Acquisitions can be effected in various ways. It may be best to structure the acquisition as an asset purchase, a stock purchase, a stock purchase treated as an asset purchase for tax purposes, or a merger. This article focuses on drafting asset acquisitions.
Clarity is key. Conciseness helps. Lawyers must pay special attention in providing clear descriptions of the following: (1) purchase price; (2) purchase price adjustments; (3) included assets; (4) excluded assets, (5) assumed liabilities; (6) excluded liabilities; (7) seller’s representations and warranties on the physical condition of assets and the financial condition of the related business; (8) the parties’ pre-closing covenants [commitments] and negative covenants [prohibitions]; (9) the parties’ post-closing covenants and negative covenants; (10) indemnification by seller and buyer; (11) conditions to closing; and (12) remedies for breach.
Most relatively complicated asset purchase agreements place the definitions of terms at the front of the document following the recitals that provide the background of the transaction. Some practitioners prefer to place the definitions at the end of the document. In general, the more complicated the transaction, the more important the definitions. A term may be defined in an uncommon way. Reference to the precise definition is the only way to make sense of the body of the agreement. Placing the definitions front and center emphasizes their importance. A novice who reads the body of the agreement before referring to the definitions may be in for a rude awakening.
Assets and Liabilities
One of the most important provisions in an asset purchase agreement is the definition of the specific assets to be acquired and the specific assets to be excluded from the transaction. From buyer’s perspective, the broader the definition of the assets to be acquired and the broader the definition of excluded liabilities, the better. If representing buyer, I would insist on a broad definition of assets where any asset of seller is excluded. An example: Require transfer of all assets used “or usable” in the business. Similarly, I would insist on a very specific list of liabilities to be assumed.
In many cases, the Purchase Price is not just a set number of dollars payable at Closing. The Purchase Price may be subject to adjustments. The Purchase Price may be payable in a form other than cash. Issues in drafting may include:
Is the Purchase Price all cash or is it payable in whole or in part in some other form? Consideration, for instance, could be a grant to seller of equity in buyer.
Is the Purchase Price subject to adjustment? Factors that may be relevant to a purchase price adjustment include the success of the business between signing and closing, a comparison between accounts receivable and accounts payable at the time of signing the agreement and the status of receivables and payables at Closing. Another comparison may be interim changes in inventory. An exacting formula is essential in the correct calculation of any adjustment.
Will there be an earn-out? An earn-out is a post-closing increase in price resulting from satisfying specified financial targets.
Will there be a claw-back? A claw-back is a post-closing reduction in price resulting from the failure to meet specified financial targets.
Representations and Warranties
Legal counsel will need to prepare the representations and warranties being made by the parties. The goal of seller representations and warranties is to force seller to disclose and verify material facts about the business. The representations and warranties are typically supplemented by a disclosure schedule pursuant to which seller may make exceptions or qualifications. Negotiation of these provisions often involve the extent of materiality and the extent of knowledge required of seller for the representations. For example, sellers will often want representations to begin, “to the actual knowledge of seller’s CEO and CFO.” At the opposite extreme, representations may not be limited at all. Limitations in between those extremes include “to the actual or presumed knowledge of seller” with or without adding “after conducting reasonable due diligence as to the truth and accuracy of the representations.” The strength and scope of the representations contained in the agreement are extremely important since a properly drawn “incorporation” provision precludes buyer’s reliance on earlier representations made by seller in connection with buyer’s due diligence. An incorporation provision also precludes buyer from relying on the specific information obtained in due diligence. An example of incorporation:
ENTIRE AGREEMENT. This Agreement contains the entire understanding of the Parties with regard to the subject matter hereof. Any express or implied warranty, representation, or agreement not expressly set forth herein shall have no force and effect and neither party shall be bound thereby. This Agreement supersedes any prior or contemporaneous agreement or understanding between the parties whether written, oral, implied, or otherwise manifested.
Representations concerning specialty areas of the law such as environmental, ERISA, patent should be reviewed by legal counsel specializing in those areas.
The indemnification provisions need to be drafted precisely. Particularly if the deal is for the purchase of all of seller’s assets, buyer must ensure it can reach the shareholders or members of seller in the event of a breach. The seller will likely attempt to negotiate a short survivability period for seller’s representations and warranties. The seller will likely want a cap on seller’s potential liability. These provisions can be negotiated to be whatever the parties desire. For example, if a buyer is particularly concerned about potential environmental liabilities, buyer may demand an indefinite survivability period and unlimited damages for environmental representations and warranties. Tax representations should survive for at least that period of time when the IRS or other taxing authority is permitted to bring a claim. It is also wise to set forth the procedures for indemnification claims and to set forth indemnification procedures for third-party claims.
Termination and Remedies
The importance of a well drafted purchase agreement becomes clear when a party wishes to terminate the agreement. Facts that become known to buyer after signing or events that occur after signing may give rise to buyer’s right to terminateTags: Asset Purchase Agreements