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November 2005 1 GREENBERG TRAURIG, LLP | ATTORNEYS AT LAW | WWW.GTLAW.COM
Moving Forward in an M&A Transaction
“The Art and Science”
Presented to the WMACCA Corporate Law Forum
September 9, 2014
Scott Meza, Esq. Greenberg Traurig, LLC
Samuel E. Logan, Jr.,
Blackboard Inc.
2
Panelist Bio: Scott Meza
Scott Meza has more than 25 years of experience assisting businesses in a wide range of complex
transactions, including mergers, acquisitions and spin offs of public and private companies and
sophisticated equity and debt financings and recapitalizations. Scott manages these types of
transactions for technology based companies in addition to companies operating in regulated
environments like government contracting, telecommunications and health care. Representative
transactions include stock-for-stock combinations, cash out mergers, tender and exchange offers,
management buyouts, stock and asset purchases, and distressed company acquisitions, including
bankruptcy auctions, corporate spin offs, divestitures and corporate governance matters.
Scott regularly represents venture funds and emerging growth companies in financing
transactions, such as preferred stock sales and subordinated debt lending and licensing. Scott has
been a leader in organizing networks of accredited "angel" investors that invest in emerging
growth companies around the country. Scott also advises senior management and boards of
directors on executive employment and compensation issues and equity incentive plans.
Scott Meza, Shareholder
Greenberg Traurig, LLP
3
Panelist Bio: Samuel E. Logan, Jr.
Samuel E. Logan, Jr. is Assistant General Counsel to Blackboard Inc., serving as chief in-house
lawyer for Blackboard’s M&A activity. Since joining Blackboard in 2010, Mr. Logan has
represented Blackboard on a number of acquisitions and in 2011 helped with Blackboard’s
successful go-private sale to Providence Equity Partners. In addition to his M&A role, Mr. Logan
directs the legal function for Blackboard’s Education Services platform, advising on day-to-day
legal matters such as commercial licensing, vendor management, customer negotiations and
intellectual property.
Prior to joining Blackboard, Mr. Logan spent five years as an associate at Latham & Watkins LLP in
Washington, DC. Mr. Logan’s practice at Latham & Watkins focused on mergers & acquisitions,
private equity, cross-border transactions, corporate governance, and venture capital financings.
He is a graduate of Georgetown University Law Center and Cedarville University, and is licensed
to practice law in New York and Washington, DC.
Samuel E. Logan, Jr.,
Blackboard Inc.
4
THE LETTER OF INTENT/TERM SHEET: PRINCIPAL DEAL
TERMS IDENTIFIED
The Letter of Intent sets the stage with basic terms “agreed upon,” including:
Structure of transaction.
(e.g. sale of stock; sale of assets)
“Headline” price (not the “net” price) is set.
A level of “normalized working capital” is required at closing.
Earnout and/or other deferred payment terms are identified but not
detailed.
An escrow/holdback in an undetermined amount is referenced.
The letter of intent references “usual and customary” representations,
warranties, and indemnifications for a transaction of this nature.
Conditions to closing include retention of key personnel, but details aren’t
stipulated in LOI.
5
LETTER OF INTENT/TERM SHEET: MAJOR DEAL TERMS
IDENTIFIED
Now it’s time to prepare a Definitive Acquisition Agreement:
We are going to focus on a few key terms of that agreement and examine
the strategy for negotiating and drafting those provisions.
How to structure these key terms from a Buyer vs. Seller perspective
is very different.
Precise drafting is essential; ambiguity in these areas generally
creates cratered deals and post closing disputes.
The letter of intent often gives little direction on how to draft these
terms and there are often huge business and legal rewards and risks
depending on your choices.
6
WHO IS ON YOUR M&A TEAM AT THIS POINT IN THE
TRANSACTION?
CAST OF CHARACTERS:
Inside and outside legal counsel need to confer closely to make right
decisions before a draft acquisition agreement is
prepared/exchanged.
Investment bankers may be consulted; can run interference and
“socialize issues” with other side in a different way.
Business decision-makers need to be engaged from the beginning and
key issues should be “outlined” for them.
Some of these agreement provisions will involve detailed accounting
and tax issues. Buyer’s and Seller’s CFOs, tax directors, and outside
accounting firms will often play important roles and should be
selectively engaged in process early on.
7
WHO IS ON YOUR M&A TEAM AT THIS POINT IN THE
TRANSACTION? (cont.)
In larger deals, Buyer’s due diligence team will need to identify the risks
in Seller’s business that may influence terms and drafting choices for
the definitive agreement.
Depending on the size of the Buyer, Seller, transaction, the Boards of
Directors and owners may need to be consulted on some of these issues.
Buyer and Seller need to know the “market” terms for their transaction;
What are the ranges of acceptable terms based on type of deal, size,
industry sector, type of Buyer (e.g. private equity firm) etc.?
Outside counsel/investment banker should be able to advise on those
market terms.
Do your homework. There are good sources for guidance and “market”
terms for these key acquisition provisions.
8
HAVE CLARITY ON THE NEGOTIATION AND DRAFTING
PROCESS
Next steps drafting the Acquisition Agreement (We will assume a Stock Purchase
Agreement for a mid-market, closely-held business)
Who drafts the Acquisition Agreement?
∙ Generally, Buyer does the first draft.
∙ In some “auction” sales led by investment banker, Seller may prepare a
“bid” draft acquisition agreement, and bidding Buyers must mark up that
draft.
The first drafter has an advantage because it can drive the initial process and
impact final terms of the definitive agreements.
What are the basic types of first draft of the definitive agreement?
∙ “Over the top” aggressively one-sided Buyer draft
∙ Seller “friendly” draft
∙ Middle of the road draft
9
HAVE CLARITY ON THE NEGOTIATION AND DRAFTING
PROCESS
That choice has ramifications for the Buyer (and Seller):
∙ “Over the top” approach can kill the deal or cause Seller to
completely redraft, create deal friction, or lengthen transaction
and costs.
∙ Middle of road draft can create good deal climate, shorter back-
and-forth time. But what if Seller comes back with very pro-Seller
mark-up? Does Buyer then lose its first drafter advantage?
Key = be pro-Buyer on the important issues that matter to your client;
go easier on things that don’t matter to your client but may matter to
other side. And leave some room to trade terms.
How to do all of this is the “art” of the deal.
10
NEGOTIATING AND DRAFTING SEVERAL KEY ELEMENTS OF
AN ACQUISITION
Attached as Appendix 1 is a list of
material terms in an acquisition
agreement. We are focusing on a few
of these:
(i) purchase price adjustments
(ii) escrows and holdbacks
(iii) Earnouts and deferred
payments
(iv) Net working capital
adjustments
(v) Representations and
warranties
(vi) Certain conditions to closing
(vii) Key indemnification issues
(viii)Employee retention
Purchase Price: It’s Not the
“Headline”; It’s the “Net” that
matters.
Gross Purchase Price:
Is generally set in the term
sheet.
Buyer may seek to change that
price based on results of due
diligence. This price change
needs to be communicated as
early as possible, and ideally,
before first draft is done.
11
NEGOTIATING AND DRAFTING SEVERAL KEY ELEMENTS OF
AN ACQUISITION
Purchase price: All cash, stock, or combination? This issue also should be resolved
before drafting the definitive agreement.
Gross Purchase price is subject to certain adjustments
∙ Reduced by escrow/holdback (see below).
∙ Reduced by Seller’s transaction expenses, which may be captured in working
capital adjustment (see below).
∙ Reduced (or increased) by working capital (or sometimes net assets or cash) of
Seller at closing.
∙ Reduced by Seller’s debt.
∙ In some deals, reduces or increases by cash on balance sheet.
∙ Reduced by specified liabilities Buyer does not want to assume.
∙ Potential upward tax adjustments (e.g. gross-up for 338(h)(10) election).
∙ Increasingly, purchase price may be reallocated to fund management carve-out; or
to fund retention pool for key employees (see below).
12
NEGOTIATING AND DRAFTING OF SEVERAL KEY ELEMENTS OF AN
ACQUISITION (Escrow or Holdback)
Escrow or Holdback? An escrow or holdback reduces the purchase
price paid at closing and is used to fund indemnity claims by Buyer
post-closing. Escrows require set aside of cash with neutral
escrow agent. Holdbacks allow Buyer to retain that amount.
Is it a cash escrow or is it a holdback by Buyer?
∙ A holdback is a key advantage to Buyer. Requires less money for
Buyer to fund at closing; Buyer keeps the money during the
pendency of an indemnity dispute which gives Buyer leverage in
the dispute.
∙ Seller wants a cash escrow for those same reasons which also
removes Buyer insolvency risk that would make Buyer unable to
pay holdback. (A holdback is usually unsecured.)
13
NEGOTIATING AND DRAFTING OF SEVERAL KEY ELEMENTS OF AN
ACQUISITION (Escrow or Holdback) (cont.)
What does the escrow or holdback cover?
∙ To fund indemnification claims by Buyer for breaches of Seller’s representations,
warranties, and covenants and for third party claims made against Buyer that are
Seller’s responsibility
∙ Does it fund a working capital deficit?
∙ Sometimes a separate escrow is established for working capital or other specified
risks.
How much is the escrow/holdback?
∙ Typically, a percentage of the total purchase price
∙ Often there is a significant difference between Buyer and Seller in potential escrow
amount but there is a typical “market” range that should provide guidance.
∙ Buyer should marshall arguments to support larger escrow (e.g. liabilities;
problems with due diligence).
∙ Seller should develop counter argument and think about “swaps” (e.g. higher
escrow for lower total cap on liability.
14
NEGOTIATING AND DRAFTING OF SEVERAL KEY ELEMENTS OF AN
ACQUISITION (Escrow or Holdback) (cont.)
How long is the escrow/holdback in effect?
Usually 12-24 months
Cover an audit cycle
Sellers seek staggered release of funds
15
EARNOUTS AND DEFERRED PAYMENTS
Earnouts and Deferred Purchase Price Payments.
An earnout is a deferred purchase price payment generally made based on the
performance of the Seller’s business (or some aspect thereof) for a period
following the closing. This is probably the most difficult part of an acquisition
to negotiate and draft.
Metrics for an earnout are often financially based: e.g. EBITDA, revenues, or
achieving specific business or technical goals.
From a Buyer’s Perspective, generally:
Have as few restrictions on how Buyer runs the purchased business post-
closing. Don’t let earnout “tail wag the business dog.”
Have a cap on the amount of the earnout.
Control the process for calculating the earnout using Buyer’s accounting
methodology.
16
EARNOUTS AND DEFERRED PAYMENTS (cont.)
Allow Buyer to offset indemnity claims against future earnout payments.
Right to require future purchaser to assume earnout obligation or liquidate at
low or fixed price in the event of such sale.
From a Seller’s Perspective, generally:
Require Buyer to covenant to run the business post-closing in a stipulated way
in order to maximize Seller’s changes of achieving the earnout (e.g., in
accordance with Seller’s past policies; continue to run as separate unit; invest
same amount into marketing and sales efforts; retain key personnel; regular
reporting on results).
No cap on amount earned and a sliding scale for earnout payments below
target. (Avoid all or nothing scenario).
No right of set off against the earnout for indemnity claims.
17
Significant liquidation payment if Buyer later sells the business
(or if Buyer itself is sold) before earnout period is completed.
Deemed tax treatment as capital gains, not ordinary income.
EARNOUTS AND DEFERRED PAYMENTS (cont.)
18
NEGOTIATING AND DRAFTING OF SEVERAL KEY ELEMENTS OF AN
ACQUISITION (Net Working Capital Adjustments)
Net Working Capital Adjustments.
What is Working Capital?: current assets (e.g. accounts receivable or cash) less
current liabilities (e.g. accounts payable or current portion of debt).
“Working Capital” means (a) the Current Assets of the Company, less (b) the
Current Liabilities of the Company, determined as of the open of business on
the Closing Date.
What Does Buyer Want?
Ensure Seller has enough “net working capital” to fund its operations post-
closing.
Also, Buyer wants to prevent Seller from stripping out cash prior to closing
(e.g. accelerating collection of its receivables and distributing cash to the
owners.)
So Buyer should stipulate in the Acquisition Agreement that there must be a
required level of working capital (e.g. “not less than $1 million of current
working capital”). This is often called a “target” or “peg”.
19
NEGOTIATING AND DRAFTING OF SEVERAL KEY ELEMENTS OF AN
ACQUISITION (Net Working Capital Adjustments) (cont.)
Buyer needs input from its finance team to help identify an acceptable level of
working capital to account for fluctuations such as seasonality in Seller’s
working capital and to develop acceptable methodology.
Buyer will want a dollar for dollar reduction in the purchase price if Seller’s
working capital at closing is less than the established amount.
Buyer will also want the right to retroactively reconcile working capital post
closing (60-90 days) to calculate what actual closing working capital turned out
to be.
If Buyer distrusts Seller’s working capital estimates, then Buyer may also want
to create a separate working capital escrow to fund that shortfall (so as to
prevent depleting the regular indemnity escrow fund or having to recover
directly from Seller).
20
NEGOTIATING AND DRAFTING OF SEVERAL KEY ELEMENTS OF AN
ACQUISITION (Net Working Capital Adjustments) (cont.)
What Does Seller Want?
To calculate working capital in manner that Seller has historically calculated
working capital in its own financial statements (and in accordance with GAAP).
∙ Remember, GAAP may allow multiple alternatives for the same item.
∙ Often include example of the principles of that calculation on separate schedule. (For
example, use Seller’s method of revenue recognition).
– “‘Working Capital’ shall be, in each case, determined in accordance with GAAP
applied consistently with the methodologies, practices and principles used in
preparation of the Working Capital Schedule and consistent with the illustrative
pro forma calculations.”
∙ Require an increase in purchase price if working capital at closing is higher than
target.
∙ Prevent “double dip” for downward working capital adjustment and indemnity claim,
for the same circumstance.
21
NEGOTIATING AND DRAFTING OF SEVERAL KEY ELEMENTS OF AN
ACQUISITION (Net Working Capital Adjustments) (cont.)
Other Choices
Both Buyer and Seller should want an orderly process to resolve working
capital disputes e.g. unresolved disputes go to an independent accountant for
final resolution. Allocation of costs of that accountant should be addressed.
Where Buyer and Seller are not confident of where working capital will be at
closing (or can’t agree on target number), consider using a working capital
“band” or “collar” where no adjustment to purchase price if closing working
capital is “close enough” (e.g. not more than $500,000 greater or less than
stipulated working capital threshold.).
Provide for the working capital adjustment to the purchase price to be made
at the closing based on an estimate of working capital with a later true-up
reconciliation of actual working capital.
22
Important Aspects of Seller’s Representations
and Warranties
Seller will be required to make representations and warranties to the Buyer.
Breach or falsity in those representations can result in indemnification claims
against the Seller and the failure to satisfy conditions to Closing. Major areas
for representation include:
Seller’s ownership rights and due authorization of the agreement
Accuracy of its financial statements
Due payment and reporting of taxes
Compliance with its obligations under its material customer, vendor
contracts
Not subject to litigation, claims, or regulatory challenges
Ownership and non-infringement of its intellectual property
Properly structured and operated benefit plans
23
Important Aspects of Seller’s Representations
and Warranties (cont.)
Compliance with law
Operational issues and results
10(b)(5) type representations
From Seller’s perspective, there are several ways to limit Seller’s
deal risk and exposure to indemnity claims arising from Seller’s reps
and warranties:
Qualify representations by “knowledge” standard
∙ E.g. To Seller’s Knowledge, it has complied with all laws and regulations in the
operation of its Business.
∙ A Seller favorable approach to defining “knowledge”:
– “Knowledge means the actual knowledge without investigation of [limited
number of specific individuals]”
24
Important Aspects of Seller’s Representations
and Warranties (cont.)
A Buyer favorable approach:
∙ “Knowledge means the actual knowledge of [wider group of individuals] and the
knowledge that each such person would reasonably be expected to obtain in the
course of diligently performing his/her duties for the Seller and after reasonable
inquiry of his/her direct reports.”
From Seller’s perspective, qualify representations by “materiality”
and “material adverse effect”.
∙ E.g. “Seller has complied in all material respects with all applicable Laws and
Regulations, except where failure to comply would not have a Material Adverse
Effect on Seller or its Business.”
∙ Seller needs to be careful to draft to account for ordinary course of business changes
that occur between signing and closing that will not be grounds for failing to close.
25
Important Aspects of Seller’s Representations
and Warranties (cont.)
From Buyer’s perspective, limit use of materiality and MAE to only a
few representations and “scrape” out those qualifiers in connection
with Buyer’s recoverable damages for indemnification (see below).
An essential part of Seller’s protection from indemnification claims
is to prepare a thorough “Schedule of Exceptions” that qualifies
Seller’s representations and warranties. If Seller discloses in that
Schedule existing circumstances that may constitute exceptions to
the accuracy of its representations, it may avoid indemnity liability
with respect to that matter.
26
Important Aspects of Seller’s Representations
and Warranties (cont.)
Buyer must review and edit the Schedule of Exceptions to prevent a
Seller from unfairly limiting its exposure on reps and warranties in
an unintended way. Sometimes, Seller’s disclosure or Buyer’s
diligence results may actually cause Buyer to create special
indemnity clauses directed to the circumstances disclosed by Seller.
Buyer will usually require a “bringdown” of representations and
warranties as of closing so the representations must be true as of
date agreement was signed and as of the closing date.
27
Addressing Certain Conditions to Closing
Most acquisition agreements drafted in Buyer’s favor state that as a
condition to closing that representations and warranties of Seller
are “true, accurate and complete” as of the closing date.
From a Seller’s perspective, a high priority is to protect the deal from not
closing because of failure of Seller’s representations and warranties at closing.
The following are three basic formulations to address these contesting
priorities:
1. Buyer Favorable. Accurate in all respects:
∙ “Each of the representations and warranties made by Target in this Agreement shall
have been accurate in all respects as of the Closing Date as if made on the Closing
Date.”
28
Addressing Certain Conditions to Closing
2. Seller Favorable. Accurate in all material respects:
∙ “Each of the representations and warranties made by Target in
this Agreement shall have been accurate in all material respects
as of the Closing Date as if made on the Closing Date.”
3. Very Seller Favorable. MAE qualification:
∙ “Each of the representations and warranties made by Target in
this Agreement shall be accurate in all respects as of the Closing
Date as if made on the Closing Date, except for inaccuracies of
representations or warranties the circumstances giving rise to
which, individually or in the aggregate, do not constitute and
could not reasonably be expected to have a Material Adverse
Effect.”
29
Key Indemnification Issues
Key Indemnification Issues
Almost every acquisition agreement will address the substance
and mechanics for a Buyer to make indemnification claims
against the Seller (and vice versa) for damages arising from
breaches of the Seller’s representations, warranties and
covenants.
This is often the most highly contested part of an acquisition
agreement and presents substantial upside advantages and
downside risks to both Buyer and Seller.
30
Key Indemnification Issues (cont.)
The following indemnification-related issues should be addressed in
the acquisition agreement
Survival; Time limitation to Assert Claims
How long does Buyer have post-Closing to make an indemnification claim
against Seller (and against the escrow)?
∙ In some cases, it is an arbitrarily limited time frame, usually between 6 months and
24 months post-closing. The longer the period, the better for the Buyer.
∙ Usually certain types of claims are not time limited, other than by the applicable
statute of limitations, e.g. taxes, due authority, fraud, pending litigation. These are
often referred to as “Fundamental Reps.”
What is the correlation between these time periods to assert claims and the
release of indemnity escrow funds? Often no correlation, in the sense that
usually indemnity claims can be made even after the escrow is released (or
used up).
31
Key Indemnification Issues (cont.)
Sandbagging (and Anti-Sandbagging)
Another contentious area relates to “sandbagging” and “anti-sandbagging”
clauses in the acquisition agreement.
∙ From Seller’s perspective, what if Buyer knows a representation and warranty by
Seller is untrue before closing and still decides to close the purchase and then bring
an indemnity claim for breach? Seller might propose anti-sandbagging language like
the following:
“No party shall be liable under this Article for any Losses resulting from or relating
to any inaccuracy in or breach of any representation or warranty in this Agreement if
the party seeking indemnification for such Losses had Knowledge of such breach
before Closing.”
∙ From Buyer’s perspective, Buyer wants the “benefit of its bargain” i.e. a company as
it existed at the signing of the agreement. So Buyer may want the following anti-
sandbagging language:
32
Key Indemnification Issues (cont.)
“The right to indemnification, reimbursement or other remedies based upon
any such representation or warranty will not be affected by any Knowledge
acquired (or capable of being acquired) at any time, whether before or after
the execution and delivery of this Agreement or the closing Date, with respect
to the accuracy or inaccuracy of such representation warranty…”
Types of damages and losses that may be recoverable (or excluded)
under an indemnification claim.
Buyer wants the right to make a broad range of damage claims for Seller’s
breach of representations, warranties and covenants, including “out-of-
pocket” damages, diminution in value, consequential damages, and incidental
and punitive damages. An example of that kind of language:
33
Key Indemnification Issues (cont.)
∙ “Loss” means any and all losses, damages, dues, penalties, interest, fines, costs,
amounts paid in settlement, judgments, Liabilities, Taxes, costs of investigative,
expenses and fees (including court costs and reasonable attorneys’ or other
professionals’ fees and expenses); provided, that Losses shall only include punitive
(sometimes referred to as exemplary) damages, to the extent such damages are
required to be paid to a third party resulting from a third party claim; and provided,
further, that Losses shall only include consequential or incidental damages to the
extent such damages are reasonably foreseeable or are required to be paid to a third
party resulting from a third party claim.
Conversely, Seller wants to limit those damage claims to actual out-of-pocket,
“direct damages.” An example:
∙ “Limitation of Liability” means notwithstanding anything in this Agreement to the
contrary, in no event shall any Seller be liable for any damages based on a multiple of
earnings, profits or EBITDA, provided, however, that nothing herein shall affect or
diminish Buyer’s rights to recover consequential damages to the extent included in the
definition of “Loss.”
34
Key Indemnification Issues (cont.)
However, there are other techniques for a Seller to limit or manage its
indemnification risks, including “baskets”, deductibles, thresholds, and
caps on damages.
Baskets provide that Buyer may not seek indemnity until the Buyer’s losses
reach a stipulated dollar amount. Baskets can be a true “deductible” (which is
desirable to Sellers) or “tipping” (which is desirable to Buyers).
For example:
“Sellers shall not be required to indemnify Buyer for Losses until the
aggregate amount of all such Losses exceeds $300,000 (the “Deductible”) in
which event Sellers shall be responsible only for Losses exceeding the
Deductible.”
35
Key Indemnification Issues (cont.)
If a Buyer agrees to a basket, Buyer would prefer it to be a
“tipping” basket:
“First Dollar Sellers shall not be required to indemnify Buyer for Losses until
the aggregate amount of all such Losses exceeds $500,000 (the “Threshold”) in
which event Sellers shall be responsible only for Losses in excess of [$300,000]
(the “Deductible”).”
In some cases, some types of claims (e.g. taxes, fraud) would be excluded
from the basket.
36
Key Indemnification Issues (cont.)
Thresholds or “Mini-baskets” provide that an individual claim must be above a
stipulated dollar amount (e.g. $5,000) to even be considered indemnifiable.
Example language:
∙ “Securityholders shall not be required to indemnify Buyer for any individual item
where the Loss relating to such claim (or series of claims arising from the same or
substantially similar facts or circumstances) is less than $25,000.”
The rationale for the Seller for a threshold is to avoid “nickel and dime” type
claims. For Buyer, either reject this concept or provide when enough of these
“nominal” claims exist, this threshold limit will phase out.
Caps on Total Damages provide that with few exceptions (e.g. fraud by Seller,
unpaid taxes), the maximum exposure a Seller may have to Buyer for
indemnification will not exceed a fixed amount (often described as a
percentage of the total purchase price).
Obviously, Seller wants as low a cap, with as few carve-outs as possible. Buyer
wants the opposite outcome.
37
Key Indemnification Issues (cont.)
In a highly negotiated deal, Seller may also want Buyer’s indemnifiable
damages to be reduced by other elements:
∙ Any insurance proceeds available to the Buyer for that loss.
∙ The net savings from any tax benefits (deductions) the indemnifiable losses produce
for the Buyer.
∙ Buyer has a duty to mitigate its losses, which includes pursuing insurance proceeds
and tax savings.
Buyer should be very careful in agreeing to these types of clauses. For
example, only insurance proceeds actually received on a timely basis for the
identical loss should be considered as offset. Tax savings are hard to pin down
and use as an offset to claims should be resisted by Buyer. Expressly agreeing
to mitigate damages creates a potential built in defense for Seller to challenge
an indemnification claim (and confirm whether case law presumes a duty to
mitigate damages).
38
Key Indemnification Issues (cont.)
Indemnification for Third Party Claims
∙ Commonly, Sellers will seek to include a provision in the acquisition agreement that
mandates that any claim by a third party made against the Buyer for which it seeks
indemnification against Seller must follow a special process.
For example, assume a customer to Seller sues the Buyer for a pre-closing claim that
Seller should have paid.
1. Seller may request that: Seller gets to defend the third party claim on behalf of
the Buyer at the Seller’s expense since if the third party claim is proven, Seller
may have to indemnify the Buyer for that claim. Conversely, Buyer would prefer
to control the defense of that claim since it impacts Buyer and the business it
bought from Seller.
2. At a minimum, in that event, Buyer should require:
∙ Buyer should be able to participate in the defense of that third party
claim with Buyer’s own counsel, at its expense.
39
Key Indemnification Issues (cont.)
∙ Seller has the right to defend the third party claim only if Seller admits it
has an obligation to indemnify Buyer if the third party wins its claim.
(This is an effective tool for Buyer).
3. Seller may settle the case only if
∙ Seller pays the third party without any contribution from Buyer.
∙ Buyer does not have to admit liability or agree to other relief.
∙ The third party is not seeking injunctive relief against the Buyer.
∙ Loss of that third party claim would not have material adverse effect on Buyer.
40
Return of the Materiality Scrapes
“Materiality Scrapes” As discussed previously, a Seller often
qualifies some of its representations and warranties by
“materiality” or “Material Adverse Effect”. However, Buyers
often seek to disregard those qualifiers for (i) purposes of
determining whether Buyer is entitled to indemnification for
breach of these representations and/or (ii) for purposes of
determining the amount of the Buyer’s indemnifiable losses.
41
Return of the Materiality Scrapes (cont.)
Here is an example of Materiality qualifications in representations
and warranties disregarded for all indemnification purposes (i.e. for
determining whether there is a breach and calculating Buyer’s losses
from that breach).
“For purposes of this Article X (Indemnification), the
representations and warranties of Seller shall not be deemed
qualified by any references to materiality or to Material Adverse
Effect.”
42
Return of the Materiality Scrapes (cont.)
The following is an example of Materiality qualifications in
representations and warranties being disregarded only for purposes
of calculation of indemnifiable losses:
“For the sole purpose of determining Losses (and not for
determining whether any breach of any representation or
warranty has occurred), the representations and warranties of
Seller shall not be deemed qualified by any references to
materiality or to Material Adverse Effect.”
These “scrapes” are often contested. Sellers argue that if the
materiality and MAE qualifiers are acceptable for representations
and warranties and for closing, why aren’t they good enough for
limiting indemnification and recoverable damages?
43
Retention of Key Employees is Big Issue for Sellers
Employee Retention Related Issues
For many Buyers, a crucial element to the success of an acquisition is that key
employees of Seller stay and work for the Buyer after the Closing. Several different
provisions of an Acquisition Agreement come into play to address that goal. For
example.
∙ Buyer may condition closing on key employees executing employment agreements
with Buyer effective at Closing that may include restrictive covenants and non-
competes.
∙ Buyer may specifically require a designated portion of the purchase price proceeds
be used to create a post-closing incentive bonus pool for Seller’s key employees.
∙ Buyer may require Seller to defer making customary severance, bonus payments,
raises in compensation and stock option acceleration prior to closing and repurpose
those payments/benefits as post-closing incentives for key employees.
∙ Conversely, Buyer may require Seller to fund severance, accrued vacation, etc. for
Seller’s non-key employees that Buyer does not want to retain.
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Retention of Key Employees is Big Issue for Sellers
From Seller’s perspective, part of the pushback is to have Buyers fund
these incentive retention payment from their own funds, not deduct that
money from the purchase price. Seller may also limit who are “key
employees” that must sign up with the Buyer as a condition to closing.
Conversely, Seller may require the Buyer to offer a certain level of
compensation and benefits to Seller’s employees post-closing.
Don’t forget the logistical challenges represented by some of these
approaches. For example, having a key employee sign a new employment
agreement as a condition to closing gives that employee significant
leverage.
Some of these issues should be addressed by a thoughtful adoption by
Seller of an incentive equity or comp plan long before closing that
achieves/promotes these post-closing retention objectives.
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Summary
Assemble and engage your key advisors to contribute to decisions
on these (and other) key issues to be proposed in the draft
Acquisition Agreement.
With respect to key transaction terms, have a feel for what is the
range of possible market based terms, and get advisors with
experience with those terms.
Understand the longer term strategic implications of these key
terms to the overall value of the transaction.
The “devil is in the details.” Sometimes the change of a few
words in these very technical provisions can have a big impact and
materially improve or degrade the “risk/reward” calculus for a
Buyer or Seller.
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Scott Meza, Shareholder
Greenberg Traurig, LLP
1750 Tysons Boulevard, 12th Floor
McLean, VA 22102
T: 703.903.7587 | [email protected]
Samuel E. Logan, Assistant General Counsel
Blackboard Inc.
650 Massachusetts Avenue, N.W., 6th Floor
Washington, DC 20001
T: 202.463.4860, ext. 2662 | [email protected]