Anatomy of a Stock

Purchase Agreement

Professors Morreale & Rivlin

Spring 2012
Environmental Issues in Business
Transactions
Types of Purchase Agreements

 Stock Purchase Agreement

 Generally, the simplest of the three
 Asset Purchase Agreement
 Agreement and Plan of Merger
 All three are largely similar in structure; difference
is primarily in the “mechanics” section
Typical Parts of an SPA
 Introductory Sections
 Preamble
 Recitals
 Definitions
 Mechanics of the Sale & Purchase
 Representations & Warranties
 Covenants
 Tax & Employee Benefits Matters
 Conditions
 Termination
 Indemnification
 Miscellaneous or “boiler-plate”
Introductory Sections

 Preamble – defines the agreement and states its date and

the parties to it
 Recitals
 There is no requirement that recitals exist
 Particularly useful in setting forth the context of a complicated
transaction
 Gives a reader a short summary of the transactions
 Generally, not intended to be legally binding, but if relevant
will be brought up in litigation
 Statement of Agreement
Definitions

 Can either be in a separate section, defined in the

context of the agreement or a combination
 Many appear to be “boiler-plate” but definitions
can be an extremely important drafting tool
 When representing a buyer, making sure terms such as
“Environmental Laws”, “Laws” and related definitions
are as expansive as possible is important
 Most heavily negotiated definition is usually
“Material Adverse Effect”
Material Adverse Effect
 The most important definition.
 US style agreements use flexible, non-quantitative formulation, though if there is a
specific quantitative metric that needs to be addressed, define it in.
 Irrespective of definition, what is an MAE?
 Buyer-Friendly Definition:
 MAE means a material adverse effect on the business, results of operations, assets, liabilities,
condition (financial or otherwise) or prospects of Company or any of its Subsidiaries.
 “Prospects” hard to get in most industries.
 Seller-Friendly Definition:
 MAE means a material adverse effect on the business, financial condition or results of
operations of Company and its Subsidiaries taken as a whole, except any such effect resulting
from or arising in connection with (i) this Agreement or the transactions contemplated hereby,
(ii) changes or conditions affecting the industry generally, (iii) changes in economic, regulatory
or political conditions generally, (iv) changes in Law or GAAP or (v) the outbreak or escalation
of hostilities involving the United States or the declaration by the United States of a national
emergency or war or the occurrence of any other similar calamity or crisis.
 Exceptions are heavily negotiated.
Purchase Mechanics
 Define the transaction and when it will close.
 Frequently includes list of closing deliverables.
 Purchase Price Adjustments:
 Working Capital
 Net Debt
 Net Assets
 Is there an estimate of the Adjustment made at Closing?
 Who controls the closing statement, buyer or seller?
 On what basis is can the closing statement be disputed?
 Adjustments to be on an “apples-to-apples” basis with the agreed target.
 Will differ tremendously between APA, SPA and Merger Agreement
Reps & Warranties

 Reps are technically statements of existing fact, while

warranties are promises that facts are true.
 One and the same for US purposes; UK practice is to use
warranties only.
 Serve a number of purposes:
 Confirm due diligence and elicit information
 Truth as a closing condition (reps are “brought-down” as of
closing)
 Indemnification for breaches
 In addition to describing the business, they act as a risk
allocation mechanism
Typical Reps & Warranties
 Organization
 Authorization, Execution and
Delivery
 No Conflicts
 Capitalization
 Financial Statements (A/R,
Inventories?)
 Undisclosed Liabilities
 Taxes
 Absence of Changes
 Compliance with Laws
 Contracts
 Customers & Suppliers
 Environmental Matters
 Benefits Matters
 IP
 Title to Assets; Condition and
Sufficiency
 Related Party Transactions
 Litigation
 Books & Records
 No Brokers
 Disclosure
Disclosure Schedules
 Reps & warranties to be read in conjunction with disclosure schedules
 Disclosure schedules set forth:
 Lists called for by the reps and other parts of the SPA
 Exceptions to the reps
 Applicability of disclosure schedules across all reps:
 Is the exception set forts in the lead-in to the reps?
 Are exceptions set forth on a rep-by-rep basis?
 What happens if an exception qualifies more than one rep?
 From a seller’s point of view, disclosure schedules are cost-free insurance, include
everything possible, but don’t make additional reps.
 From a buyer’s point of view, need to understand and be comfortable with everything
disclosed on disclosure schedules.
 Buyers frequently help sellers populate disclosure schedules through their diligence.
 Is there a right to update?
Qualifications to Reps
 MAE:
 “except as has not had an MAE”
 “except as, individually or in the aggregate, has not had and would not reasonably be
expected to have an MAE”
 Materiality, “in all material respects”
 Dollar-based qualifications
 Knowledge:
 “means the actual knowledge of those individuals listed on Schedule 1.1, after due inquiry”
 “to the knowledge of Seller, there are no pending or threatened litigations”
 “there are no pending, or to the knowledge of Seller, threatened litigations”
 “As of the date hereof” – seems innocuous, but can cause a rep not to be brought
down, shifting risk to buyer.
 How long is the “look-back”?
 In public deal, qualification based on SEC filings.
Important Reps
 Financial statements – “the financial statements fairly present the financial condition
and results of operation” – this most important rep.
 No Undisclosed Liabilities:
 “there are no undisclosed liabilities other than as disclosed on the balance sheet”
 “there are no undisclosed liabilities required by GAAP to be disclosed on the balance sheet
that are not so disclosed”
 Disclosure:
 The representations and warranties contained in this Article 4 do not contain any untrue
statement of a material fact or omit to state any material fact necessary to make the
statements contained in this Article 4 not misleading.
 Extremely powerful from a buyer’s point of view – resist as strongly as possible from the
seller’s point of view.
 Absence of Certain Changes – “since the Balance Sheet Date:
 there has not occurred any MAE
 Company has taken no action that it would not be permitted to take under Section 5.1”
Covenants

 Covenants are promises to do something (not do

something) in the future.
 Both buyer and seller will give covenants.
 Compliance with covenants is typically a closing condition.
 Breach of covenants typically results in indemnification
claims.
 Many covenants are relatively innocuous (records, further
assurances, access and investigation, public
announcement, confidentiality)
 In a public deal, “no-shop” covenant is heavily negotiated.
 Many include non-compete and no-solicit covenants.
Conduct of Business Covenant

 Conduct of business covenant – as there is a gap between

signing and closing, seller’s ability to take actions during this
period will be limited
 Generally, both an affirmative covenant and negative covenants:
 “Seller shall use reasonable efforts to preserve intact the business”
 “Seller shall not, without the consent of Buyer, take any of the
following actions”
 Argument is that Seller need flexibility to run its business, while
Buyer needs to know what it’s buying.
 There are antitrust considerations that relevant in negotiating this
covenant – “gun-jumping” is not permitted.
Regulatory Approvals Covenant

 Parties agree to make required filings and seek required

regulatory approvals (i.e. HSR and EC merger clearance).
 How strong is the covenant?
 “reasonable best efforts” without definition?
 Affirmative requirement to make divestures, agree to hold-
separate order and litigate with the covenant?
 Requirement that no divestitures need to be made?
 Cooperation provisions in connection with these filings.
Benefits Matters

 Employee benefits are increasingly important in

M&A transactions.
 Benefits covenant can address:
 “Continuance” covenant – buyer agrees to provide
comparable benefits for a period of years
 Mechanical issues with benefit plans (transfers of
accounts, credit for past service, deductibles, etc.)
 Allocation of severance costs
Tax Matters

 In a stock purchase, tax matters are generally limited to

allocation of historical liabilities, as the transaction itself will
be taxable to the seller.
 338(h)(10) Election – allows the buyer to treat the purchase
as a asset purchase, giving it a “stepped-up” basis
 Allocation of historical liabilities can be done either through:
 Detailed reps on tax matters, including in particular adequate
reserves.
 Pre-/Post-Closing Split where seller indemnifies buyer for
pre-closing tax liabilities, while buyer indemnifies seller for
post-closing tax liabilities
Conditions to Closing
 Mutual conditions:
 Receipt of required governmental approvals (might be an obligation to close over some)
 Absence of injunctions
 Buyer’s conditions:
 “Bring-down” of sellers’ reps
 Compliance by seller with its covenants (generally qualified by “in all material respects”)
 MAE Condition (though is it really necessary?)
 No proceedings (how qualified? government? MAE? any?)
 Third party consents
 Financing
 Other deal specific conditions
 Seller’s Conditions
 “Bring-down” of buyer’s reps
 Compliance by buyer with its covenants (generally qualified by “in all material respects”)
Bring-Down Condition

 Seller friendly form:

 The reps and warranties shall be true and correct on and as
of the Closing Date as if made on and as of the Closing Date
(other than such reps and warranties that speak as of a
specific date, which shall be true as of such specific date),
except for such failures to be so true and correct as would
not have a MAE.
 This is often referred to as having a “global MAE”
qualification.
 Note the “specific date” language – this is the source of the
problem with accepting “as of the date hereof” in the reps.
Bring-Down Condition (cont.)

 Buyer friendly form:

 Each rep and warranty shall be true and correct in all
[material] respects when made and on and as of the Closing
Date as if made on and as of the Closing Date, other than
such reps and warranties that speak as of a specific date,
which shall be true as of such specific date [(without giving
any effect to any qualification as to “materiality” or “MAE”
therein)], [except for such failures as would not, individually
or in the aggregate, reasonably be expected to have an
MAE].
 Note the restatement of the reps as of signing.
 “Double materiality” is eliminated.
Termination Rights

 Mutual agreement
 Drop-dead date (frequently a tiered approach)
 Breach of reps, covenants so that condition won’t
be satisfied (consider notice and cure)
 Other impossibility of condition (though make
clear not available to any party responsible)
 Effect of termination – doesn’t change remedies
for breach. Should indemnity and boiler-plate
survive?
Indemnification

 Indemnification for:
 breaches of rep
 breaches of covenant
 other specific issues (pre-closing environmental liabilities for
examples)
 Survival of reps:
 Survival period is how long buyer can enforce the reps, it
doesn’t mean that the reps have to be true after closing
 Focus on number of audit cycles, rather than actual length
 Tiered survival for different reps (title, authority, capitalization
reps survive forever; tax, benefit, enviro survive to applicable
statute of limitations.
Baskets & Caps

 Seller doesn’t have to indemnify unless claims

reach a specified level
 Can be either a “tipping” basket or a deductible
 May also be a minimum claim threshold or “mini-
basket” (i.e. no claim under a specified level can be
made)
 Seller’s aggregate obligations may be capped
 Baskets and caps should generally only apply to
breaches of reps, not to breaches of covenants
Indemnification Procedures

 Indemnifying party will typically want the right to

control the proceedings
 Indemnified party will not always want
indemnifying party to have full control, exceptions
in the event of a conflict.
 Exclusivity of remedies
 Does indemnification apply prior to closing?
Other Indemnification Issues

 Should buyer be able to claim indemnification for breaches

of rep that it knew about as of closing?
 Should seller have the right to update disclosure
schedules? If so, should they count as being disclosed?
 Should the reps be subject to reading out of qualifiers for
indemnity purposes given the basket and cap?
 Is the Seller sufficiently solvent to provide the
indemnification? Is an escrow or guarantee necessary?
Miscellaneous/Boiler-Plate
 Notices
 Dispute resolution
 Arbitration
 Forum selection
 Submission to jurisdiction
 Governing law
 Integration
 Amendment and waiver
 Assignment
 Third party beneficiaries
 Severability
 Counterparts