No Solicitation of Other Bids
What is This? As the Buyer spends more resources on the transaction, it wants to know that the Seller is serious about completing the deal. Agreeing not to ask for or facilitate competing bids is a signal of the Seller’s intent, and from a practical standpoint it lowers the chances that a successful competing bid will be made.
The Middle Ground: This covenant restricts the Seller from encouraging third parties to provide a competing bid by actively soliciting bids, negotiating with third parties, or providing those third parties with information that would be useful in preparing and making a bid. It is essentially an exclusivity clause aimed at preventing the Seller from trying to increase the Purchase Price by encouraging competitive bids. However, it does not prevent the Seller from accepting an unsolicited, superior offer should one be made.
Purpose: This covenant is essential if there is a meaningful time period between the parties signing the Agreement and closing the deal. That is because this covenant provides the Buyer with some assurance that the Seller is serious about the deal and is not using the Buyer’s interest as a bargaining tool with other buyers. Such exclusivity removes one major source of deal risk and empowers the Buyer to commit further time and resources to conducting due diligence and closing the transaction. Typically, the parties will agree on exclusivity as part of the letter of intent, but the time period will be limited to a set time frame or will expire once the Agreement is signed, so an exclusivity provision in the Agreement itself is necessary to protect the Buyer’s interests.
Buyer Preference: The Buyer wants this provision to be as strict as possible, and some even go so far as to prohibit acceptance of unsolicited, superior offers. Others will require the Seller to inform the Buyer of any unsolicited offers so the Buyer can either match the offer or limit its spending in connection with the deal. Additionally, the Buyer can include a specific performance provision that requires the Seller to move forward with the deal even if it breaches this clause and obtains a higher offer, on the grounds that the damages to the Buyer for the Seller’s breach would be impossible to quantify. One alternative to a specific performance provision would be a liquidated damages provision that sets a monetary amount to be paid upon the Seller’s breach. If using a liquidated damages clause, the Buyer wants to avoid setting the amount too high to avoid characterization as a “penalty clause.”
Seller Preference: The Seller likely wants to exclude this provision, or at the very least include one or more exceptions within it. For example, it may want to be able to negotiate with third parties with the understanding that it would only move forward with them if the deal with the Buyer falls through. Or it may seek a “fiduciary out” (common in public company acquisitions) that requires it to accept the highest offer even if that offer is made during the exclusivity period.
Differences in a Stock Sale Transaction Structure: None.
Organization of Buyer
What is This? In this section, the Buyer provides information regarding its current legal status. 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 its entity was legally organized and is in good standing under the laws of its state of organization.
Purpose: As a practical matter, the main concern of most sellers involved in a transaction is whether they will receive their payment in accordance with the terms of the Agreement. Whether the Buyer’s company was correctly organized and maintains good standing is only of consequence to the Seller if the deal is structured as a merger or a stock for stock acquisition, or if the Seller plans on continuing to work for the Business after the transaction. If the Buyer is setting up a new entity as an investment vehicle to complete the transaction or is paying the entire Purchase Price in cash at Closing, the most pragmatic of sellers will not give a second thought to whether the Buyer’s company was created properly. However, if the Seller’s payment depends in part on the success of the Buyer’s business, the Seller will want to ensure that the entity validly exists and is not in jeopardy of losing its “good standing” status.
Buyer Preference: None, this is a standard representation.
Seller Preference: None, this is a standard representation.
Differences in a Stock Sale Transaction Structure: The content of the representation will not change based on the transaction structure, but its importance will vary based on the payment structure of the transaction.
Environmental Matters
What are Environmental Matters? In this section, the Seller provides information regarding environmental issues relating to the Business. 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: Here, the Seller makes comprehensive representations regarding its compliance with Environmental Laws. Those representations include:
(1) The Business is and always has been in compliance with applicable environmental laws and the Seller has not received notice of an Environmental Violation or Claim, or a request for information pursuant to Environmental Law that remains unresolved;
(2) The Seller has obtained all Environmental Permits necessary to conduct the Business or use the Purchased Assets as currently conducted or used and all such Environmental Permits are in full force and effect. Nothing has occurred, to the Seller’s knowledge, that would interfere with the validity of the Environmental Permits after the Closing Date, and the Seller has undertaken all measures necessary to transfer the Environmental Permits on the Closing Date;
(3) None of the Purchased Assets or any real property used or formerly used (whether owned or leased) by the Business have been listed on, or proposed for listing on, the National Priorities List under CERCLA or any similar state list;
(4) There has been no Release of Hazardous Materials in violation of Environmental Law with respect to the Business or the Purchased Assets, including on any real property currently or formerly used by the Business. Furthermore, the Seller has not received any notice that it violated an Environmental Law or the terms of an Environmental permit, or that could reasonably be expected to result in an Environmental Claim against the Seller, the Business, or the Purchased Assets;
(5) The Disclosure Schedules contain a complete and accurate list of all active or abandoned storage tanks owned or operated by Seller in connection with the Business or the Purchased Assets;
(6) The Disclosure Schedules contain a complete and accurate list of all off-site facilities or locations for the treatment, storage, or disposal of Hazardous Materials used by the Seller, and any predecessor to the extent the Seller may retain liability, in connection with the Business or Purchased Assets. No such facilities or locations have been placed on or proposed for placement on the National Priorities List under CERCLA, or any similar state list, and the Seller has not received any Environmental Notice of potential liability with respect to any such facilities or locations;
(7) The Seller has not retained or assumed any liabilities or obligations from third parties with respect to Environmental Laws (whether by contract or operation of law);
(8) The Seller has provided Buyer with (i) all material documents in Seller’s possession or control relating to compliance with Environmental Laws, Claims, or Notices in connection with the Business or Purchased Assets, or any real property used by the Business at any time, and (ii) all material documents relating to actual or potential capital expenditures made to ensure current or future compliance with Environmental Laws; and
(9) The Seller is not aware of and does not reasonably anticipate, as of the Closing Date, any condition or event relating to Hazardous Materials that may, after the Closing Date, prevent, impede, or materially increase the costs associated with performance of the Business or use of the Purchased Assets as currently conducted or used.
Purpose: The importance of this section depends largely on the Business and the industry in which it operates, as well as the location of the properties utilized by the Business. If the Business uses Hazardous Materials as part of its normal operations, this section is essential for the Buyer. Likewise, if the Business’s real property is adjacent to another business that uses Hazardous Materials, these representations lessen the risk that the Buyer will have to pay for the environmental violations of others. However, if the Business itself does not use any materials that are subject to environmental regulation and there is no similar threat posed by neighboring landowners, the scope of representations contained here may not be necessary. In the event that the Seller only used Hazardous Materials at a specific point in time or at one specific location, the parties can agree to limit the Seller’s representations to address those situations without including the entire set of representations listed above.
Buyer Preference: Due to the potential magnitude of penalties related to environmental violations, the Buyer wants to include the most comprehensive set of environmental representations that will be acceptable to the Seller and may also want to exclude environmental matters from any limits on its indemnification rights. If there are identifiable environmental issues and the Seller wants to limit the representations to those situations, the Buyer has a number of options. It may insist on the Seller correcting those issues prior to the sale or require a portion of the Purchase Price to be placed in escrow until the problems are remedied. A more conservative Buyer might seek to exclude the property from the transaction or lower the Purchase Price based on projected remediation costs. Another option would be to purchase environmental insurance. Still, the Buyer will want representations that apply to the entire Business and all properties utilized by the Seller. The Buyer prefers specific, material exceptions to the representations listed in the Disclosure Schedules, but nothing more, since it wants the representations to be as widely applicable as possible. Lastly, if the Business operates in an industry that interacts with climate change regulation (e.g. the energy, utility, and manufacturing industries), the Buyer may want to include a representation that speaks to the validity and transferability of “Environmental Attributes” (e.g. emissions allowances or renewable energy credits).
Seller Preference: If real property is not involved in the purchase and/or the Business does not utilize Hazardous Materials, the Seller may want this section to be excluded in its entirety. If that is not the case and these representations are included, the Seller can try to limit the environmental representations to this section by including a statement to that effect. As for the representations themselves, the Seller will want them to be qualified using a materiality or Material Adverse Effect standard, and/or with knowledge qualifiers. It may also want to limit them to cover specific properties or time frames if it can identify specific situations that are more likely to result in environmental-related costs for the Buyer. If the Seller agrees to deal with the Buyer’s environmental concerns prior to the sale, it can include those terms in a separate agreement and limit the representations to exclude the subject matter of the separate agreement. Because the Seller is most likely to provide an incomplete or misleading representation when instances or exceptions are listed with specificity in the Disclosure Schedules, it will want to make broad disclosures to avoid unintentionally breaching a representation.
Differences in a Stock Sale Transaction Structure: Since the Buyer inherits all the liabilities of the Business in a stock sale, the environmental representations are likely to be more comprehensive under that structure than in an asset sale.
Compliance with Laws; Permits
What is the Compliance with Laws; Permits section? In this section, the Seller provides information regarding the Business’s compliance with legal requirements. 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 it is currently in compliance with all laws applicable to the Business and that it has previously complied with all such laws for a specified period (e.g. the previous three years). The Seller also represents that it has all permits necessary to conduct the Business, all fees related to those permits are paid, the permits are in full force and effect, and nothing has occurred that would result in their limitation or revocation.
Purpose: The Seller’s current and past compliance with laws applicable to the Business is obviously a significant issue; the Buyer will not want to purchase a business operating outside the confines of the law or be stuck with liabilities created by the Seller. However, whether the parties will spend a substantial amount of time during due diligence and negotiations to cover legal compliance depends largely on the industry in which the Business operates. In a highly regulated industry, the Buyer will find it worth the time to inquire about specific laws and negotiate over the extent of the Seller’s compliance representations. On the other hand, if any potential penalties are minuscule and/or the chances of enforcement are remote, the parties may insert this clause into the Agreement and leave it at that.
Buyer Preference: The Buyer wants a clause that does not limit the Seller’s representation regarding past compliance. Regardless of when the bad act occurred, the Buyer does not want to be liable for someone else’s misconduct. The Buyer also wants to avoid materiality qualifiers for both sets of representations included here.
Seller Preference: The Seller wants to limit this representation to current compliance only, especially if past violations have already been cured. It can also limit its risk by inserting some sort of materiality qualifier (e.g. requiring a violation or lack of a permit to have a Material Adverse Effect on the Business before indemnification applies). Finally, the Seller may seek to exclude entire areas of law from these representations because they are dealt with elsewhere in the Agreement (e.g. environmental laws and permits).
Differences in a Stock Sale Transaction Structure: None.
Customers and Suppliers
What are Customers and Suppliers? In this section, the Seller provides information regarding the Business’s customers and suppliers. 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: In this portion of the Agreement, the Seller discloses certain details relating to its material customers and suppliers. Specifically, the Seller lists the identity of customers and suppliers who have reached a set monetary threshold (e.g. customers that have spent more than $1 million annually for both of the prior two years), as well as the amounts spent annually for each customer or supplier. The Seller also represents that the customers and suppliers listed have not indicated an intent to end or significantly alter their relationship with the Business.
Purpose: The Buyer wants to know the identity and financial details for the Seller’s top customers and suppliers, and while most will obtain that information during exploratory due diligence, including the information in the Agreement serves two important functions. First, it creates distinct penalties for misrepresentations and, additionally, it provides some assurance that the top customers and suppliers do not plan to jump ship. This representation is always useful, but it is most important when (1) a few customers and/or suppliers make up a major portion of the company’s revenue and/or supply streams, or (2) there is a lack of trust between the Buyer and Seller.
Buyer Preference: Regardless of the level of trust between Buyer and Seller, the Buyer wants to include this section if the Business has a small number customers or suppliers that make up a hefty portion of its sales or supply. The Buyer also wants as much assurance as the Seller can give regarding future plans of major customers and suppliers, but as a practical matter any such assurances will usually be qualified based on the Seller’s knowledge. Rather than qualifying the lists based on a monetary threshold, the Buyer may prefer to see a list of the top ten or twenty customers or suppliers depending on the level of customer or supplier concentration.
Seller Preference: The Seller will likely try to exclude this provision altogether, especially when customer and/or supplier relationships are solidified by contractual agreements. If there is significant customer or supplier concentration in the Business, the Seller may include the disclosures but try to exclude the representations regarding the future relationship between the parties. In any event, the Seller will not want to make representations about what third parties will or will not do in the future unless those representations are qualified based on the Seller’s knowledge.
Differences in a Stock Sale Transaction Structure: This section does not need to be altered based on the structure of the transaction. However, in situations where customers or suppliers have contracts with the Business and the sale is structured as an asset acquisition, the Buyer will want to make a point early on in the negotiation process to ensure that those contracts will be assigned to the Buyer.
Inventory
What is Inventory? In this section, the Seller provides information regarding the inventory of the Business. 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 the inventory held by the Business is consistent with the Business’s past practices, in terms of both quality and quantity. The Seller also represents that the inventory does not have any Encumbrances that would prevent its sale.
Purpose: Inventory is another area that drives some companies but is utterly irrelevant for others. If inventory is a necessity it will receive significant attention during the due diligence process. Buyers want to know everything about it: how much there is, how often it comes in and goes out, how is it accounted for, etc. On the other end of the spectrum, inventory is a non-issue on which neither side will spend much time or money.
Buyer Preference: The Buyer wants this representation included if inventory is an essential part of the Business, and it wants to be specific about the representation to ensure that the inventory referred to is sufficient to satisfy customer needs and expectations.
Seller Preference: The Seller likely wants to exclude this representation entirely. Since inventory is an item listed on the balance sheet, the Seller may argue that the issue is adequately covered by the financial statement representations contained elsewhere in the Agreement.
Differences in a Stock Sale Transaction Structure: None.
Intellectual Property
What is Intellectual Property? In this section, the Seller provides information regarding the intellectual property used by the Business. 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: This section requires the Seller to make a number of disclosures and representations relating to the Intellectual Property (“IP”) used in the Business. Specifically, the Seller will be asked to provide lists in the Disclosure Schedules of:
Registered IP;
Unregistered IP Assets;
All IP Agreements; and
All joint owners of IP Registrations and/or IP Assets;
The Seller will be asked to represent that:
All required filing fees and administrative tasks relating to the Registered IP have been taken care of;
It has provided all documentation relating to the Registered IP to the Buyer;
Each IP Agreement is valid, binding, and is currently in full force and effect;
It is not in breach or default of any IP Agreement and, to its knowledge, neither is any other party to those agreements;
No party to the Seller’s IP Agreements have indicated a desire to terminate those agreements;
No events have occurred that would cause default of, result in termination of, or otherwise alter the rights of any party to any of the Seller’s IP Agreements;
It is the sole owner of all IP Registrations and IP Assets used in the Business, other than those disclosed in the Disclosure Schedules;
It has the right to use the IP disclosed in the Disclosure Schedules in the Business, free and clear of Encumbrances other than Permitted Encumbrances;
It has entered into written agreements with every current and former employee and independent contractor to (i) assign to the Seller any rights related to IP used in the Business, and (ii) acknowledge the Seller’s exclusive ownership in any such IP;
The IP Assets and the IP licensed under the IP Agreements, taken together, constitute all the IP necessary to conduct the Business as previously conducted;
The transaction does not create additional requirements for the Buyer to use the IP as it is currently used to conduct the Business;
Its rights in the IP Assets are valid and enforceable, and it has taken all reasonable steps to protect the confidentiality of all IP Assets, including requiring all Persons with access to trade secrets to sign written non-disclosure agreements;
The Business’s use of IP does not violate the IP rights of any Person, and no Person has violated the Business’s IP rights;
There are no settled, pending, or threatened Actions (i) alleging infringement by the Seller of third party IP, (ii) challenging the validity or enforceability of the IP Assets or the Seller’s rights to the IP Assets, or (iii) brought by the Seller alleging infringement or any other violation of the IP Assets; and
There is no outstanding or prospective Governmental Order restricting the Seller’s use of the IP Assets in any way.
Purpose: Much like real property, intellectual property can drive the value of a business or it can be next to irrelevant. Without its famous trade secret protections, Coca-Cola would have lost its main competitive advantage (its distinctive taste) long ago. Disney relies heavily on copyright protection to maximize the profits from its most famous characters, which is why they have repeatedly sought to extend the term for copyright protection. Any company that relies on its brand name or logo as a source of competitive advantage is enjoying the protections of trademark law, even if their trademark is not registered. On the other hand, some businesses rely almost entirely on product or service quality to succeed. If their quality drops for any significant period of time, their competitors will simply eat up their share of the market. Therefore, in some transactions the parties will rightly spend extensive time and money to make sure the Seller’s IP is protected and properly transferred. In others, the topic will be an afterthought.
Buyer Preference: The Buyer wants these representations to be as broad as possible to encompass all IP used by the company. On the whole, and particularly with respect to infringement, the Buyer also wants to exclude knowledge or materiality qualifiers. If the Seller’s statements and disclosures are qualified, the Buyer either has to expend extra resources to verify ownership and/or non-infringement, or it has to live with a significant amount of additional risk. From the Buyer’s perspective, the risk of IP infringement or non-ownership should rest with the one who created and/or has controlled the IP.
Seller Preference: The Seller wants to include a materiality qualifier for these disclosures, and it may also want its representations in this section to include a knowledge qualifier. Both approaches help the Seller limit its costs, while providing the Buyer with the information necessary to operate the business. As a minimum precaution, the Seller wants to limit the third-party infringement representation using a knowledge qualifier, as conclusively verifying that no third-party infringement has occurred may be practically impossible.
Differences in a Stock Sale Transaction Structure: The representations relating to intellectual property will not be as extensive in a stock sale as in an asset acquisition. For example, the Seller’s ability to assign the IP it uses is not an issue in a stock sale because there is no need to transfer the IP to a new entity.
Real Property
What is Real Property? In this section, the Seller provides information regarding the real property used by the Business. 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: In the Real Property representation and the corresponding Disclosure Schedules, the Seller discloses the Owned Real Property and Leased Real Property used by the Business and represents that: (1) it has not received notice of any building code violations, zoning ordinance violations, or violations of any other laws or governmental restrictions; (2) there are no existing, pending, or threatened condemnation proceedings affecting Real Property used by the Business; (3) the disclosed Real Property is sufficient to conduct the Business as conducted prior to the Closing; and, (4) no other real property is necessary to conduct the Business as conducted prior to the Closing.
With respect to the Owned Real Property, the Seller represents that it has marketable fee simple title free of any Encumbrances other than those listed in the Disclosure Schedules and the Permitted Encumbrances, that it has not leased the property or given anyone permission to use it (other than as disclosed in the Disclosure Schedules), and that no one holds any option rights on the property (e.g. rights of first refusal or rights of first offer).
With respect to the Leased Real Property and each individual lease, the Seller represents that the lease is valid and possession of the property is undisturbed, all rent due has been paid and nothing has occurred that would result in breach or default, there has been no notice given regarding termination of the lease, and the Seller has not created an Encumbrance on its interest in the property.
Purpose: For some businesses, real property such as office space is merely a necessary but fungible tool. With a little planning, the business could easily move down the street or to another part of town without breaking stride. For other companies, the real property they own or lease is itself the business, and the company would not be nearly as valuable if that specific property was not included in the transaction. The result is that some acquisition negotiations will focus heavily on real property and will require the input of real property experts, while others will deal with real property issues quickly and move on.
Buyer Preference: If the Real Property held by the Business is an important aspect of the deal, the Buyer will want to consult a real property attorney regarding the content of the Seller’s representations, the mechanics of transfer, and necessary due diligence procedures. Generally, as the importance of property to the Business increases, the Seller’s representations and Buyer’s property-focused due diligence will increase as well.
Seller Preference: The Seller wants to limit its representations as much as possible. For example, the representation regarding notice of building code or zoning ordinance violations is arguably covered by the more general “Compliance with Laws” representation, so the Seller may try to exclude the more specific representation contained in this section. The Seller can also constrain its representations by adding materiality or knowledge qualifiers, and by limiting its title representation to “valid” or “insurable” title rather than “marketable” title.
Differences in a Stock Sale Transaction Structure: Because a transfer of property is not necessary in a stock sale, representations regarding Owned and Leased Real Property are included with the Title to Purchased Assets representation (i.e. the property is treated, for the most part, as just another asset). There are a few representations that pertain only to the Seller’s Owned Real Property, but they are more focused on providing the administrative information necessary to operate the Business rather than focusing on the transferability of the property.
Third Party Consents
What are Third Party Consents? Many times, businesses (or governmental entities) other than the Buyer and Seller will need to provide consent to some aspect of the transaction. This section lays out the consents that are required, which side is responsible for obtaining them, and addresses what happens if they’re not obtained.
The Middle Ground: In written legal agreements there is often language that either allows or prohibits unilateral assignment of the contract or a change of control with regard to a contracting party (such as the sale of a controlling interest of their business). A contract typically contains one or the other, and each has different legal consequences, but for ease of discussion we’ll refer to them collectively as “assignment” unless an explicit distinction is made between the two. In agreements that explicitly allow assignment or are silent on the issue, the Buyer will assume the place of the Seller. In agreements that explicitly prohibit it, the Buyer still needs to take the place of the Seller. In such cases, the Third Party Consents provision states that the Seller must use its reasonable best efforts to obtain the third party’s consent to an assignment. If the third party refuses to grant an assignment, the Seller is required to remain a party to the contract and act on behalf of the Buyer, to the extent the law and the contract at issue allow such an arrangement. Finally, the provision explicitly states that the Buyer retains its right to abandon the transaction if a third-party consent is not obtained, unless the Buyer waives that right in writing or moves forward with the Closing despite the absence of such consent.
Purpose: The Third Party Consents provision determines, where applicable, how third parties will be handled in transitioning contractual relationships. Some industries function almost entirely on the basis of formal contracts that prohibit assignments, while other industries involve few, if any, written agreements. When the target company operates in the former category, this provision is an important element of the Agreement because of its impact on the value of the deal to the Buyer. If the target company is in an industry involving few written agreements, and leased real estate is not an issue, a formal conversation on the issue of third-party consents is likely unnecessary.
Buyer Preference: For the Buyer, the two most important aspects of this clause are the ability to abandon the transaction if third-party consents are not obtained and the standard of effort the Seller must put forth to obtain them. In certain companies and industries, one contract may contribute a significant amount of value to the Business, and if the Buyer cannot benefit from that contract the Business is not worth the contemplated Purchase Price. In that situation, the Buyer must be able to walk away with impunity. By setting an effort standard for obtaining third-party consents, the Buyer has some assurance that the time and money spent on due diligence is not being wasted and that the Seller will attempt to procure the consents even after the Purchase Price has been paid (if the parties have mutually agreed to allow consents to be obtained after Closing). The Buyer wants to set a high effort standard, but one that is within the Seller’s ability to meet. Furthermore, if obtaining third-party consents is critical to the success of the Business moving forward the Buyer may require the Seller to represent that all such consents have been obtained (with any exceptions listed in the Disclosure Schedules).
Seller Preference: The Seller has numerous options for altering this provision to reduce its level of risk. First, it wants to negotiate an effort standard it is confident of being able to meet, which may be something less than “reasonable best efforts.” In lieu of a general standard, it might prefer to set out specific actions it must take to comply with this clause. Other options for controlling the risk presented by this provision include setting an end date for obtaining consents and setting a cap on expenses incurred as a result of trying to comply with this section.
Differences in a Stock Sale Transaction Structure: In a stock sale, no assignment of contracts is necessary since the Business is the party bound by the contract both before and after the acquisition. However, change of control provisions are specifically intended to prevent the Buyer taking the Seller’s place in a contract without the third party’s consent. Therefore, this provision is still necessary in a stock purchase to address the transfer of the Seller’s contracts that contain change of control language.
Purchase Price Allocation
What is the Purchase Price Allocation? The Buyer and Seller are both taxed on the sale of the Business. As part of the taxation process, they must match (or allocate) the Purchase Price and the value of Assumed Liabilities to different asset classes. Both parties must report the same allocation, so they typically agree on it shortly after Closing in accordance with this provision.
The Middle Ground: This section indicates where the Allocation Schedule can be found, which party is responsible for preparing it, when it must be completed, and a dispute resolution procedure in case the parties cannot agree on the allocation scheme. It also states that the tax returns of both parties must be filed in accordance with the Allocation Schedule.
Purpose: How the Purchase Price is allocated directly affects the taxes paid by both parties, and allocations that benefit the Seller typically work against the Buyer (and vice versa). While this dynamic can cause some tension and lead to a lengthy negotiation, the issue is unlikely to derail the entire transaction. That is, in part, because the parties do not have the ability to allocate the Purchase Price as they see fit; their allocation must be within the bounds of the law, which essentially means it must reflect the reality of the situation. Each party has some latitude to negotiate, but neither party will get a “perfect scenario,” and disagreements can usually be resolved by making the allocation that most closely mirrors the actual value of the assets.
Buyer Preference: One of the major benefits of an asset sale is the Buyer’s ability to receive a “stepped-up” tax basis in depreciable and amortizable assets. A higher tax basis on those assets means greater depreciation and/or amortization, which translates to a lower tax bill. Thus, allocating the bulk of the Purchase Price to those assets effectively lowers the price paid for the Business.
Seller Preference: The Seller wants the same benefit from the allocation as the Buyer hopes to achieve – a lower tax bill. In order for the Seller to accomplish that, it will want to allocate as much of the Purchase Price as possible to capital assets (such as land) so that it is taxed at the capital gains rate rather than the ordinary income rate.
Differences in a Stock Sale Transaction Structure: This section is not necessary in a stock sale structure (unless the parties opt to make a 338(h)(10) election) because the Purchase Price will be treated as capital gains to the Seller and the Buyer will assume the Seller’s tax basis in the assets, which limits the benefits it receives from depreciation and amortization.