Critical (But Often Overlooked) Issues in Private M&A Transactions By: Jim Junewicz and Greg Hawver
Speakers Jim Junewicz Partner, Securities, M&A & Capital Markets Chicago: +1 (312) 558-5257 New York: +1 (212) 294-6700 jjunewicz@winston.com Jim focuses his practice on securities offerings, mergers and acquisitions, and corporate governance. He represents companies, underwriters, and placement agents in debt and equity offerings. His experience includes IPOs, offerings of high-yield securities (HY) and U.S. offerings by foreign issuers. Jim regularly handles major cross-border merger and acquisition transactions and corporate restructurings, and advises boards of directors and executive management teams on Delaware law, federal securities laws, and Sarbanes- Oxley. He has represented every major investment bank. Before entering private practice, Jim served as Assistant General Counsel of the U.S. Securities and Exchange Commission. Jim is an Adjunct Professor of Law at Cornell University. Greg Hawver Associate, Mergers & Acquisitions Chicago: +1 (312) 558-3194 ghawver@winston.com Greg represents public and private clients in a wide variety of complex business transactions, with a particular emphasis on mergers and acquisitions. His experience includes domestic and cross-border mergers & acquisitions, minority equity investments, recapitalizations, joint ventures, corporate reorganizations and related general corporate counseling. Greg also advises clients on day-to-day matters such as corporate governance, business entity formation and commercial contracts. 2
Presented by J. Junewicz M&A Market Update
Overview of Global M&A Market* Global M&A market has been losing momentum since beginning of year Monthly averages over first five months of 2017 are down 30% from first five months of 2016 But note that in prior two years, May was the beginning of a surge in M&A that lasted through end-of-year *Source: Citi Executive M&A Summary May 2017 edition (unless otherwise noted) 4
Middle-Market M&A While the number of announced $5B+ deals is up 3% YTD... Number of mid-market deals ($200M $1B) is down 3% YTD Number of deals from $1B $5B is flat YTD Some analysts believe 2017 is on track to finish approx. 16% lower than 2016 and 30% lower than 2015 (one of the biggest years ever for M&A) 5
Cross-Border M&A Flows Cross-border M&A volume is on pace to be down 17% from 2016 M&A volume between North America and Western Europe remains near highest levels ever as a share of total cross-border volume 6
Financial Sponsor M&A Activity Private-equity M&A represents over 20% of global M&A market On pace to be down slightly from 2016 PE firms are monetizing assets 60% of deals are sales to corporates and other financial sponsors (largest share since 2007) 7
Efforts Requirements in M&A Presented by Jim Junewicz
Efforts Provisions Purchase agreements often require Buyers and Sellers to do various things after the signing and before the closing to facilitate the transaction... run the business in the ordinary course obtain customer or government consents maintain customer relationships seek shareholder approval seek anti-trust clearance and obtain HSR approval Rarely will the parties want to agree to an ironclad obligation usually just agree to use certain efforts to do so Formulations include: best efforts reasonable best efforts commercially reasonable efforts reasonable efforts 9
Hierarchy Among the Variations Exactly what does each one entail? Buyers and Sellers often worry about what each one requires (and with good reason) and what the differences are among them Basic question: how hard do you have to try? Pay additional consent fees? Commence litigation? Call once, twice or every day? A lot can ride on it... For example, if a party agrees to use its best efforts to get HSR clearance, does it have to sell one of its businesses to get HSR approval? For example, if a Seller agrees to use best efforts to get the consent of a customer to the sale of control, what does it have to do if the customer resists (e.g., make payments?) Would result be different with a different standard? Lawyers sometimes quibble endlessly over which formulation is appropriate 10
Hierarchy Among the Variations What do the courts say? As practical matter, best efforts seems to impose a higher obligation than the other three variants (in Delaware and New York) But court decisions reflect little uniformity about what best efforts means acting in good faith and based on sound business judgment work toward the object of a contract to the extent of its total capabilities pursue all reasonable methods Each of these definitions came from a case, each is different, and none provides much specificity Most practitioners regard best efforts as fundamentally more rigorous than any formulation that includes the word reasonable Use of reasonable implies there is some limit to what must be done But the word reasonable itself can be ambiguous In a recent case the Delaware Supreme Court defined commercially reasonable efforts as actively taking all reasonable steps to solve problems and consummate the transaction (The Williams Companies, Inc. v. Energy Transfer Equity, L.P.) Not merely refraining from exacerbating a problem Had to proactively try to facilitate delivery of a legal opinion by its counsel 11
Specificity in Contract Is Best Practice Best answer is not to rely blithely on any verbal formulations Clear that no matter what formulation is used, parties can contractually limit what is required for example: Will not include the commencement of litigation Or the divestiture of businesses in the case of an obligation to seek and try to obtain the approval of anti-trust regulators After some dollar cap on size of business to be divested Parties should think about what specific steps they want the other party to take and then set them forth in the agreement No payment of fees for consents, etc. Overall, any formulation with the term reasonable is probably less rigorous than best efforts and worth trying for if you are the party on whom the obligation would rest 12
Fraud, Reliance, and Representations Outside of the Purchase Agreement Presented by Greg Hawver
Actions for Representations Not Made in Stock or Asset Purchase Agreements Without language to the contrary in agreement, Buyers can sue for: breaches of reps in the agreement and, potentially... statements made during due diligence or negotiations that are not set forth in the agreement Typically addressed in three ways in purchase agreements 1. Integration or entire agreement provision 2. No other representations provision But #1 and #2 are not enough in Delaware... 3. Non-reliance provision (states that Buyers have relied only on representations set forth in the agreement) Express non-reliance provisions were found in only 40% of agreements in most recent ABA Deal Points Study of private targets So in 60% of cases, Sellers are open to arguments that reps in purchase agreements are perfectly truthful, but that liability may exist on basis of what was said over coffee, etc. 14
Fraud Carve-out From Indemnification Limits Purchase agreements typically limit recovery for indemnity claims to caps and baskets Buyers and Sellers negotiate extensively over caps, baskets, etc. Indemnity caps often limited to about 10-20% of claims 15
Fraud Definitions When can Buyers argue that agreed caps don t apply? Buyers can use fraud claims to rewrite indemnity caps But what exactly is fraud? Definitions of fraud can vary from state-to-state Includes black hearted lying / actual wickedness But in some states, can also include statements where the Seller did not have confidence in the accuracy of the statement being made or knew he or she did not have the informational basis for making the statement so-called negligent misrepresentation To avoid negligent misrepresentation claims, limit any fraud carve-out to deliberate lying with respect to the reps and warranties in the agreement Going further could violate state law... 16
ABRY Partners v. F&W Acquisition For example, in ABRY Partners V., L.P. v. F&W Acquisition LLC (Del. Ch. 2006), the Court held that only a fraud involving the conscious participation in the communication of lies by the Seller itself and with respect to the representations and warranties specifically set forth in the stock purchase agreement rises to the type of fraud that cannot be excluded as a matter of public policy To sum up, the best position for Sellers is to: restrict reliance on anything outside of the agreement, and provide that fraud carve-outs will not include negligent misrepresentations 17
Letters of Intent Presented by Jim Junewicz
Introduction Letters of Intent Often dismissed as perfunctory, pro forma, preliminary document Sometimes signed in a hurry before counsel involved Nevertheless, can have dramatic effect on future discussions and outcome of negotiations Helpful to set forth preliminary agreement on: price terms who does the drafting? schedule for due diligence scope of due diligence 19
Mechanics; Observations LOIs can set expectations that haunt future negotiations Generally not binding Except for expenses and, more importantly, non-solicitation of Seller s employees and exclusivity Non-solicitation restrict Buyer from hiring all employees of Seller or just those that Buyer meets in due diligence? Exclusivity can have pivotal effect on negotiations, especially during auctions, because provision terminates other discussions with prospective Buyers that could lead to a promising bid Buyer says it is not willing to be a stalking horse or supply back-up bid in case simultaneous discussions with bidder in first place don t go anywhere Wants to know that it has exclusivity before incurring legal and due diligence expenses Seller should be concerned that other Buyers will realize when their calls aren t returned that another bidder is preferred and that Seller could be left at the altar after the other bidders have lost interest in the deal 20
Mechanics; Observations (cont d) Exclusivity (cont d) A very important point: Sellers may want to resist exclusivity as long as possible Buyers may not want to start due diligence, etc. without exclusivity Possible solutions for Seller: Limit period to a few days or week Can be extended if negotiations are moving Part way through exclusivity period, require Buyer to re-affirm terms in LOI in a letter and if they don t, exclusivity terminates Offer limited expense reimbursement if no exclusivity and if Seller signs deal with another party Possible solutions for Buyer: Make exclusivity period as long as possible But even a short period can be competitively helpful Provide that period shall be automatically extended if negotiations are moving forward May start without exclusivity but ask for it after a week or two 21
Navigating Litigation Privilege Issues in M&A Context Presented by Greg Hawver
Attorney-Client Privilege in M&A Deals What happens if the Buyer believes it needs to see privileged information about litigation in order to decide if it wants to proceed with the deal? Buyer understandably wants access to any information that may have an impact on valuation Example: Infringement case with respect to a tech company s key patent Problem is that disclosure to Buyer could destroy the privilege between Seller and its counsel General Rule: Disclosure of privileged communications to a third party (i.e., the Buyer) results in waiver of the attorneyclient privilege, unless an exception applies 23
Common Interest Exception State law allows the privilege to continue if the Buyer and the Seller have a common interest But common interest varies from state-to-state Key Question in M&A Context: Do negotiations and/or a signed purchase agreement give rise to a common legal interest? In Delaware, negotiations or a signed purchase agreement may constitute a common interest that allows the privilege to continue In New York, it doesn t work litigation is required Common interest exception extends only to those communications relating to pending or anticipated litigation, and not those relating to transaction matters (Ambac Assurance Corp. v. Countrywide (N.Y. June 9, 2016)) 24
Takeaways Check state law Take stock of all potentially privileged materials before populating data room (not just those materials relating to litigation) To the extent possible, limit disclosure to non-privileged information Ex: Documents that have already been produced to the government or civil plaintiffs Limit discussions of sensitive matters to later in the process limit such discussions to select individual representatives of the Buyer keep all discussions oral prohibit the memorialization of such discussion in written form Finally, parties can enter into a common interest agreement that specifies the common interest involved but applicable state law is ultimately dispositive 25
Conflicts / Waivers Presented by Jim Junewicz
Conflicts Issues in Stock Deals In asset deals, after the closing, counsel to Seller obviously can continue to represent Seller in the case of indemnity proceedings In stock deals, situation is far less clear: If Seller s counsel is also counsel to the company being sold, Buyer may argue that counsel may not represent Seller in indemnity claims on the grounds that the counsel continues as counsel to the company, which is now owned by Buyer Sellers may be able to avoid issue by specifying in the purchase agreement that Buyer may not assert that Seller s counsel is conflicted and unable to represent Sellers in indemnity claims because it also represents the company 27
Sample Provision to Address Issue Each of the parties hereto acknowledges and agrees, on its own behalf and on behalf of its directors, members, shareholders, partners, officers, employees and Affiliates, that: (i) Winston & Strawn LLP has acted as counsel to Stockholders and their Affiliates (individually and collectively, the "Seller Group"), and the Company in connection with the negotiation, preparation, execution and delivery of this Agreement and the consummation of the transactions contemplated hereby. Buyer agrees, and shall cause the Company to agree, that, following consummation of the transactions contemplated hereby, such representation and any prior representation of the Company by Winston & Strawn LLP (or any successor) (the "Seller Group Law Firm") shall not preclude Seller Group Law Firm from serving as counsel to the Seller Group or any director, member, shareholder, partner, officer or employee of the Seller Group, in connection with any litigation, claim or obligation arising out of or relating to this Agreement or the transactions contemplated hereby. (ii) Buyer shall not, and shall cause the Company not to, seek or have Seller Group Law Firm disqualified from any such representation based upon the prior representation of the Company by Seller Group Law Firm. Each of the parties hereto hereby consents thereto and waives any conflict of interest arising from such prior representation, and each of such parties shall cause any of its Affiliates to consent to waive any conflict of interest arising from such representation. Each of the parties acknowledges that such consent and waiver is voluntary, that it has been carefully considered, and that the parties have consulted with counsel or have been advised they should do so in connection herewith. The covenants, consent and waiver contained in this Section shall not be deemed exclusive of any other rights to which the Seller Group Law Firm is entitled whether pursuant to law, contract or otherwise. This Section is intended for the benefit of, and shall be enforceable by, the Seller Group Law Firm. This Section shall be irrevocable, and no term of this Section may be amended, waived or modified, without the prior written consent of the Seller Group Law Firm. 28
Successor Liability in Asset Deals Presented by Greg Hawver
Assumption of Liabilities in Asset Deals Generally: In stock deals, all liabilities transfer In asset deals, no liabilities transfer Exceptions where successor liability may attach in asset deals: Environmental (CERCLA) Certain state taxes (various state laws) Ex: Sales/use taxes, employment taxes and property taxes (run with the land) But income taxes generally will not transfer in an asset deal Collective Bargaining Agreements Other Employee Liabilities (ERISA, etc.) 30
Approach to Exceptions Do rigorous due diligence on environmental, taxes and employees because they may transfer as a matter of law Explore special indemnities with Seller in case liabilities are asserted against Buyer Consider insurance policies to bridge negotiating differences 31
Approaches to Exceptions Taxes Prior to closing, Buyers can obtain tax clearance certificates from the various states in which the target may owe taxes However, not typically done as it can slow down the closing process substantially Consult a tax attorney Environmental Even if there are existing environmental issues at a target company, Buyer may be able to establish a bona fide prospective purchaser defense Consult an environmental attorney 32
Post-Signing, Pre-Closing Developments Presented by Jim Junewicz
Developments Between Signing and Closing: Who Bears the Risk? A common negotiation point is what happens if an event occurs (e.g., the commencement of litigation; loss of a customer or supplier) after the purchase agreement is signed but before it closes In some jurisdictions (e.g., the UK), a Seller (particularly in an auction) will often successfully argue that risk should pass to the Buyer at signing As a result, Buyer must close over the new problem and has no indemnity protection for it 34
Seller s Response MAE Standard Sellers often offer up an MAE standard the Buyer must close so long as the development doesn t constitute a material adverse effect Problem for Buyers is that the term material adverse effect is subject to Delaware cases that say that, without clarification in the agreement, the development, to constitute an MAE, must threaten the overall earnings potential of the target in a manner that is durationally significant ( measured in years rather than months ) (IBP, Inc. v. Tyson Foods, Inc. (Del. Ch. 2001)) Cases have held that failure to meet quarterly earnings projections is not an MAE because it is not durationally significant See also Cooper Tire & Rubber Co. v. Apollo; Hexion v. Huntsman But a development that is not an MAE still could drastically affect the value the Buyer is getting Buyer may argue that the MAE standard alone leaves it with too much risk that it won t be getting what it s paying for... 35
Potential Solutions Better for Buyers: Provide that a development is not an MAE unless it involves a specified dollar amount (e.g., greater than 5-10% of the purchase price) Better for Buyers: Provide that post-signing developments are subject to indemnity claims after closing Better for Buyers: Provide that Sellers may refuse to close if reps aren t true in all material respects lower standard than MAE Variation would say that Buyer can walk for breaches of representations that fall short of an MAE but no indemnity if the Buyer elects to close; not ideal for public companies Better for Sellers: Define the term MAE to exclude various developments out of the Sellers control, e.g., industry developments 36
Dispute Resolution Presented by Jim Junewicz
Dispute Resolution Courts or Arbitration? There are a number of views on this question, which arises in every agreement Court proceedings generally take longer and may involve judges that are unfamiliar with the business and legal principles involved Arbitration proceedings generally move more quickly Parties can pick arbitrators and can specify in the agreement the qualifications of the arbitrator to be selected e.g., a person with 10 years of experience as a lawyer or investment banker working on M&A transactions 38
Courts or Arbitration (cont d) Arbitrations can be confidential; court proceedings are always public Perspectives might vary whether you are a Buyer or a Seller A Buyer might prefer arbitration because it is faster and provides a faster avenue to recovery A Seller might prefer a court proceeding because it will take longer, which could reduce the settlement value of the Buyer s claim Consulting with a litigator is always a good idea 39
Market Data Arbitration vs. Courts 27% of deals in 2016 provided for alternative dispute resolution Binding arbitration was dominant form at 96% Other alternatives include (a) mediation or (b) mediation, then binding arbitration 40