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.
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.
Brokers (Buyer)
What are Brokers? In this section, the Buyer provides information regarding relationships it has with business brokers and other third-party transaction advisors. 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 no intermediaries are entitled to any brokerage fee or commission in connection with the acquisition, except for the intermediaries listed in the Agreement.
Purpose: Just like the Seller’s “Brokers” representation, this representation is used to manage risk, albeit a small and remote risk. The reciprocal nature of this representation, as well as its relatively minor status within the context of the Agreement, means that it is often included in its standard form and is not the subject of explicit negotiation between the parties.
Buyer Preference: None.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: None.
Brokers (Seller)
What are Brokers? In this section, the Seller provides information regarding relationships it has with business brokers and other third-party transaction advisors. 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 Seller represents that no intermediaries are entitled to any brokerage fee or commission in connection with the acquisition, except for the intermediaries listed in the Agreement.
Purpose: This provision serves a small risk management function by assuring the Buyer that if a third party claims a right to some portion of the Purchase Price based on an agreement with the Seller, it will be the Seller’s responsibility to resolve the claim. The Buyer makes a reciprocal representation, meaning both sides bear some of the risk of third-party claims.
Buyer Preference: Even with this representation included, if the broker’s fee is not paid by the Seller such nonpayment can result in a lien on the Business, which will undoubtedly cause headaches for the Buyer. To avoid such a situation, in addition to including this representation, the Buyer will require a post-Closing statement from the broker indicating that its fee has been paid in full.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: None.
Closing
What is the Closing section? Both sides have to agree when and where the Closing will happen; this section is where they put those details in writing.
The Middle Ground: This clause states the procedural details relating to the Closing, including the date, time, and place where the Closing will occur. It also states when the Closing will take effect for legal purposes (often at 11:59 pm on the Closing Date).
Purpose: This section is purely informational and is included mostly for the sake of convenience. Once the parties agree on a Closing Date they are not likely to give a second thought to this section until that date approaches.
Buyer and Seller Preference: Both parties will want the Closing Date to fall on a weekday so wire transfers can be executed and any last-minute approvals or other closing-related items can be obtained.
Differences in a Stock Sale Transaction Structure: None.
Withholding Tax
What is Withholding Tax? Sometimes a transaction requires the Buyer to withhold a portion of the Purchase Price for tax purposes (e.g. if the Seller is a foreign person or entity). This provision clarifies whether withholding is necessary and, if so, whether the withheld amount is included in the stated Purchase Price.
The Middle Ground: This section allows the Buyer to withhold from the Purchase Price all Taxes that the Buyer is required by law to withhold or, alternatively, waives the withholding requirement based on a statement by the Seller that no withholding is required.
Purpose: If the Buyer is required to pay withholding tax it will naturally want to reduce the price actually paid to the Seller by the taxes due. The parties include this provision to avoid disputes over whether the agreed upon Purchase Price includes withholding tax or must be “grossed up” to cover such tax. In other words, this provision is included purely for the sake of clarity, and the parties will likely spend no time actually discussing it with one another.
Buyer Preference: The Buyer will want this provision included to avoid a potential dispute, but it need not include any special terms over and above the standard language.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: None.