Expenses, Notices, Interpretation, Headings, Severability, etc
What is all this? These are the standard, “boilerplate” terms that appear in almost all contracts. They are focused on addressing legal issues and don’t typically change the value of the deal for the parties.
The Middle Ground: Most of these terms are procedural or technical and use standard language. Thus, there is generally no need for the parties themselves to evaluate the terms; the lawyers on each side will look them over and report back if there are any issues worthy of discussion. The two clauses that are worth a second look here are the Specific Performance provision and the Venue provision.
The Specific Performance provision can be used by one party to force the other party to comply with the terms of the Agreement instead of paying monetary damages following a breach. Due to its practical implications, the parties will want to carefully assess whether they want to provide the other side with the power to require specific performance.
The Venue provision only plays a role if one party initiates litigation against the other, but when that happens the term dictates where the litigation will occur. If the parties reside in different states, the provision creates a sizable disparity in terms of costs to pursue the litigation in favor the side with the home state advantage.
Purpose: These are standard terms that are included in the Agreement due to concerns arising out of contract law rather than the specific needs of the parties. If all goes as planned, most of them will never even come into play. Generally, these terms can be seen as setting the ground rules for the administration and interpretation of the Agreement and for the handling of any disputes that may arise out of the Agreement.
Buyer and Seller Preference: These provisions are drafted to be equally applicable to both parties, so without knowing the context of the particular transaction it is difficult to point to any specific changes that either party might want to make to the standard terms. The one thematic area where it can safely be said that the parties’ interests will diverge is with regard to locational provisions, such as choosing which state’s law governs the Agreement and where claims can be brought (unless both parties reside in the same state). For those terms and many of the others in this section, the content preferences will likely depend on the personalities of the parties (e.g. which side is more likely to sue) and the dynamics created by the Agreement (e.g. which side is more likely to have to give notice).
Differences in a Stock Sale Transaction Structure: None.
Termination and Effect of Termination
What is the Termination and Effect of Termination section? These two clauses describe when either party (or both) can terminate the Agreement without breaching it and the effect termination would have on their respective covenants and obligations contained in the Agreement.
The Middle Ground: The Termination section allows for termination of the Agreement based on: (1) mutual consent of the parties; (2) only one party being in breach of the Agreement, if the other party sends written notice of the breach and it is not cured within ten days; (3) if one party will not be able to fulfill their Conditions to Closing, and such failure is not the fault of the other party; or (4) the existence or issuance of a Law or Governmental Order prohibiting the transaction. The Effect of Termination section makes clear that, once termination occurs, the Agreement is void and no party is liable to the other except that the Termination and Miscellaneous Articles survive termination, as does the Confidentiality provision, and the parties remain on the hook for any willful violation of any provision of the Agreement.
Purpose: In conjunction with other clauses throughout the Agreement, the Termination provision provides both parties with the opportunity to walk away from the deal without penalty under certain circumstances. By making it easier to walk away, the provision encourages the parties to be on their best behavior. The result is that the transaction is actually more likely to be completed.
Without the Effect of Termination clause, the prospect of abandoning the transaction prior to the Closing would be a difficult decision given concerns regarding confidentiality and the information provided to the other side during due diligence. Furthermore, if claims for willful breach of the Agreement died along with the Agreement, the mere proposal of mutual termination would be grounds for suspicion of bad behavior, and termination by mutual consent would likely only occur when the relationship between the parties is broken beyond repair.
In other words, the termination provisions set the bar for walking away from the transaction at just the right height; the bar is not so high that the parties are forced into completing a bad deal, and not so low that committing significant time and money to the due diligence process simply isn’t worth the risk of the other party walking away on a whim.
Buyer Preference: If there are any specific facts or circumstances that are not encompassed by the middle ground term and would make the Buyer want to terminate the Agreement, the Buyer can include them as grounds for termination. Also, if the Buyer must obtain financing for the transaction and there is no “financing out” in the Agreement, the Buyer may want to include a provision allowing it to pay a reasonable “reverse break-up fee” to walk away from the transaction. If a reverse break-up fee is included, the Buyer may seek to include a traditional break-up fee to be paid by the Seller if it is the one who walks away from the deal. The Buyer may also want to expand the claims that would survive termination to include any breaches of the Agreement whatsoever and any fraud or intentional misrepresentations.
Seller Preference: Because the Seller’s representations and warranties are so much more expansive than those of the Buyer, the Seller does not want to extend the Effect of Termination provision to cover any breach of the Agreement. However, it does want to be able to recover for any willful breaches by the Buyer, so the Seller will typically be content with the grounds for termination provided by the middle ground term. Additionally, while the Buyer prefers a financing out and, in its absence, a nominal reverse break-up fee, the Seller prefers no financing out and a significant reverse break-up fee to compensate it for the time and expense associated with the due diligence process. However, if the Seller insists on a reverse break-up fee it can expect the Buyer to demand a similar fee to be applied if the Seller refuses to close the transaction.
Differences in a Stock Sale Transaction Structure: None.
Exclusive Remedies
What are Exclusive Remedies? Buyers and sellers usually spend significant time agreeing on an indemnification scheme, so they tend to want most claims for breaches of the Agreement to be governed by indemnification. This section identifies the claims that must be pursued through indemnification and those that are exempt from that limitation.
The Middle Ground: Subject to the equitable remedies provided for in the Agreement, this provision limits the parties’ available remedies in the event one of them breaches the Agreement, except for situations involving fraud, criminal activity, or intentional misconduct. More specifically, if a breach occurs that is not due to one of the three listed exceptions and for which an equitable remedy is not available, the non-breaching party’s only option is to make an indemnification claim (if the parties have chosen to make all covenants and other terms subject to indemnification in addition to the representations and warranties).
Purpose: This restriction is intended to limit the parties’ risk by making indemnification the sole avenue for resolving most claims related to the Agreement. In fact, this term is necessary if indemnification is intended to be the Agreement’s main enforcement mechanism, because without it the parties could simply bypass the indemnification process by filing a lawsuit.
Buyer Preference: Being a fairly standard provision, most buyers accept it as part of the Agreement and, consequently, spend a considerable amount of time negotiating their indemnification rights. However, more aggressive buyers may argue for an alternate provision that allows for indemnification in addition to the usual legal and equitable remedies.
Seller Preference: The Seller wants the exceptions included in this provision to be as narrow as possible since it is typically the party against whom a complaint is being made. In particular, the definition of fraud varies from state to state and may not be as limiting as the Seller intends it to be. To prevent an unwelcome surprise, the Seller (and/or its attorney) must be aware of the legal bounds of fraud, criminal activity, and intentional misconduct in the state whose law governs the Agreement.
Differences in a Stock Sale Transaction Structure: None.
Tax Treatment of Indemnification Payments
What is Tax Treatment of Indemnification Payments? The parties use this section to address how indemnification payments will be treated for tax purposes.
The Middle Ground: This provision states that indemnification payments made under the Agreement are to be treated as an adjustment to the Purchase Price for tax purposes, so long as such treatment is allowed by law.
Purpose: This is a technical term that allows the Indemnified Party to avoid paying tax on indemnification payments. It provides a benefit to one party without harming the other, and either party could be in the beneficial position at some point, so neither side will object to its inclusion and it likely won’t even be explicitly discussed.
Buyer Preference: None.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: None.
Payments
What are Payments? Here, the parties focus on the specific issue of when payments must be made following a valid indemnification claim.
The Middle Ground: This section provides a deadline for when indemnification payments must be made, how they must be made (e.g. by wire transfer), and dictates that interest is to accrue if the payment deadline is missed.
Purpose: This section is purely procedural and, standing alone, has little effect on deal value (and no effect on the other two classification factors). The parties may devote a small amount of negotiation time to determining the payment window and the interest rate that applies if that window is missed. However, those issues will typically be agreed upon quickly given the fact that they may never come into play and, even if they do, they don’t present a particular hardship to either side so long as the terms are reasonable. Furthermore, since either side could end up as the Indemnifying Party it is in both their best interests to institute reasonable and impartial payment terms.
Buyer Preference: The Buyer typically prefers a shorter payment period and a higher interest rate, but that preference will be tempered by the fact that it may end up making a payment subject to those terms.
Seller Preference: The Seller favors a longer payment period and a lower interest rate, but it will also want the terms to be reasonable since it could wind up on the receiving end of indemnification payments.
Differences in a Stock Sale Transaction Structure: None.
Indemnification by Buyer
What is Indemnification by Buyer? Indemnification is used to enforce representations, warranties and covenants made in the Agreement. Here, the parties list out which breaches by the Buyer are subject to the Seller’s right to indemnification.
The Middle Ground: Much like the previous provision, this one requires the Buyer to indemnify the Seller, its Affiliates, and its Representatives for any Losses caused by an inaccuracy or breach of the Buyer’s representations, warranties, covenants, and other Buyer obligations that the parties agree will be covered by indemnification. The provision is meant to mirror the “Indemnification by Seller” section, with the only difference being the list of items for which indemnification is available.
Purpose: While the Buyer is usually the party most concerned with managing the risk that accompanies the transaction, there are significant areas of risk that the Seller has to deal with as well. Often, that risk is allocated to the Buyer through other pieces of the Agreement because the Buyer is in the best position to control it. This clause gives effect to the risk allocation agreed upon by the parties by providing the Seller with a relatively quick and simple method of recouping damages caused by a Buyer’s breach or misrepresentation.
Buyer Preference: Ideally, the Buyer wants this list to be as short as possible. In practice, the categories listed above will likely all be included because they all represent issues associated with potential liabilities, and they are the areas within the Buyer’s control. Furthermore, if there are any additional issues listed in the Seller’s indemnification section for which the Buyer has a reciprocal responsibility, the Buyer can expect for those issues to be included here since this provision is meant to mirror the Indemnification by Seller provision.
Seller Preference: The Seller wants the Buyer’s responsibilities to extend to any situation where the Seller could lose money due to the actions of the Buyer. For example, if the Seller leases a piece of land from a third party and the landowner requires the Buyer to sublease that land from the Seller rather than take it by assignment (perhaps because the landowner knows the Seller but not the Buyer), the Seller could end up being responsible for unpaid rent if the Buyer fails to live up to its obligations. Typically, the Buyer’s duty to pay rent will be established elsewhere in the Agreement, so it need not be listed separately here, but the Seller would want it listed here if not previously addressed.
Differences in a Stock Sale Transaction Structure: None.
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 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.
Further Assurances
What are Further Assurances? Buying a business requires paying attention to many different areas of the business, and some steps that are needed to accomplish the transition from one owner to the next happen after the Closing Date. Rather than list out every single step within the Agreement (an exercise that would inevitably result in important steps being overlooked), both parties promise to take any reasonable actions that are required in order to carry out the terms of the Agreement.
The Middle Ground: This provision requires each party (and their respective Affiliates) to take any further actions following the Closing that are reasonably required to fulfill the Agreement and the other Transaction Documents.
Purpose: The covenant is included to address miscellaneous, post-Closing issues that are not explicitly covered elsewhere in the Agreement. It serves as a risk management tool for both sides and is meant to ensure that the actual outcome mirrors the bargained-for exchange.
Buyer Preference: None.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: None.
Tax Clearance Certificates
What are Tax Clearance Certificates? When a company is registered to conduct business in a particular state, the state keeps records of state-level taxes owed by the company. A tax clearance certificate is a document provided by the state indicating that the Business does not have any overdue taxes or, if taxes are owed, indicating the amount that the Business is required to pay.
The Middle Ground: This covenant requires the Seller to notify the taxing authorities (in jurisdictions that impose taxes on the Seller) of the transaction and to request tax clearance certificates from those taxing authorities where available. If the taxing authority indicates that the Seller is liable for unpaid taxes, the Seller must promptly pay those taxes and provide evidence of the payment to the Buyer.
Purpose: The goal of this provision is to prevent the Buyer from becoming liable for the Seller’s delinquent tax obligations. It plays a small role in risk allocation, but its importance is limited by the fact that the Buyer is indemnified for any such tax obligations. Thus, the covenant is most useful for the Buyer in situations where the Caps or Baskets on indemnification would preclude the Buyer from making a claim. With that said, indemnification can be tricky to negotiate and can involve a long claims process, so this covenant also serves to provide some peace of mind that state-level taxes will not cause problems for the Buyer.
Buyer Preference: The Buyer wants to include this covenant, especially if time is not an issue and including it would not place an undue burden on the Seller. The Buyer may even prefer to obtain the certificates itself rather than putting that task on the Seller’s plate. However, most buyers will not object to omitting it, especially if they can exclude tax-related claims from the limitations on indemnification.
Seller Preference: The Seller wants to exclude this covenant on the grounds that it unnecessarily adds more work to an already lengthy and exhaustive process. The Seller can point to the Buyer’s indemnification rights to show that the Buyer’s risk from delinquent taxes is already addressed elsewhere in the Agreement.
Differences in a Stock Sale Transaction Structure: This covenant is not included in stock sales. In the asset acquisition context, the covenant only requires the Seller to make notifications and requests of the relevant taxing authorities if the failure to do so would result in the Seller’s tax liability being transferred to the Buyer. Since that transfer is automatic in a stock sale, the Buyer relies on its indemnification rights to shield it from becoming responsible for the Seller’s unpaid taxes.
Transfer Taxes
What are Transfer Taxes? Some states tax certain aspects of a business acquisition, such as imposing taxes on the transfer of Owned Real Property. Here, the parties identify the party responsible for paying those taxes and taking care of any associated obligations.
The Middle Ground: This covenant requires the Seller to pay all taxes and fees incurred in connection with the transfer of the Purchased Assets (“transfer taxes”) when such taxes come due, and calls for the Buyer to reimburse the Seller for 50% of the taxed amount. It also requires the Seller to make any necessary filings in relation to transfer taxes, with the Buyer’s cooperation.
Purpose: This main function of this requirement is to ensure that someone pays the transfer taxes so that neither side has to deal with fines or other penalties resulting from one or both parties overlooking their tax obligations. The likelihood is that the Buyer and Seller will not even discuss it and will simply accept the local custom to determine who pays.
Buyer Preference: The Buyer wants the Seller to pay the transfer taxes, but will usually settle for either splitting the bill or allowing local custom to dictate the outcome.
Seller Preference: Similarly, the Seller wants this obligation to fall on the Buyer but will typically agree to a 50-50 split or to defer to local custom.
Differences in a Stock Sale Transaction Structure: None.
Receivables
What are Receivables? Acquisitions are a process, and even after the sale is closed it takes all those involved some time to adjust to their new circumstances. That includes customers, many of whom will continue to send their payments to the Seller (especially in business-to-business relationships). Also, customers are not aware of the specific deal terms, so they may send money to the Buyer that is actually owed to the Seller. Regardless of where the payments are initially sent, this covenant is aimed at making sure they end up where they’re supposed to be.
The Middle Ground: For any funds received by the Seller on or after the Closing Date that relate to the Purchased Assets, the Seller agrees to pass them along to the Buyer within a set number of days. Similarly, the Buyer agrees to send to the Seller any funds it receives that relate to the Excluded Assets within a similar time frame.
Purpose: The rights to the money mentioned here are established elsewhere in the Agreement, so the legal effect of this section is really to set a time frame for when that money must be turned over.
Buyer Preference: None.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: This clause need not be included in a Stock Purchase Agreement because there are no Purchased Assets or Excluded Assets. Everything, good or bad, goes to the Buyer after the Closing.
Bulk Sales Laws
What are Bulk Sales Laws? Bulk sales laws apply to transfers of significant assets that are not made in the ordinary course of business, and they generally require the Buyer to notify the Seller’s creditors of the acquisition prior to the Closing so the creditors can protect their interests.
The Middle Ground: The notification requirements associated with bulk sales laws can be burdensome, so typically the parties agree to waive compliance with those laws, and the Seller agrees to take responsibility for any Liabilities arising from the parties’ noncompliance.
Purpose: The provision plays a small role in limiting the Buyer’s transaction risk, but its main purpose is to speed up the acquisition process and limit transaction costs.
Buyer Preference: The Buyer wants to include the Seller’s explicit assumption of liabilities in this provision, as the default rule automatically transfers liability to the Buyer along with the transfer of assets. An aggressive Buyer may require indemnification for claims related to bulk sales laws rather than simply relying on the Seller’s covenant. Additionally, a Buyer may impose a requirement on the Seller to litigate any claims brought by creditors under the bulk sales laws. Alternatively, a more conservative Buyer might comply with bulk sales laws if it is not comfortable with the Seller’s level of debt or with a particular creditor.
Seller Preference: The Seller will likely seek to limit this provision to a waiver of compliance while remaining silent regarding the assumption of liability related to bulk sales. If the Seller does agree to assume that liability it might not object to granting the Buyer indemnification rights, but it will most likely resist any requirement to litigate claims brought by creditors. The Seller’s views on complying with bulk sales laws may depend on the transaction timeline (i.e. if compliance would delay the Closing), but the more decisive factor is likely to be how much additional work it creates for the Seller, who is already having to balance running the Business while simultaneously trying to sell it.
Differences in a Stock Sale Transaction Structure: This provision is not included in a stock sale because there is no transfer of assets between entities, the Buyer simply stands in the Seller’s shoes with regard to Business-creditor relationships.
Public Announcements
What are Public Announcements? The timing and content of acquisition announcements can be important to each side for various reasons, but it is not so critical that the parties should spend valuable time on it before the deal is closed. Instead of agreeing on the specifics of the announcement pre-Closing, the parties use this covenant to agree more generally about who will draft the announcement and who must consent to its release.
The Middle Ground: Both parties agree that they will not publicly announce the acquisition without the cooperation and consent of the other party (unless required to do so by law, as determined by the reasonable advice of legal counsel). The Agreement may also stipulate that the consent required here cannot be unreasonably withheld or delayed.
Purpose: This provision allows both sides to control how and when interested third parties find out about the acquisition. In the lower middle market context, this covenant is aimed less at controlling the media coverage around the transaction and more at limiting its disruptive effect on employees. However, since limiting such disruption is in the best interests of both sides, in the absence of this provision, these transactions would be consummated as planned 99% of the time.
Buyer and Seller Preference: This clause will likely make it into the Agreement unaltered since it is usually not worth the time for either party to bring it up during negotiations. If the parties do address it directly, the discussion will probably focus on when and how the deal announcement will be made. With that being said, some buyers may not want to qualify the consent requirement, and there may be minimal negotiations devoted to that issue. Whether the consent requirement is altered, or even instituted in the first place, will likely be an outcome determined by the level of trust between the parties. Additionally, the “cooperation requirement” may not be included if the parties trust one another and one side has significantly more PR-related resources than the other.
Differences in a Stock Sale Transaction Structure: None.
Closing Conditions
What are Closing Conditions? Both the Buyer and Seller will have various tasks they must complete prior to the Closing in order to get the deal across the finish line. While those tasks are listed out elsewhere, this covenant sets the minimum standard of effort that must be used to achieve them.
The Middle Ground: Both parties promise to use their reasonable best efforts to satisfy their respective closing conditions.
Purpose: This provision is intended to increase the likelihood that the parties complete the transaction, and it does so by serving as a “catchall” provision that applies the “reasonable best efforts” standard to all closing conditions. Without this provision, one party could decide it doesn’t want to complete the transaction after it has already signed the Agreement, and it could avoid liability for failing to perform by simply not meeting its closing conditions. At that point, the other party would have to decide whether to abandon the transaction or waive those conditions and move forward, and neither of those options is very attractive. This covenant helps avoid that situation by requiring the parties to use a certain level of effort to satisfy the closing conditions, and if that level is not met it is considered a breach of the Agreement.
Buyer Preference: None.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: None.
Books and Records
What are Books and Records? Sometimes the Buyer needs access to pre-Closing information about the Business or the Seller needs similar post-Closing information. The need may arise because the two parties are in dispute and the relevant information is under the other side’s control, or it may result from a third-party claim or government inquiry (among other reasons). To address these situations ahead of time and in a fair manner, both sides agree on when access will be granted to the other’s books and records, and the length of time those records must be kept.
The Middle Ground: Here, both parties agree to keep copies of the Business’s pre-Closing Books and Records for a set period of time and to provide the other side with reasonable access to them. The parties may agree to provide access only under certain circumstances, such as if a claim is brought against either party in relation to the Business, or they can use a more general standard and allow access for any reasonable purpose. The amount of time the pre-transaction Books and Records are kept is typically based on the Seller’s past practices, and the other party is afforded access for an agreed-upon number of years. The right of access does not extend to situations in which granting such access would violate the law.
Purpose: This provision may never be utilized, but it is included nonetheless as a way to assist both sides in the event of a future claim (i.e. as a risk management tool). Memory is incredibly fallible and having to rely on it years down the road in the midst of a dispute is not a situation in which the Buyer or Seller wants to find itself. However, the risk being protected against is minute and each party is more likely to consult its own copies as opposed to those of the other side should the need arise (unless, perhaps, the claim is being brought by the other side). Thus, the provision does little more than provide a redundant fail-safe option that will likely never be used. That fact, in addition to the reciprocal nature of the covenant, means it will likely be included in the Agreement without any explicit discussion.
Buyer Preference: None.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: The only difference in this term in a stock sale is that the retention period for the Business’s Tax Records is based on statutory time limitations rather than the Seller’s past practices. Since the Buyer is assuming the tax liabilities of the Seller, it will want to retain those records for as long as a tax-related claim can be brought against the Business.
Governmental Approvals and Consents
What are Governmental Approvals and Consents? The lack of an important governmental approval or third-party consent can kill a deal despite the Buyer and Seller both wanting to move forward. To avoid that situation, the parties list out the necessary consents and approvals and split up the work in a way that makes sense for both sides. They also use this covenant to set boundaries around how far they must go in order to obtain a consent or approval.
The Middle Ground: This covenant requires both the Buyer and Seller to make all filings necessary to consummate the transaction, and to use their reasonable best efforts to obtain all the requisite consents from governmental authorities and third parties (e.g. customers and suppliers). It then lists out specific actions that the parties must carry out or avoid in order to obtain the necessary consents, such as litigating any order blocking the transaction, again modified by a reasonable best efforts standard. It also requires the parties to share certain information regarding communications with Governmental Authorities. Lastly, it expressly states that the Buyer is not required to sell off any part of its business or change the terms and conditions of the transaction to appease a Governmental Authority seeking to halt the transaction based on antitrust concerns.
Purpose: Once a potential deal reaches the exclusivity stage, it’s unlikely that a third party will prevent it from going through unless that third party is the government or has an important contract with the Seller and won’t consent to a change of control. This covenant seeks to deal with those two threats by allocating the serious risks they present between the parties.
Buyer Preference: The Buyer’s main concern with this clause is the application of the “reasonable best efforts” standard. The Buyer wants the standard included, but in defining what it means the Buyer needs to be aware of what it is willing (and unwilling) to do to close the transaction. For anything that it is unwilling to do, the Buyer will want an express statement to that effect included in the definition of reasonable best efforts. Given that the Seller will be the one that has the pre-existing relationships with important third parties other than the government, the Buyer generally wants the risk of not obtaining a third-party consent to fall on the Seller, with the risk of not obtaining Governmental Approval shared equally.
Seller Preference: The Seller wants to place the risk of not obtaining necessary Governmental Approvals on the Buyer, and it can do so by replacing the reasonable best efforts standard with a more demanding one. The Seller’s main concern is avoiding governmental interference with the deal, so it wants to place the burden relating to any such interference on the Buyer. The Seller can allocate that risk to the Buyer by requiring the Buyer to either divest assets to satisfy regulators or litigate any Governmental Order blocking the transaction. If the Buyer objects, the Seller can suggest putting caps on the amount of assets the Buyer must divest or that the parties list out specifically which assets would be subject to divestiture.
Differences in a Stock Sale Transaction Structure: None.
Equitable Remedies and Reasonableness of Restrictive Covenants
What is he Equitable Remedies and Reasonableness of Restrictive Covenants section? These two terms help enforce the three important restrictive covenants: the Confidentiality, Non-Compete and Non-Solicitation provisions. All of those restrictive covenants call for non-monetary (“equitable”) remedies, and the restrictions must be reasonable for a court to enforce them. By agreeing to this section, the Seller is agreeing that a non-monetary remedy is appropriate for the situation and that the specific restrictions included in the restrictive covenants are reasonable in the context of the transaction.
The Middle Ground: The Equitable Remedies provision states that a violation of any of the restrictive covenants would cause the Buyer irreparable harm for which money would not provide adequate compensation. It is meant to allow the Buyer to obtain an equitable remedy such as an injunction to prevent violations. The Reasonableness provision includes an acknowledgement from the Seller that the Confidentiality, Non-Compete and Non-Solicitation covenants are reasonable. It also states that if a court finds the restrictive covenants unreasonable, the Seller agrees that the court should reform the terms to the point where they are considered reasonable but still achieve the desired effect to the maximum extent allowed by law.
Purpose: These two provisions are aimed at protecting the viability of the restrictive covenants. The Confidentiality, Non-Compete and Non-Solicitation covenants do most of the heavy lifting in terms of protecting deal value, and these two covenants perform a smaller risk management function by ensuring that the more important covenants remain enforceable and effective.
Buyer Preference: Although there will typically be a specific performance clause applicable to the entire Agreement, the Buyer wants to include the Equitable Remedies covenant here so that there is no question that it applies to all restrictive covenants. The Buyer wants to be sure to include language that tracks the standard for granting injunctions and other equitable remedies (i.e. “irreparable harm…for which monetary damages would not be an adequate remedy”). In regard to the Reasonableness covenant, the ability to modify restrictive covenants rather than completely invalidating them is not available in all states. So, the Buyer’s counsel should adjust its approach depending on whether the law governing the agreement allows “blue-pencil” revisions. If not, the Buyer may want to include a choice of law clause or reduce the covenant restrictions so there is no doubt they are enforceable.
Seller Preference: If the Seller agrees that the restrictive are reasonable, it will likely have no objection to these two subsections since the entire purpose of both is to protect the viability of the restrictive covenants.
Differences in a Stock Sale Transaction Structure: None.
Confidentiality and Non-Disparagement
What is the Confidentiality and Non-Disparagement section? All businesses possess information that is beneficial to them because it is not known by the public (e.g. customer lists, trade secrets, etc.). Prior to the Closing, the Seller protects that information by requiring the Buyer to keep non-public information confidential. Post-Closing, the Buyer wants to place a similar confidentiality requirement on the Seller, and this covenant is used to accomplish that goal.
The Middle Ground: This covenant requires the Seller, its Affiliates, and its Representatives to use their reasonable best efforts post-Closing to keep confidential all information about the Business that is not otherwise publicly available. It also requires the Seller to take certain precautions if it is required by law to disclose the information, such as only providing information it is legally required to provide (as advised by legal counsel) and taking steps to limit who is able to access the confidential information that is disclosed. The parties also agree not to make negative or disparaging comments about each other to third parties.
Purpose: This covenant is intended to protect the value of the Business after the transfer of ownership has occurred by protecting the confidential information of the Business. For a serial buyer such as a private equity firm, it also protects future deals by preventing the Seller from providing potential future sellers with information about terms the Buyer is willing to accept and/or the Buyer’s negotiation strategies.
Buyer Preference: The Buyer wants to pay close attention to the definitions of Affiliates and Representatives to ensure that everyone who has access to the information sought to be protected has a duty of confidentiality with regard to that information. If the sale was initially conducted by auction, expansive definitions of Affiliates and Representatives may not adequately protect the Buyer’s risk, so the Buyer can have the Seller assign the confidentiality agreements signed by the other auction participants to protect the Business’s sensitive information. The Buyer also wants to be able to enforce this covenant using an injunction rather than indemnification, because preventing a violation is more valuable than receiving monetary compensation after one has occurred. To achieve that goal, the Buyer should explicitly carve out this covenant from the Exclusive Remedies provision.
Seller Preference: The Seller may want to include language indicating that the Buyer’s confidentiality obligations (often originating in the Letter of Intent) apply to information disclosed pursuant to the Agreement and that the Buyer’s confidentiality obligations survive termination of the Agreement. Essentially, such language provides protection for the Seller if the deal does not go through. The Seller will also pay attention to the scope of the disclosure restrictions so it can avoid being penalized for sharing information that doesn’t have the potential to hurt the Business or the Buyer.
Differences in a Stock Sale Transaction Structure: None.
Notice of Certain Events
What is Notice of Certain Events? The Buyer makes its decision to invest based on the information available to it, but new or changed information could lead to a different decision. The Buyer can use this section to identify the types of information that may change its decision and to ask the Seller to communicate such information as it is received.
The Middle Ground: This covenant requires the Seller to notify the Buyer if certain events occur and provides a list of events for which notice is required. That list includes events that would or have had a Material Adverse Effect on the Business, anything that would make a Seller representation or warranty untrue, and anything that prevents the Seller from satisfying its Conditions to Closing, among others. The covenant also explicitly states that providing notice of the listed events does not result in the Buyer losing its right to make an indemnification claim or terminate the Agreement.
Purpose: Without this notice requirement, the Buyer would be forced to spend considerable time and money checking on the status of its potential investment at a point in time when someone else (the Seller) has much better knowledge and access. In that scenario, the cost and risk are all on the Buyer, who would likely pass along some of those costs to the Seller by lowering the Purchase Price. With this covenant, the Seller monitors the Business and the Buyer’s cost of obtaining the information is eliminated, as is some of its risk, which means more money in the Seller’s pocket and a safer investment for the Buyer.
Buyer Preference: The Buyer does not want a disclosure under this covenant to prevent it from claiming indemnification or terminating the Agreement, so an explicit statement that the covenant does not affect those rights is in the Buyer’s best interest (and may be necessary, depending on the circumstances and governing state law). If the Seller insists on limiting the Buyer’s indemnification rights for information known prior to the Closing, the Buyer can compromise by negotiating for a Cap and/or Basket on the indemnification rights stemming from any such information.
Seller Preference: If notice is given based on this covenant that corrects an inaccuracy or breach of one of the Seller’s representations or warranties, the Seller wants the notice to serve as a cure for that inaccuracy or breach to prevent an indemnification claim. If the Buyer wants to reserve its right to terminate the Agreement or bring an indemnification claim, the Seller can try to negotiate (1) for a limited time period to terminate the Agreement or make a claim, (2) to impose a materiality or Material Adverse Effect standard on cured representations and warranties, or (3) to institute a procedure for resolving these disputes before the Buyer is allowed to terminate the Agreement.
Differences in a Stock Sale Transaction Structure: None.