In today's current business climate, mergers and acquisitions are often the pinnacle of a CEO's success. I, personally, would be delighted to sell my firm for a hefty fee and retire. Mergers and acquisitions (commonly called M&As) are on the rise. In the promotional products industry alone, I counted at least four notable M&As that took place in July 2013. August barely started, and another M&A was announced—Standard Register acquired top 50 distributor WorkflowOne in a transaction valued at $218 million.
The number of M&As will continue to increase, along with the amount of lawsuits that accompany them. To provide some perspective, in 2012, litigation was brought 92 percent of the time in transactions involving more than $100 million.* In fact, the average transaction resulted in five different lawsuits.† As an example, earlier this year, Dell announced that it would be subject to a buyout. In light of that proposed transaction, 24 lawsuits were filed.
Dell is an example of pre-acquisition litigation, where investors or others sue to stop a transaction from happening (or, in lieu thereof, to obtain a monetary payout in exchange for not contesting or trying to stop the deal from closing). Substantial litigation also occurs after acquisitions occur, where one party to the transaction sues after the deal closes and seeks money damages. Post-acquisition litigation involves claims where, for instance, a buyer sues the seller for making misrepresentations concerning the business that was being acquired, or a key employee or executive of the selling company violates a restrictive covenant with the buyer.
Pre-acquisition litigation cases are attractive to plaintiffs' lawyers because they present significant settlement leverage—defendants are typically under pressure to close the deal quickly. Increasingly, however, plaintiffs' lawyers are keeping pre-acquisition litigation alive after the deal closes by, among other things, limiting their claims to money damages.
While it is impossible to guarantee a litigation-proof deal, here are a few basics to keep in mind:
Make Sure the Deal Structure is Right for You
Deals can be structured in three ways: a stock purchase (where the acquiring company purchases some or all of the shares of another company from its shareholders), an asset sale (where one company purchases all or substantially all of the assets of another company), or a merger (where one company combines with another company). Since the acquiring company and selling company have conflicting interests (the selling company wants to get as much money as possible for the company, and the buying company wants to pay as little as possible for it), it is important that each company have its own legal counsel in the transaction.
Approval of Shareholders
Whether or not shareholders are required to approve a particular transaction varies depending on the jurisdiction in which the company is formed. Generally, shareholders holding a majority of the company's outstanding stock must approve any stock purchase, asset sale or merger. In a merger, necessity of shareholder approval becomes more complex if the target company is a public company. In a stock sale, although unanimous shareholder approval is not required by law, the acquirer will often require that all shareholders approve the deal so that no minority shareholders remain after the transaction. In some instances, the shareholders of a target company may have entered into a Shareholders' Agreement that requires a greater percentage of the shareholders to approve a transaction than would otherwise be required by applicable law. Therefore, it's important for an acquirer to have its attorneys conduct a thorough review of the target's corporate documents.
Frequently, litigation is brought where one or more shareholders claim they were not fully informed of the specifics of the deal, and thus did not consent. For this reason, when obtaining shareholder approval it is imperative that the shareholders be informed of the specific provisions of the transaction, including any valuations obtained for the company.
Liabilities
In any significant M&A transaction, consideration must be given to liabilities of the target/acquired company and whether those liabilities will be transferred to the acquirer. The following are general guidelines:
(A) Mergers. In a merger, the target company's liabilities are transferred to the acquiring company and the surviving entity assumes all liabilities of the target company.
(B) Asset Sale. In an asset sale, not all liabilities are transferred. Rather, the only liabilities that are transferred are the ones designated as such in the purchase agreement. However, if there are allegations of fraud or similar acts, courts may hold the acquiring company liable for liabilities that were excluded from the transaction under the doctrine of "successor liability."
(C) Stock Purchase. In a stock purchase, the company's liabilities stay with the company for whose stock is being transferred.
Accordingly, when agreeing on a deal structure, it is imperative that the parties be fully informed of and disclose all existing and potential liabilities of the seller/target. Undisclosed liabilities are almost certain to result in litigation against seller/target (or even principals of those companies) by the seller/acquirer.
Tax Implications
Depending on the structure, transactions can be taxable or non-taxable. It is important to consult with a tax professional to determine which transactions meet your tax objectives.
Consent of Third Parties to Contracts
Be sure to review the material contracts that the selling company has in place. They may contain "no assignment" clauses, or they may require consent of the other party to the contract. If consent is required, obtain written consent from the other contract party before the closing. Generally, no consent is needed in a stock purchase or merger deal, unless the contract contains a provision that prevents an assignment if there is a change of control in the company. (Note: there may be exceptions to this rule in some jurisdictions.)
Method of Payment/Consideration
Consideration or payment for a deal can be structured in several ways, including cash and equity. Cash as payment for a company is typically preferred. But, it is commonplace for larger deals to include a mix of cash, equity and debt. Equity consists of providing the selling company with stock of the acquiring company.
It is commonplace for there to be contingencies in payment of the purchase price, such as any required escrows or earn-outs. Placement of purchase price funds in an escrow account provides some level of recourse for a buyer or acquirer in the event the seller breaches the applicable contracts or misrepresents warranties.
Earn-out provisions provide additional consideration or funds to the seller based on future performance of the company or achievement of milestones (such as future revenue). In other words, some buyers will provide sellers with additional purchase price money if the company does well in the future.
Earn-outs and escrows have been the subject of much M&A litigation. As a result, it is imperative to draft the provisions as precisely as possible and free from vagueness or doubt.
Representations and Warranties
Every deal will require both sides to make several representations and warranties of the selling and acquiring companies; if the deal is structured as a stock purchase, this will be required from the shareholders of the target company, as well. Representations and warranties include such things as:
- Capitalization
- Authority of the parties to enter into the deal
- Material contracts
- Intellectual property of the seller/target
- Tax matters (e.g., that the selling company has paid all taxes to date)
- Financial statements
- Compliance with all revenant laws.
Counsel for the seller and acquirer must carefully review these representations and warranties as breaches thereof become subjects of post-acquisition lawsuits and/or can trigger indemnification claims from the acquirer. Disclosure schedules (listing exceptions to the representations and warranties in the contract) are relied on by the alleged breaching party to show that the alleged breach was in fact disclosed to the party alleging the breach. Therefore, these schedules should contain detailed information of exceptions to the representations and warranties.
Indemnification
Typically, deal agreements contain provisions that provide for indemnification of the acquirer/purchaser for any claims brought against the seller after the closing and/or for any breach of seller's representations and warranties made to buyer/acquirer. Sellers may want to have caps on indemnification claims, both in terms of amounts of claims and time periods for which indemnification will apply.
Restrictive Covenants of Sellers
Another "must-have" provision in any M&A deal agreement is a restrictive covenant of the seller and/or selling shareholders, in which they agree, among other things, that after the closing or after their employment ends (if they will remain employed with the company after closing), they will: (i) not engage in any competitive business with the buyer/acquirer; (ii) not solicit employees or customers of the buyer/acquirer; and (iii) destroy, not use, and/or keep confidential any confidential information or trade secrets of the seller/target.
About the Author:
Lisa A. Lori, Esq., is a partner in the law firm of Royer Cooper Cohen Braunfeld, LLC. Lori focuses her practice on litigation and business disputes across a range of industries including the advertising specialty, real estate, technology, health care, pharmaceutical, consumer goods, media and financial services sectors. Lori's practice is national in scope, and includes successfully conducting bench and jury trials, arbitrations and mediations as lead counsel. Lori represents clients throughout all aspects of the litigation process—from pre-litigation counseling and settlement negotiations, to trials and appeals. To contact Lori, call (215) 620-4370 or email llori@rccblaw.com.
* See Daines, Robert M. and Koumrian, Olga. Shareholder Litigation Involving Mergers and Acquisitions. Cornerstone Research 1 (February 2013 Update).
† Id.