Conditions to Obligations of Seller
What are the Conditions to Obligations of Seller? This provision contains a comprehensive list of requirements that must be completed by the Buyer or waived by the Seller in order for the Seller to be obligated to complete the purchase. If the Buyer fails to fulfill any condition included in the list, the Seller can walk away from the deal without penalty.
The Middle Ground: The main difference between this provision and the Conditions to Obligations of Buyer is that there aren’t as many conditions to the Seller’s obligations since its paramount concern in most instances is whether the Buyer can pay the Closing payment. With that said, the typical list of requirements in this provision includes conditions to be completed at (or before) Closing such as:
The Buyer’s representations and warranties are true and correct in all (material) respects at the time of signing the Agreement and at the Closing;
The Buyer has complied with all terms of the Agreement and the Transaction Documents in all material respects;
No Governmental Authority has issued an order or injunction restraining the transaction;
The Buyer has obtained all third-party consents listed in its Disclosure Schedules, if applicable to the transaction;
The Buyer has delivered signed copies of the Transaction Documents;
The Buyer has transferred the Closing payment by wire transfer and the amount to be held in escrow to the Escrow Agent, if applicable;
The Seller has received a signed copy of the Buyer Closing Certificate;
The Seller has received a signed copy of the Buyer’s Secretary’s Certificate; and
The Buyer has provided other documents and instruments reasonably requested by the Seller and that are reasonably necessary to consummate the transaction.
Purpose: If the Buyer does not meet any one of the conditions listed in this provision, the transaction could fall apart instantly. This provision places the risk of that happening on the Buyer. It’s important to note here that the risk allocation scheme created by this provision and the previous one is not unfair to either side; both are afforded the opportunity to walk away if the other side does not meet its obligations, and the obligations each must meet are the product of negotiation and, typically, within the control of the party who must meet them.
Buyer Preference: The Buyer wants as few conditions listed here as possible, with those listed being wholly within its control, if possible. Furthermore, the Buyer will want materiality qualifiers included, particularly relating to conditions (1), (2), (3), and (4). However, this is another area where the requirements applicable to the Buyer will largely mirror those of the Seller, so the Buyer will have to decide what level of accuracy it is comfortable promising regarding its own deliverables. One condition for which it makes sense to have some divergence between Buyer is Seller is the “litigation out” listed in condition (3). With that condition, the Buyer is rightfully worried about any litigation whatsoever affecting the Seller’s Business since the Buyer will undoubtedly be impacted by that litigation. Depending on the Seller’s post-transaction plans and the nature of the litigation, it may or may not be concerned with a lawsuit brought against the Buyer. In regard to the third-party consent condition, it may not be necessary for the Buyer to obtain any such consents, but if it is the Buyer will want the condition limited to those consents which are material to the transaction.
Seller Preference: Here, the Seller is looking for equality. In the Seller’s mind, whatever standards are applied in the Conditions to Obligations of Buyer section should also be applied here. For example, the Seller will want the Buyer’s representations and warranties qualified by materiality only to the same extent that its own are subject to those qualifications. More specifically, it will want any representations or warranties already qualified by a general materiality standard or a Material Adverse Effect standard to not be qualified by any such standard in this section. Going even further, it will not want the Buyer’s representations regarding its organization and authority to conduct the transaction to be subject to any materiality qualifier whatsoever.
While the Seller’s overall goal in this section is parity between the conditions applicable to the Buyer and the conditions that it must meet, to retain its negotiating credibility the Seller only wants to insist upon parity when it makes sense in the context of the transaction. By the nature of the deal, not every condition that the Seller must fulfill will need to be fulfilled by the Buyer. So, the Seller’s best approach is to be aware of its interests, have an understanding of the conditions necessary to meet those interests, and fight for the conditions that matter while not wasting resources on those that don’t.
Differences in a Stock Sale Transaction Structure: None.
Conditions to Obligations of Buyer
What are the Conditions to Obligations of Buyer? This provision contains a comprehensive list of requirements that must be completed by the Seller or waived by the Buyer in order for the Buyer to be obligated to complete the purchase. If the Seller fails to fulfill any condition included in the list, the Buyer can walk away from the deal without penalty.
The Middle Ground: Typically, the list states that:
(1) the Seller’s representations and warranties are true in all material respects at the time of the signing of the Agreement and the Closing;
(2) the Seller has complied with the Agreement and any other Transaction Documents in all material respects;
(3) no legal action has been taken that would prevent the transaction;
(4) all third-party approvals, consents, and waivers listed in the Disclosure Schedules relating to the Seller’s representations and warranties have been obtained;
(5) nothing has occurred that would constitute or cause a Material Adverse Effect;
(6) all Closing Deliverables and Transaction Documents have been signed by the Seller (as applicable) and delivered to the Buyer;
(7) the Buyer has received all Permits necessary to conduct the Business as conducted by the Seller;
(8) the Seller has provided the Buyer with title insurance and a Land Title Survey (or other appropriate deliverables) for each piece of Owned Real Property;
(9) written evidence has been provided to the Buyer that all Encumbrances, other than Permitted Encumbrances, have been released;
(10) the Buyer has received a signed copy of the Seller Closing Certificate;
(11) the Buyer has received a signed copy of the Seller’s Secretary’s Certificate;
(12) the Buyer has received a FIRPTA Certificate relating to the Business; and
(13) the Seller has delivered any other documents or instruments reasonably requested by the Buyer that are reasonably necessary to consummate the transaction.
Purpose: This provision provides numerous “outs” for the Buyer that create a relatively painless path out of the deal if the Seller does not meet its obligations, including some obligations that are relatively minor. The fact that the Buyer can walk away without penalty if a condition is not met means the risk of the Seller’s failure to deliver is shifted entirely to the Seller, who is obviously in a much better position to control that risk.
Buyer Preference: In addition to the conditions listed above, any number of requirements can be added to this section through negotiation among the parties. Common additional conditions sought by the Buyer include: (a) a “due diligence out” that allows the Buyer to walk away if it cannot complete due diligence to its satisfaction; (b) a “financing out” that conditions the Buyer’s obligation to close on it being able to obtain financing to fund the deal; and (c) financial or operating targets, such as sales or working capital, that, if not met, provide the Buyer with a way out of the deal. If the Seller operates in a highly-regulated industry, the Buyer may also require a legal opinion from the Seller’s legal counsel regarding the Business’s compliance with applicable laws. In addition to these general additional conditions, the Buyer also has certain preferences regarding the listed conditions, such as:
(1) The Buyer will likely include a materiality qualifier but will not want that qualifier to apply to any representation or warranty that already contains a materiality qualifier (i.e. the Buyer does not want a “double materiality” standard). Some exceptions for which the Buyer will want no materiality qualifier whatsoever include the representation regarding the organization and authority of the Seller, any monetary obligations, and financial statements. The Buyer will typically want this condition to Closing to be satisfied both at the time of signing the Agreement and at the Closing so that it can walk away if it receives materially inaccurate information at either time.
(2) Here, the Buyer once again wants to avoid a double materiality standard.
(3) The Buyer does not want any materiality qualifiers whatsoever in this “litigation out.” The Buyer will want to include any actions brought against it in addition to those brought against the Seller.
(4) The Buyer wants all third-party consents to be obtained as a condition to Closing, not just specifically-identified material consents.
(5) The Buyer may want to eliminate the Material Adverse Event condition altogether and replace it with specific event-based conditions, such as operational or financial benchmarks. Or, it may want to keep the Material Adverse Event condition and merely supplement it with specific benchmarks. In either case, the Buyer should be aware when selecting such benchmarks that financials usually lag behind operations and it is easier to manipulate the financial measurements than to inaccurately represent that an operational benchmark was met.
(8) To determine which conditions relating to real property need to be included here, the Buyer should consult a real estate attorney. If the transaction involves Leased Real Property, the Buyer will seek estoppel certificates from the landlord of the property.
(9) If the Buyer knows which documents are necessary to release Encumbrances associated with the Seller’s property, it will want to specify the documents and include a general statement like the one seen above to cover any documents needed but not listed. If the only way the Seller can have the Encumbrances released is to pay the creditor using the Closing payment, the Buyer will want to have the release documents placed in escrow until the creditor is paid.
Seller Preference: In general, the Seller wants to avoid allowing any conditions in this section that are not within its control, such as a due diligence out and a financing out. More specifically, the Seller will generally have the following preferences regarding the listed conditions:
(1) The Seller wants to go beyond a general materiality standard and require that, in order for the Buyer to walk away, a false representation or warranty must have a Material Adverse Effect on the Business. The Seller also wants this condition to apply only at the Closing so that it can cure any inaccuracies that exist when the Agreement is signed.
(3) The Seller wants to limit this condition to legal actions that are reasonably likely to succeed on the merits as a way of excluding frivolous claims that do not have any practical chance of preventing the transaction. Regarding any legal actions taken by a Governmental Authority, the Seller will want only those that prevent a material transaction contemplated by the Agreement to qualify as a litigation out for the Buyer.
(4) The Seller wants to limit this condition to specifically-identified material third-party consents, especially if there are a significant number of third-party consents to be obtained.
(5) Because it is difficult to prove that an event had a Material Adverse Effect on the Business, and because the burden is on the Buyer to prove a Material Adverse Effect, the Seller wants that standard to be applied here, rather than using specific financial or operational benchmarks. If the Buyer insists on specific benchmarks, the Seller will likely favor financial metrics over operational ones.
(8) The party customarily held responsible for paying survey and title insurance costs varies by jurisdiction, but regardless of convention the Seller will want the parties to split any costs related to these items (unless, of course, local custom says the Buyer pays).
Differences in a Stock Sale Transaction Structure: In a stock sale, the Buyer wants any representations and warranties relating to the shares of the Seller to be true and correct in all respects or, in other words, not subject to any sort of materiality qualifier. If the Buyer in a stock purchase is going to replace the directors and/or officers of the Business, receipt of their resignations should be included as a condition to the Buyer’s obligation to close. The Buyer in a stock purchase will also need a certificate of good standing for the Business from the appropriate Governmental Authority in the company’s state of organization.
Conditions to Obligations of All Parties
What are Conditions to Obligations of All Parties? Certain events will make a transaction impractical or even impossible, and this clause is included to give both parties a legal “out” of the deal if one of those events occurs.
The Middle Ground: This provision lists the conditions that must be met at or prior to Closing for both sides to be obligated to move forward with the transaction. The conditions include: (1) all required filings under the HSR Act have been made and any applicable waiting periods have expired (if the Act applies to the transaction); (2) no Governmental Authority has taken any action that would cause the transaction to be illegal or that would otherwise prevent it from becoming and remaining effective; and (3) all consents, authorizations, etc. required to be obtained by either party from any Governmental Authorities were received and have not been revoked.
Purpose: The intent of this provision is to allow both sides to walk away from the deal without penalty if the government interferes with the transaction (or if their approval is required but not given). While there is a very low probability that any Governmental Authority would implement a law or ruling preventing an acquisition in the lower middle market, if it were to happen it would certainly put an end to the transaction. Similarly, it is highly unlikely that either side would fail to obtain a necessary authorization or consent absent sheer incompetence or severe procrastination. Yet, if such failure were to occur it would also be an almost-certain death knell for the deal. Because of the low probability, high magnitude dynamic at play, the provision is worth paying attention as the Closing approaches, but it is not something that is likely to eat up negotiation time or cause significant disagreement.
Buyer and Seller Preference: None, other than deleting certain inapplicable conditions such as the HSR Act filing requirements or obtaining governmental approvals.
Differences in a Stock Sale Transaction Structure: None.