Disclosure Schedules in M&A: Seller and Buyer Perspectives on Preparing and Updating Disclosures

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Disclosure Schedules in M&A: Seller and Buyer Perspectives on Preparing and Updating Disclosures THURSDAY, JANUARY 14, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Carol Osborne, Managing Partner, Bryan Cave, London Peter D. Feinberg, Attorney, Hoge Fenton Jones & Appel, San Jose, Calif. Alexander J. Davie, Co-Founder & Member, Riggs Davie, Nashville, Tenn. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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5 Disclosure Schedules in M&A Transactions: Seller and Buyer Perspectives in Preparing and Updating Disclosures One firm, one solution. Stronger. Together. Peter D. Feinberg January 14, 2016

6 Purpose of Disclosure Schedules Disclosure schedules are one of two parts of the overall due diligence process in M&A transactions: The other part of the process is production of seller s documents and usually occurs in steps beginning before preparation of the disclosure schedules. Due diligence helps parties determine the appropriate purchase price, identify assets and liabilities and allocate risks. Disclosure schedules have two different but important purposes: disclosure of key aspects of seller s operations, and allocation of risk between the parties Hoge Fenton Jones & Appel

7 Preliminary Steps Initial Diligence Document production begins before preparation of the letter of intent (LoI) with buyer entering into a non-disclosure agreement (NDA) or Confidentiality Agreement with seller. Seller should never disclose anything without this agreement being in place! Buyer will want basic financial information before preparation of the LoI (note that some or all of this may already be publicly available if seller is a public company) Hoge Fenton Jones & Appel

8 Preliminary Steps Initial Diligence After the LoI is signed, Buyer will give Seller a document request covering most aspects of Seller s operations including employees, intellectual property, financials, assets and liabilities, litigation, etc. Timing and extent of disclosures is always a subject of discussion between the parties. Notwithstanding the NDA, Seller may choose to withhold certain documents until just before or even after closing, particularly those relating to specific customers or trade secrets Hoge Fenton Jones & Appel

9 Buyer Goals in Disclosure Process The disclosure process helps the buyer understand the seller s business (i.e., key customers, suppliers, employees, owned assets, liabilities, etc.) This is of critical importance to the parties in determining what is the appropriate purchase price. The Buyer also wants to know 2 opposite things on a postclosing basis: Can it continue running the business as the Seller has done on a pre-closing basis, and if not, what needs to be done for this to be the case? (Pre-closing consents, regulatory approvals, etc.) Alternatively, the buyer wants to know that it can cancel any commitments that it doesn t want after the closing without penalty or other financial consequence Hoge Fenton Jones & Appel

10 Impact of Buyer s Knowledge The intersection of knowledge obtained in the document production process and from the disclosure schedules is somewhat hazy: If Buyer learns about a risk in a document provided by Seller but it isn t specifically disclosed, would Buyer be deemed to have constructive notice of the risk, and thus, absent a provision to the contrary, to be responsible for it? Hoge Fenton Jones & Appel

11 Allocation of Risk - Generally Seller representations and warranties (and related disclosure schedules), gain their importance primarily through the indemnification provisions which allocate risk. A breach of a representation and warranty by seller which creates liability for buyer after the closing will lead, subject to some combination of limitations and conditions discussed below, to an obligation for the seller to indemnify the buyer. Customary to have a closing condition in favor of buyer that seller s representations and warranties are true and correct in all material respects. If the representations and warranties are not true and correct in all material respects, buyer will not be required to complete the transaction Hoge Fenton Jones & Appel

12 What Constitutes a Breach by Seller? General answer: a statement which is untrue and not modified by any conditions or disclosures. The main conditions on representations and warranties are: materiality (that the breach has a certain level of consequence on the business; dependent on both the breach and the size of the business), and knowledge (that the statement was absolutely true vs. it was true as far as the giver of the representation knew) Hoge Fenton Jones & Appel

13 Role of Knowledge of Seller and Disclosures 13 Several key negotiation points on Seller s knowledge : Whose knowledge is relevant? What kind of special inquiry, if any needed, should be made? Which representations and warranties can be modified by knowledge? The role of disclosure schedules in modifying seller s potential liabilities for breaches will depend on: The nature and specificity of the disclosure and whether there is anything in the agreement providing that disclosure will not negate liability or actions which the buyer may take which would lead to seller retaining the liability or buyer s liability being limited 2015 Hoge Fenton Jones & Appel

14 Indemnification Key Features Indemnification provisions ordinarily contain: a minimum loss a buyer must incur (a basket ) before the buyer may receive indemnification a maximum amount of loss after which the seller is no longer liable for any of buyer s losses (a cap ) offsets for insurance or tax benefits which the buyer may receive a maximum duration for such indemnification rights indemnification procedure under which the seller may choose to either directly defend the claim, and assume any liability relating thereto, or tender the claim to the buyer, in which case the seller will likely waive its right to contest liability as against buyer. Note potential common law indemnification rights may exist in favor of buyer Hoge Fenton Jones & Appel

15 Case Study - Facts Seller is an individual and the 100% owner of a business selling canned foods to markets and restaurants. In the course of a transaction to sell 100% of the stock to buyer, seller gives the following representation and warranty: Inventory. To Seller s knowledge, all inventory, including raw materials, work in process, finished goods, service parts and supplies ( Inventory ) consists of items of a quantity and quality historically useable and/or saleable in the normal course of business, except for items of obsolete and slowmoving material and materials that are below standard quality, all of which have been taken into account for purposes of valuation in accordance with GAAP Hoge Fenton Jones & Appel

16 Case Study The Problem A small but material part of Seller s inventory had passed its expiration date. Inventory management was normally done by the company s chief of operations and not a part of seller s own job responsibility so seller was not aware that these items had passed their expiration dates. After the closing, buyer was sued for selling these expired goods. Buyer sought indemnification from seller, who defended himself based on the fact that he did not know that goods had passed their expiration dates. Subject to the applicable cap, basket and duration of the representations and warranties, would the seller have a duty to indemnify buyer for its loss? Hoge Fenton Jones & Appel

17 Case Study The Outcome Maybe. The questions will be: Was knowledge defined in the agreement? Is the knowledge standard, seller s actual knowledge, and if so, did he have a duty of due inquiry, which would have pointed him to the appropriate manager? Is the knowledge standard knew or should have known, which would look less at what this seller should have done and more what an objective seller would have done? If knowledge wasn t defined, how would this be determined by the law of the state in which disputes were to be decided? Important note: there is relatively little law on many issues about which disputes arise relating to disclosure schedules (or even merger & acquisition agreements generally) Hoge Fenton Jones & Appel

18 Best Practices in Drafting Disclosure Schedules As counsel to Seller, try to limit the scope of the representations and warranties: limits Seller s potential liabilities minimizes the amount of time spent preparing schedules Example: rather than having to disclose all contracts which have been in place in the past 5 years, limit disclosure to material contracts currently in place or terminated within the past year. Once the scope is agreed, schedule a review meeting with the client before drafting Hoge Fenton Jones & Appel

19 The Review Meeting Attendees: A mid-level to senior attorney and a junior attorney should meet with the seller and any key employees who might have knowledge of Seller s operations (CFO, General Counsel, Chief of Operations, VP of HR, etc.). Note: Junior attorneys may not pick up on the intricacies of some of the representations. Explain what the representations mean to your client. Example: the representation that the seller is qualified to do business as a foreign corporation in any state or country so required is difficult for all but the most knowledgeable client to grasp, as it may entail a mix of volume of business, persons engaged, real property used, etc Hoge Fenton Jones & Appel

20 Drafting the Disclosure Schedules - Generally The process of preparing disclosure schedules really begins with the circulation of the definitive transaction documents. Initial draft of definitive agreements usually prepared by the buyer. Separate from the document disclosure, the disclosure schedules correlate with the representations and warranties given by the seller. Negotiations around the representations and warranties can reduce (or change) the extent of required disclosure. Disclosure schedule preparation can be one of the most time and labor-intensive parts of a merger & acquisition transaction Hoge Fenton Jones & Appel

21 Drafting Disclosure Schedules - Mechanics Establish a game plan on how to assemble information, both narrative and documentary, which pertains to each representation. Until 10 years or so ago, this information was usually compiled in a physical data room, but as most lawyers who have done a merger & acquisition in the 21 st century are aware, virtually all information is now stored online in virtual depository sites such as box.com, dropbox, etc. The information you receive from clients relating to the disclosure schedules should be the first word, but not necessarily the last one. Sellers should reserve the right to update schedules before closing: particularly in sign and subsequent close transactions the buyer may want a closing out for a new post-signing disclosure, or at least a right to indemnification, regardless of the potential liability being disclosed Hoge Fenton Jones & Appel

22 Drafting Disclosure Schedules Roles and Resources The Law Firm: Junior attorney takes the lead in reviewing documents, issue spotting and preparing schedules. Senior attorney is the gatekeeper only. The Deal Advisors Investment bankers or business brokers often tell clients that they can take a major role in preparing disclosure schedules. Be careful! Their knowledge varies greatly, and their conversations with clients, unlike yours, will not be privileged. Other Advisors CPA, insurance agent, benefits consultant and any other outside professionals, and you should send them the representations which apply to the work which they have done for the company Hoge Fenton Jones & Appel

23 Drafting Disclosure Schedules Roles and Resources Utilize outside sources to confirm client information when available: Order a certificate of good standing, ideally at the start of preparation of the disclosures then shortly before closing; Order certified copies of the client s articles/certificate of incorporation and a lien search. Consider performing a litigation docket search as well. The disclosure schedule process is interactive; often, the more information the attorney receives, the more questions he or she will have for the client. Although the attorneys will be the primary drafters and much of the consideration of what is included, as discussed below, will be legal in nature, it is critical that the client understands and signs off on the schedules Hoge Fenton Jones & Appel

24 How Much Should Seller Disclose? Questions inevitably arise over the scope of disclosures: Clients may believe that documents disclosed to buyer may be sufficient disclosure of an item without putting it in a schedule to notify the buyer, or that extensive disclosures may jeopardize a buyer s willingness to go through with a transaction. Inviolate rule of the schedule preparation process: The client should disclose any possibly relevant information to its lawyer; and The lawyer makes the determination of the necessity for disclosure Hoge Fenton Jones & Appel

25 How Much Should Seller Disclose? Unless the disclosure in question is extremely remote or speculative, more disclosure is generally better than less: More disclosure may negate potential liability, and Takes the possibility of fraud for non-disclosure off the table Language has to be carefully crafted so that the buyer is notified without being unduly alarmed. It is important for seller to get out in front of key disclosures, so that the first time the buyer hears of them will not be in the schedules, but: Sellers may need to consider the timing of sensitive disclosures. Some information, often relating to customers or trade secrets, should not be disclosed until shortly before closing (or even at the closing), even with a NDA in place Hoge Fenton Jones & Appel

26 Should the Buyer Ever Make Disclosures to Seller? Shouldn t a seller consider receiving something similar from buyer when seller is receiving a significant amount of buyer s stock (or even a note or contingent cash after the closing) and it needs to understand the buyer s operations and ability to perform? Yes, but this is invariably a difficult and contentious negotiation between the parties Hoge Fenton Jones & Appel

27 When Are There no Disclosures? Rarely, but: Bankruptcy when a buyer may be buying as is, subject to the fact that the buyer will likely be receiving a significant discount for doing so. The trustee or receiver may need to amass all of the assets of the seller s estate then distribute them to creditors, so having contingent liabilities, such as indemnifications for representations and warranties, may not be feasible. Public company sales where seller will still give representations and warranties and make disclosures but the representations and warranties will not survive the closing of the transaction. Instead, the representations and warranties act more as covenants, which, if breached, will give the buyer the opportunity to avoid closing the transaction Hoge Fenton Jones & Appel

28 Thank You! If you have any questions... Peter D. Feinberg (408) Silicon Valley Office 60 S. Market Street, Suite 1400 San Jose CA Tri-Valley Office 4309 Hacienda Drive, Suite 350 Pleasanton CA hogefenton.com This presentation was provided as an educational service. It is an overview only, and should not be construed as legal advice or advice to take any specific action. If you have questions regarding any of the content contained in this presentation, we recommend you seek the assistance of a knowledgeable legal professional Hoge Fenton Jones & Appel

29 U.K. and U.S. Disclosure Conventions Compared Carol Osborne Bryan Cave - London 29

30 Why relevant to a U.S. practitioner? U.S.-U.K. acquisitions remain an important element of middle market deal flow: Since 2000, it is estimated that $572.4bn has been invested by U.S. corporations in mergers and acquisitions into the United Kingdom and approximately $535.1bn by U.K. Companies in mergers and acquisitions into the U.S. Since 2000, 1,386 U.S. companies, subsidiaries, divisions or assets have been acquired by British firms and 1,986 U.K. companies, subsidiaries, divisions or assets have been acquired by U.S. firms. [Winchester Capital M&A Advisor Symposium 2015] U.K. remains a desirable first entry point into the EU for U.S. companies. 30

31 Purposes of Disclosure Practice Same as in the U.S. Post-closing price adjustment mechanism if facts are not as represented. Pre-closing diligence opportunity for the buyer which allows a preclosing price adjustment, an opportunity to seek a specific indemnity (with or without liability caps) or the right to walk away. Special situations (auction or bankruptcy/administration) limit opportunities for full diligence. 31

32 Overview of the U.K. Disclosure Process Warranties given on either a contract or indemnity basis Key Wording in the Acquisition Agreement The Disclosure Letter and Disclosure Bundle General Disclosures Specific Disclosures Choosing not to disclose 32

33 Contract vs. Indemnity Basis Make sure the letter of intent (LoI) is clear on this point! COMPARE: In the U.S., warranties are always given on an indemnity basis but the opposite is true in the U.K. Damages on a contract basis. Damages on an indemnity basis. 33

34 Definition of Disclosed and Legal Consequences Definition of Disclosed in acquisition agreement: Disclosed: fairly[, fully, clearly and accurately] disclosed (with sufficient details to identify the nature and scope of the matter disclosed) in or under the [Disclosure Letter] [Disclosure Schedule]. English law rule: protection by disclosure will not exist merely by making known the means of knowledge that will allow a party to work out certain facts and conclusions. Effect of Buyer s Knowledge or Investigation Sandbagging and Anti-Sandbagging discussed below. 34

35 The Disclosure Bundle Why have a bundle of documents at all? The contents of the documents referred to in this letter are deemed to be Disclosed [and copies of all these documents are annexed to this letter and have been initialed by the parties for the purpose of identification]. Can you just disclose the entire data room? Different desired outcomes. Mechanics: Two identical bundles initialed by the parties are delivered. Timing is important especially for the buyer. 35

36 The Disclosure Letter Preamble Like a legal opinion letter, the preamble sets the context for the disclosure letter and what is (and isn t included). General Disclosures Information available through public sources or which the seller can obtain independently. COMPARE: This is generally not considered disclosure in the U.S. Specific Disclosures Facts, matters or circumstances which, if not disclosed, would result in a breach of one or more warranties. COMPARE: This is the U.S. style disclosure schedule. When delivered? If sign and subsequent close, then usually delivered just prior to signing and again just prior to closing. 36

37 General Disclosures Contents of Acquisition Agreement Companies House searches Company books and records Property Searches Other public record searches (e.g. UK Intellectual Property Office) Physical inspections of properties or assets Audited accounts Documents in the disclosure bundle Matters in the public domain 37

38 Specific Disclosures Include details of any specific matters that are known to the seller or persons with knowledge. The specific disclosures are produced by reference to the warranties themselves. Disclosure against one warranty would normally count as disclosure against all warranties unless the disclosure is not precise enough to qualify as fair disclosure. COMPARE: In the U.S., disclosures are usually tied to specific warranties. Disclosure must be sufficiently precise or it may not serve as a defense to a breach of warranty claim. Seller s best defense? Add the following clause: Where brief particulars only of a matter are set out or referred to in this letter, or a document is referred to but not attached, or a reference is made to a particular part only of such a document, full particulars of the matter and the full contents of the document are deemed to be Disclosed and it is assumed that the Buyer does not require any further particulars." COMPARE: In the U.S., brief particulars might be enough. The buyer should not hesitate to mark up the specific disclosures if necessary. 38

39 Sandbagging and Anti-Sandbagging Yes, we have it in the U.K. too (we just don t call it that). The definition of Disclosed sometimes excludes matters known to the buyer merely as a result of due diligence or data room access. If the matter is not discussed in the disclosure letter or the document is not in the bundle, it is not considered fairly disclosed. Case law suggests the buyer may not be able to rely on such a savings clause if it (directly or through its advisors) had actual knowledge of a matter. 39

40 Deciding not to disclose Full or partial disclosure might be undesirable for commercial reasons: Risk of losing attorney-client privilege in a sensitive litigation matter Concern over unduly aggressive pre-closing purchase price adjustments Seller runs the risk of having no defense to a breach of warranty claim. Seller also runs the risk of criminal securities law violation in a share purchase or civil action for misrepresentation. No general obligation to disclose But, if the seller speaks at all, the seller must speak completely. 40

41 Thank you! If you have any questions: Carol Osborne Bryan Cave 88 Wood Street, London EC2V 7AJ This presentation was provided as an educational service. It is an overview only, and should not be construed as legal advice or advice to take any specific action. If you have questions regarding any of the content contained in this presentation, we recommend you seek the assistance of a knowledgeable legal professional. 41

42 Disclosure Schedules in M&A Hot Topics: US and EU Data Privacy Alexander Davie

43 Overview of US Data Privacy Law California Online Privacy Protection Act Requires Privacy Policy Federal Trade Commission Act Requires you to follow privacy policy General Principal: privacy is an issue of contract between the parties and only truthful disclosure is mandated. Special Categories: HIPAA, Gramm Leach Biley 43

44 EU Data Protection Directive In general, data collection, use, and sharing is much more strictly regulated Must register with member state authorities Must process data fairly, lawfully, and only for the purposes it is collected Cannot transfer data on EU citizens out of EU unless there is an adequate level of protection. Has broad territorial scope 44

45 Applications: What is personal data in the EU? The Data Protection Directive defines personal data as "any information relating to an identified or identifiable natural person" (Article 2(a)). As a rule, personal data includes: Personal details. Family and lifestyle details. Education and training. Medical details. Employment details. Financial details. Contractual details (for example, goods and services provided to or by a data subject). 45

46 Cross Border Transfers from EU to US US does not provide adequate level of protection, therefore you can t do it, unless there is an exemption: US Safe Harbor Filing No longer available Model Contract Clauses Binding Corporate Rules Unambiguous Consent 46

47 Application to Preparation of Disclosure Schedules 47

48 Applications: Employees Schedule X lists, with respect to each Employee, such Employee s name, position, current rate of compensation, and any entitlement to bonus, commission, severance or other additional compensation, and indicates whether any such Employee is on leave of absence, short-term disability or other similar status. 48

49 Applications: Suppliers and Customers Schedule X contains an accurate and complete list, and Seller has delivered to Buyer accurate and complete copies, of (i) each Seller Contract that involves performance of services or delivery of goods or materials by Seller of an amount or value in excess of dollars ($ ); and (ii) each Seller Contract that involves performance of services or delivery of goods or materials to Seller of an amount or value in excess of dollars ($ ). 49

50 Options? Anonymous Format Redacting Names is NOT enough Obtain consent 50

51 Dealing With Substantive Data Privacy Law in Disclosure Schedules 51

52 Substantive Data Protection Law: Privacy Policies Schedule X identifies each Company Privacy Policy and with respect to such Company Privacy Policy: (A) the period of time during which such privacy policy was or has been in effect, (B) whether the terms of a later Company Privacy Policy apply to the data or information collected under such privacy policy, and (C) if applicable, the mechanism (such as opt-in, optout, or notice only) used to apply a later Company Privacy Policy to data or information previously collected under such privacy policy. A copy of each Company Privacy Policy has been provided to Buyer. 52

53 Substantive Data Protection Law: Types of Data Collected Schedule X describes the types of all User Data collected by or on behalf of the Company. 53

54 Substantive Data Protection Law: Technologies Used Schedule X sets forth a list of technologies the Company uses to collect User Data. 54

55 Substantive Data Protection Law: Identify Databases & Security Schedule X contains a list of the names of each distinct electronic or other database which contains (in whole or in part) User Data maintained by or for the Company, the types of User Data contained in each such database, and the security policies that have been adopted and maintained with respect to each such database. 55

56 Substantive Data Protection Law: Contracts with Third Parties Except as set forth Schedule X, in connection with each third party vendor, outsourcing entity or similar third party that has access to the User Data, Company has entered into a written agreement that requires the third party to comply with all applicable Laws with respect to the User Data including implementing and maintaining appropriate physical, administrative and technical safeguards to protect the User Data; restrict use of the User Data to only those with a need to know; and afford Company the right to audit the places of business and systems to test such third party's compliance with the foregoing. 56

57 If you have any questions: Alexander Davie Riggs Davie PLC (615)