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.
Certain Limitations
What is the Certain Limitations section? If no limits are set on the right to indemnification it is a tool that can be abused by the parties, especially in situations where there is not a working relationship between the Buyer and Seller after the Closing. Here, the parties implement boundaries around indemnification to avoid the problems caused by abuse of indemnification rights.
The Middle Ground: This provision limits the indemnification claims that can be brought by setting “Caps” and “Baskets” around the right to indemnification. A Basket sets a minimum amount of damages that must be incurred before an indemnification claim can be brought, and it is typically limited to claims based on breaches of the representations and warranties in the Agreement. Typically, the Basket sets a minimum threshold for making a claim and once that threshold is reached the injured party is eligible to receive 100% of the damages it suffered. A Cap may also be included, and it serves as an upper limit on the amount that will be paid in the event of a claim or the aggregate amount that will be paid out for all indemnification claims of a party.
Purpose: The purpose of a Basket is to prevent one party from trying to recapture some of the value given up in the deal by making numerous “nickel and dime” claims against the other side. In other words, it prevents the parties from abusing their indemnification rights. By doing so, the provision protects the parties’ expectations regarding their risk exposure and the value received from the transaction. Caps are also used as a tool to manage overall risk exposure, and they are especially important in situations where there is a reasonable potential for one of the parties to make a large indemnification claim. In addition to their risk management function, Caps and Baskets also increase the chances that the transaction will be completed by encouraging the parties to provide expansive indemnification rights since they know those rights are not subject to abuse and will not create unlimited liability.
Buyer Preference: The Buyer is the party most likely to bring an indemnification claim, which has a number of implications for how it wants to structure this provision. At the most basic level, it wants the Basket to be small (to allow for the payment of moderate claims) and the Cap to either be large or nonexistent. It may also want to tailor the Cap to its specific concerns; if the potential Losses based on one representation are much greater than for the other representations, the Buyer may be better off negotiating for a significantly higher Cap (or no Cap at all) in that area and a smaller Cap in the other areas than for a moderate Cap applicable to every representation. It certainly wants no Cap regarding any liabilities kept by the Seller, as it has no control over those liabilities. It also wants to carve out certain fundamental representations from the Basket and Cap, such as the Organization and Authority representations.
The Buyer wants to resist additional limitations on indemnification payouts, such as a Duty to Mitigate or a requirement to subtract from such payouts any tax or insurance amounts. However, when a Basket is included in the Agreement the Buyer is more likely to seek a “materiality scrape,” which is a provision that removes any materiality qualifiers from the representations and warranties for indemnification purposes. When a materiality scrape is used, the materiality qualifiers used in the representations and warranties still apply to limit what the Seller must disclose in the Agreement, but they do not apply for purposes of determining whether an indemnification claim can be brought and what the damages for the claim will be. The reasoning underlying the use of a materiality scrape in this context is that the Basket already screens out any non-material claims, so including an additional materiality requirement will likely complicate the indemnification process and lead to needless disputes.
Seller Preference: Since the Seller is going to be paying out an indemnification claim in most cases, it will typically seek a high Basket and a low Cap. In addition to this basic position, the Seller will also prefer a “deductible” Basket rather than a “dollar one” or “tipping” Basket. The distinguishing factor about deductible Baskets is that the Basket amount is more than just a threshold, it is also the amount deducted from the total damages to determine the required payment. To put it another way, with a deductible Basket the side making the claim is only entitled to the amount of damages exceeding the Basket amount. In lieu of a deductible Basket, the parties could settle on a hybrid approach, in which the amount deducted from the payout is less than the threshold amount but more than zero. Another beneficial option for the Seller is to include one or more “mini-baskets” that require damages from a particular representation to reach a certain amount before they are counted toward the overall Basket.
Over and above changing how the Basket functions, the Seller could also try to have the Basket apply to all representations, warranties, covenants, and obligations contained in the Agreement, not just the selected representations and warranties. Similarly, the Seller can try to negotiate for the Cap to extend to all indemnification claims. If unsuccessful on that front, the Seller can argue that some Cap (e.g. the Purchase Price amount) should be placed on payments for breach of fundamental representations and warranties, as well as the remaining covenants and obligations in the Agreement, even if that Cap is higher than the Cap applied to the non-fundamental representations and warranties.
Furthermore, the Seller can avoid a “double recovery” situation by including language reducing any indemnification payments by the amount of any insurance money paid to the Buyer for the claim, and it can make the language more effective by requiring the Buyer to use its reasonable best efforts to pursue any viable insurance claim. Another way to avoid double recovery is to reduce the amount of any indemnification claims that result in a tax benefit to the Buyer by the amount of the tax benefit. For instance, if the Seller breaches a representation and the Loss from that breach causes the Business to sustain a net operating loss (NOL) for the year, the amount of the indemnification claim would be reduced by the tax value of the NOL. One final way to limit double recovery applies in situations where the Agreement allows for a Purchase Price Adjustment, and the goal is to ensure that any such adjustment is subtracted from the Losses payable based on an indemnification claim. The Seller could also seek to impose on the Buyer a “Duty to Mitigate,” meaning the indemnified party would be required to try to reduce its damages from a breach by taking some sort of corrective action.
Finally, if the Agreement contains an escrow provision, the Seller can negotiate for its money held in escrow to be paid out to satisfy a claim for indemnification before it is required to pay money out of its own pocket to do so.
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.
Indemnification by Seller
What is Indemnification by Seller? Indemnification is used to enforce representations, warranties and covenants made in the Agreement. Here, the parties list out which breaches by the Seller are subject to the Buyer’s right to indemnification.
The Middle Ground: This provision requires the Seller to reimburse the Buyer, its Affiliates, and their Representatives for any Losses arising out of: (1) the inaccuracy or breach of any representation or warranty contained in the Agreement or other Transaction Documents, if the representation or warranty was inaccurate or breached when made or at the Closing; (2) non-fulfillment of any covenant, agreement, or obligation undertaken by the Seller pursuant to the transaction; (3) any of the Excluded Assets or Excluded Liabilities; and (4) any Third Party Claim resulting from the Seller’s (or its Affiliates) operation or handling of the Business or Assets prior to the Closing Date.
Purpose: The indemnification aspect of the Agreement is the most efficient tool available for motivating the parties to stand by their agreed-upon obligations. As such, it is the main way for the parties to enforce the risk allocation scheme created throughout the Agreement.
Buyer Preference: If the Buyer is particularly worried about exposure from certain liabilities, it can specifically include those liabilities in this section so there is no debate whether they fall under the Seller’s indemnification obligation. Examples of the liabilities the Buyer may want to specify include retained employee liabilities, product liability claims, environmental issues concerning any assets or property transferred as part of the deal, and noncompliance with any applicable bulk sales laws. The Buyer also wants to carefully evaluate the definitions of “Affiliates” and “Representatives” to ensure the terms cover all those who may have an indemnification claim against the Seller in the future.
Seller Preference: The Seller wants to limit the matters eligible for indemnification as much as possible. Particularly, the Seller will be looking out for issues it cannot control to avoid being held responsible for problems caused by third parties.
Differences in a Stock Sale Transaction Structure: In a stock sale, there are no Excluded Assets or Excluded Liabilities, so it is even more essential for the Buyer to specifically list the liabilities for which the Seller has indemnification obligations. An often-used alternative to including a specific list in this section is to address those concerns in the representations and warranties since they are incorporated here by reference.
Survival
What is the Survival section? This section allows the parties to use indemnification to resolve post-Closing disputes. But what is indemnification? In short, it is a built-in enforcement mechanism that allows the parties to be made whole following a breach of the Agreement without going through the costly and time-consuming legal system. Rather than enforcing the representations and warranties (and, potentially, other areas of the Agreement) through litigation, the parties agree that certain breaches will be handled between the parties without going to court. For example, if the Buyer breaches a portion of the Agreement that is subject to indemnification, the Seller calculates the damage suffered because of the breach and makes a claim to the Buyer for payment. The Buyer can accept the claim and make the payment, or object and it is resolved by an agreed upon dispute resolution process (one that is meant to be faster and cheaper than litigation).
The Middle Ground: The Survival provision states that the representations and warranties (and any other provisions) subject to indemnification under the Agreement will survive after the Closing, and provides an explanation of when each representation is no longer applicable. Typically, the general survival period is anywhere between one and two years, with certain specified representations lasting for a longer period of time. The portions of the Agreement that tend to last longer than the baseline survival period include representations regarding fundamental corporate matters (i.e. organization and authority of both parties), Title to Purchased Assets, the Condition and Sufficiency of Assets, Taxes, Environmental Matters, and Employment Matters.
Purpose: Since most purchase agreements terminate at the Closing, certain portions must be identified for “survival” in order to remain effective after Closing. The indemnification provisions are some of the most important to survive termination of the Agreement. Without this survival clause, any cause for indemnification would have to be discovered prior to Closing, and that is simply not a reasonable expectation, especially for the Buyer who won’t take control of the Business until after the Closing. So, the Survival section is used to show how long claims for indemnification are available and ensures that those claims can be made after the ownership transition has taken place.
Buyer Preference: Ideally, the Buyer would be able to negotiate for indefinite survival of all representations, warranties, and covenants made by the Seller. In practice, that’s probably not going to happen since the Seller does not want to perpetually plan for the possibility of a claim, and because some states do not allow for contractual extension of a statute of limitations. To address the second concern, the Buyer has a couple options: (1) it can negotiate to change the governing law provision to a state with a longer statute of limitations or to a state that allows for contractual extension of the statute of limitations, or (2) state explicitly in the Agreement that a claim for indemnification does not accrue until the wrongdoing is discovered or should have been discovered. In addition to these general strategies, the Buyer wants to assess which representations, covenants, etc. present the greatest loss potential down the road and negotiate for the extended survival of those provisions. For example, whether companies are properly collecting sales tax has arisen as a major issue for buyers of e-commerce businesses, so the Buyer in that situation wants the representation relating to sales tax to survive for as long as it could be exposed to pre-Closing sales tax liability.
Seller Preference: Other than the payment provisions that favor the Seller and extend past the Closing, the Seller will prefer a short survival period for the representations, warranties, and covenants contained in the Agreement. That is because, by the nature of the transaction, the Buyer is more likely to bring a claim for indemnification than the Seller. In some jurisdictions, simply limiting the survival period is not enough to prevent an indemnification claim during that period; the survival language must actually limit the time in which a claim can be brought for a breach. Unlike the Buyer, the Seller should have intimate knowledge of where its risk lies regarding the Purchased Assets, so its top priority on this point is to attempt to limit the survival periods in those areas.
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 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.
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.
Non-Solicitation of Employees and Clients
What is Non-Solicitation of Employees and Clients? In addition to limiting the Seller’s ability to compete, this covenant is another way for the Buyer to protect the value of the Business post-Closing. Because non-compete covenants are limited to a certain geographic area, buyers include this covenant to protect relationships with customers and employees in case the Seller decides to compete in a geographic area that is not covered by the non-compete restriction.
The Middle Ground: This covenant prevents the Seller and its Affiliates from attempting to lure employees away from the Business. It may also prevent the solicitation of clients and prospective clients of the Business, if that restriction is not included in the Non-Competition covenant. In regard to employees of the Business, the restriction is typically aimed at employees who have been offered employment by the Buyer, but does not apply to general solicitations, employees terminated by the Buyer, or employees who terminated their own employment with the Business after a specified time period.
Purpose: The Seller has a massive informational advantage over the Buyer in being able to identify the key employees and clients of the Business. If the Seller were allowed to poach them away from the Business, it could easily decimate the value of the Buyer’s investment. Put another way, the Buyer agrees to a Purchase Price based on expectations for how the Business will perform in the future, and the purpose of this covenant is to protect those expectations.
Buyer Preference: Similar to other restrictive covenants, the Buyer wants this covenant to be as broad as possible while still being enforceable. That means any and all restrictions should be rationally related to protecting the Business. The Buyer may also seek to prevent the general solicitation of employees (and will surely want to do so for clients), and it will want the restrictive language to apply to the Seller’s affiliates and to indirect attempts to solicit employees.
Seller Preference: The Seller wants to include all exceptions contained in the middle ground term, and additionally it might try to reduce the waiting period required to hire any employees who leave the Business of their own volition. It may also want to reduce the effective period for this covenant, if there is a logical reason for it to be shorter than the effective period for the non-compete covenant (generally the Buyer wants the time periods to mirror one another for ease of enforcement). An ambitious Seller may want to avoid this covenant altogether, but most Buyers will refuse to make an acquisition without some protection regarding clients and employees of the Business.
Differences in a Stock Sale Transaction Structure: None.
Non-Competition
What is the Non-Competition section? One of the ways a Buyer protects its investment is by limiting future competition by the Seller, who is more knowledgeable about the Business (and often the industry) than the Buyer. By limiting competition from the Seller, this covenant protects the Business’s relationships with customers, suppliers, employees, and other stakeholders.
The Middle Ground: In most acquisitions, the Seller agrees not to compete with the Business after the Closing. The covenant terms describe who is not allowed to compete (generally, the Seller and its Affiliates); the duration of the restriction, which varies from state to state based on differences in state law (typically anywhere from 1-10 years); the specific acts that are restricted, either defined in detail or by reference to the acquired Business (e.g. any business that directly or indirectly competes with the Business); the geographic scope of the restriction, which is also either defined in detail or based on where the Business operates; and any exceptions to the restriction on competition. The covenant will likely also prevent the Seller from inducing any current or prospective clients to end their relationship with the Business, although this restriction is sometimes included in a separate non-solicitation covenant.
Purpose: This covenant is an essential component of the Agreement because of its impact on the value of the deal to the Buyer. In small to mid-sized businesses, much of a company’s value is derived from the owner’s relationships with customers, suppliers, and others in the community. Significant value also stems from the owner’s know-how and familiarity with the industry. If the owner were to go out and start a competing business following the acquisition, the value of the Business in the hands of the Buyer would likely plummet.
Buyer Preference: The Buyer wants each term in the covenant other than the exceptions to be defined as broadly as possible while still being enforceable. Restrictive covenants such as non-compete agreements are disfavored by the courts. In this context, that means overbroad restrictions that don’t directly protect the acquired Business will likely not be enforced. Whether a restriction goes too far depends on the facts and circumstances surrounding the particular acquisition, as well as the state law that governs the Agreement, so it’s important to tailor the covenant terms to the situation.
Seller Preference: Whether the Seller wants to spend significant time and effort negotiating these terms depends on its post-acquisition plans, but in general it wants the restrictions to be as limited as possible and the exceptions to be plentiful. More specifically, if the Seller plans to invest in other ventures following the acquisition it wants to make sure that this covenant does not prevent it from doing so. Some investments will undoubtedly be restricted (e.g. investing in a direct competitor), but the Seller wants to make sure that any such restrictions are directly related to protecting the value of the Business. If the Seller is only selling a division of its business, it also needs to make sure none of the restrictions affect its ongoing operations.
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.
Conduct of Business Prior to Closing
What is Conduct of Business Prior to Closing? The Buyer’s due diligence investigation and, ultimately, its decision to buy the Business assume that the Business will continue to operate as it has in the past until the Closing Date (i.e. while the Seller is still in charge). Here, the Seller promises not to make any major changes to the Business without the Buyer’s consent.
The Middle Ground: This covenant requires the Seller to conduct the Business consistently with how it has been conducted in the past and to use reasonable best efforts to maintain the Business’s operations and relationships prior to the Closing. In addition to those general directives, the Seller agrees not to deviate from certain practices without the Buyer’s consent, such as paying debts and taxes when due and performing its duties under the Assigned Contracts.
Purpose: The Buyer bases its valuation of the Business in part on how it has been conducted by the Seller in the past. The best way to protect that value is to ensure that the Business is operated the same way between the signing and Closing as it was in the past. Without this provision, the Buyer would be stuck with the risk stemming from some fundamental change in the Business that occurs after the Buyer signs the Agreement. With it, that risk is shifted to the Seller, who is in the best position to prevent those changes from taking place.
Buyer Preference: Here, the Buyer may want to include a comprehensive list of both the actions the Seller is required to take prior to the Closing and those it is forbidden from taking. If the Buyer is financing the acquisition, the list should also include anything the Seller must do in order for the Buyer to obtain financing. For maximum protection, the Buyer can require consent on all material operational decisions, but there are two important limits on such a requirement. From a practical standpoint, the Buyer may not have the time or expertise to make those decisions, and it would be best served by letting the Seller continue ordinary operation of the Business. From a legal standpoint, if the Buyer and Seller operate in the same industry they must be careful to avoid violating antitrust law by consolidating control before they obtain the proper approval (if governmental approval is required).
Seller Preference: The Seller wants as few restrictions listed here as possible so that it does not inadvertently violate the Agreement. It also wants language in the covenant that allows it to back out of a particular duty if the Buyer consents, with the Buyer’s consent governed by a standard of reasonableness (e.g. the Buyer cannot unreasonably withhold or delay consent). The Seller may also try to mitigate some of the Buyer’s requested restrictions by narrowing their applicability where it makes sense to do so. Both parties want to avoid antitrust issues, so they may include a “No Control of Other Party’s Business” clause if the list included here is particularly comprehensive and/or restrictive.
Differences in a Stock Sale Transaction Structure: None.
Absence of Certain Changes, Events, and Conditions
What is This? In this section, the Seller provides information regarding the current state of the Business. It is part of the Representations and Warranties of Buyer section.
The Representations and Warranties of Buyer portion of the Agreement is used to save the Seller time and money. Rather than require the Seller to go through third parties to find certain information, the Buyer provides the information and must reimburse the Seller for any Losses it suffers if the information is false or misleading.
The Middle Ground: In this provision, the Seller represents that certain aspects of the Business (e.g. accounting practices) have not changed, or certain events or conditions have not occurred, since the Balance Sheet Date. The most important inclusion in this section is the representation that nothing has occurred since that date that could reasonably have a Material Adverse Effect on the Business. The representation excludes changes, events, and conditions that occur in the ordinary course of business and are consistent with the Seller’s past practices.
Purpose: A Buyer’s decision to invest in a business involves the consideration of dozens of different factors, and sometimes it is just one of them that tips the balance from a “pass” to a “buy.” If the Business undergoes a significant change after the investment decision is made, the Buyer may want to reassess its calculation. This clause allows the Buyer to identify the changes it is most concerned about, and in doing so, it requires the Seller to disclose such changes or represent that they have not occurred.
Buyer Preference: The Buyer wants the list of prohibited changes, events, and circumstances to be comprehensive. It may also want to prevent changes to the Seller’s cash management and accounting practices, especially if the deal involves a Purchase Price adjustment that could be manipulated by varying such practices. In defining Material Adverse Effect, the Buyer wants to strike a balance between a broad definition that encompasses the Buyer’s major concerns and a definition that is relatively easy to measure and enforce. Many buyers are uncomfortable with the vague nature of the materiality standards used, and instead use dollar amount thresholds to qualify certain aspects of the list.
Seller Preference: The Seller wants a short list of prohibited changes, events, and circumstances, especially if they are not likely to affect the Buyer or the Purchased Assets after Closing. The Seller is typically more comfortable with the Material Adverse Effect standard than is the Buyer because it is difficult to enforce, and the same can be said for the other materiality standards in this section. However, if the Buyer insists on dollar thresholds, the Seller will want those thresholds to be as high as possible.
Differences in a Stock Sale Transaction Structure: The list of prohibited changes is likely to be longer in a stock sale because the Buyer is purchasing the entire business instead of certain assets.
Legal Proceedings (Buyer)
What are Legal Proceedings? In this section, the Buyer provides information regarding its involvement in legal proceedings that could interfere with or prevent the transaction. It is part of the Representations and Warranties of Buyer section.
The Representations and Warranties of Buyer portion of the Agreement is used to save the Seller time and money. Rather than require the Seller to go through third parties to find certain information, the Buyer provides the information and must reimburse the Seller for any Losses it suffers if the information is false or misleading.
The Middle Ground: The Buyer represents that, other than those disclosed in the Disclosure Schedules, there are no legal actions, pending or threatened, that would prevent or delay the transaction. It also represents that no events have occurred and no circumstances exist that could lead to such an action delaying or preventing the deal.
Purpose: Even when a Buyer and Seller are in complete agreement on terms and want to move forward, a legal action can dismantle the entire acquisition. Including this representation shifts the risk associated with a legal challenge to the party that is most likely to have knowledge of it, which in this case is the Buyer.
Buyer Preference: Other than the representation regarding pending legal actions, the Buyer wants its representations in this section to include knowledge qualifiers. If part of the Purchase Price includes a transfer of the Buyer’s stock or a seller note, the Buyer may also have to include a statement regarding its property or assets, as the Seller did in its Legal Proceedings representation. If not, the Buyer will want to avoid making any extraneous representations that do not directly relate to the acquisition.
Seller Preference: The Seller wants to avoid including knowledge qualifiers as a way to encourage the Buyer to investigate whether any potential claims could be made that would stop the transaction. If the future success of the Buyer’s company is relevant to the Seller’s payout, either in terms of the payout level or the Buyer’s ability to make the payments, the Seller may also seek a representation relating to the assets and property of the Buyer.
Differences in a Stock Sale Transaction Structure: None.
Sufficiency of Funds
What is Sufficiency of Funds? In this section, the Buyer provides information regarding its ability to fund the acquisition. It is part of the Representations and Warranties of Buyer section.
The Representations and Warranties of Buyer portion of the Agreement is used to save the Seller time and money. Rather than require the Seller to go through third parties to find certain information, the Buyer provides the information and must reimburse the Seller for any Losses it suffers if the information is false or misleading.
The Middle Ground: Here, the Buyer represents that it has enough cash on hand, or immediate access to funds from other sources, to be able to pay the Purchase Price and take the other necessary steps to complete the transaction. If the Buyer is financing the acquisition instead of paying the Purchase Price out of its available cash, this representation should be revised accordingly.
Purpose: The portion of the Purchase Price to be paid at Closing is typically a substantial share of the overall Purchase Price, and it is often the most anticipated payment from the Seller’s perspective. By obtaining this representation, the Seller is provided some assurance that the Buyer has the capacity to follow through on its most important commitment. Furthermore, it’s essential that the Buyer is able to make the payment as a way to build trust if the parties will continue to work together after the Closing. In short, few things, if any, will cause the Seller to abandon the transaction quicker than the Buyer failing to make the Closing Payment.
Buyer Preference: The Buyer will likely be satisfied with this representation as written if no financing is required. However, if the Buyer is utilizing acquisition financing it will want the representation to reflect those terms, and it may want additional covenants such as a requirement for the Seller to take any reasonable actions necessary to assist the Buyer in obtaining such financing. It may also want to add, as a condition to Closing, that a failure to obtain financing allows it to walk away from the deal. Most sellers will strongly resist that sort of condition, but may agree to a “reverse break-up fee” that allows the Buyer to pay a specified amount and abandon the transaction if it’s not able to find financing. If the Buyer is required to make a solvency representation (which it generally wants to avoid doing), it will want to explicitly include certain assumptions to minimize its potential liability for a breach, such as that the Seller’s representations and warranties are true, the target company has not suffered a Material Adverse Effect, and that any financial projections regarding the Business are still reasonable at the time of Closing.
Seller Preference: If the Buyer is using acquisition financing, the Seller will want assurances that the Buyer has satisfied all the conditions to obtaining the financing and is not in breach of its agreement with the lender. If the Buyer is using the Purchased Assets as collateral for the financing, the Seller will want to include a solvency representation so that it is protected if the Buyer is unable to repay its creditor(s). The Seller may also want to consider a covenant requiring the Buyer to use reasonable best efforts (or some other effort standard) to find alternative financing if the arrangement with the initial lender falls through.
Differences in a Stock Sale Transaction Structure: None.
No Conflicts; Consents (Buyer)
Significance: Deal Driver
Section: Representations and Warranties of Buyer
Negotiation Time: Minimal
Transaction Costs: Insignificant to Intermediate
Major Impact: Risk Management and Transaction Completion
What is the No Conflicts; Consents section? In this section, the Buyer provides information regarding its ability to complete the transaction without third-party interference. It is part of the Representations and Warranties of Buyer section.
The Representations and Warranties of Buyer portion of the Agreement is used to save the Seller time and money. Rather than require the Seller to go through third parties to find certain information, the Buyer provides the information and must reimburse the Seller for any Losses it suffers if the information is false or misleading.
The Middle Ground: Much like the Seller’s reciprocal representation, here the Buyer represents that performance of its obligations under the Agreement does not conflict with its organizational documents or any law or Governmental Order. It states that execution of the Agreement does not require notice to or consent from any party that has a contract with the Buyer, other than the parties listed in the Disclosure Schedules. It also represents that no consents, approvals, permits, or Governmental Orders are required from the government, and no notice or filings are required to be provided to the government, to consummate the transaction (other than those required by the HSR Act, if applicable).
Purpose: The rationale for classifying this representation as a Deal Driver mirrors that of the Seller’s “No Conflicts; Consents” representation. Both indicate there are no legal roadblocks to completing the deal, which, if true, makes it much more likely that the transaction will be finalized. This representation also has a substantial effect on the allocation of risk between the parties because the Buyer is assuming responsibility if the transaction doesn’t go through based on a failure to obtain necessary consents.
Buyer Preference: Depending on the situation, the Buyer may want to include a materiality qualifier regarding the consents, approvals, and notices contemplated by this section. It may even want a Material Adverse Effect standard to limit its required disclosures. However, the Buyer must keep in mind that any qualifiers it insists upon will almost always be mirrored in the Seller’s representation. So, the Buyer wants to weigh its desire to limit its own disclosures against its need for full disclosure from the Seller. Most buyers will opt for full disclosure in this section since anything short of that has the potential to reduce the value of the deal or put the entire acquisition at risk.
Seller Preference: The Seller wants the Buyer to disclose any conflicts, consents, Governmental Orders, etc. that could interfere with the transaction. Although this is a reciprocal representation, the Buyer’s representation may be somewhat more limited than that of the Seller since the Seller is not concerned with the post-Closing operation of the Buyer’s business. The Seller should find a more limited representation acceptable, so long as the concerns it does have regarding conflicts, consents, and Governmental Orders are addressed.
Differences in a Stock Sale Transaction Structure: None.
Authority of Buyer
What is Authority of Buyer? In this section, the Buyer provides information regarding its legal ability to enter into the Agreement. It is part of the Representations and Warranties of Buyer section.
The Representations and Warranties of Buyer portion of the Agreement is used to save the Seller time and money. Rather than require the Seller to go through third parties to find certain information, the Buyer provides the information and must reimburse the Seller for any Losses it suffers if the information is false or misleading.
The Middle Ground: In this representation, the Buyer states that it has the power and authority to enter into the Agreement, and that it has taken the necessary corporate action to authorize the transaction.
Purpose: In order for the Seller to be paid the agreed upon amount of cash at Closing, the Buyer must have the power and authority, and take the requisite corporate procedural steps, to transfer the payment. This representation provides the Seller with assurance that the Buyer will make the Closing payment in a legally valid way, ensuring that it will not be recalled later on the grounds that it was never properly approved.
Buyer Preference: If the Seller’s “Authority” representation was changed in any way from the middle ground term, the Buyer wants the same change(s) made to this representation.
Seller Preference: The Seller is likely content with the middle ground term for this representation, but it does want any changes that were made to the Seller’s own Authority representation to also be made here.
Differences in a Stock Sale Transaction Structure: None.
Legal Proceedings; Governmental Orders
What are Legal Proceedings and Governmental Orders? In this section, the Seller provides information regarding legal proceedings and Governmental Orders that may impact the Business moving forward. It is part of the Representations and Warranties of the Seller section.
The Representations and Warranties of Seller portion of the Agreement is used to save the Buyer time and money. Rather than require the Buyer to go through third parties to find certain information, the Seller provides the information and must reimburse the Buyer for any Losses it suffers if the information is false or misleading.
The Middle Ground: The first part of this representation states that, other than the legal proceedings listed in the Disclosure Schedules, there are no legal actions, pending or threatened, relating to the Business, the Seller, or any of the Business’s assets. It also states that no events have occurred that would give rise to any such legal actions. The second part states that there are no outstanding Governmental Orders or judgments against the Business or its assets other than those listed in the Disclosure Schedules. If one or more Governmental Orders are listed in the Disclosure Schedules, there is typically an additional representation that the Business is in compliance with the order and nothing has happened that would constitute or result in a violation of it.
Purpose: Any legal proceedings against the Business, or any events that could lead to such proceedings, have the potential to seriously damage the health of the Business. Some buyers will shy away if there is even the prospect of a significant legal claim against the Business. Similarly, Governmental Orders can lead to future liability or restrictions that most buyers will not want to contend with, or they may even be directed at preventing the proposed transaction. This provision is intended to alert the Buyer to those circumstances so that it can take measures to manage its risk, which may include abandoning the transaction altogether.
Buyer Preference: The Buyer may want to add a provision stating that nothing has occurred that would give rise to a company obligation to indemnify any current or former directors or employees.
Seller Preference: The Seller wants to add a materiality or a Material Adverse Effect qualifier to the Legal Proceedings representation. Some sort of materiality requirement is especially important if the Business operates in an industry where immaterial claims are common. However, if the Buyer’s indemnification rights are limited by a Basket, a materiality qualifier is not as vital. The Seller also wants a knowledge qualifier to apply to the part of the representation that asserts no events have occurred that would result in legal proceedings against the Business or the Purchased Assets.
Differences in a Stock Sale Transaction Structure: None.
Accounts Receivable
What are Accounts Receivable? In this section, the Seller provides information regarding the Business’s Accounts Receivable. It is part of the Representations and Warranties of the Seller section.
The Representations and Warranties of Seller portion of the Agreement is used to save the Buyer time and money. Rather than require the Buyer to go through third parties to find certain information, the Seller provides the information and must reimburse the Buyer for any Losses it suffers if the information is false or misleading.
The Middle Ground: The typical representations in this section include: (1) Accounts Receivable figures are based on legitimate transactions that are consistent with past practice; (2) the amounts are not disputed by the person or business on the other side of the transaction; and (3) the amounts will be collectible within some standard time frame, taking into consideration the company’s “bad debt allowance” that has been computed based on prior experience.
Purpose: The Accounts Receivable portion of the balance sheet indicates the strength of a company’s incoming cash flow and provides the Business with some assurance that it will be able to pay future debts. It is an essential component of the working capital calculation, which is often directly tied to the valuation of the Business. Therefore, it has a significant impact on the final Purchase Price. Additionally, if a company has sold its Accounts Receivable to another company (called a “factoring relationship”), that can have a substantial negative effect on a company’s value.
Buyer Preference: The Buyer wants to include the middle ground term as a baseline representation and may want to include additional receivables accounts if they make up a significant portion of the business.
Seller Preference: Since Accounts Receivable is an item on the Balance Sheet, the Seller wants to exclude this representation on the grounds that it is covered by the Financial Statements representation. In lieu of complete removal, the Seller may try to remove the language referencing collectability of Accounts Receivable since the ability to collect payment within a set time frame relies largely on the actions of third parties over which the Seller has little or no control.
Differences in a Stock Sale Transaction Structure: None.