CHEAT SHEET Material adverse change. European sellers generally prefer to pass contractual risk to the buyer upon signing. Post-closing purchase

Transcription

1 CHEAT SHEET Material adverse change. European sellers generally prefer to pass contractual risk to the buyer upon signing. Post-closing purchase price adjustments. The decrease of post-closing purchase price adjustments in Europe is arguably due to the generally strong negotiation position of sellers. Earn-out. This option, which involves a portion of the purchase price payable dependent upon the target company s future performance, has decreased in Europe in the finance and hospitality industries. Non-compete clauses. Over the last two years, the use of non-compete clauses in European deals has been quite stable at an average of 50 percent.

2 Globalization of mergers and acquisitions has become the norm rather than the exception. Consequently, deal terms for mergers and acquisitions are becoming more uniform, with very important key differences. Take the example of a US manufacturer acquiring in Europe. Or it may be equally likely that one European entity may be acquiring another. European in-house counsel in such a scenario would gauge deal terms in several countries in Europe or in the United States when a European entity executes mergers and acquisitions across the pond. STRUCTURING EUROPEAN M&A TRANSACTION TERMS Imagine you are the general counsel of a medium-sized, privately-owned US manufacturer that has recently made a strategic acquisition of a key, privately-owned US supplier that has in addition to its core business several non-essential businesses in Europe, including the United Kingdom, Germany, France, Switzerland and Italy. The CEO has advised you that he and the board have decided to divest and sell these European subsidiaries in order to focus on the group s core business, including the newly acquired supply business. It is anticipated that each of the subsidiaries will be sold separately, so that local laws will govern the sale of each such subsidiary. Although you and your company have experience with mergers and acquisitions in the United States, you do not have experience with mergers and acquisitions in every European country. The CEO has asked you to prepare a share purchase agreement (SPA) for the sale of each of the European subsidiaries, and to brief him on the key differences that will impact the deal. By Robert Loewer ACC DOCKET NOVEMBER

3 STRUCTURING EUROPEAN M&A TRANSACTION TERMS Fundamental deal term differences between Europe and the United States With the help of local counsel from each of the relevant European jurisdictions, you start with amending an SPA precedent used by your company for several prior transactions in the United States. The key deal terms to be discussed with your local counsel and your company include the following: MAC clauses; purchase price adjustments; earn-outs; other closing conditions; and limitation of liability. Each local counsel in Europe provides you with a baseline of key deal terms, and refers you to the data and statistics regarding European M&A transactions that are derived from the 2013 CMS European M&A Study 1 for deals completed in 2012 and the 2014 CMS European M&A Study 2 for deals completed in 2013 (CMS Studies, collectively). As a basis of comparison, each local counsel in Europe uses comparative data of US transactions derived from the 2013 Private Target Mergers & Acquisition Deal Study published by the Mergers & Acquisitions Committee of the American Bar Association for transactions completed in 2012 (2013 ABA Study). Deal term analysis As a result of the consultation with European counsel in each of the relevant jurisdictions, you determine that comparative differences between US M&A deal terms and European deal terms are as follows: Material adverse change clauses A material adverse change or material adverse effect (MAC) clause is used as a negative condition precedent to closing (closing condition), which entitles the buyer to withdraw from completing the transaction in case certain interim risks of adverse changes affecting the target company between signing and closing occur. Such clauses essentially enable buyers to avoid assuming contractual risks until after the closing of transactions. Therefore, the definition of a MAC is usually one of the most intensively negotiated items among the parties. In the United States, MAC clauses are prevalently used in M&A transactions, with 96 percent coverage in deals completed in The pervasive usage of such a buyer friendly clause is partly attributable to the common practice in US transactions that the sellers emphasize securing a higher purchase price up-front more than deal certainty. In addition, MAC clauses contained in financing documents often need to be mirrored in the SPA. In practice, however, it has been extremely challenging, if not impossible, to succeed in establishing a claim for breach of a MAC clause in a merger or purchase agreement in front of US courts. As early as 2008, the Delaware Chancery Court noted, Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement in one of the most-cited MAC cases: Hexion Specialty Chems. v. Huntsman Corp. 3 It was further held in In re IBP Inc. Shareholders Litigation 4 that a MAC must be a long-term effect rather than a short-term failure to meet a financial target, and that a MAC clause is best read as a backstop protecting the acquirer from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally significant manner. With such high and abstract standards to meet, US practitioners often find it difficult to determine if a MAC has occurred. In Europe, MAC clauses are far less used in M&A transactions (the CMS Studies show a total of only 14 percent in both 2012 and 2013). Unlike US sellers, European sellers generally prefer a higher degree of deal certainty, and we see tendencies that contractual risk is passed to the buyer already upon signing. Closing is often a mere formality following antitrust or other regulatory clearance. In addition, there are a greater number of European deals with simultaneous signing and closing compared to those in the United States. Such practice is attributable to several factors. First of all, it has been traditionally more difficult to exit from contractual obligations in civil law systems than in common law jurisdictions. One of the most paramount doctrines of contract law pacta sunt servanda (i.e., the contract has to be respected) is deeply rooted in civil law countries, such as Germany and France. As a matter of legal principle, parties must adhere to the terms of their contract and respect the sanctity of the contract. Therefore, contractual clauses (e.g., MAC clauses) that increase the uncertainty of closing M&A transactions have been less acceptable in continental Europe, and buyers have much more difficulty negotiating MAC clauses. Second, acquisition financings in European transactions have been accustomed to the so-called Certain Funds Model, which provides more certainty of funding, and the lending banks are generally not permitted to refuse funding in the event of, for example, a MAC between signing and closing. In other words, it is rarely necessary to reflect the MAC clause contained in financing documents in the SPA for European transactions. In Europe, MAC clauses are most likely to be introduced or used in crossborder transactions, particularly when a US buyer is involved or the buy-side Robert Loewer is the general counsel of National Railway Equipment Co., which globally manufactures and services locomotives. Prior to joining NREC, he worked for an M&A, financial and strategic consulting firm. He is licensed to practice law in Illinois and England. r.loewer@nre.com 42 ASSOCIATION OF CORPORATE COUNSEL

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5 STRUCTURING EUROPEAN M&A TRANSACTION TERMS competition is limited. Within Europe, it is worth noting, according to the CMS Studies, that the usage of MAC clauses is divergent among different sectors. For example, in 2013, MAC clauses were hardly seen in sectors such as energy & utilities, infrastructure & project finance, and life-sciences, while relatively more popular in finance & insurance, industry, and real estate & construction sectors. While US courts have rarely upheld claims for occurrence of a MAC, it remains to be seen how local courts in certain Europe countries (e.g., France and Germany) would interpret or treat a MAC clause in M&A transactions. It is, however, to be expected that a MAC clause will be applied very closely along the wording used in such clause, so that the principle of pacta sunt servanda prevails, except in those circumstances explicitly covered by the MAC clause. When MAC clauses are used, the parties commonly agree to include carve-outs and exceptions to the MAC definitions in both US and European transactions. Typical carve-outs may include, for example, overall economic condition and/or unforeseeable economic development in the sector of the target. These exceptions essentially shift the risk of certain events between signing and closing from the seller to the buyer and, therefore, are usually subject to heavy negotiation and contain deal-specific customization. US M&A transactions in recent years have exhibited a trend towards more specifically defined MAC clauses featuring a number of carve-outs and exceptions. For European transactions completed in 2012, however, the CMS Studies show that the parties were less inclined to include specific exemptions, but instead chose to refer to general economic conditions or developments and/ or to unforeseeable economic development relating to the target compared to those transactions from 2007 to Purchase price adjustments In an M&A transaction, the buyer normally would wish to ensure that the net assets of the target company it receives at closing do not deviate from what was agreed upon at signing. In the United States, while there are warranties and covenants that provide the seller with little flexibility outside the ordinary course of business for non-current assets, the purchase price is typically adjusted by a calculation based on the target company s latest available financial statements and the earnings trend reflected therein. Therefore, it is fairly common to see post-closing purchase price adjustments in a purchase agreement. Such adjustments normally include comparison of working capital, net debt/cash or net asset value between the most recent financial information available at signing and that as of closing. The structure of purchase price adjustments depends largely on how the target business is valued, and the details and calculations are often subject to lengthy negotiation among the parties. Post-closing purchase price adjustments are prevalent in US transactions (85 percent in 2012), and the majority of transactions contained more than one adjustment metric. Working capital adjustment is identified as the most pervasive purchase price adjustment metric, according to the 2013 ABA Study (91 percent in 2012). A working capital adjustment is generally used to compensate the relevant party for growth or decline in working capital as measured at closing compared to an agreed baseline balance. Without such an adjustment, an increase in the working capital balance between signing and closing could result in a windfall to the buyer, while a decrease in the balance might result in the buyer having to invest additional funds in the target, thereby increasing the dollar cost of the deal. The second commonly used adjustment metric for US deals is the cashfree, debt-free formula (more than 35 percent 5 ), which means that all free cash at closing is paid for on a dollarfor-dollar basis (or excluded from the acquisition in an asset deal and left with the target), while all (longterm) debt will be deducted from the purchase price at closing or paid off at closing with part of the purchase price. Due to direct interaction between debt/cash and working capital, a combined purchase price adjustment mechanism is very common. Compared to US transactions, postclosing purchase price adjustments are currently far less popular in Europe (only 44 percent in 2012). According to the CMS Studies, 2012 and 2013 saw a continued overall decrease of postclosing purchase price adjustments in Europe, which is arguably due to sellers desire to secure deal certainty in light of the Euro crisis, as well as the generally strong negotiation position of sellers in today s M&A business in Europe. However, in Central and Eastern Europe 6 (CEE), the use of purchase price adjustments increased noticeably in Among the transactions with purchase price adjustments, working capital adjustment has also been the most popular metric used in Europe (40 percent in 2013), followed by net cash/debt adjustments (27 percent in 2013). It is worth noting that a large number of European transactions implement the so-called locked-box mechanisms (41 percent in both 2012 and 2013). A typical locked-box transaction essentially means that the purchase price for the target company is calculated based on a defined historical (but still very recent) balance-sheet date agreed upon by the parties before signing the agreement, and this price is fixed without being subject to post-closing adjustments. The economic risk of the company is effectively passed to the buyer from the pre-agreed balance-sheet date in a locked-box transaction. Consequently, the buyer will usually require the seller to ensure that it will not distribute any payments to the company s shareholders 44 ASSOCIATION OF CORPORATE COUNSEL

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7 STRUCTURING EUROPEAN M&A TRANSACTION TERMS or related parties as profits, dividends or other payments that are not permitted in the SPA after the agreed balance-sheet date the so-called no leakage undertakings. In addition, the seller s warranties would normally contain detailed provisions relating to the completeness or accuracy of the locked-box date financials, which will entitle the buyer to claim damages (instead of a purchase price adjustment) in case of breach of such warranties, or the buyer can choose to terminate the transaction if it is determined on the closing date that the no leakage covenants have not been met. In 2012, popularity of locked-box transactions in Europe increased in sectors such as technology, media & telecommunications, infrastructure & project finance, and industry. In 2013, the use of locked-box mechanisms significantly increased in France, while CEE had a noticeable decrease. Earn-outs An earn-out is a portion of the purchase price payable dependent upon the target company s future performance, which is typically measured by its ability to reach certain milestones during a specified period after the closing. Earn-outs are often used when buyer and seller cannot agree on the value of the target company, and are particularly useful in dynamic or volatile industries. An earn-out potentially rewards the seller if its business projections are accurate, while protecting the buyer from overpaying if they are not. From the buyer s perspective, having an earn-out also means minimizing the cash down payment and the possibility to offset warranty and indemnification claims against future payments of earn-outs. In any event, the parties spend considerable time negotiating the provisions (i) protecting the seller against the buyer shifting revenue/profit to time periods outside the earn-out period or from the target to other entities of the buyer s group and (ii) allowing the buyer to run the business at its free discretion. While earn-outs are not predominantly used in either the United States or Europe, they are relatively more common in US transactions (25 percent in 2012) than in Europe (only 14 percent in 2013). In Europe, the use of earn-outs in 2013 has significantly decreased in the finance & insurance and hotel & leisure sectors, compared to The benchmarks used to determine the milestone thresholds of earn-outs are usually heavily negotiated. Common metrics include revenue (called turnover in Europe), EBIT/EBITDA or earnings per share. Non-financial benchmarks may also be used on a caseby-case basis. In Europe, EBIT/EBITDA is the most commonly used criteria for earn-out calculations (43 percent in 2013), while turnover/revenue is more popular in the United States (32 percent in 2012). The length of the earn-out period is usually linked to the period required to measure the projected value of the target or the period during which the buyer desires to incentivize the seller. In US transactions, an earn-out period between 12 to 24 months is typical (50 percent in 2012), while earn-out periods between six and 24 months are more often seen in European transactions (53 percent in 2013). Other closing conditions Other than merger clearances and MAC clauses, bring-downs of representations and warranties are also as commonly used in US transactions as closing conditions (57 percent in 2012). A warranty bring-down essentially means that all of the sellers representations and warranties have to be true and correct not only at signing, but also closing, the breach of which normally entitles the buyer to withdraw from completing the deal. Such a warranty bring-down is often seen in US transactions as a supplement to the MAC clause (51 percent of transactions in 2012 contained both clauses as closing conditions). European jurisdictions, on the other hand, are less open to closing conditions, which increase deal uncertainty, as discussed above. Consequently, bring-downs of warranties are less frequently used in European M&A transactions, particularly not as a closing condition. The buyer is normally only entitled to claim damages or purchase price adjustment, rather than the right to terminate the agreement in case of a breach of the warranty bring-downs clause. In addition, unlike in the United States, antitrust/ competition clearance and other regulatory approvals are the most common closing conditions for European transactions (33 percent in 2013). Although securing of buyer s financing has rarely been used as a closing condition in most European counties (only 9 percent in 2013), there has been a significant increase in the use of such closing condition in Southern Europe 7 in 2012, partly due to the impact of the debt-crisis in Europe and the sellers desire to secure financing. Limitation of liability Sellers of M&A transactions normally seek to limit their liabilities arising under the purchase agreements, particularly from breach of the sellers warranties. Such limitations typically include monetary limitations (e.g., caps, de-minimis or baskets), as well as a limitation period on claims. A de-minimis is the minimum threshold that any individual claim must exceed in order to be considered, while a basket is the threshold that the aggregate of all individual claims of the buyer must exceed in order to be recovered. When a basket threshold is exceeded, the buyer may be entitled to recover all amounts that exceed such threshold (the so-called first dollar recovery) or only the excess over the basket ( excess only recovery). Provisions limiting the aggregate liabilities of the sellers under the purchase agreements (the so-called liability caps ) are standard features in both the 46 ASSOCIATION OF CORPORATE COUNSEL

8 United States (96 percent) and Europe (96 percent). However, the liability caps in US transactions are generally lower than those in Europe. The vast majority of deals in the United States (75 percent) contain liability caps of no more than 25 percent of the purchase price, while the CMS Studies display that only one-third of the deals in Europe have the same level of liability caps. Within Europe, regional divergences are also notable: While the UK and CEE have consistently seen more deals with a liability cap exceeding 50 percent of the purchase price, France has a relatively lower cap, with an average cap of around 30 percent of the purchase price. Further, certain carve-outs to liability caps are common to all European deals so that the sellers have unlimited liability or an (additional) cap equal to the purchase price. The carveout generally applies to the sellers liability for taxes pertaining to pre-effective date periods and in case of specific indemnifications. Again, there are regional differences. Italy, for example, more often sees a limitation of liability for taxes below the purchase price. In 2013, the use of de-minimis markedly increased in Europe (63 percent), whereas less than one-third of US transactions contained de-minimis provisions (30 percent in 2012). Regional differences within Europe are apparent: De-minimis are most prevalent in UK deals (84 percent), whereas Southern European deals are relatively less likely to welcome de-minimis provisions (52 percent). Basket provisions are almost universal in US transactions (96 percent in 2012). In Europe, the use of such provisions has been less pervasive (66 percent in 2013). While first dollar recovery remains the most popular mechanism in Europe (74 percent), excess only applies to the majority of US deals (62 percent). Within Europe, excess only is most commonly seen in France, while first dollar recovery is used in almost all deals in the UK and CEE. Most deals in the United States (95 percent) and Europe (88 percent) have a limitation period of not less than 12 months for warranty claims. A period of between 12 to 24 months seems to be the standard in both the United States (87 percent) and Europe (60 percent). However, regional differences in Europe are evident: A large number of transactions in France contain a period exceeding 24 months, whereas Southern Europe has increasingly used a shorter limitation period of six to 12 months. Within the industry sectors, limitation periods of more than 24 months are more commonly found in European deals involving real estate & construction and consumer products in When the seller breaches a purchase agreement, negotiations often revolve around the types of losses incurred by the buyer that are deemed recoverable. The most common forms of contractually recoverable losses usually include direct or actual damages and consequential damages (or indirect or special damages). In the common law system, direct damages are generally considered to be those that directly, immediately and naturally flow from the breach of contract, while consequential damages are those that could not have been fairly and reasonably foreseen by the parties when signing the contract. 8 In such context, consequential damages typically include loss of business opportunity and loss of profit or revenue. Continental European civil law countries, however, have different perceptions on classification of damages. For example, German contract law basically distinguishes between damages in lieu of performance and damages in addition to performance. These types of damages stand alternatively to each other (i.e., the plaintiff may only claim one or the other). Both types of damages generally cover all damages which are directly and indirectly caused by the relevant breach of contract but require different preconditions: In general, damages in lieu of performance can only be claimed if the claimant set an appropriate grace period during which the obligor had the opportunity to cure the breach of contract. Regardless of the divergent treatments of damages in different jurisdictions, foreseeability of the damages and (close) causal link between the damages and the breach seem to be the key elements in determining whether certain damages should be recoverable in both US and continental European transactions. Other features of European M&A The CMS Studies has revealed other notable features or trends of European M&A transactions. Security for warranty claims less common in Europe In order to secure their claims against the sellers under the purchase agreements, buyers usually request certain security from the sellers, typically in the form of escrow accounts, bank guarantees/letters of credit, partly retentions/holdbacks of the purchase price or earn-out set-offs. Unlike in the United States, where most deals use security for warranty claims (89 percent in 2012), around one-third of European deals have such security (35 percent in 2013). Escrow accounts are used as the most popular form of warranty claims security in Europe. Around half of European deals contain non-compete and non-solicitation Non-compete clauses typically serve to restrict the sellers from entering into or starting similar professions or businesses competing with those of the target company after closing. Such clauses are usually used together with non-solicitation provisions, which aim to prohibit the sellers from employing or otherwise soliciting the employees (or customers) of the target company after closing. The scope of the ACC DOCKET NOVEMBER

9 HAVE A COMMENT ON THIS ARTICLE? VISIT ACC S BLOG AT prohibited businesses, and the duration of such restrictions are normally subject to lengthy discussions among the parties. Over the last two years, the use of non-compete clauses in European M&A deals has been quite stable, with 46 percent in 2012, compared to 53 percent in 2011, which was partly attributable to a greater number of transactions with financial or private equity sellers in 2012, who generally do not accept such clauses, and 49 percent of all reviewed deals in A noncompete period of between 18 to 24 months is most common in European deals. The use of non-solicitation clauses in European deals has continued to increase in 2012 (40 percent) and 2013 (45 percent). It is notable that European non-compete clauses either have no or less strict penalty/damages clauses. Use of warranty and indemnity insurance significantly increased in Europe Warranty and indemnity insurance (W&I insurance) is a product that helps protect a seller or buyer from financial loss resulting from inaccuracies in the representations and warranties in purchase agreements. They are particularly popular among financial sellers, who usually are reluctant to provide warranties and indemnities to ACC EXTRAS ON Mergers and acquisitions QuickCounsel Action Items to Avoid FCPA Liability in Mergers, Acquisitions and Joint Ventures (Oct. 2013). Top Ten Top Ten Rules for Mergers and Acquisitions Success (Jan. 2012). m&a_jan12 Program Materials Merger Market M&A Insights: Spotlight On IP Rights (June 2013). jun13 Avoiding Boilerplate Blunders in Mergers and Acquisitions (Sept. 2012). boilerplate-m&a_sep12 the buyers. The use of W&I insurance in Europe has been significantly increased in 2012 (8 percent) and slightly increased in 2013 (9 percent), which could be partly driven by certain bidders who strategically used such insurance in auction processes to make their bids more attractive. Although W&I insurance can be taken out by either the buyer or the seller, it has been more commonly taken out by the buyer in European deals (76 percent in 2013). Conclusion For many different reasons, it is especially important to understand what deal terms are market (i.e., what terms are ordinarily negotiated between the parties). First, it enables you to better understand and counsel your business team on the likely risks of potential transactions, so the impact on the deal s valuation can be better assessed. Second, it enables you to better calibrate negotiation strategies to maximize negotiation success. Third, an understanding of what is market will accelerate the deal timetable and increase the likelihood a deal will close, because opposing parties (especially attorneys) will be less likely to engage in gamesmanship to take advantage of an opponent they perceive as inexperienced. As general counsel, you may Article EU Adopts Three New Procurement Directives (Feb. 2014). feb14 Practice Resource For more information on M&A, read ACC Alliance Partner Thomson Reuters article regarding antitrust issues in mergers and acquisitions. bit.ly/antitrustissues ACC HAS MORE MATERIAL ON THIS SUBJECT ON OUR WEBSITE. VISIT WHERE YOU CAN BROWSE OUR RESOURCES BY PRACTICE AREA OR SEARCH BY KEYWORD. also find that you can better articulate your positions and solutions to contentious matters. For cross-border M&A transactions between US and European countries, it is important for attorneys on both sides to understand and respect each other s market practices and legal concepts in order to better protect the interest of their client and to facilitate the transaction. Most important, due to the large discrepancies in legal systems, cultures, languages and market practices between the United States and Europe (or those within European countries), close cooperation with local counsel is indispensable for M&A transactions in Europe. ACC NOTES 1 The 2013 CMS Study has derived its data from the following European countries: (a) Benelux: the Netherlands and Belgium; (b) Central and Eastern Europe: Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, Russia, Slovakia and Ukraine; (c) Austria, Germany and Switzerland; and (d) Southern Europe: Italy, Spain and Portugal. 2 The 2014 CMS Study has derived its data from the following European countries: (a) Benelux: the Netherlands and Luxembourg; (b) Central and Eastern Europe: Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, Russia and Ukraine; (c) Austria, Germany and Switzerland; and (d) Southern Europe: Italy, Spain and Portugal. 3 See 965 A.2d 715, 738 (Del. Ch. 2008). 4 See 789 A.2d 14, 68 (Del. Ch. 2001) Private Target Mergers & Acquistions Deal Points Study by the ABA, Business Law Section. 6 Includes Bulgaria, Croatia, Czech Republic, Hungry, Poland, Romania, Russia, Slovakia and Ukraine. 7 Includes Italy, Spain and Portugal. 8 See the landmark English contract law case Hadley v. Baxendale (1854) 9 Exch ASSOCIATION OF CORPORATE COUNSEL

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