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.
Exclusive Remedies
What are Exclusive Remedies? Buyers and sellers usually spend significant time agreeing on an indemnification scheme, so they tend to want most claims for breaches of the Agreement to be governed by indemnification. This section identifies the claims that must be pursued through indemnification and those that are exempt from that limitation.
The Middle Ground: Subject to the equitable remedies provided for in the Agreement, this provision limits the parties’ available remedies in the event one of them breaches the Agreement, except for situations involving fraud, criminal activity, or intentional misconduct. More specifically, if a breach occurs that is not due to one of the three listed exceptions and for which an equitable remedy is not available, the non-breaching party’s only option is to make an indemnification claim (if the parties have chosen to make all covenants and other terms subject to indemnification in addition to the representations and warranties).
Purpose: This restriction is intended to limit the parties’ risk by making indemnification the sole avenue for resolving most claims related to the Agreement. In fact, this term is necessary if indemnification is intended to be the Agreement’s main enforcement mechanism, because without it the parties could simply bypass the indemnification process by filing a lawsuit.
Buyer Preference: Being a fairly standard provision, most buyers accept it as part of the Agreement and, consequently, spend a considerable amount of time negotiating their indemnification rights. However, more aggressive buyers may argue for an alternate provision that allows for indemnification in addition to the usual legal and equitable remedies.
Seller Preference: The Seller wants the exceptions included in this provision to be as narrow as possible since it is typically the party against whom a complaint is being made. In particular, the definition of fraud varies from state to state and may not be as limiting as the Seller intends it to be. To prevent an unwelcome surprise, the Seller (and/or its attorney) must be aware of the legal bounds of fraud, criminal activity, and intentional misconduct in the state whose law governs the Agreement.
Differences in a Stock Sale Transaction Structure: None.
Effect of Investigation
What is the Effect of Investigation section? The Buyer and Seller may view the role and consequences of due diligence differently, so this section is used clarify how knowledge gained during due diligence affects the parties’ rights under the Agreement.
The Middle Ground: This clause states that the parties’ indemnification rights are not affected by its pre-Closing knowledge (or that of its Representatives) or by the waiver of any of the Conditions to Closing. It is often referred to as a “sandbagging” provision because the non-breaching party can claim indemnification after Closing even if it knew or should have known prior to Closing that a representation or warranty was inaccurate.
Purpose: This provision is included to fortify the parties’ indemnification rights in situations where one party knew or should have known prior to the Closing that one or more of the other party’s representations was false. Because the Buyer is typically the one conducting an investigation and gathering information, it is most helpful to the Buyer. It lessens the Buyer’s transaction risk, helps it protect the value it receives from the deal, and makes for a much quicker transaction process for both sides.
Without this provision, the Buyer would need to either (i) investigate every time a Seller’s statement doesn’t match up to the Buyer’s information and make an indemnification claim before the deal is even done, or (ii) complete no investigation whatsoever. Both of those options are detrimental to the Buyer and may cause headaches for the Seller (or blow up the deal), so most parties will turn to this provision to allow the Buyer to conduct a thorough but measured due diligence investigation.
Buyer Preference: Because knowledge of a breach may not equate to knowledge of its consequences, and because it is the Seller’s duty to provide accurate representations, most buyers insist that a sandbagging provision be included in the Agreement. The Buyer wants to include this provision even in states that, as a default rule, allow for sandbagging. State statutes may require the Buyer to prove additional elements beyond the falsity of the representation or warranty, so including the provision in the Agreement simplifies the process for making an indemnification claim.
Seller Preference: The Seller will likely try to exclude this provision or add an anti-sandbagging provision that explicitly removes the Buyer’s indemnification rights if it has knowledge of the breach prior to Closing. Alternatively, if the Seller learns that the Buyer knows of a breach prior to the Closing, the Seller may seek to obtain a waiver from the Buyer for that specific breach rather than fighting to have the entire sandbagging provision thrown out. In terms of time allocation, most sellers will prefer to spend time making sure their representations are accurate rather than using up time and negotiating leverage to avoid the cost of a misrepresentation (and buyers will prefer that too, making for a smoother negotiation).
Differences in a Stock Sale Transaction Structure: None.
Tax Treatment of Indemnification Payments
What is Tax Treatment of Indemnification Payments? The parties use this section to address how indemnification payments will be treated for tax purposes.
The Middle Ground: This provision states that indemnification payments made under the Agreement are to be treated as an adjustment to the Purchase Price for tax purposes, so long as such treatment is allowed by law.
Purpose: This is a technical term that allows the Indemnified Party to avoid paying tax on indemnification payments. It provides a benefit to one party without harming the other, and either party could be in the beneficial position at some point, so neither side will object to its inclusion and it likely won’t even be explicitly discussed.
Buyer Preference: None.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: None.
Payments
What are Payments? Here, the parties focus on the specific issue of when payments must be made following a valid indemnification claim.
The Middle Ground: This section provides a deadline for when indemnification payments must be made, how they must be made (e.g. by wire transfer), and dictates that interest is to accrue if the payment deadline is missed.
Purpose: This section is purely procedural and, standing alone, has little effect on deal value (and no effect on the other two classification factors). The parties may devote a small amount of negotiation time to determining the payment window and the interest rate that applies if that window is missed. However, those issues will typically be agreed upon quickly given the fact that they may never come into play and, even if they do, they don’t present a particular hardship to either side so long as the terms are reasonable. Furthermore, since either side could end up as the Indemnifying Party it is in both their best interests to institute reasonable and impartial payment terms.
Buyer Preference: The Buyer typically prefers a shorter payment period and a higher interest rate, but that preference will be tempered by the fact that it may end up making a payment subject to those terms.
Seller Preference: The Seller favors a longer payment period and a lower interest rate, but it will also want the terms to be reasonable since it could wind up on the receiving end of indemnification payments.
Differences in a Stock Sale Transaction Structure: None.
Indemnification by Buyer
What is Indemnification by Buyer? Indemnification is used to enforce representations, warranties and covenants made in the Agreement. Here, the parties list out which breaches by the Buyer are subject to the Seller’s right to indemnification.
The Middle Ground: Much like the previous provision, this one requires the Buyer to indemnify the Seller, its Affiliates, and its Representatives for any Losses caused by an inaccuracy or breach of the Buyer’s representations, warranties, covenants, and other Buyer obligations that the parties agree will be covered by indemnification. The provision is meant to mirror the “Indemnification by Seller” section, with the only difference being the list of items for which indemnification is available.
Purpose: While the Buyer is usually the party most concerned with managing the risk that accompanies the transaction, there are significant areas of risk that the Seller has to deal with as well. Often, that risk is allocated to the Buyer through other pieces of the Agreement because the Buyer is in the best position to control it. This clause gives effect to the risk allocation agreed upon by the parties by providing the Seller with a relatively quick and simple method of recouping damages caused by a Buyer’s breach or misrepresentation.
Buyer Preference: Ideally, the Buyer wants this list to be as short as possible. In practice, the categories listed above will likely all be included because they all represent issues associated with potential liabilities, and they are the areas within the Buyer’s control. Furthermore, if there are any additional issues listed in the Seller’s indemnification section for which the Buyer has a reciprocal responsibility, the Buyer can expect for those issues to be included here since this provision is meant to mirror the Indemnification by Seller provision.
Seller Preference: The Seller wants the Buyer’s responsibilities to extend to any situation where the Seller could lose money due to the actions of the Buyer. For example, if the Seller leases a piece of land from a third party and the landowner requires the Buyer to sublease that land from the Seller rather than take it by assignment (perhaps because the landowner knows the Seller but not the Buyer), the Seller could end up being responsible for unpaid rent if the Buyer fails to live up to its obligations. Typically, the Buyer’s duty to pay rent will be established elsewhere in the Agreement, so it need not be listed separately here, but the Seller would want it listed here if not previously addressed.
Differences in a Stock Sale Transaction Structure: None.
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 Buyer
What are the Conditions to Obligations of Buyer? This provision contains a comprehensive list of requirements that must be completed by the Seller or waived by the Buyer in order for the Buyer to be obligated to complete the purchase. If the Seller fails to fulfill any condition included in the list, the Buyer can walk away from the deal without penalty.
The Middle Ground: Typically, the list states that:
(1) the Seller’s representations and warranties are true in all material respects at the time of the signing of the Agreement and the Closing;
(2) the Seller has complied with the Agreement and any other Transaction Documents in all material respects;
(3) no legal action has been taken that would prevent the transaction;
(4) all third-party approvals, consents, and waivers listed in the Disclosure Schedules relating to the Seller’s representations and warranties have been obtained;
(5) nothing has occurred that would constitute or cause a Material Adverse Effect;
(6) all Closing Deliverables and Transaction Documents have been signed by the Seller (as applicable) and delivered to the Buyer;
(7) the Buyer has received all Permits necessary to conduct the Business as conducted by the Seller;
(8) the Seller has provided the Buyer with title insurance and a Land Title Survey (or other appropriate deliverables) for each piece of Owned Real Property;
(9) written evidence has been provided to the Buyer that all Encumbrances, other than Permitted Encumbrances, have been released;
(10) the Buyer has received a signed copy of the Seller Closing Certificate;
(11) the Buyer has received a signed copy of the Seller’s Secretary’s Certificate;
(12) the Buyer has received a FIRPTA Certificate relating to the Business; and
(13) the Seller has delivered any other documents or instruments reasonably requested by the Buyer that are reasonably necessary to consummate the transaction.
Purpose: This provision provides numerous “outs” for the Buyer that create a relatively painless path out of the deal if the Seller does not meet its obligations, including some obligations that are relatively minor. The fact that the Buyer can walk away without penalty if a condition is not met means the risk of the Seller’s failure to deliver is shifted entirely to the Seller, who is obviously in a much better position to control that risk.
Buyer Preference: In addition to the conditions listed above, any number of requirements can be added to this section through negotiation among the parties. Common additional conditions sought by the Buyer include: (a) a “due diligence out” that allows the Buyer to walk away if it cannot complete due diligence to its satisfaction; (b) a “financing out” that conditions the Buyer’s obligation to close on it being able to obtain financing to fund the deal; and (c) financial or operating targets, such as sales or working capital, that, if not met, provide the Buyer with a way out of the deal. If the Seller operates in a highly-regulated industry, the Buyer may also require a legal opinion from the Seller’s legal counsel regarding the Business’s compliance with applicable laws. In addition to these general additional conditions, the Buyer also has certain preferences regarding the listed conditions, such as:
(1) The Buyer will likely include a materiality qualifier but will not want that qualifier to apply to any representation or warranty that already contains a materiality qualifier (i.e. the Buyer does not want a “double materiality” standard). Some exceptions for which the Buyer will want no materiality qualifier whatsoever include the representation regarding the organization and authority of the Seller, any monetary obligations, and financial statements. The Buyer will typically want this condition to Closing to be satisfied both at the time of signing the Agreement and at the Closing so that it can walk away if it receives materially inaccurate information at either time.
(2) Here, the Buyer once again wants to avoid a double materiality standard.
(3) The Buyer does not want any materiality qualifiers whatsoever in this “litigation out.” The Buyer will want to include any actions brought against it in addition to those brought against the Seller.
(4) The Buyer wants all third-party consents to be obtained as a condition to Closing, not just specifically-identified material consents.
(5) The Buyer may want to eliminate the Material Adverse Event condition altogether and replace it with specific event-based conditions, such as operational or financial benchmarks. Or, it may want to keep the Material Adverse Event condition and merely supplement it with specific benchmarks. In either case, the Buyer should be aware when selecting such benchmarks that financials usually lag behind operations and it is easier to manipulate the financial measurements than to inaccurately represent that an operational benchmark was met.
(8) To determine which conditions relating to real property need to be included here, the Buyer should consult a real estate attorney. If the transaction involves Leased Real Property, the Buyer will seek estoppel certificates from the landlord of the property.
(9) If the Buyer knows which documents are necessary to release Encumbrances associated with the Seller’s property, it will want to specify the documents and include a general statement like the one seen above to cover any documents needed but not listed. If the only way the Seller can have the Encumbrances released is to pay the creditor using the Closing payment, the Buyer will want to have the release documents placed in escrow until the creditor is paid.
Seller Preference: In general, the Seller wants to avoid allowing any conditions in this section that are not within its control, such as a due diligence out and a financing out. More specifically, the Seller will generally have the following preferences regarding the listed conditions:
(1) The Seller wants to go beyond a general materiality standard and require that, in order for the Buyer to walk away, a false representation or warranty must have a Material Adverse Effect on the Business. The Seller also wants this condition to apply only at the Closing so that it can cure any inaccuracies that exist when the Agreement is signed.
(3) The Seller wants to limit this condition to legal actions that are reasonably likely to succeed on the merits as a way of excluding frivolous claims that do not have any practical chance of preventing the transaction. Regarding any legal actions taken by a Governmental Authority, the Seller will want only those that prevent a material transaction contemplated by the Agreement to qualify as a litigation out for the Buyer.
(4) The Seller wants to limit this condition to specifically-identified material third-party consents, especially if there are a significant number of third-party consents to be obtained.
(5) Because it is difficult to prove that an event had a Material Adverse Effect on the Business, and because the burden is on the Buyer to prove a Material Adverse Effect, the Seller wants that standard to be applied here, rather than using specific financial or operational benchmarks. If the Buyer insists on specific benchmarks, the Seller will likely favor financial metrics over operational ones.
(8) The party customarily held responsible for paying survey and title insurance costs varies by jurisdiction, but regardless of convention the Seller will want the parties to split any costs related to these items (unless, of course, local custom says the Buyer pays).
Differences in a Stock Sale Transaction Structure: In a stock sale, the Buyer wants any representations and warranties relating to the shares of the Seller to be true and correct in all respects or, in other words, not subject to any sort of materiality qualifier. If the Buyer in a stock purchase is going to replace the directors and/or officers of the Business, receipt of their resignations should be included as a condition to the Buyer’s obligation to close. The Buyer in a stock purchase will also need a certificate of good standing for the Business from the appropriate Governmental Authority in the company’s state of organization.
Conditions to Obligations of All Parties
What are Conditions to Obligations of All Parties? Certain events will make a transaction impractical or even impossible, and this clause is included to give both parties a legal “out” of the deal if one of those events occurs.
The Middle Ground: This provision lists the conditions that must be met at or prior to Closing for both sides to be obligated to move forward with the transaction. The conditions include: (1) all required filings under the HSR Act have been made and any applicable waiting periods have expired (if the Act applies to the transaction); (2) no Governmental Authority has taken any action that would cause the transaction to be illegal or that would otherwise prevent it from becoming and remaining effective; and (3) all consents, authorizations, etc. required to be obtained by either party from any Governmental Authorities were received and have not been revoked.
Purpose: The intent of this provision is to allow both sides to walk away from the deal without penalty if the government interferes with the transaction (or if their approval is required but not given). While there is a very low probability that any Governmental Authority would implement a law or ruling preventing an acquisition in the lower middle market, if it were to happen it would certainly put an end to the transaction. Similarly, it is highly unlikely that either side would fail to obtain a necessary authorization or consent absent sheer incompetence or severe procrastination. Yet, if such failure were to occur it would also be an almost-certain death knell for the deal. Because of the low probability, high magnitude dynamic at play, the provision is worth paying attention as the Closing approaches, but it is not something that is likely to eat up negotiation time or cause significant disagreement.
Buyer and Seller Preference: None, other than deleting certain inapplicable conditions such as the HSR Act filing requirements or obtaining governmental approvals.
Differences in a Stock Sale Transaction Structure: None.
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.
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.
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.
Confidentiality and Non-Disparagement
What is the Confidentiality and Non-Disparagement section? All businesses possess information that is beneficial to them because it is not known by the public (e.g. customer lists, trade secrets, etc.). Prior to the Closing, the Seller protects that information by requiring the Buyer to keep non-public information confidential. Post-Closing, the Buyer wants to place a similar confidentiality requirement on the Seller, and this covenant is used to accomplish that goal.
The Middle Ground: This covenant requires the Seller, its Affiliates, and its Representatives to use their reasonable best efforts post-Closing to keep confidential all information about the Business that is not otherwise publicly available. It also requires the Seller to take certain precautions if it is required by law to disclose the information, such as only providing information it is legally required to provide (as advised by legal counsel) and taking steps to limit who is able to access the confidential information that is disclosed. The parties also agree not to make negative or disparaging comments about each other to third parties.
Purpose: This covenant is intended to protect the value of the Business after the transfer of ownership has occurred by protecting the confidential information of the Business. For a serial buyer such as a private equity firm, it also protects future deals by preventing the Seller from providing potential future sellers with information about terms the Buyer is willing to accept and/or the Buyer’s negotiation strategies.
Buyer Preference: The Buyer wants to pay close attention to the definitions of Affiliates and Representatives to ensure that everyone who has access to the information sought to be protected has a duty of confidentiality with regard to that information. If the sale was initially conducted by auction, expansive definitions of Affiliates and Representatives may not adequately protect the Buyer’s risk, so the Buyer can have the Seller assign the confidentiality agreements signed by the other auction participants to protect the Business’s sensitive information. The Buyer also wants to be able to enforce this covenant using an injunction rather than indemnification, because preventing a violation is more valuable than receiving monetary compensation after one has occurred. To achieve that goal, the Buyer should explicitly carve out this covenant from the Exclusive Remedies provision.
Seller Preference: The Seller may want to include language indicating that the Buyer’s confidentiality obligations (often originating in the Letter of Intent) apply to information disclosed pursuant to the Agreement and that the Buyer’s confidentiality obligations survive termination of the Agreement. Essentially, such language provides protection for the Seller if the deal does not go through. The Seller will also pay attention to the scope of the disclosure restrictions so it can avoid being penalized for sharing information that doesn’t have the potential to hurt the Business or the Buyer.
Differences in a Stock Sale Transaction Structure: None.
Notice of Certain Events
What is Notice of Certain Events? The Buyer makes its decision to invest based on the information available to it, but new or changed information could lead to a different decision. The Buyer can use this section to identify the types of information that may change its decision and to ask the Seller to communicate such information as it is received.
The Middle Ground: This covenant requires the Seller to notify the Buyer if certain events occur and provides a list of events for which notice is required. That list includes events that would or have had a Material Adverse Effect on the Business, anything that would make a Seller representation or warranty untrue, and anything that prevents the Seller from satisfying its Conditions to Closing, among others. The covenant also explicitly states that providing notice of the listed events does not result in the Buyer losing its right to make an indemnification claim or terminate the Agreement.
Purpose: Without this notice requirement, the Buyer would be forced to spend considerable time and money checking on the status of its potential investment at a point in time when someone else (the Seller) has much better knowledge and access. In that scenario, the cost and risk are all on the Buyer, who would likely pass along some of those costs to the Seller by lowering the Purchase Price. With this covenant, the Seller monitors the Business and the Buyer’s cost of obtaining the information is eliminated, as is some of its risk, which means more money in the Seller’s pocket and a safer investment for the Buyer.
Buyer Preference: The Buyer does not want a disclosure under this covenant to prevent it from claiming indemnification or terminating the Agreement, so an explicit statement that the covenant does not affect those rights is in the Buyer’s best interest (and may be necessary, depending on the circumstances and governing state law). If the Seller insists on limiting the Buyer’s indemnification rights for information known prior to the Closing, the Buyer can compromise by negotiating for a Cap and/or Basket on the indemnification rights stemming from any such information.
Seller Preference: If notice is given based on this covenant that corrects an inaccuracy or breach of one of the Seller’s representations or warranties, the Seller wants the notice to serve as a cure for that inaccuracy or breach to prevent an indemnification claim. If the Buyer wants to reserve its right to terminate the Agreement or bring an indemnification claim, the Seller can try to negotiate (1) for a limited time period to terminate the Agreement or make a claim, (2) to impose a materiality or Material Adverse Effect standard on cured representations and warranties, or (3) to institute a procedure for resolving these disputes before the Buyer is allowed to terminate the Agreement.
Differences in a Stock Sale Transaction Structure: None.