The essentials of a first-rate M&A agreement
Infotech and the Law | Legal insights for today's markets
- By David Charles
- Aug 20, 2008
Whether you are buying or selling a company ? and regardless of the size of the transaction, the nature of the parties, the target company's industry or even the deal structure ? the basic architecture of the definitive agreement is generally the same.
Most companies involved in mergers and acquisitions use a form of acquisition agreement that addresses the following topics in the same order: preamble and recitals; transaction (structure and consideration); closing; representations and warranties of the seller; representations and warranties of the buyer; pre-closing covenants; conditions precedent to the buyer's obligations; conditions precedent to the seller's obligations; indemnification; post-closing covenants; and general and miscellaneous. Those agreements are typically designed like the U.S. Constitution, with articles that are subdivided into sections.
All M&A agreements begin with a preamble or recital. The preamble identifies the type of agreement (stock purchase, merger or asset purchase), the parties to the transaction and the effective date. The recitals (or the "whereas" clauses) provide the context for the deal. For example, they might explain the subject business, how the parties are related to the target company, and whether the parties are trying to achieve a specific operational, financial or tax-advantaged objective. The recitals are a useful vehicle for defining terms that appear throughout the document.
The first article generally sets forth the technical structure and basic financial terms for the deal. It details how the parties will carry out the transaction. Article I will specify the amount and form of the consideration and whether any portion of the consideration is contingent on or otherwise subject to an escrow or post-closing adjustment. If there are multiple sellers and the parties are agreeable, this article may also include a section appointing a specific individual as their representative with respect to the transaction.
The specifics for the closing ? date, time and place ? are often provided in a separate article, although they could be included in Article I. Sometimes overlooked, the section that defines the closing contains significant, binding terms. For example, the section might state that the parties will effect the closing on the third business day after the satisfaction or waiver of all conditions precedent to the parties' obligations to consummate the transaction (other than conditions that can be satisfied only at the closing). For a public company buyer, this requirement might pose disclosure challenges if the third business day falls within a reporting period rather than just after the end of the reporting period. Therefore, a public-company buyer should focus on this section and modify it accordingly.
The longest part of most M&A agreements is Article III, which sets forth the seller's representations and warranties. This article can be 30 pages or more ? or 20 percent to 50 percent of the document. Each of the sections in this article will include detailed assertions about operational and legal matters regarding the target company or business and the seller's right to enter into the agreement. The representations and warranties perform the dual functions of disclosure and risk allocation. Some sections in this article will require the seller to generate specific lists regarding the subject business, which the buyer will rely on to confirm its due-diligence review. Although it seems duplicative to many sellers to prepare those lists after compiling documents in response to a buyer's due-diligence request, it is properly their responsibility to deliver such disclosure in connection with the definitive agreement.
Other sections in Article III require the seller to make certain assertions about the target company's status in specific areas. For example, buyers almost always insist that sellers represent and warrant that the business they are buying has been operated in compliance with applicable laws. This representation allocates risk between the parties because the seller will be liable to the buyer if, in fact, it turns out the company violated any laws before the closing. The parties typically negotiate the breadth of these representations, using materiality and knowledge qualifiers to shift risk on specific items.
The buyer's representations appear in the next article and are more limited than those of the seller. They tend not to address business or operational matters unless some of the consideration is contingent or deferred or otherwise consists of buyer's paper. They are typically focused on the buyer's authority to enter into the agreement and its ability to consummate the transaction.
After the representations and warranties, M&A agreements contain one or more articles that describe how the parties will conduct themselves between the signing and the closing. Such interim or pre-closing covenants might cover a range of topics, including confidentiality, access to information, exclusivity/no-shop agreements, employee matters (e.g., terminations, amendments to compensation plans) and specific operational requirements (e.g., managing accounts payable and accounts receivable in the ordinary course of business consistent with past practices).
The articles establishing the conditions precedent to each party's obligations to complete the deal provide the road map for what must happen between signing and closing. They address factors both within and beyond the parties' control. To be sure, sellers try to minimize the number and scope of conditions that are beyond their control to enhance the likelihood the deal will actually close once signed. Buyers almost always want a condition regarding the absence of material adverse changes that is broadly written so they don't have to close if something unexpected occurs during the interim period that could affect their anticipated return on investment.
The next article in a typical M&A agreement stipulates available remedies. Most often, the parties agree to indemnify each other for losses they incur as a result of breaches of the representations and warranties and failures to perform covenants or agreements. The seller's indemnification obligations might extend to specific matters the buyer identifies in its due-diligence review. The indemnification obligations are limited by survival periods (the period within which a particular claim must be made), baskets (a deductible or threshold below which the buyer cannot collect a specific loss from the seller) and caps (the maximum amount for which a seller can be held liable). The provisions of this article effectively adjust the purchase price, so it is often appropriate to address them early, at the letter-of-intent stage, as part of the negotiations over the other financial terms.
Post-closing covenants and general legal terms and conditions are found in the last two articles. The parties' obligations to each other after the deal is completed are generally limited matters, such as reasonable cooperation on litigation, restrictions on disclosure and news releases about the transaction, and restrictions on competition, commercial interference and/or soliciting employees. The general legal terms and conditions, which are always the last few pages, are often mistakenly treated as boilerplate, receiving too little attention in the overall process. But they can contain tricky language regarding notices, termination rights and expenses, among other things.
Armed with this overview of M&A agreements, when you decide to sell or buy a company, you will be prepared to review that first draft of the definitive document, whether it is a stock purchase agreement, merger agreement or asset purchase agreement.
David Charles (David.Charles@Pillsburylaw.com) is a partner in the Corporate and Securities-Technology practice at Pillsbury Winthrop Shaw Pittman LLP.