When entering into a stock purchase agreement or an asset purchase agreement, buyers and sellers should be aware that no matter how simple the transaction, there is always the possibility that dispute arises and results in litigation within months or years of closing.
The COVID-19 pandemic has introduced a once-in-a-generation disruption to the market. Buyers and sellers have in many cases faced sometimes catastrophic changes in circumstances after the transactions have been completed, causing them to seek any possible advantage in post-closing litigation.
In this respect, the parties have found that the content, scope and clarity of certain provisions, examined below, are essential.
The Power of Representations and Warranties
The parties should be fully responsive to the representations and warranties made by both parties in the agreement. Representations and warranties exist so that each party may receive critical assurances as to the accuracy of certain claims or circumstances without engaging in their own due diligence to confirm it.
If the representation or warranty is found to be incorrect, the party who relied on the truthfulness of the representation or warranty will be indemnified for any damages suffered as a result. Typically, the seller provides more representations and warranties than the buyer because they have unique knowledge of the corporate structure, financial condition and trajectory of the underlying company and its assets, liabilities and relationships.
For example, a seller often represents and warrants that it has no knowledge of any event within a number of months prior to the effective date that would materially adversely affect the value of the business or its assets. Given the obvious value of some representations and warranties, a buyer often negotiates for the seller to remain liable for a representation and warranty even though the buyer knew or should have known that they were false. this.
Post-Closing Purchase Price Adjustments
The stock purchase agreement or asset purchase agreement should establish a clear and unambiguous protocol for resolving disputes related to post-closing purchase price adjustments.
For example, where an agreement contemplates a post-closing adjustment to reconcile any difference between reported and actual accounts receivable or working capital, or any difference between the reported and actual value of any inventory acquired, the agreement should allow time for Buyer to provide Seller with total accounts receivable collected or inventory sold and for Seller to challenge the accuracy of such totals.
The same applies when an agreement provides for an increase or decrease in the purchase price depending on the seller’s ability to meet certain key performance indicators in the months or years following closing.
The agreement should clearly set out next steps in the event that the seller and buyer dispute any price adjustment by requiring that:
- The party seeking to invoke its right to a price adjustment shall serve notice on the other party on a certain date and the party receiving the notice shall serve proper notice on a certain date;
- The parties engage in good faith negotiations to resolve any disputes;
- The parties engage an independent accountant to render a binding decision on any dispute; and
- The parties submit the dispute to mediation or arbitration. The agreement should also clearly state who will bear the fees and costs associated with any third party such as an accountant, mediator or arbitrator.
The parties may agree that they should share the costs equally; that the party whose position is furthest from the determination of the third party must pay all costs; or, that the parties pay a certain percentage of the cost of the third party based on a carefully worked out formula that takes into account the range between the numbers offered by the buyer and seller and the amount determined.
Where the stock purchase agreement or asset purchase agreement provides that certain disputes thereunder are subject to arbitration, in particular, the agreement must state directly and expressly which disputes are or are not governed by the clause, what happens when a dispute touches on a subject that can be addressed in arbitration and before the courts, and whether the arbitration clause must be interpreted in the broad sense or in the strict sense.
The more specific the clause, the more likely it will provide parties with certainty so they can avoid what happened in the 2020 Keystone Food Holdings Ltd decision. vs. Tyson Foods Inc. in the U.S. District Court for the Southern District of New York. .
There, the share purchase agreement provided that all breaches of representations and warranties would be governed by a court of competent jurisdiction, but all disputes regarding compliance with International Financial Reporting Standards would be determined by Grant Thornton LLP; however, he did not address what happens when litigation arises over a breach of representation or warranty that the vendor’s financial statements were accurate and in accordance with IFRS.
For example, when the buyer challenged the seller’s post-closing purchase price adjustments, which increased the company’s indebtedness by changing an incorrect classification of equipment finance leases, adding a portion of a shareholder loan to a Chinese joint venture and adding long-term loans to retirement obligations that should have been reserved previously, the parties argued over the appropriate forum to settle their dispute.
The parties were ultimately left at the mercy of the court, which recognized the ambiguity of the stock purchase agreement and engaged in its own analysis before determining that all disputes should be submitted to arbitration. Had the parties considered the conflict between its arbitration and litigation clauses, they would have been better served.
The interaction between chords
The buyer must ensure that any person on the selling side who is critical, in his opinion, for the continued success of the acquired entity/assets or for the profitability of the transaction, is mentioned in the purchase agreement shares, the asset purchase contract or other contracts executed simultaneously. Buyers and sellers generally consider how owners and shareholders and senior management and management will be affected by the transaction.
However, they do not always consider how the transaction will affect executives, managers and mid- or lower-level employees, and in some situations these mid- or lower-level employees are essential in the short term or even in the long term. operation of the company.
Baskets and caps
Buyer and Seller should also consider the limitations of any limitation of loss clauses. The parties may agree that the damages identified by the buyer will not be subject to compensation by the seller unless and until they exceed a certain threshold — that is, a basket — in order to avoid low value disputes. The parties may also agree, for example, to limit Seller’s liability with certain exceptions for willful misrepresentation, willful default, gross negligence or otherwise.
Finally, the parties should not overlook the value of negotiating boilerplate provisions, such as those regarding:
- Jurisdiction or location;
- jury dispensation; and
- The prevailing party’s right to attorneys’ fees.
Each of these provisions can be used to the advantage or disadvantage of a party in the event of litigation or threat of litigation. In these types of transactions, often the buyer is not located in the same county, state or even country as the seller and, in this respect, if the seller is skeptical that the buyer will honor any adjustment of price after purchase or otherwise, the seller may find it advantageous to obtain the buyer’s consent to the jurisdiction of his home state.
For example, a seller based in the Hamptons area of New York on Long Island clearly stands out, in one respect, if acquired by a buyer based in Europe who has a US presence in California and is able to obtain Buyer’s consent for jurisdiction and venue in the Eastern District of New York, Central Islip – approximately 50 miles from Manhattan, presumably where Buyer would seek counsel in the event of a dispute.
The existence or omission of a provision setting out the prevailing party’s right to a fee may also be helpful as it may help to level the playing field or ensure unequal playing fields if a party has good more assets and resources than another. If, for example, the buyer is a large, deep-pocketed US company, they might resist this provision because, after all, a fee-forwarding provision won’t have a dramatic effect on their bottom line, but it may embolden the sole shareholder who has sold his shares or assets to sue in the event of a dispute.
Moreover, while jury waivers are common in stock purchase agreements and asset purchase agreements because a judge is well placed to decide sophisticated business issues, sympathetic salespeople who, by example, sell their small family business to a large conglomerate may consider a jury trial.
The authors of this article were integral to the transactions and disputes concerning SPAs and APAs. , representing both sellers and buyers. Whether you are committing to the sale of your $25 million New York-based manufacturing business to an international conglomerate subject to a post-closing price adjustment after reaching an EBITDA target, you are committing to the sale of your business start-up and considering future employment by the acquiring entity with an incremental purchase price based on key performance indicators, or seeking to buy out and relaunch the assets of a small family business valued at six figures, the authors of this article are well placed to provide legal advice.