Conditions to Obligations of All Parties
What are Conditions to Obligations of All Parties? Certain events will make a transaction impractical or even impossible, and this clause is included to give both parties a legal “out” of the deal if one of those events occurs.
The Middle Ground: This provision lists the conditions that must be met at or prior to Closing for both sides to be obligated to move forward with the transaction. The conditions include: (1) all required filings under the HSR Act have been made and any applicable waiting periods have expired (if the Act applies to the transaction); (2) no Governmental Authority has taken any action that would cause the transaction to be illegal or that would otherwise prevent it from becoming and remaining effective; and (3) all consents, authorizations, etc. required to be obtained by either party from any Governmental Authorities were received and have not been revoked.
Purpose: The intent of this provision is to allow both sides to walk away from the deal without penalty if the government interferes with the transaction (or if their approval is required but not given). While there is a very low probability that any Governmental Authority would implement a law or ruling preventing an acquisition in the lower middle market, if it were to happen it would certainly put an end to the transaction. Similarly, it is highly unlikely that either side would fail to obtain a necessary authorization or consent absent sheer incompetence or severe procrastination. Yet, if such failure were to occur it would also be an almost-certain death knell for the deal. Because of the low probability, high magnitude dynamic at play, the provision is worth paying attention as the Closing approaches, but it is not something that is likely to eat up negotiation time or cause significant disagreement.
Buyer and Seller Preference: None, other than deleting certain inapplicable conditions such as the HSR Act filing requirements or obtaining governmental approvals.
Differences in a Stock Sale Transaction Structure: None.
Further Assurances
What are Further Assurances? Buying a business requires paying attention to many different areas of the business, and some steps that are needed to accomplish the transition from one owner to the next happen after the Closing Date. Rather than list out every single step within the Agreement (an exercise that would inevitably result in important steps being overlooked), both parties promise to take any reasonable actions that are required in order to carry out the terms of the Agreement.
The Middle Ground: This provision requires each party (and their respective Affiliates) to take any further actions following the Closing that are reasonably required to fulfill the Agreement and the other Transaction Documents.
Purpose: The covenant is included to address miscellaneous, post-Closing issues that are not explicitly covered elsewhere in the Agreement. It serves as a risk management tool for both sides and is meant to ensure that the actual outcome mirrors the bargained-for exchange.
Buyer Preference: None.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: None.
Tax Clearance Certificates
What are Tax Clearance Certificates? When a company is registered to conduct business in a particular state, the state keeps records of state-level taxes owed by the company. A tax clearance certificate is a document provided by the state indicating that the Business does not have any overdue taxes or, if taxes are owed, indicating the amount that the Business is required to pay.
The Middle Ground: This covenant requires the Seller to notify the taxing authorities (in jurisdictions that impose taxes on the Seller) of the transaction and to request tax clearance certificates from those taxing authorities where available. If the taxing authority indicates that the Seller is liable for unpaid taxes, the Seller must promptly pay those taxes and provide evidence of the payment to the Buyer.
Purpose: The goal of this provision is to prevent the Buyer from becoming liable for the Seller’s delinquent tax obligations. It plays a small role in risk allocation, but its importance is limited by the fact that the Buyer is indemnified for any such tax obligations. Thus, the covenant is most useful for the Buyer in situations where the Caps or Baskets on indemnification would preclude the Buyer from making a claim. With that said, indemnification can be tricky to negotiate and can involve a long claims process, so this covenant also serves to provide some peace of mind that state-level taxes will not cause problems for the Buyer.
Buyer Preference: The Buyer wants to include this covenant, especially if time is not an issue and including it would not place an undue burden on the Seller. The Buyer may even prefer to obtain the certificates itself rather than putting that task on the Seller’s plate. However, most buyers will not object to omitting it, especially if they can exclude tax-related claims from the limitations on indemnification.
Seller Preference: The Seller wants to exclude this covenant on the grounds that it unnecessarily adds more work to an already lengthy and exhaustive process. The Seller can point to the Buyer’s indemnification rights to show that the Buyer’s risk from delinquent taxes is already addressed elsewhere in the Agreement.
Differences in a Stock Sale Transaction Structure: This covenant is not included in stock sales. In the asset acquisition context, the covenant only requires the Seller to make notifications and requests of the relevant taxing authorities if the failure to do so would result in the Seller’s tax liability being transferred to the Buyer. Since that transfer is automatic in a stock sale, the Buyer relies on its indemnification rights to shield it from becoming responsible for the Seller’s unpaid taxes.
Transfer Taxes
What are Transfer Taxes? Some states tax certain aspects of a business acquisition, such as imposing taxes on the transfer of Owned Real Property. Here, the parties identify the party responsible for paying those taxes and taking care of any associated obligations.
The Middle Ground: This covenant requires the Seller to pay all taxes and fees incurred in connection with the transfer of the Purchased Assets (“transfer taxes”) when such taxes come due, and calls for the Buyer to reimburse the Seller for 50% of the taxed amount. It also requires the Seller to make any necessary filings in relation to transfer taxes, with the Buyer’s cooperation.
Purpose: This main function of this requirement is to ensure that someone pays the transfer taxes so that neither side has to deal with fines or other penalties resulting from one or both parties overlooking their tax obligations. The likelihood is that the Buyer and Seller will not even discuss it and will simply accept the local custom to determine who pays.
Buyer Preference: The Buyer wants the Seller to pay the transfer taxes, but will usually settle for either splitting the bill or allowing local custom to dictate the outcome.
Seller Preference: Similarly, the Seller wants this obligation to fall on the Buyer but will typically agree to a 50-50 split or to defer to local custom.
Differences in a Stock Sale Transaction Structure: None.
Receivables
What are Receivables? Acquisitions are a process, and even after the sale is closed it takes all those involved some time to adjust to their new circumstances. That includes customers, many of whom will continue to send their payments to the Seller (especially in business-to-business relationships). Also, customers are not aware of the specific deal terms, so they may send money to the Buyer that is actually owed to the Seller. Regardless of where the payments are initially sent, this covenant is aimed at making sure they end up where they’re supposed to be.
The Middle Ground: For any funds received by the Seller on or after the Closing Date that relate to the Purchased Assets, the Seller agrees to pass them along to the Buyer within a set number of days. Similarly, the Buyer agrees to send to the Seller any funds it receives that relate to the Excluded Assets within a similar time frame.
Purpose: The rights to the money mentioned here are established elsewhere in the Agreement, so the legal effect of this section is really to set a time frame for when that money must be turned over.
Buyer Preference: None.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: This clause need not be included in a Stock Purchase Agreement because there are no Purchased Assets or Excluded Assets. Everything, good or bad, goes to the Buyer after the Closing.
Bulk Sales Laws
What are Bulk Sales Laws? Bulk sales laws apply to transfers of significant assets that are not made in the ordinary course of business, and they generally require the Buyer to notify the Seller’s creditors of the acquisition prior to the Closing so the creditors can protect their interests.
The Middle Ground: The notification requirements associated with bulk sales laws can be burdensome, so typically the parties agree to waive compliance with those laws, and the Seller agrees to take responsibility for any Liabilities arising from the parties’ noncompliance.
Purpose: The provision plays a small role in limiting the Buyer’s transaction risk, but its main purpose is to speed up the acquisition process and limit transaction costs.
Buyer Preference: The Buyer wants to include the Seller’s explicit assumption of liabilities in this provision, as the default rule automatically transfers liability to the Buyer along with the transfer of assets. An aggressive Buyer may require indemnification for claims related to bulk sales laws rather than simply relying on the Seller’s covenant. Additionally, a Buyer may impose a requirement on the Seller to litigate any claims brought by creditors under the bulk sales laws. Alternatively, a more conservative Buyer might comply with bulk sales laws if it is not comfortable with the Seller’s level of debt or with a particular creditor.
Seller Preference: The Seller will likely seek to limit this provision to a waiver of compliance while remaining silent regarding the assumption of liability related to bulk sales. If the Seller does agree to assume that liability it might not object to granting the Buyer indemnification rights, but it will most likely resist any requirement to litigate claims brought by creditors. The Seller’s views on complying with bulk sales laws may depend on the transaction timeline (i.e. if compliance would delay the Closing), but the more decisive factor is likely to be how much additional work it creates for the Seller, who is already having to balance running the Business while simultaneously trying to sell it.
Differences in a Stock Sale Transaction Structure: This provision is not included in a stock sale because there is no transfer of assets between entities, the Buyer simply stands in the Seller’s shoes with regard to Business-creditor relationships.
Public Announcements
What are Public Announcements? The timing and content of acquisition announcements can be important to each side for various reasons, but it is not so critical that the parties should spend valuable time on it before the deal is closed. Instead of agreeing on the specifics of the announcement pre-Closing, the parties use this covenant to agree more generally about who will draft the announcement and who must consent to its release.
The Middle Ground: Both parties agree that they will not publicly announce the acquisition without the cooperation and consent of the other party (unless required to do so by law, as determined by the reasonable advice of legal counsel). The Agreement may also stipulate that the consent required here cannot be unreasonably withheld or delayed.
Purpose: This provision allows both sides to control how and when interested third parties find out about the acquisition. In the lower middle market context, this covenant is aimed less at controlling the media coverage around the transaction and more at limiting its disruptive effect on employees. However, since limiting such disruption is in the best interests of both sides, in the absence of this provision, these transactions would be consummated as planned 99% of the time.
Buyer and Seller Preference: This clause will likely make it into the Agreement unaltered since it is usually not worth the time for either party to bring it up during negotiations. If the parties do address it directly, the discussion will probably focus on when and how the deal announcement will be made. With that being said, some buyers may not want to qualify the consent requirement, and there may be minimal negotiations devoted to that issue. Whether the consent requirement is altered, or even instituted in the first place, will likely be an outcome determined by the level of trust between the parties. Additionally, the “cooperation requirement” may not be included if the parties trust one another and one side has significantly more PR-related resources than the other.
Differences in a Stock Sale Transaction Structure: None.
Closing Conditions
What are Closing Conditions? Both the Buyer and Seller will have various tasks they must complete prior to the Closing in order to get the deal across the finish line. While those tasks are listed out elsewhere, this covenant sets the minimum standard of effort that must be used to achieve them.
The Middle Ground: Both parties promise to use their reasonable best efforts to satisfy their respective closing conditions.
Purpose: This provision is intended to increase the likelihood that the parties complete the transaction, and it does so by serving as a “catchall” provision that applies the “reasonable best efforts” standard to all closing conditions. Without this provision, one party could decide it doesn’t want to complete the transaction after it has already signed the Agreement, and it could avoid liability for failing to perform by simply not meeting its closing conditions. At that point, the other party would have to decide whether to abandon the transaction or waive those conditions and move forward, and neither of those options is very attractive. This covenant helps avoid that situation by requiring the parties to use a certain level of effort to satisfy the closing conditions, and if that level is not met it is considered a breach of the Agreement.
Buyer Preference: None.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: None.
Books and Records
What are Books and Records? Sometimes the Buyer needs access to pre-Closing information about the Business or the Seller needs similar post-Closing information. The need may arise because the two parties are in dispute and the relevant information is under the other side’s control, or it may result from a third-party claim or government inquiry (among other reasons). To address these situations ahead of time and in a fair manner, both sides agree on when access will be granted to the other’s books and records, and the length of time those records must be kept.
The Middle Ground: Here, both parties agree to keep copies of the Business’s pre-Closing Books and Records for a set period of time and to provide the other side with reasonable access to them. The parties may agree to provide access only under certain circumstances, such as if a claim is brought against either party in relation to the Business, or they can use a more general standard and allow access for any reasonable purpose. The amount of time the pre-transaction Books and Records are kept is typically based on the Seller’s past practices, and the other party is afforded access for an agreed-upon number of years. The right of access does not extend to situations in which granting such access would violate the law.
Purpose: This provision may never be utilized, but it is included nonetheless as a way to assist both sides in the event of a future claim (i.e. as a risk management tool). Memory is incredibly fallible and having to rely on it years down the road in the midst of a dispute is not a situation in which the Buyer or Seller wants to find itself. However, the risk being protected against is minute and each party is more likely to consult its own copies as opposed to those of the other side should the need arise (unless, perhaps, the claim is being brought by the other side). Thus, the provision does little more than provide a redundant fail-safe option that will likely never be used. That fact, in addition to the reciprocal nature of the covenant, means it will likely be included in the Agreement without any explicit discussion.
Buyer Preference: None.
Seller Preference: None.
Differences in a Stock Sale Transaction Structure: The only difference in this term in a stock sale is that the retention period for the Business’s Tax Records is based on statutory time limitations rather than the Seller’s past practices. Since the Buyer is assuming the tax liabilities of the Seller, it will want to retain those records for as long as a tax-related claim can be brought against the Business.
Governmental Approvals and Consents
What are Governmental Approvals and Consents? The lack of an important governmental approval or third-party consent can kill a deal despite the Buyer and Seller both wanting to move forward. To avoid that situation, the parties list out the necessary consents and approvals and split up the work in a way that makes sense for both sides. They also use this covenant to set boundaries around how far they must go in order to obtain a consent or approval.
The Middle Ground: This covenant requires both the Buyer and Seller to make all filings necessary to consummate the transaction, and to use their reasonable best efforts to obtain all the requisite consents from governmental authorities and third parties (e.g. customers and suppliers). It then lists out specific actions that the parties must carry out or avoid in order to obtain the necessary consents, such as litigating any order blocking the transaction, again modified by a reasonable best efforts standard. It also requires the parties to share certain information regarding communications with Governmental Authorities. Lastly, it expressly states that the Buyer is not required to sell off any part of its business or change the terms and conditions of the transaction to appease a Governmental Authority seeking to halt the transaction based on antitrust concerns.
Purpose: Once a potential deal reaches the exclusivity stage, it’s unlikely that a third party will prevent it from going through unless that third party is the government or has an important contract with the Seller and won’t consent to a change of control. This covenant seeks to deal with those two threats by allocating the serious risks they present between the parties.
Buyer Preference: The Buyer’s main concern with this clause is the application of the “reasonable best efforts” standard. The Buyer wants the standard included, but in defining what it means the Buyer needs to be aware of what it is willing (and unwilling) to do to close the transaction. For anything that it is unwilling to do, the Buyer will want an express statement to that effect included in the definition of reasonable best efforts. Given that the Seller will be the one that has the pre-existing relationships with important third parties other than the government, the Buyer generally wants the risk of not obtaining a third-party consent to fall on the Seller, with the risk of not obtaining Governmental Approval shared equally.
Seller Preference: The Seller wants to place the risk of not obtaining necessary Governmental Approvals on the Buyer, and it can do so by replacing the reasonable best efforts standard with a more demanding one. The Seller’s main concern is avoiding governmental interference with the deal, so it wants to place the burden relating to any such interference on the Buyer. The Seller can allocate that risk to the Buyer by requiring the Buyer to either divest assets to satisfy regulators or litigate any Governmental Order blocking the transaction. If the Buyer objects, the Seller can suggest putting caps on the amount of assets the Buyer must divest or that the parties list out specifically which assets would be subject to divestiture.
Differences in a Stock Sale Transaction Structure: None.
Equitable Remedies and Reasonableness of Restrictive Covenants
What is he Equitable Remedies and Reasonableness of Restrictive Covenants section? These two terms help enforce the three important restrictive covenants: the Confidentiality, Non-Compete and Non-Solicitation provisions. All of those restrictive covenants call for non-monetary (“equitable”) remedies, and the restrictions must be reasonable for a court to enforce them. By agreeing to this section, the Seller is agreeing that a non-monetary remedy is appropriate for the situation and that the specific restrictions included in the restrictive covenants are reasonable in the context of the transaction.
The Middle Ground: The Equitable Remedies provision states that a violation of any of the restrictive covenants would cause the Buyer irreparable harm for which money would not provide adequate compensation. It is meant to allow the Buyer to obtain an equitable remedy such as an injunction to prevent violations. The Reasonableness provision includes an acknowledgement from the Seller that the Confidentiality, Non-Compete and Non-Solicitation covenants are reasonable. It also states that if a court finds the restrictive covenants unreasonable, the Seller agrees that the court should reform the terms to the point where they are considered reasonable but still achieve the desired effect to the maximum extent allowed by law.
Purpose: These two provisions are aimed at protecting the viability of the restrictive covenants. The Confidentiality, Non-Compete and Non-Solicitation covenants do most of the heavy lifting in terms of protecting deal value, and these two covenants perform a smaller risk management function by ensuring that the more important covenants remain enforceable and effective.
Buyer Preference: Although there will typically be a specific performance clause applicable to the entire Agreement, the Buyer wants to include the Equitable Remedies covenant here so that there is no question that it applies to all restrictive covenants. The Buyer wants to be sure to include language that tracks the standard for granting injunctions and other equitable remedies (i.e. “irreparable harm…for which monetary damages would not be an adequate remedy”). In regard to the Reasonableness covenant, the ability to modify restrictive covenants rather than completely invalidating them is not available in all states. So, the Buyer’s counsel should adjust its approach depending on whether the law governing the agreement allows “blue-pencil” revisions. If not, the Buyer may want to include a choice of law clause or reduce the covenant restrictions so there is no doubt they are enforceable.
Seller Preference: If the Seller agrees that the restrictive are reasonable, it will likely have no objection to these two subsections since the entire purpose of both is to protect the viability of the restrictive covenants.
Differences in a Stock Sale Transaction Structure: None.
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.
Employees and Employee Benefits
What is the Employees and Employee Benefits section? Transferring employees and their benefit plans from the Seller’s business entity to the Buyer’s is a process that involves quite a few underlying issues that must be worked out between the parties. This covenant lays out how the parties have answered questions such as which employees will be transferred, what benefits they will receive, and who is responsible for employee-related issues that pop up after the Closing.
The Middle Ground: In this covenant, the Seller promises to terminate its employees on the Closing Date so the Buyer can hire some or all of them on its own terms. Next, the Seller agrees to be responsible for all compensation (including benefits) owed to its employees up to the Closing Date, and to pay out that compensation by the Closing Date. The Seller also agrees to remain responsible for all insurance, disability, and workers’ compensation claims that are based on events that occur on or prior to the Closing Date. For those employees of the Seller that the Buyer does hire, the Buyer typically agrees to offer them substantially similar compensation and benefits as previously offered by the Seller or as offered to Buyer’s similarly situated employees. Finally, the Buyer agrees to give the employees it hires from the Seller “service credit” under the Buyer’s health and retirement benefits plans according to their length of service with the Seller.
Purpose: The most important feature of this covenant is the Buyer’s promise to hire the Seller’s employees because it can be used to maintain employee stability and quell any panic that may arise after the acquisition is announced. It is something the Seller can point to in order to assure its employees that the sale of the company does not automatically translate to a loss of their jobs. In other words, it is a wonderful risk management tool. However, the Buyer retains the discretion not to hire employees as it sees fit and the other promises made by the Buyer relate only to the employees it ends up hiring. Thus, the covenant does not guarantee that no employees will be worse off after the sale, but if the Buyer agrees to include it that is a good signal that its intent is to disrupt normal operations of the Business as little as possible.
Buyer Preference: The Buyer wants to retain as much discretion as possible, especially with regard to who it must hire and the level of compensation it must provide. While stability is typically in the Buyer’s best interest, some buyers may use the transition as an opportunity to cut costs by selectively reducing the number of employees, and it is not unreasonable for the Buyer to want to maintain the discretion to do so. Also, if the Seller is subject to the WARN Act (or any state-level corollaries), the Buyer wants to ensure that the Seller takes responsibility for any resulting liabilities.
Seller Preference: The Seller will typically seek a promise from the Buyer to hire all or most of the Seller’s employees at comparable compensation and benefit levels. The desire for the Buyer to hire as many employees as possible is even stronger when the Seller is subject to the WARN Act or a similar state law, since liability under the Act can be minimized or avoided entirely if enough employees are hired by the Buyer. Another tactic for the Seller to avoid WARN Act liability is to explicitly shift that liability to the Buyer in the Agreement, but that will likely take significant negotiation leverage.
Differences in a Stock Sale Transaction Structure: This covenant is not included in a stock sale because the target company remains intact so there is no need to transfer employees to a new entity.
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.
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.
Access to Information
What is Access to Information? For many issues that the Buyer will investigate during due diligence, the best or only source of information is the Business itself (e.g. financial statements). So, in order to conduct its investigation, the Buyer needs access to the Business’s records, employees, and advisors. This section grants that access under certain agreed upon conditions.
The Middle Ground: In this covenant, the Seller promises: (1) to allow the Buyer full access to the books, assets, and properties of the Business (including regulatory and tax filings); (2) to provide reasonably requested financial and operating data of the Business; and (3) that its Representatives will cooperate with the Buyer in its investigation of the Business. In return, the Buyer promises not to conduct its investigation in a way that unreasonably interferes with the Business (or other businesses of the Seller). The covenant also states that no investigation by the Buyer or other information received by the Buyer will act as a waiver or otherwise impact the representations, warranties, and other agreements made within the Agreement.
Purpose: By allowing the Buyer to take an inside look at certain aspects of the Business, this covenant significantly lowers the Buyer’s transaction risk without increasing the risk to the Seller. Buyers will invariably be more comfortable making an investment after conducting its own investigation rather than relying on the promises of the person that stands to benefit from the investment, and this provision gives buyers that opportunity without interfering with the Seller’s operations.
Buyer Preference: The Buyer wants to ensure that the language used here (and in any affiliated definitions) is broad enough to permit the desired level of access. For example, if there are environmental concerns relating to the Business and the Buyer plans to engage an environmental specialist to conduct an investigation, the Buyer can insert language into the covenant detailing the specialist’s rights of access. The Buyer may also want to include language regarding access to the customers and suppliers of the Business, so long as there are no confidentiality-related issues and the Seller does not object to providing such access.
Seller Preference: The Seller’s main concern here is preventing the Buyer’s investigation from interfering with the Business (or any of Seller’s other businesses), especially if the fact that the Business is being sold has not been disclosed to the employees. To prevent problems, the Seller may want to limit the covenant in one or more ways, including: restricting the hours of access, requiring advance notice of visits, requiring any visitors representing the Buyer to be supervised by personnel of the Seller, requiring all communications to be funneled through one or more designated employees, requiring the Buyer to obtain written consent before contacting customers or suppliers, limiting the Buyer’s right to physically inspect the Seller’s properties without advance notice, and prohibiting disclosure of information that is either privileged or could cause competitive harm if the deal does not close.
Differences in a Stock Sale Transaction Structure: None.
Conduct of Business Prior to Closing
What is Conduct of Business Prior to Closing? The Buyer’s due diligence investigation and, ultimately, its decision to buy the Business assume that the Business will continue to operate as it has in the past until the Closing Date (i.e. while the Seller is still in charge). Here, the Seller promises not to make any major changes to the Business without the Buyer’s consent.
The Middle Ground: This covenant requires the Seller to conduct the Business consistently with how it has been conducted in the past and to use reasonable best efforts to maintain the Business’s operations and relationships prior to the Closing. In addition to those general directives, the Seller agrees not to deviate from certain practices without the Buyer’s consent, such as paying debts and taxes when due and performing its duties under the Assigned Contracts.
Purpose: The Buyer bases its valuation of the Business in part on how it has been conducted by the Seller in the past. The best way to protect that value is to ensure that the Business is operated the same way between the signing and Closing as it was in the past. Without this provision, the Buyer would be stuck with the risk stemming from some fundamental change in the Business that occurs after the Buyer signs the Agreement. With it, that risk is shifted to the Seller, who is in the best position to prevent those changes from taking place.
Buyer Preference: Here, the Buyer may want to include a comprehensive list of both the actions the Seller is required to take prior to the Closing and those it is forbidden from taking. If the Buyer is financing the acquisition, the list should also include anything the Seller must do in order for the Buyer to obtain financing. For maximum protection, the Buyer can require consent on all material operational decisions, but there are two important limits on such a requirement. From a practical standpoint, the Buyer may not have the time or expertise to make those decisions, and it would be best served by letting the Seller continue ordinary operation of the Business. From a legal standpoint, if the Buyer and Seller operate in the same industry they must be careful to avoid violating antitrust law by consolidating control before they obtain the proper approval (if governmental approval is required).
Seller Preference: The Seller wants as few restrictions listed here as possible so that it does not inadvertently violate the Agreement. It also wants language in the covenant that allows it to back out of a particular duty if the Buyer consents, with the Buyer’s consent governed by a standard of reasonableness (e.g. the Buyer cannot unreasonably withhold or delay consent). The Seller may also try to mitigate some of the Buyer’s requested restrictions by narrowing their applicability where it makes sense to do so. Both parties want to avoid antitrust issues, so they may include a “No Control of Other Party’s Business” clause if the list included here is particularly comprehensive and/or restrictive.
Differences in a Stock Sale Transaction Structure: None.
Absence of Certain Changes, Events, and Conditions
What is This? In this section, the Seller provides information regarding the current state of the Business. It is part of the Representations and Warranties of Buyer section.
The Representations and Warranties of Buyer portion of the Agreement is used to save the Seller time and money. Rather than require the Seller to go through third parties to find certain information, the Buyer provides the information and must reimburse the Seller for any Losses it suffers if the information is false or misleading.
The Middle Ground: In this provision, the Seller represents that certain aspects of the Business (e.g. accounting practices) have not changed, or certain events or conditions have not occurred, since the Balance Sheet Date. The most important inclusion in this section is the representation that nothing has occurred since that date that could reasonably have a Material Adverse Effect on the Business. The representation excludes changes, events, and conditions that occur in the ordinary course of business and are consistent with the Seller’s past practices.
Purpose: A Buyer’s decision to invest in a business involves the consideration of dozens of different factors, and sometimes it is just one of them that tips the balance from a “pass” to a “buy.” If the Business undergoes a significant change after the investment decision is made, the Buyer may want to reassess its calculation. This clause allows the Buyer to identify the changes it is most concerned about, and in doing so, it requires the Seller to disclose such changes or represent that they have not occurred.
Buyer Preference: The Buyer wants the list of prohibited changes, events, and circumstances to be comprehensive. It may also want to prevent changes to the Seller’s cash management and accounting practices, especially if the deal involves a Purchase Price adjustment that could be manipulated by varying such practices. In defining Material Adverse Effect, the Buyer wants to strike a balance between a broad definition that encompasses the Buyer’s major concerns and a definition that is relatively easy to measure and enforce. Many buyers are uncomfortable with the vague nature of the materiality standards used, and instead use dollar amount thresholds to qualify certain aspects of the list.
Seller Preference: The Seller wants a short list of prohibited changes, events, and circumstances, especially if they are not likely to affect the Buyer or the Purchased Assets after Closing. The Seller is typically more comfortable with the Material Adverse Effect standard than is the Buyer because it is difficult to enforce, and the same can be said for the other materiality standards in this section. However, if the Buyer insists on dollar thresholds, the Seller will want those thresholds to be as high as possible.
Differences in a Stock Sale Transaction Structure: The list of prohibited changes is likely to be longer in a stock sale because the Buyer is purchasing the entire business instead of certain assets.