merger transaction • Background of the Transaction — A chronological description of the facts and circumstances behind the proposed transaction and how the parties came to sign the definitive agreement • Reasons for the Transaction — A description of reasons that the board deems the proposed transaction to be in the best interests of the corporation and its stockholders • Recommendation of the Board of Directors — A statement as to the board’s recommendation whether or not to approve the transaction • Fairness Opinion — A description and background behind any fairness opinion rendered by financial advisors as to the fairness of the proposed transaction to the stockholders from a financial point of view • Interests of Officers and Directors in the Transaction — Disclosure regarding the interests of the officers and directors of the corporation in the transaction, including deal consideration, change of control payments, severance, employment arrangements, etc. • Appraisal or Dissenters Rights — A description of any appraisal or dissenters rights available to stockholders that do not vote in favor of the transaction • Material Tax Consequences — A discussion of the tax impact of the transaction on the stockholders of the subject corporation • The Definitive Acquisition Agreement — A description of the material terms of the definitive acquisition agreement, including mechanics and effects, consideration, representations and warranties, covenants, conditions to closing and termination rights and effect of termination 100
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The corporation seeking stockholder consent will need to file the proxy statement with the SEC in preliminary form at least ten days prior to distributing the materials to the stockholders. These preliminary proxy materials are subject to review and comment by the SEC. The SEC will promptly advise the corporation if it intends to review the preliminary proxy materials. If the SEC advises that it will not review the materials, the corporation is free to distribute the definitive proxy materials to its stockholders and concurrently file them with the SEC. If the SEC comments on the preliminary proxy materials, the corporation may be required to file amended proxy materials or may be able to make requested changes in its definitive proxy statement. In the event the SEC elects to review the preliminary proxy materials, it may take thirty days to receive comments and forty-five to sixty days to complete the review and comment process, sometimes longer. Accordingly, it is prudent to file the preliminary proxy materials well in advance of the anticipated mailing date of the definitive proxy materials to stockholders. A filing fee is required with the filing of a proxy statement and is generally equal to one 50th of one percent of the aggregate value of the transaction. If instead the transaction is being accomplished without a filing with the SEC, the target company will have to determine the material information required to disclose the transaction; it is advisable to consider the types of information deemed material by the SEC in making this determination. If the buyer is issuing stock, the buyer will also need to determine that all material information is provided to the target stockholders for their determination as to whether to approve the transaction. Regulation D sets forth information requirements for the sale of securities, and state securities laws may provide information requirements, particularly if the buyer is relying on an exemption from registration under Section 3(a)(10). State case law may also provide further rules on information to be provided to stockholders. Once the definitive proxy statement has been completed, it will be mailed to the stockholders. State corporate law and the corporation’s charter documents will establish the time frames for delivery of notice of the stockholder’s meeting concerning the transaction. The notice period is generally no less than twenty days and no more than sixty days prior to the stockholders’ meeting. The notice is usually included as part of the proxy statement. In order to ensure that stockholders have sufficient time to receive and act upon the proxy materials, the corporation will want to distribute the materials as far in advance of the meeting date as permitted. Recently, electronic distribution (via Internet and e-mail) of proxy materials has become available and is encouraged by the SEC, subject 101
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to certain requirements and constraints. These methods help increase the efficiency and decrease the costs of the proxy solicitation process. However, care should be taken to comply with both federal securities laws, with respect to disclosure and delivery, and state laws, with respect to voting procedures. Proxy Solicitors To help ensure that the required stockholder consent to the transaction is obtained, the publicly traded corporation seeking consent will often employ a proxy solicitor. Proxy solicitors can be particularly helpful dealing with brokerage houses that hold large numbers of shares in “street name”. The role of the proxy solicitor becomes more important in a transaction that is contentious or not universally viewed as a positive event for the corporation. The Stockholders’ Meeting The time and location of the stockholders’ meeting will have been included in the notice of meeting and proxy statement and may be held at the offices of the corporation or at any other facility that is adequate to accommodate the stockholders. Oftentimes, a corporation will choose to hold the stockholders’ meeting at an off-site location to minimize disruptions among employees. However, if the proposed transaction is generally viewed as a positive event, the corporation may want to encourage employee attendance and participation. Given that many stockholders will simply complete and return their proxy card, rather than appear at the meeting to vote in person, frequently only stockholders that live in the vicinity of the meeting will attend. Attendance can be expected to increase in a contentious transaction. In addition to the stockholders, senior management and some or all of the members of the board of directors will attend the stockholders’ meeting. This gives the stockholders the opportunity to ask questions and obtain feedback from management and the directors concerning the issues raised by the proposed transaction. The corporation will also appoint an inspector of elections to tabulate the votes cast at the meeting in person and by proxy and to certify the results of the vote. The inspector of elections is usually a representative of the corporation’s transfer agent, but may be another independent third party. In most cases, the corporation will also have its legal counsel attend the special meeting to address any voting or procedural issues. Presence of 102
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legal counsel may be particularly important in the context of an unpopular or contested transaction. Once it has been determined that a quorum is present at the meeting either in person or by proxy, the vote will proceed. Thereafter, the inspector of elections will tabulate the votes to determine if the requisite stockholder consent was obtained. Oftentimes, corporations will include as a proposal in the proxy statement the adjournment of the meeting if deemed necessary to facilitate the approval of the proposed transaction, including to permit the solicitation of additional proxies if there are not sufficient votes at the time of the meeting to approve the transaction. Information Statements and Written Consents As noted above, if the corporation seeking stockholder consent to a proposed transaction is a privately held corporation, the process will likely be simpler and faster than a public corporation. Depending on the circumstances of the transaction, the information requirements for the stockholder solicitation may be substantially the same as those for a proxy statement or somewhat less. Either way, the corporation should strive to provide as much information as practicable on which the stockholders can base their decision whether or not to consent to the deal. The simple fact that the corporation will not be required to file the information statement with the SEC and potentially deal with a review and comment period will greatly streamline the process. The other factor that will simplify the stockholder consent process by a privately held corporation is that the stockholders of many privately held corporations are permitted by the charter documents of the corporation or applicable state corporate law to act by written consent in lieu of a meeting. In this circumstance, the corporation can save the expense and time of a stockholders meeting and circulate a written consent with the information statement. As noted above, a buyer may insist that a private seller provide consents sufficient to approve the transaction at the time of signing of a definitive agreement. This will be possible if the affiliates of directors and officers knowledgeable about the transaction hold sufficient shares to approve the transaction. In most states, if approval by written consent is obtained by less than unanimous vote, the other stockholders must be notified “promptly� of the stockholder approval. Alternatively, a target might mail an information statement to all stockholders on the date of signing of the definitive agreement and accept consents from those stockholders who have sufficient knowledge of the transaction at the date of signing. 103
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Registration Statements for Buyer’s Securities As noted above, if the buyer proposes to use its own securities as the consideration for the transaction, it must either register those securities with the SEC or have an available exemption from registration in order to distribute the securities to the seller’s former stockholders at the closing of the transaction. The buyer’s securities will normally be registered on Form S-4, if no exemption from registration is available. The prospectus contained as part of the registration statement becomes a proxy statement for the seller’s stockholders meeting and is usually referred to as a proxy statement/prospectus. In the event the consent of the buyer’s stockholders is also required (e.g., due to stock listing requirements), the same document may be used as a proxy statement for the buyer’s stockholder’s meeting. The information requirements of Form S-4 are voluminous and require, in addition to all of the information contained in a proxy statement, detailed information regarding the businesses of the corporations, financial information, stock ownership information and much more. Incorporation by reference to SEC filings is permitted subject to various requirements, and legal counsel should be consulted about the preparation of the proxy statements/prospectus. Alternatively, buyers may rely on Regulation D or Rule 3(a)(10) for an exemption from registration; as noted above, each of these exemptions has requirements as to information and procedures for seeking stockholder approval. Given the timing considerations and overall importance to the parties’ ability to close the deal, an early assessment of the stockholder approval and securities registration requirements for a proposed transaction is key.
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Chapter 10 The Role of Investment Bankers in M&A Transactions Up to this point, we have assumed that the prospective buyer and seller unilaterally found each other and commenced acquisition discussions. While a prospective seller may have a sense of who in its market is a potential buyer and vice versa, even the most sophisticated company is unlikely to fully grasp the universe of prospects, valuation issues, market deal terms and the like. That’s where outside advisors such as lawyers, accountants and, in particular, investment bankers add value to a transaction. Accordingly, this chapter focuses on considerations in engaging an investment banker in an M&A transaction, as well as what to consider when engaging a banker. • Bankers come in all shapes and sizes. Investment bankers and deal brokers can help a prospective seller identify and attract prospective buyers and vice versa. Oftentimes, a banking firm will, on its own volition, identify potentially synergistic transactions and present such potential deals to either the potential buyer or seller in the hopes of being engaged by one party. Because they are immersed in the world of M&A transactions, investment bankers typically have a deep industry knowledge that even seasoned managers can benefit from. Therefore, beyond the introductory step of identifying a willing buyer and a willing seller, bankers have other key roles to play as well. For example, a banker can: • develop the sales process for a target company or the acquisition process for a serial buyer; • provide advice not only on deal terms but also deal psychology; • help a buyer or seller determine how to bridge a valuation gap, or identify solutions to issues arising in due diligence; • assist a seller who is concerned about a deal term by thinking of alternatives that may address the issue; • identify terms that might be traded to achieve the parties’ goals in order to get a deal done; and • advise a buyer or seller when a deal is simply too difficult to close the gap between the parties. Despite considerable consolidation, by some estimates, there are more than 2,000 companies in the U.S. offering investment banking services. Larger banks, particularly those at the upper end of the market 105
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referred to as in the ‘bulge bracket’, tend to have expertise in a broader array of industries and may also be able to assist with buyer financing and international transactions. Smaller regional banks may focus on specific industries within their particular region; while boutique investment banks often maintain a national and even international focus in a particular industry. Some firms structure and find deals for clients but do not advise on the transaction itself. These so-called “deal brokers” can also be helpful particularly for smaller transactions that may not be of interest to larger banks. The reputation of an investment bank with a prominent name can bring credibility to a proposed transaction. Note that the company’s management will be working with a particular lead banker and his or her team. Therefore, it is important to know which bankers management will be working with and find those individuals who have the expertise and approach the company is seeking. If the company is hiring a banker for an M&A transaction, it will want to consider the firm’s credentials and experience in mergers and acquisitions rather than just its general experience. • Fees Fees vary among investment banks and deal brokers. Smaller banks, regional and boutique banks and brokers typically offer lower fees, and larger banks may have minimum fees. Therefore, consider the level of outside advice and fees that are appropriate for the deal. A company completing a series of small “roll-up” transactions may prefer to allow its own managers to identify, structure and negotiate the deals, and only turn to an outside expert for advice on a merger of equals or other significant transaction.
Who Should Choose? In most instances the managers of the company interview and hire or suggest to the board that the company hire a particular investment bank. However, the board should consider retaining this decision or delegating the decision to a special committee when the transaction brings significant financial gain to management, controlling stockholders or inside directors. Removing these interested individuals from the engagement process will enhance the actual and perceived independence of the investment banker and its advice. 106
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Directors who rely on the advice of outside advisors with links to interested parties leave themselves open to arguments that they did not properly inform themselves about the proposed transaction. A company can benefit from talking to investment bankers early in the transaction process, even in an interview setting, but should balance the benefit of early advice against any need it may have to maintain confidentiality prior to engagement of the banker.
The Engagement Letter After a company selects an investment banker to assist in an M&A transaction, the banker will deliver the bank’s standard form of engagement letter tailored to the particular engagement and setting forth the financial terms. Engagement letters are negotiated, and a company should involve counsel familiar with these types of arrangements. Because the investment banker will be a key member of the transaction team and will be working with management and outside legal counsel for several months, negotiating the engagement letter can be a delicate process. The negotiators should modify the letter where appropriate to reflect the interests of the company and eliminate overreaching in the bank’s form but also demonstrate an understanding of and sensitivity to the banker’s legitimate concerns. The goal is an engagement letter that aligns the interests of the company and the investment bank. Covered Transactions The first section of the engagement letter will describe the “transactions” for which the investment banker will be paid a fee. The initial draft of the letter will likely contain broad language defining the included “transactions” as any sale of stock or assets. The scope of this language would include a transaction for even one share of stock or a single piece of inventory. Thus, while the investment banker has a legitimate interest in securing its right to receive its fee, it is important that the letter accurately reflect the economic realities of what the company is intending to accomplish in the deal — e.g., an M&A transaction involving all or a material portion of a company’s stock or assets. Because there is often a minimum fee payable upon a qualifying transaction, the sale of a percentage of the company’s stock or assets triggering a fee should be evaluated in light of the minimum fee’s relationship to the expected fee for a complete transaction. 107
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The company should also exclude routine business transactions that might meet the technical definition of a qualifying transaction such as: • licensing its intellectual property in the ordinary course of business; • borrowing money or issuing equity to lenders or stockholders outside the transaction; or • other transactions unique to the company. The company should review the company’s charter, securities and any stockholders agreement to determine whether there are any transactions that should be excluded. Investment bankers do not like to share the risk that a deal will fall apart after a term sheet is signed, however, they generally accept that they should receive the success fee only if the deal is actually consummated. Consequently, the appropriateness of any language providing for a success fee upon the signing of a term sheet or letter of intent should be thoughtfully considered. If the company was investigating or shopping the transaction before hiring the investment banker, it must decide whether the potential buyers or targets it previously identified will trigger a payment to the investment banker. If the negotiations are advanced, the company may wish to exclude these parties from an included transaction. The tension in this situation is the banker’s concerns that it will lose its success fee because of the exclusions. The company may also consider allowing a banker to earn a fee for these buyers or sellers as well, particularly when a significant amount of work remains to be done. One compromise approach is to provide for a discounted fee if the identified buyer or target becomes the ultimate counterparty to the deal. Scope of Services The services the investment banker will provide should be spelled out in sufficient detail to insure both that the company knows how much support it can expect from the banker and to limit those services to the specific transaction. Engagement letters often specify that the banker is the “exclusive” banker for the transaction, which is acceptable so long as that exclusivity does not carry over into other assignments. Bankers often request that that they be retained for follow-up transactions and financing or to complete a partial transaction. 108
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Fees The fee section will attract considerable attention from both the company and investment banker and presents a key opportunity to align the interests of the company and banker. The most common fee arrangement is a success fee formulated as a percentage of the total transaction value. When a banker represents the seller, the percentage typically increases as the sale price exceeds the expected price. Thus the banker has an incentive to seek the highest sale price for the seller and will be less tempted to promote a low bid. This practice reverses a long-standing approach, in which the percentage of the transaction value paid as a fee decreased as the size of the transaction increased. Minimum fees and fees paid even if a transaction does not close are appropriate when the banker will do a significant amount of work and a transaction is not seen as likely to occur. Bankers often request these fees to protect themselves against risks in completing a deal identified by the banker that is unraveled by something outside the banker’s control. To avoid disputes at the end of the transaction, the engagement letter should specify that any deposit made by the company is credited toward the final success fee. Investment bankers prefer to be paid their entire expected fee in one lump sum at closing, but the sale consideration is often paid over time and may be contingent on meeting certain “earn-out” targets such as annual EBITDA or revenue targets. If a portion of the purchase price is subject to an earn-out, the fee should typically be paid and the base calculated when the consideration is finally determined and actually received by the company. Fees on sale consideration held by an escrow agent should also typically be paid when the money is released from escrow. How Fees Are Measured An investment banker’s success fee will typically be measured as a percentage of the aggregate consideration in the transaction. Aggregate consideration is often defined very broadly to include not only obvious consideration such as cash or stock but other arrangements including payments for services, rent, separate real estate transactions and contingent payments. This broad definition evolved to protect the investment bankers from attempts by companies to exclude consideration from the fee base by recasting it as a side payment or part of a separate transaction. Traditionally, assumed debt is also included in the aggregate basis in asset sales, 109
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and that trend has expanded to include the target’s debt in a stock transaction. Whether bonuses and payments to managers should be included in the base depends on whether they are intended to be part of the sale price but merely structured as a payment to managers. This situation is most likely to occur when the stockholders are also the managers of a company. Expenses The company will typically agree to the investment bank’s request for reimbursement of “reasonable” expenses but may establish a cap beyond which the banker must request permission to incur any additional expenses. Conflicts and Confidentiality Investment banks often work for more than one company in an industry. Further, a bank and its affiliates may hold the stock of the company or a proposed buyer in the accounts of its customers or trade in the stock of the company. While these arrangements are often permitted, in some industries, companies are more sensitive to banks representing their competitors or dealing in their stock, and each company must negotiate these items with its banker. Banks may wish to represent more than one bidder for a company in a formal auction, and companies typically prohibit multiple representations unless there is an irreplaceable advantage for using that particular bank. Some investment banks will also seek permission to take the somewhat less controversial step of representing the seller and providing financing to the buyer in an M&A transaction. This can occur as “stapled financing” in which the seller’s investment banker offers the same financing to every potential buyer or on an ad hoc basis. While the banker’s initial draft of the engagement letter will likely explain the banker’s procedure for protecting and not sharing information with its affiliates and third parties, these internal provisions do not protect the company if information is accidentally or intentionally released. Therefore, the company should add a duty on the part of the banker to maintain the confidentiality of the company’s information. Duration of Engagement and Tail Periods The investment banker is likely to request that the company use its services for as long a term as possible. However, given that most M&A 110
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transactions can be accomplished within six months, and a deal may be perceived as “stale” if shopped for a longer period of time — a flexible month to month or a fixed term of six to twelve months is an appropriate arrangement for most engagements. A company will not want to be obligated to continue working with an investment banker if the transaction is not progressing and the company does not wish to continue the relationship. The company will want an express right to terminate the banker’s engagement after the initial period has expired. However, following termination, the engagement letter will likely provide for a “tail period” of some duration (a negotiated point) in which the banker will still earn its fee if the transaction that it was hired to negotiate occurs. This arrangement is ostensibly to protect the good work of the banker when a transaction is slow to materialize or delayed. This approach, however, will often prevent the company from pursuing similar transactions on its own or hiring different investment bankers. Therefore, a better approach is to negotiate a shorter tail period and limit the qualified transactions to ones solicited by the banker. This standard can be tightened to include only those counterparties that were: • contacted by the banker; • expressed an interest in the transaction; and • executed the confidentiality agreement. Intermediate positions agreeable to both parties can also be negotiated. Indemnification Companies generally agree to indemnify the investment bank against losses arising from the bank’s representation of the company. The company’s obligation to indemnify will exclude losses caused by the bank’s willful misconduct, gross negligence or bad faith. Often companies will also attempt to exclude indemnification for losses resulting from the bank’s ordinary negligence, but this term is accepted by banks only in rare circumstances. In any event, the company will want the ability to control the defense of any indemnifiable litigation and restrict the bank from settling without consent of the company. What happens in the situation in which the company and investment bank are both involved in litigation but no liability is ultimately found? Who pays for the bank’s litigation costs? Generally the company is required to pay for litigation costs unless the investment bank is found to be the cause of the liability through its willful misconduct, gross negligence or bad faith. 111
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Finally, the company will also be asked to waive any claims arising from the bank’s representation except, again, those resulting from the bank’s willful misconduct, gross negligence or bad faith.
Fairness Opinions A fairness opinion is a letter from an outside investment banker to a company’s board of directors stating that the consideration the company or its stockholders is receiving or paying in a transaction is “fair from a financial point of view.” Fairness opinions may also address other aspects of the transaction — e.g., the board may seek outside confirmation that an unusual or complicated structure is financially fair. The primary function of a fairness opinion is to help directors demonstrate that they have met their fiduciary obligation to act in the best interest of stockholders. Courts have created the “business judgment rule,” which is also codified in some statutes, to grant directors protection from liability while managing a company. The rule is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company and its stockholders. A fairness opinion can help demonstrate that the directors were informed and acting in good faith when approving an M&A transaction and refute a claim that the directors should be liable for alleged losses resulting from the transaction. After having fallen out of favor over a period of years, in 1985, in response to a decision from the Delaware Supreme Court, companies, public companies in particular, rekindled their affinity for fairness opinions. That case was the Van Gorkom decision, which is discussed at some length in Chapter 8. In Van Gorkom, the court determined that the directors of a target company failed to meet their fiduciary obligation to the stockholders because they had not informed themselves of the relevant facts by use of information reasonably available to them. The court elaborated that the board’s consideration of a fairness opinion would have supported an argument that they were informed. Thus despite the court’s further clarification that a fairness opinion from an independent banker is not a legal requirement, directors often request opinions to demonstrate that they were informed and to place themselves squarely within the protections of the business judgment rule. The letters serve a second purpose of educating shareholders voting to approve a proposed merger, and as described later, 112
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are often summarized or included in proxy materials delivered to stockholders. Advance and Retreat After the Van Gorkom decision, fairness opinions were viewed by many as a requirement for target boards, and their popularity may have undermined their integrity. Recently, fairness opinions have run into criticism causing companies and investment banks to reevaluate their opinion practices. Most of these criticisms stem from the relationship between investment banks and their clients. In an acquisition, investment banks will often provide more than one type of service to a company. The bank may be hired to find a suitable target or buyer, underwrite the financing of the transaction or give other strategic advice. An investment bank earns up to ten times more fees for these services than for preparing a fairness opinion, and these larger fees are often contingent on a successful conclusion of the transaction. If the same investment bank is asked to prepare the fairness opinion for the transaction, it has an incentive to produce a favorable opinion regardless of the underlying evidence or risk losing substantial success fees for its acquisition work. In other cases, banks may advise more than one party in a transaction, which creates an incentive to justify the transaction to all parties since it has already deemed it advisable. Fairness opinions have also been criticized for the variety of valuation methods and assumptions used. In the most favorable light, the array of valuation methods: discounted cash flow, value of the company’s assets if sold separately, multiples of revenue or EBITDA, comparable transactions, and other methods, is necessary to give bankers latitude to use the most appropriate valuation methodology for the transaction and industry. It is worth noting, however, that even when a fairly objective valuation method, such as discounted cash flow, is employed it can produce different results based on the assumptions that are used in the formula.
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Make the Fairness Opinion Count
Practical Tip: Effective Fairness Opinions If the directors desire the benefit of a fairness opinion, they should be sensitive to the inherent shortcomings of such opinions and create a process that will render an opinion on which they can justifiably rely. The board should be sensitive to: • the general reputation of the investment bank; • the experience and training of the opinion team; • whether the valuation methodology is appropriate and if the selection of that methodology is adequately explained; • whether the assumptions in the valuation are appropriate; • who hired the investment banker — to avoid pro-management bias, the board should consider hiring and supervising the banker directly; • to whom does the banker report — is a special disinterested committee of the board necessary to avoid the influence of interested directors; and • whether the fee is sufficient to compensate the banker for a thorough opinion. Ultimately, in deciding whether to request a fairness opinion, who will deliver it and what methodologies will be used, the board must balance its need for reliance on the opinion against the cost of the opinion. A public company has the option of including a fairness opinion in any proxy materials submitted to shareholders in connection with a transaction and in a registration statement for shares to be issued as consideration in the merger, and the SEC’s rules require a public company to describe any fairness opinion it receives. Thus, when a challenge to the transaction is expected, it is not only important that the fairness opinion be the professional work of an independent investment banker, it must be perceived as such by the courts and those who will criticize the transaction. 114
Chapter 11 Hart-Scott-Rodino and Related Regulatory Matters The Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the “HSR Act” or the “Act”) was enacted to enable the federal antitrust enforcement agencies to detect and deter potentially anticompetitive M&A transactions before they occur. While the purpose of the Act is fairly straightforward, the statutory scheme is a maze of technical tests and “triggers” that typically require specialized expertise for accurate interpretation. This chapter offers a high-level roadmap through the HSR Act and related regulatory requirements, but should not be considered an all-inclusive guide to the Act. Obtaining the advice of specialized counsel to address the HSR Act implications of specific M&A transactions is recommended.
Brief History and Purpose of the Act In 1914, Congress passed the Clayton Act to prohibit, among other things, mergers and acquisitions that may “substantially lessen competition” or “tend to create a monopoly.” The Clayton Act created a specific legal basis to challenge potentially anticompetitive business combinations in court, but did not provide federal enforcement agencies with a mechanism to detect such combinations before they occurred. This left the agencies facing substantial practical difficulties in seeking to undo mergers and acquisitions long after consummation, giving rise to market inefficiencies that often were seen to outweigh the potential competitive benefits of enforcement. The HSR Act was enacted in 1976 to address that problem by requiring parties to transactions meeting certain thresholds to notify the federal agencies in advance, and to await the expiration of a statutory waiting period before consummating the transaction. Thus, the HSR Act gave the Federal Trade Commission (“FTC”) and the Antitrust Division of the United States Department of Justice (“DOJ”) a window of opportunity to review certain potentially anticompetitive M&A transactions and, when appropriate, file a lawsuit to prevent consummation of those that may substantially reduce competition or tend to create a monopoly.
HSR Notification Requirements Reportable Transactions The HSR Act generally applies to acquisitions of voting securities, assets, or non-corporate interests that satisfy the so-called “Size-of-Transaction” test and, if applicable, the so-called “Size-of-Persons” test. In an 115
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effort to keep pace with changes in the gross national product, the Federal Trade Commission revises the thresholds to be applied under these tests annually (effective at the end of February). This chapter uses the thresholds effective as of February 21, 2007. Size-of-Transaction Test Under the Size-of-Transaction test, no transaction is reportable unless, as a result of it, the acquiring person will hold assets, voting securities, or non-corporate interests of the acquired person valued at more than $59.8 million. When, as a result of the transaction, the acquiring person will hold voting securities, assets, or non-corporate interests of the acquired person valued above $59.8 million but not above $239.2 million, then the transaction is reportable only if the Size-of-Persons test is also satisfied. Size-of-Persons Test As noted above, the Size-of-Persons test only comes into play if the transaction is valued above $59.8 million and not in excess of $239.2 million. When it applies, the Size-of-Persons test is generally satisfied if either the acquiring person or the acquired person has annual net sales or total assets equal to or greater than $119.6 million and the other person has annual net sales or total assets equal to or greater than $12 million. When the acquired person is not engaged in manufacturing and the acquiring person has annual net sales or total assets equal to or exceeding $119.6 million, then the annual net sales of the acquired person are irrelevant and the Size-ofPersons test is satisfied only if the acquired person has total assets equal to or exceeding $12 million. Joint Ventures The formation of a joint venture or other corporation may be subject to the Act. In such a formation, the entity to be formed is treated as an acquired person and the entities or natural persons contributing to the formation are deemed acquiring persons. Only these acquiring persons, and not the entity to be formed, may be subject to a filing requirement, and the waiting period will begin to run only when all contributors that are required to file do so. The reportability of each contributor’s “acquisition� of the voting securities, assets, or non-corporate interests of the entity to be formed must be analyzed separately under the Size-of-Transaction and Size-of-Persons tests summarized above. Generally, the size of the acquired person consists of all assets being contributed to the venture. 116
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When the joint venture to be formed is an unincorporated entity, the transaction is reportable only if, as a result of it, at least one person will control the new entity. Multiple Reportable Transactions Certain transactions give rise to more than one reportable acquisition, each requiring separate reporting and the payment of a separate filing fee. Two examples of transactions giving rise to multiple filings include acquisitions in which the consideration consists, at least in part, of the stock of the buyer, giving rise to a potentially reportable acquisition of the buyer’s stock by one or more sellers; and so-called “secondary” acquisitions, in which the acquiring person buys a target that in turn holds a reportable amount of voting securities in a company outside the target’s person, thereby causing the acquiring person to make a reportable acquisition of that outside company’s stock. Exempt Transactions The HSR Act contains a number of specific exemptions and confers upon the FTC the power to create additional ones by regulation. As a result, there is a wide variety of exemptions that may apply to a particular transaction. Some of the most frequently used exemptions are summarized in Annex 11.
Reporting an M&A Transaction Notification and Report The HSR Act generally requires the “ultimate parent entity” of each acquiring and acquired person in a reportable transaction to file a Notification and Report Form with the FTC and the DOJ, and to certify the person’s present intention to carry out the subject transaction. Subject to certain exceptions, in order to make such a filing the parties must have entered into a written agreement, at least in principle, to proceed with a particular transaction. Generally, a letter of intent to proceed towards a specific transaction is sufficient to support an HSR filing, but the execution of such a letter does not mandate that a filing be made at that stage. In fact, there is no deadline for filing under the HSR Act — if a transaction is reportable, however, the HSR Act prohibits consummation until the necessary filings have been made and the applicable waiting period (discussed below) has been observed. 117
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The Notification and Report Form requires the submission of both documents and information. Notably, in addition to basic information about the transaction and the parties, the form requires each person to submit: • information about revenues derived in a “base” year (currently 2002) and in the most recent year (these must be categorized by NAICS code at varying levels of detail); • information regarding the parties’ corporate structure and securities holdings; • information concerning the acquiring person’s acquisitions in the previous five years in the same industries in which the target is active; and • certain SEC filings, annual reports, and recently prepared balance sheets. In addition, the parties must submit certain documents, known as “4(c)” documents after the relevant item on the form, containing information relevant to the competitive analysis of the transaction. Item 4(c) seeks “all studies, surveys, analyses and reports which were prepared by or for any officer(s) or director(s)...for the purpose of evaluating or analyzing the acquisition with respect to market shares, competition, competitors, markets, potential for sales growth or expansion into product or geographic markets...” The definition covers any type of “document,” ranging from an informal e-mail or hand-written note to a lengthy and carefully prepared report. It is limited, however, to documents that relate to the specific transaction under scrutiny. The agencies are particularly attentive to Item 4(c) and the consequences of noncompliance can be severe, including significant monetary penalties and injunctive relief against the transaction. It is therefore imperative for filing persons both to conduct a thorough search for 4(c) documents and to create a reliable paper trail of having done so. The item 4(c) requirement also raises issues with respect to document creation, because the agencies often rely on 4(c) documents to form their initial impression of the competitive effects of a transaction. For this reason, it is essential to use great care in preparing analyses (or even descriptions) of the proposed transaction. Parties to transactions that may raise substantial competitive issues are well-advised to engage antitrust counsel in the early stages of deal negotiation, in order to develop a successful regulatory strategy and review all documents relating to the acquisition, 118
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such as board materials, press releases, public announcements and internal assessments. Confidentiality All submissions made by acquiring and acquired persons to the antitrust agencies under the HSR Act are confidential (even with respect to other filers in the same transaction) and not subject to the Freedom of Information Act (“FOIA”). An exception to this general rule occurs when the parties request early termination of the waiting period (as discussed below) and that request is granted. In such cases, the fact that early termination was granted to a transaction between an identified acquiring person and an identified acquired person is published in the Federal Register and on the FTC’s Website. By contrast, no public announcement is associated with the expiration (as opposed to the early termination) of the waiting period. Because only the grant of early termination of the waiting period is disclosed to the public, in some cases parties may prefer not to request early termination in order to avoid the risk of premature disclosure. Although HSR Act submissions are not subject to FOIA, in cases raising substantial competition issues certain documents and information submitted under the Act eventually may enter the public domain as a result of becoming part of the record in a court action brought by the agencies to enjoin the transaction. The Act’s confidentiality provisions also do not prevent access to the information by Congress. Transactions that raise competitive concerns also present unique challenges from the standpoint of confidentiality because the agencies will contact third parties — such as customers or competitors — in the context of investigating such transactions. While the agencies are not permitted to reveal that an HSR filing has been made, the nature of their inquiries may very likely tip off third parties that a particular transaction is about to occur. For this reason, parties to transactions that may raise competitive issues often choose to initiate the HSR process only after entering into a definitive agreement. Confidentiality concerns can also arise vis-à-vis other filers in the same transaction. Preparing an HSR filing often requires counsel for the various parties to consult with each other with respect to limited aspects of the Form and documents to be produced. Similarly, counsel to parties in a transaction that is likely to raise competitive issues will need to communicate with each other, and possibly with each other’s clients and expert economic consultants, in advance of the filing in order to prepare and implement a defense 119
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strategy. Because HSR filings are made in anticipation of the possibility that the government may sue to enjoin the transaction, the joint defense privilege typically attaches to all such communications regardless of whether a specific written agreement is executed to that effect. Nevertheless, parties to transactions that are likely to raise competitive issues are well-advised to formalize a joint defense agreement in written form during the early stages of preparing their respective HSR filings. Filing Fees The acquiring person in a reportable transaction is responsible for paying the applicable filing fee. Although the rules permit filers to split the fee, the common practice is for one party, typically the acquiring person, to pay the entire applicable fee and seek separate reimbursement from the other party(ies). This minimizes confusion and ensures that the appropriate fee is linked to the corresponding transaction. The amount of the filing fee depends upon the size of the transaction, and the relevant thresholds are also subject to annual adjustment by the FTCO. The following table shows current transaction value thresholds and the corresponding filing fees: TRANSACTION VALUE
FILING FEE
Greater than $59.8 million, but less than $119.6 million
$ 45,000
$119.6 million or more, but less than $597.9 million
$125,000
$597.9 million or more
$280,000
Waiting Period The Act prescribes a waiting period (typically 30 days) during which the parties may not consummate the acquisition. The waiting period is intended to maintain the competitive status quo while the agencies analyze whether the proposed transaction may substantially lessen competition in any relevant market. The start of the waiting period is usually triggered by the agencies’ receipt of complete filings from each person that is required to make one for the transaction in question. If a transaction raises no competitive issues, the agencies may simply let the waiting period expire without further action. Upon expiration of the waiting period, the parties may close the transaction without any form of official “clearance� by the agencies. 120
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The parties also may request early termination of the waiting period by checking the appropriate box on the Notification and Report Form. A single filing person’s request for early termination is sufficient to trigger the agencies’ review and possible grant of the request and, as discussed above, the grant of early termination is published in the Federal Register and on the FTC’s Website. Therefore, parties wishing to maintain the confidentiality of the transaction must ensure that no person making a filing in connection with the transaction requests early termination. If early termination is requested and granted, the grant typically comes two to three weeks after all filings required for the particular transactions are received by the agencies. Don’t Jump the Gun While the HSR Act proscribes formal consummation of a reportable transaction prior to the expiration, or early termination, of the waiting period, certain conduct by the parties short of actual consummation can also be deemed to transfer “beneficial ownership” of the voting securities, assets, or non-corporate interests of the acquired person to the acquiring person, and thereby to violate the Act’s waiting period provisions. This type of conduct is known as “jumping the gun” and can lead to severe consequences, including substantial monetary penalties and injunctive relief against the parties and the transaction. In addition to the HSR Act, the parties’ conduct prior to closing must also comply with the substantive provisions of the Sherman Act, which prohibits collusion among competitors. Indeed, the Sherman Act requires the parties prior to closing to consider one another as separate, independent entities (and competitors, if appropriate), and to continue to deal with each other accordingly. For example, the Sherman Act requires parties prior to closing not to share with each other certain information (such as detailed, competitively sensitive information about customers, prospective strategic plans or current and future pricing) that would put the owner of that information at a competitive disadvantage vis-à-vis the other party(ies) in the event that the deal falls through. The antitrust agencies also understand, of course, that the success of most mergers and acquisitions depends on meticulous due diligence and the ability to plan in advance for a smooth transition post-closing. The agencies recognize, therefore, that a flexible, fact-specific approach is required in the application of the rules that govern the parties’ conduct during the HSR waiting period and, more generally, during the period between the signing of the deal documents and closing. It is also broadly 121
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understood that the range of permissible conduct in this context increases as the closing draws nearer and conditions precedent to closing are satisfied, making consummation increasingly likely. Because the permissibility of particular conduct depends heavily on the specific circumstances of each case, reliance on the advice of specialized counsel in this context is particularly advisable. Certain clear “DOs” and “DON’Ts” nevertheless emerge against this background. The following is a list of the major ones, but it is not intended, and should not be taken, as a substitute for the advice of counsel under specific circumstances: • DON’T: • Transfer beneficial ownership of assets from one party to the other; • Commingle the business or assets of the two parties; • Take part in the business decisions of the other party; • Allocate customers; • Jointly negotiate with or sign agreements with customers; • Jointly market specific products to customers; • Coordinate pricing; • Agree to terminate any product lines or implement other output restrictions; • Begin joint product development; • Agree to eliminate a marketing or promotional program; • Share current and/or future pricing information and/or strategies; • Share internal planning documents; and • Share competitively sensitive cost information. • DO: • Plan for a successful transition without actually implementing it until after closing; • Create specialized teams — possibly consisting, if practicable, of third party consultants — to handle particular transition planning or due diligence tasks, and create firewalls to protect competitively sensitive information; 122
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• Jointly inform customers about the impending transaction, without, however, jointly marketing specific products to customers or reaching joint agreements with customers; and • To the extent necessary, exchange aggregate — not specific — customer or product information.
Practical Tip: Diligence and Transition Planning One way to ensure thorough due diligence and a successful transition without running afoul of the antitrust laws is to make sure that due diligence and transition personnel for each company are different from the personnel involved in daily business operations.
What are the consequences of non-compliance? In a word: severe. Failure to report an otherwise reportable transaction, gun-jumping, failure to produce all 4(c) documents, and other HSR Act violations can carry stiff penalties. The antitrust agencies can seek fines of up to $11,000 per day of non-compliance and drastic injunctive relief, including retroactive relief like the undoing of the transaction and “disgorgement” of unlawful monopoly gains. The HSR Act and rules also punish efforts to structure or analyze transactions in particular ways solely for the purpose of avoiding an HSR filing. The agencies condemn such “creative” practices as “devices for avoidance” and will disregard them, deeming the parties to the transaction to be in violation of the Act unless and until compliance is achieved. Heavy fines can also be imposed for engaging in such practices. For example: • To settle gun-jumping allegations by the Department of Justice, Gemstar-TV Guide agreed to pay a fine of $5,676,000. See United States v. Gemstar-TV Guide International Inc., 2003 WL 21799949 (D.D.C July 11, 2003). • The Hearst Trust agreed to pay a $4 million fine for failure to disclose certain 4(c) documents in connection with its acquisition of Medispan. United States v. The Hearst Trust and The Hearst Corp., Civ. No. 01-2119 (D.D.C. Oct. 10, 2001). 123
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• Smithfield Foods, Inc. was fined $2 million for failing to report its acquisition of voting securities of IBP, Inc. (total exposure was almost $5.5 million). United States v. Smithfield Foods, Inc. Civ. No. 04-526 (D.D.C. Nov. 12, 2004).
Beyond Notification What Does the Government Do with the Information Provided? During the statutory waiting period, one of the agencies (either the FTC or the DOJ) takes the lead in analyzing the transaction to determine whether it may substantially lessen competition or tend to create a monopoly. In the vast majority of cases, the agency will determine that the transaction does not raise competitive concerns. In these cases, the agencies will either let the waiting period expire or, if requested by the parties and appropriate, will grant early termination of the waiting period. Upon expiration or early termination of the waiting period, the parties are free to proceed to closing as far as the HSR Act is concerned. Additional Requests for Information and “Second Requests” In some (relatively few) cases, an agency will identify one or more aspects of the transaction that, in the agency’s view, may harm competition and warrant further investigation. In these cases, as a first step the agencies typically request some additional information from the parties on a voluntary basis during the pendency of the waiting period. These requests for voluntary production of information are designed to address specific concerns identified by the agencies and may include, among other things, requests for more detailed product or service information, capacity and location of facilities, sales information, top customers, suppliers, and competitors, industry or market analyses, and strategic business plans. The agencies very likely will contact customers to elicit their views about the state of competition in relevant markets. The agencies may also request to speak with one or more company representatives on an informal basis about specific issues. Generally, it is in the parties’ best interest to respond promptly and effectively to these informal requests for voluntary production in order to address the agencies’ concerns before the end of the initial waiting period. Indeed, parties to transactions that may raise serious competitive issues are well-advised, with counsel’s assistance, to identify in advance the likely areas of agency concern, to prepare documents and presentation materials to address those concerns, and to anticipate the agencies’ likely requests 124
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for voluntary production of information in order to respond as promptly as possible. The reason for this is that, if the agencies’ concerns are not put to rest within the initial waiting period, the agencies will pursue the investigation by issuing a formal Request for Additional Information or Documentary Material, otherwise known as a “Second Request.” A Second Request is an extensive and considerably burdensome request for documents and narrative responses that, among other things, extends the waiting period for most types of transactions until 30 days after all parties have “substantially complied” with its demands. This usually translates into at least a several-month delay in the HSR review process and indicates the agencies’ belief that the transaction may have serious detrimental effects on competition. While the parties can, and usually do, negotiate the scope and timing of a Second Request, the burden of compliance remains a heavy one. It is not unusual for a submission in response to a Second Request to include tens or even hundreds of thousands of pages of documents and extensive and detailed narrative responses, and to impose considerable costs on the parties in the way of diverted resources and very substantial professional fees for attorneys and expert economic consultants. The investigation that accompanies a Second Request is also likely to require a company to produce one or more employees to discuss relevant issues in person with government lawyers. What if the transaction may “substantially lessen competition?” At any time during the HSR review period, the antitrust agencies can challenge the legality of the transaction in court by filing a complaint alleging that consummation likely would lessen competition substantially or tend to create a monopoly. The agencies likely also would request, and very likely obtain, a preliminary injunction preventing the transaction from closing until the legal process had run its course. By way of relief, the agency most likely would seek either to block the transaction altogether or to dilute its perceived anticompetitive effects by compelling the parties to divest (or, in appropriate cases, license) certain assets to a third part or parties. In the absence of a compromise or settlement, the parties and the government would proceed to litigate the antitrust claims, which are widely recognized as being among the most expensive and time-consuming varieties of litigation. Most frequently, however, the impending threat of litigation against the government leads the merging parties either to abandon the transaction altogether or to seek a compromise before a lawsuit is filed. The nature of 125
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such a compromise is obviously closely tied to the specific facts of the industry and transaction in question, but often involves some form of divestiture to a third party. There is also the possibility, of course, that either before, during, or as a result of issuing a Second Request, the investigating agency will conclude that the transaction does not raise substantial antitrust concerns and will notify the parties of its present intention not to take further action.
Beyond the HSR Act “Government Challenges Outside the Statutory Context” While the HSR Act provides the federal antitrust agencies with a framework to review certain transactions and the opportunity to raise a timely challenge in court, the Act does not limit the agencies’ ability to challenge any transaction in any way. In other words, the federal agencies — and the offices of the state attorneys general — are generally free to file a lawsuit against both a transaction that was not reportable under the HSR Act and against a transaction that was reported and went through the HSR process without challenge. The only limitations on these types of challenges are of a practical nature. Absent the HSR statutory scheme, governmental agencies may find it inefficient or impractical to challenge transactions after consummation or to learn about unreportable transactions in time to act effectively. “International Pre-Merger Notification Requirements” Today, approximately 68 national and regional jurisdictions around the world have some form of merger notification law, most of which include compulsory filing and waiting period provisions similar to the HSR Act and may carry penalties for noncompliance. Parties to transactions involving non-U.S. assets or companies are well-advised to seek the advice of specialized counsel to determine in advance whether the transaction in question may be subject to one or more non-U.S. merger notification regimes.
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Chapter 12 Tax Considerations Taxable Transactions The following are the basic rules that apply to the taxation of business acquisitions in the absence of a valid tax-free structure. Generally speaking, a taxable transaction from the seller’s standpoint can have very beneficial results for the buyer. Taxable Asset Sale • The seller recognizes gain on the sale of its assets and its stockholders will recognize gain on the distribution of any proceeds from the sale. Thus, an asset sale results in two levels of tax on the seller side if proceeds are distributed, an unfavorable result for the seller and its stockholders if significant appreciation exists. If the seller in an asset acquisition is an S-corporation, any income or gain realized on the sale will be passed through to the S corporation’s stockholders and taxed directly to the stockholders, avoiding the corporate-level tax. Generally, only one level of tax is paid where assets of an 80%-owned subsidiary are acquired. The result may not trouble the seller if it has substantial net operating losses (NOLs). • The buyer will receive a step-up in basis of the assets it acquired from the seller, enabling the buyer to take greater depreciation on the assets acquired. This can be a significant benefit for the buyer on a going-forward basis. • A taxable forward direct merger transaction or forward-triangular merger is treated for tax purposes as an asset sale. Taxable Stock Purchase Transaction • In a taxable stock purchase transaction, the individual stockholders who sell their shares to the buyer will be taxed on any gain they realize on the sale of their shares. The seller will not realize any tax unless a 338(h)(10) election is made, which causes the transaction to be treated as if it were an asset sale. This election is only allowable if the seller is an S corporation (i.e., flow-through treatment is available) or is an 80%-owned subsidiary. The buyer will not get a step-up in basis of the seller’s assets unless a 338(h)(10) election is made. 127
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• A taxable reverse-triangular merger is treated for tax purposes as a stock purchase.
Tax-Free Reorganizations To qualify as a tax-free reorganization under the Internal Revenue Code and related IRS rules and regulations, several requirements must be satisfied. Two of the most important requirements are, broadly speaking, that the buyer must continue the seller’s business in some form and that the seller’s stockholders must continue to hold on to the shares of buyer stock they received in the transaction (the so-called “continuity of interest” test). In practice, a critical factor in whether the deal will receive tax-free treatment is the nature of the consideration the seller and its stockholders received. Under some tax-free reorganization structures, only stock may be paid, whereas in others some non-stock consideration (also known as “boot”) may be permissible. In other words, the type of tax-free reorganization the transaction is structured as will dictate the amount of cash that can be paid in the deal. Under no circumstances, however, will tax-free treatment be available if more than 60% of the total value of the deal is in cash or property other than buyer stock. In a valid tax-free reorganization, the seller’s stockholders will not recognize any gain on the sale of stock and the seller will not recognize gain with respect to its assets, except that tax must be paid by the stockholders on the value of any non-stock consideration paid. Thus, a “tax-free” deal will in reality often result in some tax to the selling stockholders to the extent cash is involved. With respect to the portion of their stock for which the stockholders received tax-free treatment, they will “carry over” their basis in that old stock to the new buyer stock they obtain in the transaction and will subsequently realize taxable income or loss only on a taxable disposition of those shares. A buyer will not be able to obtain a step-up in the basis of the seller’s assets in the event of a valid tax-free reorganization. The following reorganizations:
transactions
may
be
treated
as
“tax
free”
• Type A — Two-party direct statutory merger where at least 40% of the consideration is buyer stock. If structured properly, this transaction will be tax-free to the seller’s stockholders and the seller, except to the extent of any non-stock consideration. • Type B — A stock purchase where the entire consideration is voting stock of the buyer. No consideration other than voting stock is 128
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permitted in a Type B reorganization, although cash received in lieu of fractional shares will not be considered boot. If structured properly, this transaction will be tax-free to the seller and its stockholders. • Type C — buyer issues voting stock in exchange for substantially all of the seller’s assets. If the buyer issues non-stock consideration, the sum of the consideration other than voting stock and liabilities assumed cannot exceed 20% of the total consideration. Per IRS guidelines, the buyer should obtain assets representing at least 90% of the fair market value of the seller’s net assets and at least 70% of the gross assets the seller holds immediately prior to the transaction. This transaction will be tax-free to the seller and its stockholders, except to the extent of any non-stock consideration. • Forward Triangular Merger — Consideration in a forward triangular merger generally includes up to 60% non-stock consideration. The newly formed subsidiary must acquire substantially all of the seller’s assets under the same 70-90 test as for a Type C reorganization. This transaction will be tax-free to the seller’s stockholders, except to the extent of any non-stock consideration. • Reverse Triangular Merger — Permissible consideration is determined under a complex rule requiring that “control” of the target must be acquired in exchange for voting stock of buyer. In practice, if (1) the buyer doesn’t already own any target stock, (2) the target has only one class of stock, and (3) all stockholders receive the same mix of consideration per share, this translates into a requirement that 80% of the total consideration be in the form of voting stock. The seller must have substantially all assets after the transaction under the same test as for a Type C reorganization. This transaction will be tax-free to the seller’s stockholders, except to the extent of any nonstock consideration. A few additional points worth noting: • So-called “multi-step” tax free reorganizations can under some circumstances enable the parties to effect a reverse-triangular merger — and thereby take advantage of some of the key benefits inherent in that structure, such as the continuity of existence of the seller that reduces the need for third-party consents — while including up to 60% boot in the deal rather than the usual 20% limit. One example of a multi-step reorganization involves a standard reverse-triangular merger, followed by an upstream merger of seller into buyer. 129
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• Other provisions in the tax code permit tax free transactions that are less relevant in the business sale context, such as spin-offs or split ups, recapitalizations and re-incorporations achieved through downstream mergers. • Parties seeking to structure a transaction as a Type B or C reorganization or a reverse triangular merger must in some cases take great care to ensure that any stock consideration delivered will qualify as voting stock. • The Internal Revenue Service rules and regulations relating to taxation of business combinations are extremely complex and evolving, and are dependent on the specific facts and circumstances of each particular case. Participants to M&A transactions must consult their tax advisors.
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Annex 3-A Mutual Nondisclosure Agreement This Mutual Nondisclosure Agreement (this “Agreement”) by and between ,a corporation, and ,a corporation (each a “Party” and collectively, the “Parties”), is dated as of the latest date set forth on the signature page hereto. 1. General. In connection with the consideration of a possible negotiated transaction (a “Possible Transaction”) between the Parties and/or their respective subsidiaries (each such Party being hereinafter referred to, collectively with its subsidiaries, as a “Company”), each Company (in its capacity as a provider of information hereunder, a “Provider”) is prepared to make available to the other Company (in its capacity as a recipient of information hereunder, a “Recipient”) certain “Evaluation Material” (as defined in Section 2 below) in accordance with the provisions of this Agreement, and to take or abstain from taking certain other actions as hereinafter set forth. 2. Definitions. (a) The term “Evaluation Material” means information concerning the Provider which has been or is furnished to the Recipient or its Representatives in connection with the Recipient’s evaluation of a Possible Transaction, including its business, financial condition, technology, operations, assets and liabilities, and includes all notes, analyses, compilations, studies, interpretations or other documents prepared by the Recipient or its Representatives which contain or are based upon, in whole or in part, the information furnished by the Provider hereunder. The term Evaluation Material does not include information which (i) is or becomes generally available to the public other than as a result of a disclosure by the Recipient or its Representatives in breach of this Agreement, (ii) was within the Recipient’s possession prior to its being furnished to the Recipient by or on behalf of the Provider, provided that the source of such information was not bound by a confidentiality agreement with, or other contractual, legal or fiduciary obligation of confidentiality to, the Provider with respect to such information, or (iii) is or becomes available to the Recipient on a non-confidential basis from a source other than the Provider or its Representatives, provided that such source is not bound by a confidentiality agreement with, or other contractual, legal or fiduciary obligation of confidentiality to, the Provider with respect to such information. A-1
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
(b) The term “Representatives” shall include the directors, officers, employees, agents, partners or advisors (including, without limitation, attorneys, accountants, consultants, bankers and financial advisors) of the Recipient or Provider, as applicable. (c) The term “Person” includes the media and any corporation, partnership, group, individual or other entity. 3. Use of Evaluation Material. Each Recipient shall, and it shall cause its Representatives to, use the Evaluation Material solely for the purpose of evaluating a Possible Transaction, keep the Evaluation Material confidential, and, subject to Section 5, will not, and will cause its Representatives not to, disclose any of the Evaluation Material in any manner whatsoever; provided, however, that any of such information may be disclosed to the Recipient’s Representatives who need to know such information for the sole purpose of helping the Recipient evaluate a Possible Transaction. Each Recipient agrees to be responsible for any breach of this Agreement by any of such Recipient’s Representatives. This Agreement does not grant a Recipient or any of its Representatives any license to use the Provider’s Evaluation Material except as provided herein. 4. Non-Disclosure of Discussions. Subject to Section 5, each Company agrees that, without the prior written consent of the other Company, such Company will not, and it will cause its Representatives not to, disclose to any other Person (i) that Evaluation Material has been exchanged between the Companies, (ii) that discussions or negotiations are taking place between the Companies concerning a Possible Transaction or (iii) any of the terms, conditions or other facts with respect thereto (including the status thereof). 5. Legally Required Disclosure. If a Recipient or its Representatives are requested or required (by oral questions, interrogatories, other requests for information or documents in legal proceedings, subpoena, civil investigative demand or other similar process) to disclose any of the Evaluation Material or any of the facts disclosure of which is prohibited under Section 4 above, such Recipient shall provide the Provider with prompt written notice of any such request or requirement together with copies of the material proposed to be disclosed so that the Provider may seek a protective order or other appropriate remedy and/or waive compliance with the provisions of this Agreement. If, in the absence of a protective order or other remedy or the receipt of a waiver by the Provider, a Recipient or its Representatives are nonetheless legally compelled to disclose Evaluation Material or any of the facts disclosure of which is prohibited under Section 4 or otherwise be A-2
Annex 3-A - Mutual Nondisclosure Agreement
liable for contempt or suffer other censure or penalty, such Recipient or its Representatives may, without liability hereunder, disclose to such requiring Person only that portion of such Evaluation Material or any such facts which the Recipient or its Representatives is legally required to disclose, provided that the Recipient and/or its Representatives cooperate with the Provider to obtain an appropriate protective order or other reliable assurance that confidential treatment will be accorded such Evaluation Material or such facts by the Person receiving the material. 6. Return or Destruction of Evaluation Material. If either Company decides that it does not wish to proceed with a Possible Transaction, it will promptly inform the other Company of that decision. In that case, or at any time upon the request of a Provider for any reason, a Recipient will, and will cause its Representatives to, within five business days of receipt of such notice, destroy or return all Evaluation Material in any way relating to the Provider or its products, services, employees or other assets or liabilities, and no copy or extract thereof (including electronic copies) shall be retained, except that Recipient’s outside counsel may retain one copy to be kept confidential and used solely for archival purposes. The Recipient shall provide to the Provider a certificate of compliance with the previous sentence signed by an executive officer of the Recipient. Notwithstanding the return or destruction of the Evaluation Material, the Recipient and its Representatives will continue to be bound by such Recipient’s obligations hereunder with respect to such Evaluation Material. 7. No Solicitation/Employment. Neither Recipient will, within one year from the date of this Agreement, directly or indirectly solicit the employment or consulting services of or employ or engage as a consultant any of the officers or employees of the Provider, so long as they are employed by the Provider and for three months after they cease to be employed by Provider. A Recipient is not prohibited from soliciting by means of a general advertisement not directed at (i) any particular individual or (ii) the employees of the Provider generally. 8. Standstill. [Note: Delete this section if target Company is not publicly-held or likely to be publicly-held in the near future] Each Company agrees that, for a period of one year after the date of this Agreement, unless specifically invited in writing by the other Company, neither it nor any of its affiliates (as such term is defined under the Securities Exchange Act of 1934, as amended (the “1934 Act”)) or A-3
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
Representatives of such Company (acting in any capacity other than as an advisor in any of the following cases) will in any manner, directly or indirectly: (a) effect, seek, offer or propose (whether publicly or otherwise) to effect, or cause or participate in, or in any way assist any other Person to effect, seek, offer or propose (whether publicly or otherwise) to effect or participate in: (i) any acquisition of any securities (or beneficial ownership thereof) or assets of the other Company or any of its subsidiaries, (ii) any tender or exchange offer, merger or other business combination involving the other Company or any of its subsidiaries, (iii) any recapitalization, restructuring, liquidation, dissolution or other extraordinary transaction with respect to the other Company or any of its subsidiaries, or (iv) any “solicitation” of “proxies” (as such terms are used in the proxy rules of the Securities and Exchange Commission) or consents to vote any voting securities of the other Company; (b) form, join or in any way participate in a “group” (as defined under the 1934 Act) with respect to the securities of the other Company; (c) make any public announcement with respect to, or submit an unsolicited proposal for or offer of (with or without condition), any extraordinary transaction involving the other Company or its securities or assets; (d) otherwise act, alone or in concert with others, to seek to control or influence the management, Board of Directors or policies of the other Company; (e) take any action which might force the other Company to make a public announcement regarding any of the types of matters set forth in (a) above; or (f) enter into any discussions or arrangements with any third party with respect to any of the foregoing. Each Company also agrees during such period not to request the other Company (or its directors, officers, employees or agents), directly or indirectly, to amend or waive any provision of this Section 8 (including this sentence). A-4
Annex 3-A - Mutual Nondisclosure Agreement
9. Maintaining Privilege. If any Evaluation Material includes materials or information subject to the attorney-client privilege, work product doctrine or any other applicable privilege concerning pending or threatened legal proceedings or governmental investigations, each Company understands and agrees that the Companies have a commonality of interest with respect to such matters and it is the desire, intention and mutual understanding of the Companies that the sharing of such material is not intended to, and shall not, waive or diminish in any way the confidentiality of such material or its continued protection under the attorney-client privilege, work product doctrine or other applicable privilege. All Evaluation Material provided by a Company that is entitled to protection under the attorney-client privilege, work product doctrine or other applicable privilege shall remain entitled to such protection under these privileges, this Agreement, and under the joint defense doctrine. 10. Compliance with Securities Laws. Each Recipient agrees not to use any Evaluation Material of the Provider in violation of applicable securities laws. [Note: Delete this section if Provider is not publiclyheld or likely to be publicly-held in the near future] 11. Not a Transaction Agreement. Each Company understands and agrees that no contract or agreement providing for a Possible Transaction exists between the Companies unless and until a final definitive agreement for a Possible Transaction has been executed and delivered, and each Company hereby waives, in advance, any claims (including, without limitation, breach of contract) relating to the existence of a Possible Transaction unless and until both Companies shall have entered into a final definitive agreement for a Possible Transaction. Each Company also agrees that, unless and until a final definitive agreement regarding a Possible Transaction has been executed and delivered, neither Company will be under any legal obligation of any kind whatsoever with respect to such Possible Transaction by virtue of this Agreement except for the matters specifically agreed to herein. Neither Company is under any obligation to accept any proposal regarding a Possible Transaction and either Company may terminate discussions and negotiations with the other Company at any time. 12. No Representations or Warranties; No Obligation to Disclose. Each Recipient understands and acknowledges that neither the Provider nor its Representatives makes any representation or warranty, express or implied, as to the accuracy or completeness of the Evaluation Material furnished by or on behalf of such Provider and shall have no liability to the Recipient, its Representatives or any other Person relating to or resulting from the use of the Evaluation Material furnished to such Recipient or its Representatives A-5
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
or any errors therein or omissions therefrom. As to the information delivered to the Recipient, each Provider will only be liable for those representations or warranties which are made in a final definitive agreement regarding a Possible Transaction, when, as and if executed, and subject to such limitations and restrictions as may be specified therein. Nothing in this Agreement shall be construed as obligating a Company to provide, or to continue to provide, any information to any Person. 13. Modifications and Waiver. No provision of this Agreement can be waived or amended in favor of either Party except by written consent of the other Party, which consent shall specifically refer to such provision and explicitly make such waiver or amendment. No failure or delay by either Party in exercising any right, power or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise thereof preclude any other or future exercise thereof or the exercise of any other right, power or privilege hereunder. 14. Remedies. Each Company understands and agrees that money damages would not be a sufficient remedy for any breach of this Agreement by either Company or any of its Representatives and that the Company against which such breach is committed shall be entitled to equitable relief, including injunction and specific performance, as a remedy for any such breach or threat thereof. Such remedies shall not be deemed to be the exclusive remedies for a breach by either Company of this Agreement, but shall be in addition to all other remedies available at law or equity to the Company against which such breach is committed. 15. Legal Fees. In the event of litigation relating to this Agreement, if a court of competent jurisdiction determines that either Company or its Representatives has breached this Agreement, then the Company which is, or the Company whose Representatives are, determined to have so breached shall be liable and pay to the other Company the reasonable legal fees and costs incurred by the other Company in connection with such litigation, including any appeal there from. 16. Governing Law. This Agreement is for the benefit of each Company and shall be governed by and construed in accordance with the laws of the State of applicable to agreements made and to be performed entirely within such State. 17. Severability. If any term, provision, covenant or restriction contained in this Agreement is held by any court of competent jurisdiction to be invalid, void or unenforceable, the remainder of the terms, provisions, covenants or restrictions contained in this Agreement shall remain in full A-6
Annex 3-A - Mutual Nondisclosure Agreement
force and effect and shall in no way be affected, impaired or invalidated, and if a covenant or provision is determined to be unenforceable by reason of its extent, duration, scope or otherwise, then the Companies intend and hereby request that the court or other authority making that determination shall only modify such extent, duration, scope or other provision to the extent necessary to make it enforceable and enforce them in their modified form for all purposes of this Agreement. 18. Construction. The Companies have participated jointly in the negotiation and drafting of this Agreement. If an ambiguity or question of intent or interpretation arises, this Agreement shall be construed as if drafted jointly by the Companies and no presumption or burden of proof shall arise favoring or disfavoring either Company by virtue of the authorship at any of the provisions of this Agreement. 19. Term. This Agreement shall terminate three years after the date of this Agreement. 20. Entire Agreement. This Agreement contains the entire agreement between the Companies regarding the subject matter hereof and supersedes all prior agreements, understandings, arrangements and discussions between the Companies regarding such subject matter. 21. Counterparts. This Agreement may be signed in counterparts, each of which shall be deemed an original but all of which shall be deemed to constitute a single instrument. IN WITNESS WHEREOF, each of the undersigned entities has caused this Agreement to be signed by its duly authorized representatives as of the date written below. Date: [COMPANY NAME] ADDRESS FOR NOTICE: By:
[COMPANY NAME] ADDRESS FOR NOTICE: By:
Name: Title:
Name: Title:
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The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
A-8
Annex 3-B Summary Checklist Definition of Confidential Information Providers should n Confirm that the definition of “confidential information” sufficiently covers the information and materials to be provided (and, to the extent applicable, confidential information that may have been previously provided). n Consider removing legending requirements (that any written materials be marked “confidential” or that oral statements be reduced to writing and so marked to be considered confidential) to avoid accidental failures to legend leading to unprotected confidential information. n Consider having any subset of extremely confidential information being supplied (such as pricing information, patent information, or source code) carved out and addressed separately under a special NDA implementing careful controls and procedures to limit the distribution and access of the information to those advisors or agreed upon personnel of the recipient whom the provider believes cannot exploit the information commercially, especially where the recipient is a close competitor. n Remove any “residual” clause that allows the recipient to use, in future products or services, any information retained in the memory of the recipient’s employees that was obtained by reviewing the confidential information. Recipients should n Confirm that the exclusions from what is considered confidential information properly reflect the principle that information should not be protected if it was created or discovered by the recipient prior to, or independent of, any involvement with the disclosing party. n Consider removing legending requirements to avoid overly burdening the due diligence process. A-9
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
Use of Confidential Information Providers should n Confirm that there exists language limiting the use of the confidential information to the contemplated purpose (evaluation of the specific transaction) and not for any other purpose. n Confirm that there exists language clarifying that no license is being granted to the recipient or its representatives to use the confidential information except for the specific purpose of evaluating the transaction, and that no license is being granted to any of the provider’s intellectual property. n Confirm that the recipient is responsible/liable for its representatives’ proper use of the confidential information to the extent that the provider does not request such representatives to be parties to the NDA. n If the provider is a publicly traded company, confirm that the recipient will not use confidential information in violation of applicable securities laws. n Consider implementing controls and procedures to limit the distribution and access of the information if there is extremely confidential information being supplied or if the recipient is a close competitor, but where these factors do not rise to the level of affording treatment of the more sensitive portion under a special NDA. n Confirm that there exists language clarifying that information provided does not constitute any representation or warranty of the provider but that such representations and warranties are limited to what is provided for in the definitive agreement.
Non-Disclosure of Discussions Providers should n Confirm that the NDA contains language clarifying that the fact that discussions are taking place between the parties regarding the transaction is confidential, especially if the provider is a publicly traded company. n If the provider is the selling company in an auction context, attempt to retain some limited ability to disclose the fact that the recipient is bidding or, to the extent possible, to disclose the terms of any bid made by recipient. A-10
Annex 3 -B - Summary Checklist
Recipients should n Confirm that the NDA contains language clarifying that the discussions between the parties regarding the transaction are confidential, including the identity of the parties and the terms of any bid if the recipient is the acquiring company. n If the recipient is the acquiring company and needs financing for the transaction, obtain a carve-out allowing information to be disclosed to financiers.
Legally Required Disclosures Providers should n Consider requiring the recipient to fully cooperate with the provider in obtaining any applicable protective orders if requested. Recipients should n Confirm that there exists an exception to the NDA allowing the recipient to disclose information that is legally required to be disclosed.
Return or Destruction of Materials Providers should n Confirm that there exists language providing for the return or destruction of any written confidential information provided. n If a copy is to be retained for archival/evidentiary purposes, confirm that it will be kept by outside counsel. Recipients should n Consider ensuring outside counsel the right to retain one copy for archival/evidentiary purposes. n Confirm that the recipient is permitted to destroy or certify destruction of information to satisfy its obligations. A-11
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
Non-Solicitation/Employment Providers should n Confirm that the NDA contains language providing for protection against the recipient’s soliciting of the provider’s employees for some amount of time (typically 6 months to 2 years, with one year being fairly common) as well as against soliciting former employees who recently departed (typically three to six months is common). n The recipient may argue strongly against this because it is a large entity that will have difficulty keeping track of solicitation and hiring activities. If this occurs, consider this alternative: limiting interaction between both parties’ employees by restricting which provider employees the recipient will be allowed to contact. Recipients should n Consider a limiting provision that would apply only to “key” employees or employees of the provider who were identified to the recipient during the diligence process. n Confirm that there exists a carve-out for general solicitation not directed at provider employees. n Consider removing this provision altogether if it concerns a large entity that would have difficulty keeping track of solicitation and hiring activities.
Term Providers should n Consider language providing that the NDA does not expire, as what is confidential now may need to remain just as confidential years from now. n Consider setting an unlimited term for trade secrets recipients. n Consider limiting the NDA to a specific time period (typically 1 to 5 years). A-12
Annex 3 -B - Summary Checklist
Remedies Providers should n Confirm that there exists language having the recipient acknowledge and agree that monetary damages are insufficient to remedy breach of the NDA, and that the provider is entitled to equitable relief in addition to any other remedies.
Miscellaneous Provisions Applicable to Providers and Recipients Privileged Information. Consider language stating that disclosure is not deemed to have waived or diminished attorney-client privilege, attorney work-product protection, or any other privilege or protection applicable to the confidential information that relies upon a form of the joint defense doctrine. Note that the effectiveness of this provision is not certain that. Binding Agreement. Confirm that language exists clarifying that the NDA does not constitute an agreement to enter into or even negotiate a transaction, as sometimes courts have found an agreement to negotiate absent such language. Standstill Provisions. These provisions are only applicable where the target company is publicly traded or likely to be public soon, and, due to their complexity, should be carefully reviewed by sophisticated M&A counsel. No Shop. The seller should delete provisions restricting it from shopping as these are not typically agreed to until at least a term sheet or basic transaction terms are agreed upon. Export. If the providers have a particular concern about providing technical information to non-U.S. persons, they should consider adding a provision ensuring that a recipient complies with applicable export laws.
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The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
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Annex 4 Sample Due Diligence Checklist MEMORANDUM TO: FROM: DATE: RE:
*
Due Diligence Request List
In connection with the proposed acquisition of seller (the “Company”), [ ], as legal counsel to the buyer, will need to review the documents described on the attached list. References in the list to the “Company” should be deemed to include the Company, its subsidiaries and their respective predecessors. When you provide requested documents or information to us, please indicate in the spaces provided whether the document or other requested information has been previously provided, is currently being provided, is available for review at [your offices or the Company’s local office]. Please note that additional documents may be requested during the course of our review of the Company. If compiling any of the requested items would be impracticable or unduly burdensome, please let us know and we would be happy to discuss the items with you. In the event of any questions or comments, please do not hesitate to contact at . [BUYER CODE NAME]’S PRELIMINARY REQUEST FOR DUE DILIGENCE MATERIAL FROM [SELLER CODE NAME] “A” “P” “H” “N”
= = = =
Access to materials provided Copy Previously provided Copy provided Herewith Not applicable
“E” = Available through EDGAR (Identify by filing type, approx. date of filing, exhibit no.) [NOTE: Delete if Seller is private; also delete Sections 19 through 21 below] 1.
BASIC CORPORATE DOCUMENTS [
] (a) Legal entity structure, including name, physical location and function of all divisions, subsidiaries or affiliated entities.
[
] (b) Certificate or Articles of Incorporation and Bylaws, including all amendments. A-15
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
2.
3.
[
] (c) Minutes of all meetings and written consents of board of directors, Board committees and other committees and stockholders, including copies of notices of all such meetings where written notices were given and all written waivers of required notices.
[
] (d) List of all states and foreign countries where property is owned or leased or where employees are located, indicating in which jurisdictions the Company is qualified to do business and indicating principal business activity at each location.
[
] (e) List of states and foreign countries in which the Company contemplates undertaking business operations, either directly or through other parties.
STOCKHOLDER INFORMATION [
] (a) Samples of common and preferred stock certificates, debentures and any other outstanding debt or equity securities.
[
] (b) The Company’s stock books.
[
] (c) Lists of all current owners of shares, including address, number of shares owned, dates of issuance and full payment, the consideration received by the Company and applicable stop transfer orders or restrictive legends.
[
] (d) List of all options, warrants and other rights to acquire equity securities, including date of grant or issuance, exercise or conversion price, number of shares, vesting schedule and names and addresses of holders.
AGREEMENTS REGARDING SECURITIES [
] (a) Stock option plans and forms of option agreements which have been used.
[
] (b) Copies of all warrants, including all amendments.
[
] (c) Stock purchase agreements and any related documents.
[
] (d) Any other documents relating to sales of securities by the Company, including any private placement memoranda or other offering circulars.
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Annex 4 - Sample Due Diligence Checklist
4.
[
] (e) Any agreements and other documentation relating to repurchases, redemptions, exchanges, conversions or similar transactions involving the Company’s securities.
[
] (f) Permits, notices of exemption and consents for issuance or transfer of the Company’s securities and other evidence of qualification or exemption under applicable state blue sky laws.
[
] (g) Forms D or any other evidence of qualification or exemption under the Securities Act of 1933, as amended.
[
] (h) Employee stock ownership plans, stock purchase plans or similar plans and forms of agreements which have been used.
[
] (i) Copies of any voting trust, buy-sell or other similar agreement covering any of the Company’s securities.
[
] (j) All agreements containing registration rights or assigning such rights or any other rights (including preemptive rights, rights of first refusal, etc.) granted with respect to the capital stock of the Company.
OTHER MATERIAL CONTRACTS [
] (a) Convertible, senior or other debt financings, if any.
[
] (b) Bank line of credit or loan agreements and guarantees, including any amendments, renewal letters, notices, etc.
[
] (c) Description of any default by any party under any contract or commitment affecting the Company or its property, or any circumstance which might reasonably be expected in the future to give rise to such default.
[
] (d) All outstanding leases of real and personal property, including equipment leases.
[
] (e) All agreements entered into by the Company or any of its subsidiaries relating to a material acquisition or disposition of assets or stock and schedules of exceptions thereto.
[
] (f) Material contracts (over $ ) with suppliers, contract manufacturers or customers, including OEM and similar agreements.
[
] (g) List of major suppliers, indicating total and type of purchases from each supplier during the last two fiscal years and the A-17
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
current fiscal year, any key suppliers not subject to supply agreements, sole source suppliers and any subcontracted work. [
] (h) Model or standard sales or license agreements, if used by the Company.
[
] (i) Agreements for loans to key employees, and any other agreements with officers, directors, employees and consultants, whether or not now outstanding.
[
] (j) Schedule of insurance policies in force covering property of the Company and any other insurance policies in force (such as “key man” policies).
[
] (k) Partnership, product development and joint venture agreements, if any.
[
] (l) All security agreements covering the Company’s assets.
[
] (m) All agreements or proposed agreements with distributors, dealers and sales representatives.
[
] (n) Indemnification agreements.
[
] (o) Research and development agreements.
[
] (p) All agreements, or proposed agreements pursuant to which the Company licenses any of its proprietary rights or is licensed by any third party to any proprietary rights.
[
] (q) All agreements concerning the sharing of R&D facilities or similar agreements.
[
] (r) List and copies of any intercompany agreements with affiliated entities relevant to the development, use or commercialization of the Company’s technology (as defined below).
[
] (s) Copies of standard forms of purchase orders, quotations and order acknowledgments relevant to the Company’s technology.
[
] (t) Description of any provisions that purport to restrict the Company’s ability to compete with respect to the Company’s technology, whether by agreement, court order, or otherwise.
[
] (u) List and copies of all source code, manufacturing, development or other form of escrow agreements, whether internal or
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Annex 4 - Sample Due Diligence Checklist
third party escrow accounts, which relate to the Company’s technology and to which Company is a party. [ 5.
6.
] (v) Other material contracts.
PRODUCTS, MANUFACTURING AND COMPETITION [
] (a) List of principal products and, for each product, (i) short description of the product, (ii) principal competitive products, (iii) principal customers and (iv) sites where manufactured.
[
] (b) List of third party developers showing total and type of project for each developer.
[
] (c) List of third party software duplicators and manual publishers, if any.
[
] (d) Copies of any non-competition agreements of the Company or employees.
[
] (e) List of the top 20 customers of the Company, indicating the types of products and the amounts of each purchased.
[
] (f) List of service and support contracts.
[
] (g) Company-financed customer purchase agreements.
[
] (h) Price lists, catalogues and brochures for the Company’s products.
[
] (i) Forms of warranties and guarantees provided to customers.
[
] (j) List of major risks, in rough priority, of technical problems or limitations which current and planned product lines may encounter.
[
] (k) Description of any significant customer relationship terminated or suspended within the last three years.
GOVERNMENTAL REGULATIONS [
] (a) Permits for conduct of business, including licenses, franchises and concessions, if any.
[
] (b) All certificates, permits, etc., evidencing compliance with specific regulations, including environmental and workers health and safety regulations. A-19
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7.
[
] (c) List and description of any government regulations (federal, state, local or foreign) of whatever kind (safety, labor, environmental, etc.) which have special application to the Company’s business.
[
] (d) Copies of all material filings, applications and correspondence with, all documents relating to investigations or reviews conducted by, and all demands, notices, requests for information, approvals, authorizations, determinations, rulings or orders received from, any federal, state, local or foreign governmental agencies.
[
] (e) Description and status statement of all pending or threatened regulatory, judicial or administrative actions relating to regulatory matters.
[
] (f) Any material agreements, correspondence, undertakings, or understandings between the Company and any regulatory body.
[
] (g) Access to the Company’s files relating to regulatory matters; copies of reports of any inspections, surveys or audits, whether generated internally or by regulatory authorities or other third parties.
TAXATION [
] (a) Provide all federal, state, local and foreign income and franchise tax returns of Company filed for the last three fiscal years and all such returns for any prior year that is still subject to audit or adjustment.
[
] (b) Identify all jurisdictions in which sales and use tax returns are filed by Company including a summary by jurisdiction of total sales and use taxes paid during the last three fiscal years. Please provide details with respect to any significant changes to this list of filing jurisdictions since incorporation.
[
] (c) Provide a schedule by jurisdiction of all property taxes paid during the last three fiscal years.
[
] (d) Identify any excise tax returns filed by the Company for the production, sale and distribution of product; identify all jurisdictions where the Company is subject to VAT or a similar tax.
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Annex 4 - Sample Due Diligence Checklist
[
] (e) Provide any private letter ruling or other letter ruling obtained from the IRS or any state, and each application for any ruling (including any pending ruling) pertaining to Company.
[
] (f) Provide summary results of all tax examinations and audits (federal, state and foreign) pertaining to Company (including income, sales and use, employment, and property tax) completed within the last five years (or still outstanding) including copies of all revenue agent reports, closing agreements, or other correspondence from or to any taxing authority addressing issues raised in the examination.
[
] (g) Identify all material intercompany transactions within the last three fiscal years, including transactions between U.S. and foreign affiliates of the Company, as well as transactions between the Company and its stockholders, if not provided elsewhere.
[
] (h) Provide all tax sharing agreements, tax indemnity agreements, and transfer pricing agreements pertaining to the Company.
[
] (i) Provide a list of states in which more than [$100,000] products or services were sold within each of the last three fiscal years.
[
] (j) Provide a list of all states in which independent contractors perform any sales, marketing or product support activities (including installation, repair or warranty service) on behalf of the Company.
[
] (k) Provide a schedule of federal and state net operating loss carryforwards and tax credit carryforwards, including years of expiration.
[
] (l) Provide a description of any tax contingency reserves on the Company’s balance sheet and any work papers explaining such tax reserves.
[
] (m) Identify any pending claims for refund of any tax, fee or similar item.
[
] (n) Describe any material tax planning strategy or tax shelter transaction implemented within the last 5 years and provide any related correspondence. A-21
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
8.
9.
LITIGATION AND AUDITS [
] (a) All management letters or special reports from the auditor and responses thereto concerning internal accounting controls in connection with any current audit and the audits for the last three fiscal years.
[
] (b) Settlement documents, if any.
[
] (c) Decrees, order and judgments of courts or governmental agencies with respect to the Company.
[
] (d) Description of any warranty claims which have been made against the Company or any related partnership or joint venture and the resolutions of such claims.
[
] (e) List of pending, asserted or threatened lawsuits or other claims or investigations, together with short summary of the claims and related facts.
EMPLOYEES AND MANAGEMENT [
] (a) Description of any significant labor problems the Company has experienced.
[
] (b) Management and Organization chart.
[
] (c) Description of any material transactions since inception with any “insider” (i.e., any officer, director, or owner of a substantial amount of the Company’s securities) or any associate of an “insider.”
[
] (d) Copy of form of any invention and confidentiality agreement to protect trade secrets and list of any officers, directors, employees or consultants who have not signed such agreements.
[
] (e) Summary of standard employee benefits (vacation, sick leave, sabbatical, medical insurance, life and disability insurance, etc.)
[
] (f) A list of the amount of cash compensation (including as separate items the amount of salary, bonus, commission and deferred salary pursuant to any plans) and other forms of compensation (such as car allowances, forgiveness of loans and other perquisites) paid to each of the Company’s officers and directors for services rendered in the last full fiscal year and to be paid in the current fiscal year.
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Annex 4 - Sample Due Diligence Checklist
[
] (g) Description of commissions paid to managers, agents, or other employees for the last fiscal year and to be paid in the current fiscal year.
[
] (h) Founders agreements, “golden parachute” and other change of control or severance agreements, if any.
[
] (i) Summary of worker’s compensation claims made.
[
] (j) Personnel policies, manuals and handbooks.
[
] (k) Number of employees by department.
10. EMPLOYEE BENEFITS [
] (a) Copies of all 401(k) and other qualified pension and profit sharing plan documents, all amendments, summary plan descriptions, adoption agreements, trust agreements, administrative services agreements, group annuity contracts, resolutions, IRS opinion/determination letter, last three years nondiscrimination and compliance testing and last five years Form 5500.
[
] (b) Copy of group health plan document and Summary Plan Description (SPD), last three years Form 5500.
[
] (c) Copy of Section 125 Plan document, SPD (include dependent care plans, health flexible spending accounts, etc.) and last three years Form 5500.
11. FINANCIAL INFORMATION [
] (a) Financial, operating or business plans and projections, including underlying assumptions.
[
] (b) Backup data for revenue forecasts by product and/or market segments and estimates of the Company’s market share in each.
[
] (c) Balance sheet account reconciliations and specific supporting detail: cash, receivables and unbilled receivables, sales-type leases, inventory, prepaids, fixed assets, reserves and accruals, sales tax, deferred income, debt, stock reconciliations.
[
] (d) Financial statements for past [three] fiscal years, and interim financial statements covering each completed quarter of current fiscal year. A-23
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
[
] (e) Most current balance sheet and income statement.
[
] (f) Quarterly projected financial statements for the next three fiscal years.
[
] (g) Quarterly analyses of sales and cost by major market segments/product lines for the current year to date and the next three fiscal years.
[
] (h) Reserves analyses as of the end of the last fiscal year and last fiscal quarter.
[
] (i) Comparison of budget to actual (summary and detail) for last fiscal year and current fiscal year to date.
[
] (j) List of all recorded or unrecorded contingent liabilities as of the end of the last year and at the latest available date.
[
] (k) Capital budget.
[
] (l) Cash report and cash flow projections.
[
] (m) Brief description of cash investment practices and policies and status of current cash balance investments.
[
] (n) Brief description of any foreign currency transactions, practice and policies.
12. MARKETING INFORMATION [
] (a) Internal market size and growth projections (by units and dollars) for each market segment.
[
] (b) Market share data (by units and dollars) for the Company and any competitors, both current and historical.
[
] (c) Any external/independent analysis of market size, growth and share data.
[
] (d) List of principal competitors by market segment.
[
] (e) Any recent analysis of competitors.
[
] (f) Any customer survey data which has recently been collected.
[
] (g) All current product and marketing literature.
[
] (h) Any noncompetition agreements or other agreements restricting the Company’s business activities.
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Annex 4 - Sample Due Diligence Checklist
[
] (i) Market research, marketing studies, long- and short-term strategic plans and valuation analyses prepared by the Company or third parties for the Company.
13. GOVERNMENT CONTRACTS [
] (a) All Government Contracts, including all modifications and attachments, and any Cooperative Agreements under any Government technology transfer program, e.g. CRADAS, which has not been “closed-out” by the Government, including any contracts which have been fully performed but for which the Company has not received final indirect cost rates (the “Government Contracts”).
[
] (b) All representations and certifications signed for each Government Contract, including any “secondary” certifications under the Procurement Integrity Act executed by personnel “substantially involved in the procurement.”
[
] (c) Any and all Small Business Subcontracting Plans drafted and/or approved for each Government Contract.
[
] (d) Any Cost Accounting Standards Disclosure Forms submitted with or applicable to a Government Contract.
[
] (e) Any “Advance Agreements” pertaining to a Government Contract regarding the allowability or allocability of contract costs.
[
] (f) All Cost or Pricing Data submissions for each Government Contract (SF 1411 and accompanying materials).
[
] (g) Descriptions of the Company’s internal system and practices used for gathering cost or pricing data, including practices with regard to conducting “final sweeps” and establishing “cutoff-dates” for submission.
[
] (h) List and briefly describe any audit conducted and audit findings for each Government Contract, including pre-award and post-award audits, and provide any DCAA or other audit reports in the Company’s possession relating to the Government Contracts.
[
] (i) List technical data provided under the Government Contracts with: (1) Unlimited Rights; A-25
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
(2) Government Purpose (License) Rights (3) Limited Rights [
] (j) List computer software provided under the Government Contracts with: (1) Unlimited Rights (2) Government Purpose (License) Rights (3) Limited Rights
[
] (k) List of any restricted rights computer software incorporated into non-commercial Government products.
[
] (l) Any Requests for Equitable Adjustment (REA’s) or claims submitted under any Government Contract, including all backup material provided by the Company to the Government, and any Government responses to such REA’s or claims.
[
] (m) List of Firm Fixed Price or Other Fixed Price Government Contracts currently in a cost-overrun position, and a brief description of the magnitude and cause of such cost overrun.
[
] (n) List and brief description of any Government claims of any sort asserted against the Company, e.g., defective cost or pricing data, deductive changes, false certifications, etc.
[
] (o) Any terminations for convenience settlement proposals/ claims submitted under any Government Contract, and a brief description of the status of any such proposal/claim.
[
] (p) List of any Government Contracts terminated for Default and any accompanying claims by the Government for excess reprocurement costs.
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Annex 4 - Sample Due Diligence Checklist
14. EMPLOYEE BENEFIT MATTERS [
] (a) List of any employee benefit plans sponsored or maintained by or for the Company, including pension, profit sharing, stock bonus, incentive stock option, nonqualified stock option, stock purchase, restricted stock, stock appreciation rights, savings, 401(k), nonqualified deferred compensation plans and all welfare benefit plans.
[
] (b) With respect to each qualified profit sharing, 401(k), money purchase pension, stock bonus, employee stock ownership, defined benefit pension and/or multiemployer pension plan sponsored or maintained by or for the Company: [
] (1) Copies of all plan documents, trust agreements, plan amendments and/or adoption agreements;
[
] (2) Certified resolutions of the Board of Directors adopting the Plan, adopting Plan amendments and/or delegating fiduciary responsibility to any person(s) or entities;
[
] (3) Copies of the last three years nondiscrimination and compliance tests (e.g., ADP/ACP, 415, 410(b), 402(g)).
[
] (4) Copies of the five most recent Forms 5500, including all schedules, attachments and audit reports, if any;
[
] (5) Copies of any third party funding contracts, including group annuity contracts, insurance contracts, investment fund contracts, investment management agreements;
[
] (6) Copies of the most recent summary of plan accounts prepared by the plan recordkeeper, or, if a defined benefit plan, the most recent plan benefit summaries;
[
] (7) Copy of the most recent summary plan description and any summary of material modifications distributed to plan participants;
[
] (8) Copy of the most favorable determination letter or opinion from the Internal Revenue Service; A-27
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
[
A-28
[
] (9) Copy of the two most recent Summary Annual Reports and information as to dates of distribution;
[
] (10) Copy of beneficiary designation form;
[
] (11) Copies of written notice of tax consequences (Section 402(f) notice) provided to participants, distribution request forms, election and waiver forms with respect to qualified joint and survivor annuities and qualified preretirement survivor annuities, if applicable;
[
] (12) Copies of employee stock ownership plan loan documents, including promissory notes, pledge agreements, escrow agreements, and any other document or agreement prepared in connection with an exempt ESOP loan or transaction under Treasury Regs. ยง 54.4975-7 or ยง 54.4975-11;
[
] (13) Copies of the two most recent actuarial reports, if applicable;
[
] (14) Copies of PBGC-1 and Schedule A for part two years;
[
] (15) Copy of fiduciary bond;
[
] (16) Information regarding any defined benefit plan funding deficiency or multiemployer plan withdrawal liability assessment, including information as to the amount of the funding deficiency or withdrawal liability, the original due date, the date the deficiency or withdrawal liability was satisfied, copies of Form 5330 and proof of payment (canceled check) and copy of notice distributed to employees disclosing a funding deficiency; and
[
] (17) Copies of any pending or previous IRS or DOL audit inquiries/examinations or related correspondence.
] (c) With respect to each welfare benefit plan sponsored or maintained by the Company (including all health, medical, dental, life insurance, dependent care reimbursement, pretax premium, health care reimbursement, section 125 flexible benefit, disability, accidental death and dismemberment insurance, severance, vacation, retiree health and group legal
Annex 4 - Sample Due Diligence Checklist
plans and any plan that otherwise satisfies the definition of a welfare benefit plan under the Employee Retirement Income Security Act): [
] (1) Copy of the plan document or contract under which benefits are provided;
[
] (2) Copy of the summary plan description and any summary of material modifications distributed to employees;
[
] (3) Copies of the Form 5500s, including all attachments and schedules, for the past three years;
[
] (4) Copy of COBRA notice (both initial and qualifying event) and written procedures;
[
] (5) Copy of or information concerning any promise to extend benefits under the plan to retirees;
[
] (6) Copies of all written communications to participants within the past two years concerning the plan;
[
] (7) Copies of HIPAA notices and certificates; and
[
] (8) Copies of Cancer Rights Act notices.
15. PROPERTY, FACILITIES, PERMITS AND ENVIRONMENTAL MATTERS [
] (a) List and description of all real property owned or leased by the Company; location, character and general nature of operations conducted at each location; nature of the title held, and any mortgages, liens or encumbrances on the property; title documents confirming ownership; report by public notary (in civil law countries) or other person authorized to conduct title searches.
[
] (b) List, with brief description, of all material personal property owned, leased or otherwise used by the Company.
[
] (c) List of all facilities currently owned, leased or otherwise used by the Company, including location, square footage, space available for expansions, presence of any known aboveground or underground chemical or fuel storage tanks or sumps, and brief description of lease/use terms (if applicable) A-29
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
and current and prior usage (including use by other owners and tenants, if known). [
] (d) Schedule of property, plant and equipment by category including gross asset value, accumulated depreciation, range of depreciable lives, depreciation methods and market value/ replacement cost estimates (if available).
[
] (e) Summary of all outstanding capital purchase commitments.
[
] (f) For material properties and facilities: deeds, mortgages, deeds of trust, title insurance policies, title reports, surveys, certificates of occupancy and appraisals and valuations; UCC searches in relevant states; judgment searches in relevant states; description of other liens, encumbrances and zoning restrictions.
[
] (g) List of all facilities formerly owned, leased or otherwise used by the Company, including location, square footage, presence of any known aboveground or underground chemical or fuel storage tanks or sumps, dates of ownership/lease/use, and brief description of usage (including use by other owners and tenants, if known).
[
] (h) List, including maximum quantity onsite at any one time and brief description of usage, of all hazardous materials/wastes currently or previously (if known) stored, used, transported, generated, manufactured, treated, discharged, or disposed in connection with the Company’s business. Provide MSDS forms for listed items, if available.
[
] (i) List, and brief description of status, of all permits, licenses, certificates, and other governmental approvals (collectively, “Permits”) held or needed by the Company in connection with its business or properties owned, leased or otherwise used by the Company, including Permits relating to environmental, hazardous materials/wastes, and worker health and safety matters.
[
] (j) All claims, demands, notices or requests for information, and responses thereto (collectively, “Notices”), given to or received from any agency or other person regarding any matters concerning the environment, hazardous materials/wastes, or worker health and safety, including any Notices of potential responsibility for environmental contamination.
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Annex 4 - Sample Due Diligence Checklist
[
] (k) List, and brief description of status, of environmental, hazardous materials/wastes, or worker health and safety problems, injuries, conditions or issues known to the Company concerning the Company’s business or any facility or property owned, leased or otherwise used by the Company, and including any environmental contamination conditions and any known or potential violations or non-compliance with applicable laws, rules, regulations or Permits.
[
] (l) List, and brief description of status, of spills, leaks, or other unauthorized discharges of hazardous materials/wastes occurring in connection with the Company’s business or at any property or facility when owned, leased or otherwise used by the Company.
[
] (m) List, and brief description of status, of all pending or threatened criminal, civil, regulatory, judicial or administrative actions or proceedings relating to the environment, hazardous materials/wastes, or worker health and safety matters.
[
] (n) Any reports, summaries or evaluations regarding matters related to worker health and safety, the environment or hazardous materials/wastes, including assessments or audits, whether internal or external, and any sampling results from any hazardous materials/wastes, soil, air or water related to the Company’s business or any facilities or property owned, leased or otherwise used by the Company
[
] (o) List, with brief description of status, any environmental investigation or remediation which the Company or another party is conducting, has completed, or which may be required (if known) in connection with the Company’s business, or any facility or property owned, leased or otherwise used by the Company.
[
] (p) List, with brief description of status, any modification, removal, repair, closure or installation of equipment or improvements, including equipment or improvements related to hazardous materials/wastes, which the Company or another party is conducting or which may be required (if known) in connection with the Company’s business, or any facility or property owned, leased or otherwise used by the Company. A-31
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16. TECHNOLOGY AND PROPRIETARY RIGHTS [
] (a) List and copies of all patents and applications pending, held or being prosecuted by the Company in the United States or elsewhere, with descriptive titles, numbers, jurisdiction, and copies of all correspondence to or from examining authorities or other parties regarding such patents and patent applications.
[
] (b) List of all copyright registrations and applications related to all intellectual property and intellectual property rights used in connection with the Company’s business or necessary for its business as presently conducted and as currently proposed to be conducted (collectively, “Technology”) pending, held or being registered by the Company in the United States or elsewhere, with descriptive titles, numbers, and jurisdiction.
[
] (c) List of all trademarks, registered or unregistered, used in connection with the Technology, whether or not owned by or licensed to the Company, with a description of products or services associated therewith, and numbers, jurisdiction, status of any registration applications pending, if any.
[
] (d) List of all categories of Technology (whether or not patented or patentable), together with a brief description of how each such Technology was developed or acquired.
[
] (e) List and copies of all license agreements and sublicense agreements related to the Technology pursuant to which the Company licenses any technology or intellectual property rights to or from third parties, including model or standard sales or license agreements (including shrink-wrap or clickwrap licenses).
[
] (f) List and copies of all agreements related to the Technology pursuant to which the Company has assigned any technology or intellectual property rights to, or obtained any technology or intellectual property rights from, third parties, including without limitation intellectual property assets transferred into the Company at or in connection with its formation or spinoff. Also include a description of all interests, whether direct or indirect, whether through ownership or otherwise, of any founder, officer, director, former officer or former director in the technology and/or intellectual property relevant to the Company, and
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copies of Company’s standard form of agreements with founders, directors, officers and advisory board members, if applicable. [
] (g) List and copies of all agreements pursuant to which the Technology are distributed or marketed by third parties, including without limitation all sales representative, referral, reseller, value-added reseller, original equipment manufacturer and all other distribution agreements.
[
] (h) List and copies of all joint ownership, research and development agreements which relate to the Technology and to which the Company is a party, including for each such relationship a description of the ownership and rights to any developed technology, and any payment or financial obligation with respect to such developed technology.
[
] (i)
List and copies of all agreements pursuant to which products or components related to the Technology are manufactured or assembled by, or pursuant to which the Company acquires products or components for products from, third parties.
[
] (j)
List of engineers and other employees who have participated in or contributed to the development of the Technology, a brief description of their roles, and copies of their resumes or other evidence of previous job history.
[
] (k) List of all non-employees (individuals and entities) who participated in any Technology development for the Company, including information concerning each project, the amount and type of services performed and whether each such person has executed an assignment of rights in intellectual property to the Company.
[
] (l)
[
] (m) Copies of confidentiality, non disclosure, and assignment of invention agreements, between the Company and employees, and between the Company and independent contractors, the contents of which differ from those set forth in the
Copies of the Company’s standard form of agreements with employees and independent contractors regarding inventions, and a list of all employees and all independent contractors who have executed the agreements, and a list of all employees and all independent contractors who have not executed the agreements.
A-33
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standard form, including a description of any work or inventions excluded from such agreements. [
] (n) Copies of the Company’s standard form of confidentiality and non disclosure agreements, between the Company and persons or organizations other than employees and independent contractors, and a list of persons or organizations who have executed the agreements.
[
] (o) Copies of confidentiality and non disclosure agreements, between the Company and persons or organizations other than employees and independent contractors, the contents of which differ from those set forth in the standard form.
[
] (p) All documents, correspondence, memos, and other papers relating to the Company’s written policies on intellectual property, including trade secrets and proprietary information.
[
] (q) Copies of all security agreements pursuant to which a lender or creditor has taken a security interest in specific intellectual property assets or “general intangibles” which relate to the Technology.
[
] (r)
[
] (s) Law firm(s) handling patent, trademark, copyright and other intellectual property matters for the Company, and any subsidiary, and contact person name, address and phone number.
[
] (t)
[
] (u) Listing of all open source software applications, programs, packages, or libraries that have been used by Company to develop any of the Technology, or that have been incorporated into the Technology, along with a copy of the accompanying license for such open source applications.
[
] (v) All documents, correspondence, memos, notes, and other papers analyzing or assessing the validity or scope of any of the Company’s copyrights, patents, or trademarks which relate to the Technology.
A-34
Uniform commercial code filings, or other state and federal filings, that relate in any way to the Technology.
All documents, correspondence, memos, notes, and other papers relating to any Technology development by the Company that involves the derivation or use of specifications or technical information derived from the products of third parties.
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[
] (w) Description of any development projects relevant to the Technology currently underway, including scope, personnel involved in the development and status.
[
] (x) Description of all Company trade secrets and related knowhow necessary or useful to conduct the business of the Company and/or to utilize the Technology.
[
] (y) List and copies of all other information, documents and agreements relating to the Technology not covered by this list but which would, in the Company’s judgment, be material to evaluation of the Technology by prospective buyers thereof.
PLEASE NOTE: If the Company uses a standard format for any of these types of agreements, please provide only a single copy of that format and any negotiated versions with material deviations from that format. 17. DEFENSE AND PROSECUTION OF INTELLECTUAL PROPERTY CLAIMS [
] (a) All documents, correspondence, pleadings, memos, notes, and other papers relating to any pending or threatened intellectual property litigation or claim against the Company concerning the Technology, or any other assertion, suggestion, or inquiry by a third party that the Company and/or the Technology is infringing its intellectual property rights.
[
] (b) All documents, correspondence, pleadings, memos, notes, and other papers applicable to any dispute or litigation with any third party (including without limitation customers, employees, suppliers and competitors) relating to ownership, use or commercialization of the Technology.
[
] (c) Materials referred to during the process of developing any Technology that is the subject of any pending or threatened litigation, claim, assertion, suggestion, or inquiry.
18. EXPORT MATTERS [
] (a) Copies of correspondence with, submissions to, or documents received from the Bureau of Industry and Security (formerly Bureau of Export Administration), Office of Defense Trade Controls, or Office of Foreign Assets Control, including but not limited to any requests for advisory opinions, commodity jurisdiction requests, commodity classification A-35
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requests, applications for export licenses and responses thereto (including notices of intent to deny, return without action notices, and denials), export licenses, “is informed” letters, reports filed pursuant to the Export Administration Regulations or an export license, requests for documents or other information, voluntary disclosures, pre-charging letters, charging letters, warning letters, and documents reflecting settlement of alleged export control violations. [
] (b) Copies of correspondence with or submissions to the Department of Justice, Federal Bureau of Investigation, or any other government agency related to any export or domestic release of any technology or software.
[
] (c) List or product matrix identifying the Export Commodity Classification Number (ECCN) or U.S. Munitions List classification that applies to each of the items produced or sold by the Company internationally. Separately identify any items that contain or utilize cryptographic functionality (encryption).
[
] (d) List of the license authority used to export each item exported by the Company, with copies of any required supporting documentation (e.g., letters of assurance to support use of License Exception TSR).
[
] (e) List of the countries to which Company exports or has exported any items.
[
] (f) List identifying Company products, technology, or services that are: (i) on the United States Munitions List; (ii) have substantial military applicability; or, (iii) are specially designed or modified for military purposes, regardless of whether such items are exported. Please indicate whether the Company has registered with the Office of Defense Trade Controls.
[
] (g) List of foreign national employees (and their countries of nationality) whose job responsibilities include or require access to technical information or software related to the design, development or production or use of the Company’s products. For the purposes of this request, a foreign national employee is any employee who is not a U.S. citizen, a lawful permanent resident alien, an asylee or a refugee.
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19. SEC AND NASDAQ [NYSE] FILINGS AND RELATED MATERIALS [
] (a) All reports and other documents filed with the SEC (e.g., 10 Ks, 10 Qs, proxy statements, registration statements, prospectuses, etc.) within the last [three] fiscal years and any interim period, all exhibits and schedules filed therewith or incorporated therein, other than documents that are available via EDGAR.
[
] (b) Comment letters or other correspondence from the SEC, if any, and responses thereto.
[
] (c) Any other filings or submissions made by the Company with the SEC within the last [three] years.
[
] (d) Filings and submissions made with The NASDAQ Stock Market [the New York Stock Exchange] and any correspondence with The NASDAQ Stock Market [the New York Stock Exchange] within the last [three] years.
20. PUBLIC FINANCIAL REPORTING [
] (a) Reports or “management letters” received by the Company from independent accountants or consultants during the past five years relating to accounting or tax policies or financial control procedures of the Company and any management responses thereto.
[
] (b) Any written documentation of internal control over financial reporting and disclosure controls and procedures, as such terms are defined in the rules of the SEC.
[
] (c) Any written documentation of management’s assessment of the effectiveness of the Company’s internal control over financial reporting; a description of any material changes that have occurred since the end of the last period covered in the Company’s periodic reports filed with the SEC or are expected to occur in the future.
[
] (d) Any written correspondence between the Company’s audit committee and its management, auditors, outside counsel or disclosure committee during the past three fiscal years and any subsequent period; any disclosures to audit committee since that date of (a) significant deficiencies or material weaknesses in internal control over financial reporting and (b) fraud A-37
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involving management or other employees with significant role in internal control over financial reporting. [
] (e) Any minutes or similar documentation of the activities of the Company’s disclosure committee, if any, during the past three fiscal years and any subsequent period.
[
] (f) Any report prepared by independent auditors pursuant to Section 204 of the Sarbanes-Oxley Act.
[
] (g) A description of any reports made pursuant to Section 307 of the Sarbanes-Oxley Act or the Company’s whistleblowing policy, and the Company’s response to such reports.
[
] (h) If the Company restated its financial statements in the last five fiscal years or in any subsequent period, furnish a description of the relevant facts pertaining thereto.
21. SEC FILINGS [
] (a) All reports and other documents filed with the Securities and Exchange Commission (e.g., 10-K’s, 10-Q’s, proxy statements, registration statements, prospectuses, etc.) within the last two years, all exhibits and schedules filed therewith or incorporated therein and all correspondence from the SEC with respect thereto, to the extent not available in complete form through EDGAR.
[
] (b) Copies of all reports or communications to security holders during the last two years.
22. GENERAL [
] (a) List and description of all actual or potential conflicts of interests that the Company’s directors, officers or employees have or may have due to their relationship with any competitor of the Company, any supplier of goods or services to the Company, any distributor of the Company, any customer of the Company or any other person or entity which has any interest, financial or otherwise, in the Company.
[
] (b) List and description of all transactions between the Company and any stockholder, director, officer, employee or affiliate of the Company (or any entity or person formerly having the
A-38
Annex 4 - Sample Due Diligence Checklist
status thereof, including amounts and names of parties involved) during the past three years. [
] (c) Description of all current or proposed loans to officers or directors or other arrangements covered by Section 402 of the Sarbanes-Oxley Act (including those that to which an exemption may apply).
[
] (d) Any director and officer questionnaires submitted within the past five fiscal years.
[
] (e) Copies of all director and officer liability insurance policies.
[
] (f) List and description of all material insurance claims submitted by the Company in the past two years.
[
] (g) All press releases issued during the last 12 months with respect to the Company or its business (if not available on the Company’s website).
[
] (h) Copies of the Company’s principal business plans for the last three years.
[
] (i) All legal opinions received by the Company during the last two years.
[
] (j) List of parties, if any, whose consent to this transaction will be required and copies of relevant documents.
[
] (k) All documents and information not covered by other items on this list disclosing material information concerning the Company.
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A-40
Annex 11 Certain HSR Exempt Transactions Following is a discussion of certain types of transactions that are generally exempt from the HSR filing requirements. Antitrust Counsel should be consulted when determining whether a particular exemption may be applicable. • Acquisitions of Goods and Realty in the Ordinary Course of Business Acquisitions of goods and realty in the ordinary course of business are generally exempt from the HSR Act. Sales of new goods are generally considered to be “in the ordinary course of business,” as are sales of certain current supplies and certain used durable goods. • Acquisitions Solely for the Purpose of Investment The HSR Act and rules exempt certain acquisitions made by the acquiring person “solely for the purpose of investment.” The existence of the requisite intent under this exemption is a fact-intensive inquiry based upon the circumstances of each case. • Acquisitions of Certain Real Property Assets The HSR rules generally exempt acquisitions of “new facilities,” used facilities acquired by lessees from lessors under certain conditions, “unproductive” real property, office and residential property, hotels and motels (except ski facilities), certain “recreational land,” certain “agricultural property,” and retail rental space and warehouses (except in connection with the acquisition of a business to be conducted on the property). • Acquisitions of Foreign Assets or of Voting Securities of a Foreign Issuer An acquisition by a U.S. person of assets located outside of the United States is exempt from the HSR Act unless the assets generated sales “in or into the United States” in excess of $56.7 million (as adjusted) in the most recent year. Similarly, an acquisition by a U.S. person of the voting securities of a foreign issuer is exempt from the HSR Act unless the foreign issuer had sales in or into the United States in excess of $56.7 million (as adjusted) in the most recent year. Whether sales in a particular case should be deemed “in or into the United States” depends upon the particular circumstances of that case. A-41
The Mergers & Acquisitions Handbook A Practical Guide to Negotiated Transactions
• Acquisitions of Voting Securities of, or Non-corporate Interests in, Entities Holding Assets the Acquisition of which Is Exempt The HSR rules generally exempt an acquisition of voting securities of an issuer, or an acquisition of non-corporate interests in an entity, when that issuer or entity, together with all entities that it controls, holds assets the acquisition of which is exempt.
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DLA PIPER DLA Piper is a global legal services organization, the members of which are separate and distinct legal entities, with offices across Europe, Asia, the Middle East and United States. Over 3,400 lawyers across 64 offices and 25 countries provide a broad range of legal services through the firm’s global practice groups. The firm is relationship driven and built to meet the ongoing legal needs of its clients, wherever they choose to do business. www.dlapiper.com Adelaide, Australia T: +61 8 8124 1811 F: +61 8 8231 0014
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Sydney, Australia T: +61 2 9286 8000 F: +61 2 9283 4144
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Paris, France T: +33 1 40 15 24 00 F: +33 1 40 15 24 03
Vienna, Austria T: +43 1 531 78 0 F: +43 1 533 52 52
Tbilisi, Georgia T: +995 (32) 92 1464 F: +995 (32) 93 2752
Antwerp, Belgium T: +32 (0) 3 287 2828 F: +32 (0) 3 230 4221
Cologne, Germany T: +49 (0) 221 277 277 0 F: +49 (0) 221 277 277 10
Brussels, Belgium T: + 32 (0) 2 500 1500 F: + 32 (0) 2 500 1600
Frankfurt, Germany T: +49 (0) 69 27133 0 F: +49 (0) 69 27133 100
Sarajevo, Bosnia-Herzegovina T: +387 33 295 236 F: +387 33 295 242
Hamburg, Germany T: +49 (0) 40 1 88 88 0 F: +49 (0) 40 1 88 88 111
Sofia, Bulgaria T: +359 2 935 5610 F: +359 2 935 5616
Munich, Germany T: +49 (0) 89 5908 2318 F: +49 (0) 89 5908 1332
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Cape Town, South Africa T: +27 (0) 21 481-6300 F: +27 (0) 21 481-6388
Hong Kong, Hong Kong T: +852 2103 0808 F: +852 2810 1345
Johannesburg (Sandton), South Africa T: +27 (0)11 290-7000 F: +27 (0)11 290-7300
Budapest, Hungary T: +36 1 325 30 20 F: +36 1 325 30 21
Madrid, Spain T: +34 91 319 12 12 F: +34 91 319 19 40
Milan, Italy T: +39 02 80 61 81 F: +39 02 80 61 82 01
Stockholm, Sweden T: +46 8 701 78 00 F: +46 8 701 78 99
Rome, Italy T: +39 06 68 88 01 F: +39 06 68 88 02 01
Bangkok, Thailand T: +66 2 686 8500 F: +66 2 670 0131
Tokyo, Japan T: +81 (0) 3-4550-2800 F: +81 (0) 3-4550-2801
Dubai, UAE T: +971 4 363 6900 F: +971 4 363 6901
Amsterdam, Netherlands T: +31 (0) 20 541 98 88 F: +31 (0) 20 541 99 99
Kyiv, Ukraine T: +380 (44) 490 95 75 F: +380 (44) 490 95 77
Auckland, New Zealand T: +64 9 303 2019 F: +64 9 303 2311
Birmingham, United Kingdom T: +44 (0) 8700 111 111 F: +44 (0) 121 262 5794
Wellington, New Zealand T: +64 4 472 6289 F: +64 4 472 7429
Edinburgh, United Kingdom T: +44 (0) 8700 111 111 F: +44 (0) 131 242 5555
Bergen, Norway T: +47 55 30 10 00 F: +47 55 30 10 01
Glasgow, United Kingdom T: +44 (0) 8700 111 111 F: +44 (0) 141 204 1902
Oslo, Norway T: +47 24 13 15 00 F: +47 24 13 15 01
Leeds, United Kingdom T: +44 (0) 8700 111 111 F: +44 (0) 113 369 2949
Warsaw, Poland T: +48 22 540 74 00 F: +48 22 540 74 74
Liverpool, United Kingdom T: +44 (0) 8700 111 111 F: +44 (0) 151 236 9208
Moscow, Russia T: +7 (495) 221 4400 F: +7 (495) 221 4401
London, United Kingdom T: +44 (0) 8700 111 111 F: +44 (0) 20 7796 6666
St. Petersburg, Russia T: +7 (812) 448 7200 F: +7 (812) 448 7201
Manchester, United Kingdom T: +44 (0) 8700 111 111 F: +44 (0) 161 235 4111
Singapore, Singapore T: +65 6512 9595 F: +65 6512 9500
Sheffield, United Kingdom T: +44 (0) 8700 111 111 F: +44 (0) 114 270 0568
Bratislava, Slovak Republic T: +421 2 5920 2123 F: +421 2 5443 4585
Atlanta, United States T: (404) 736-7800 F: (404) 682-7800
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THE MERGERS & ACQUISITIONS HANDBOOK First Edition
SecuritiesConnect™ WWW.SECURITIESCONNECT.COM
THE MERGERS & ACQUISITIONS HANDBOOK A Practical Guide to Negotiated Transactions First Edition
Printed in Canada
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DIANE HOLT FRANKLE STEPHEN A. LANDSMAN JEFFREY J. GREENE DLA PIPER