Drafting Asset Purchase Agreements: Reps, Warranties, Covenants, Conditions, Indemnity and Other Key Provisions

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WEDNESDAY, SEPTEMBER 24, 2014

Presenting a live 90-minute webinar with interactive Q&A

Lori Buchanan Goldman, Attorney, Stradley Ronon Stevens & Young, Philadelphia

David Lee Kovacs, Partner, Moses & Singer, New York

Joshua N. Silverstein, Co-Chair, Mergers & Acquisitions Practice Stradley Ronon Stevens & Young, Cherry Hill, N.J.

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Key Provisions in Asset Purchase Agreements

September 24, 2014

Presented by: Joshua N. Silverstein, Esquire

Lori Buchanan Goldman, Esquire David Lee Kovacs, Esquire

Outline and Topics Key provisions in Asset Purchase Agreements Sale and Transfer of Assets

Representations and Warranties

Covenants

Conditions

Termination

Indemnification

Confidentiality

Jurisdiction and Venue

Anticipating and avoiding common drafting and enforcement issues

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Who We Are

Lori Buchanan Goldman, Associate Stradley Ronon Stevens & Young, Philadelphia Ms. Goldman advises a broad range of public and private companies on securities, mergers and acquisitions, commercial transactions, public financing, and corporate organization and compliance. In her mergers and acquisitions practice, her experience includes merger, stock and asset transactions. She also regularly counsels public and private companies on preparation and negotiation of commercial contracts and purchase agreements, formation of business entities and general corporate counseling.

David Lee Kovacs, Partner Moses & Singer, New York Mr. Kovacs focuses his practice on mergers and acquisitions, joint ventures, strategic alliances, private equity, lending, licensing, business enterprise structuring and formation and dispute and “corporate strife” resolution. He has represented clients in diverse industries, including those in computer software, Internet, new media, natural health products, information technology, newspapers and magazines, apparel and several others. He has been an active speaker and lecturer at law schools and legal education organizations.

Joshua N. Silverstein, Partner and Co-Chair, Mergers & Acquisitions Practice Stradley Ronon Stevens & Young, Cherry Hill, N.J. Mr. Silverstein serves as co-chair of the firm’s Mergers & Acquisitions Practice Group and as co-chair of its Investment Management Mergers & Acquisitions Practice Group. He focuses his practice on mergers and acquisitions and general corporate counseling, and has extensive experience in middle market ($10 million-$300 million) merger and acquisition transactions. He also has experience in corporate matters involving registered investment companies, registered investment advisers and insurance companies.

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Acquisitions: Asset vs. Stock Purchases

Asset and stock purchases are commonly seen deal structures • Asset purchase transaction: purchase of the selling company’s

assets, including contractual relationships and intellectual property – purchase price is paid to the company, and the company distributes

income to its shareholders – company is often an empty shell following the sale

• Stock purchase transaction: purchase of the selling company’s stock only – purchase price is paid to the shareholders – legal and corporate status of the company generally remains the

same except that the stock is owned by the purchaser

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Sale and Transfer of Assets Transfer mechanism for an asset purchase

• Four categories

‒ “Transferred Assets” or “Acquired Assets” go to the buyer

‒ “Excluded Assets” stay with the seller

‒ “Assumed Liabilities” go to the buyer

‒ “Retained Liabilities” stay with the seller

• Separate transfer documents for different types of assets

Purchase Price

‒ Amount and Timing of Payment; Allocation

‒ Escrow

‒ Working Capital Adjustment

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Representations and Warranties Representations and Warranties vs. Agreements and

Covenants • Looking backward vs. Looking forward

• Describing a state of facts for a prior period vs. Committing to take, or not to take, an action in the future

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Representations and Warranties (continued)

Purpose of Representations and Warranties in an Asset Purchase Agreement • Right to walk away before Closing (See Conditions)

• Right to a downward adjustment of the purchase price post Closing ( See Indemnification)

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Representations and Warranties (continued)

Types of Representations and Warranties Given by Seller • Organization and Qualification of Sellers

• Authority of Seller

• No Conflicts; Consents

• Financial Statements

• Undisclosed Liabilities

• Absence of Certain Changes

• Material Contracts

• Title to Purchased Assets

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Representations and Warranties (continued)

Types of Representations and Warranties Given by Seller • Condition and Sufficiency of Assets

• Real Property

• Intellectual Property

• Inventory

• Accounts Receivable

• Customers and Suppliers

• Insurance

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Representations and Warranties (continued)

Types of Representations and Warranties Given by Seller • Legal Proceedings; Government Orders

• Compliance with Laws; Permits

• Environmental Matters

• Employee Benefit Matters

• Employment Matters

• Taxes

• Full Disclosure

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Representations and Warranties (continued)

Types of Representations and Warranties Given by Purchaser • Organization of Purchaser

• Authority of Purchaser

• No Conflicts; Consents

• Brokers

• Sufficiency of Funds

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Representations and Warranties (continued)

Certain Drafting and Negotiating Issues • Materiality

• To the best of Seller’s knowledge

• It is all about allocation of risk

• Exclusions set forth in Disclosure Schedules

• Exclusions for information in data room

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Covenants Covenants in M&A Transactions

• What is a covenant? • Pre-closing covenants

‒ Apply between signing and closing ‒ Seller makes “interim operating covenants” regarding operation of

target in the ordinary course ‒ Deal specific pre-closing covenants may relate to due diligence

findings ‒ Other pre-closing covenants relate to completion of the deal

Best efforts to consummate

No-shop clauses

Fiduciary outs

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Covenants (continued)

• Post-closing covenants

‒ Only applies after closing

‒ Common seller post-closing covenants

Restrictive covenants

Restrictions on seller dissolution and distributions

Further assurances

• Common buyer post-closing covenants

‒ Agreement to honor the indemnification obligations of the target company

‒ An agreement to make employment offers to the target’s employees

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Covenants (continued)

• Common mutual post-closing covenants

‒ Maintain business records of the target

‒ Transfer of third-party contracts for which required consents were not obtained

‒ Agreements allocating responsibility between the parties for payment of transfer taxes and other acquisition expenses

• Impact of earn-outs on post-closing covenants

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Closing Conditions Purpose of Conditions to Closing

• Simultaneous signing/closing vs. Non-simultaneous signing/closing

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Closing Conditions (continued)

Types of Conditions to Closing • Conditions to Obligations of All Parties

‒ HSR Compliance

‒ No Governmental Prohibitions

• Conditions to Obligations of Purchaser:

‒ Representations and Warranties are true and correct as of the Closing Date

‒ Compliance with Agreement

‒ No Litigation

‒ Approvals; Consents; Waivers

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Closing Conditions (continued)

Types of Conditions to Closing • No Material Adverse Change

• Delivery of Transaction Documents

• Purchaser Received Permits

• Release of Encumbrances

• Seller Closing Certificate

• Secretary’s Certificate

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Closing Conditions (continued)

Types of Conditions to Closing • Conditions to Obligations of Seller:

‒ Representations and Warranties are true and correct as of the Closing Date

‒ Compliance with Agreement

‒ No Litigation

‒ Approvals; Consents; Waivers

‒ Delivery of Transaction Documents

‒ Purchaser Closing Certificate

‒ Secretary’s Certificate

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Closing Conditions (continued)

Certain Drafting and Negotiating Issues • Double materiality

• “Read out” materiality for MAE qualifiers for representations and warranties but subject to overall MAE (with some exceptions)

• Financing out

• Financial or operating targets

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Termination

Standard Reasons for Termination • Mutual Consent

• Material Breach of, inaccuracy in or failure to perform a representation, warranty, covenant or agreement

• Failure to meet a closing condition

• Legal impediment

Effect of Termination • Agreement becomes void except for clauses that survive (e.g., confidentiality provisions,

miscellaneous provisions, termination provisions themselves, etc.)

• Possible termination fee

• Termination does not preclude liability for breach

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Indemnification - Overview Indemnification in Context

Scope of Indemnification

Survival of Representations, Warranties and Covenants

Limitations on Indemnification

Indemnification Procedures

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Indemnification in Context In commercial agreements, indemnification is often limited to

third-party claims • One party reimburses the other party for claims brought by third

parties

• Applies when the party most likely to be sued is not the party at fault ‒ E.g., a manufacturer indemnifies a distributor against product liability claims

from retail customers

• Claims between the parties are claims for breach of contract, not indemnification

In acquisition agreements, claims between the parties are also subject to indemnification • Attorneys’ fees, which are not normally recoverable in a breach of

contract claim, are recoverable as indemnified losses 27

Scope of Indemnification The claims and losses subject to indemnification will be very

broadly defined • E.g., “all claims, proceedings, losses, damages, liabilities, obligations

and expenses”

• Will expressly include “reasonable attorneys’ fees”

• May exclude non-cash losses, such as diminution in the value of the business

• May exclude incidental, consequential, punitive or other categories of damages

The related parties to whom indemnification is available will be similarly broadly defined • E.g., “Purchaser and its affiliates and each of their respective officers,

directors, employees, stockholders, agents and representatives.”

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Scope of Indemnification (continued)

Indemnification will be available for claims and losses arising out of: • Breaches of representations and warranties

‒ Should be its own subsection

‒ Materiality qualifiers may be disregarded in calculating losses

‒ Although the words will be parallel, Seller’s more extensive reps and warranties mean that the Seller’s indemnification obligation is more significant

• Breaches of covenants

• In an asset deal, Assumed Liabilities (indemnified by Purchaser) and Excluded/Retained Liabilities (indemnified by Seller).

• Specific matters listed on disclosure schedules for which the parties agree that Seller is to remain liable

‒ E.g., Seller discloses pending litigation on a schedule, so there is no breach of the “no claims” representation

‒ Absent an express indemnification right, Purchaser will have no right to recover the post-closing costs of the litigation from Seller

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Survival Survival Periods for Reps and Warranties

• “Fundamental” representations typically survive indefinitely ‒ Should include organization, good standing, authority, execution delivery and

enforceability

‒ In a stock or merger deal, should also include title to shares and capitalization

‒ Indefinite survival may be unenforceable as against public policy

• Some representations survive through the applicable statute of limitations ‒ Typically tax, environmental and employee benefits reps; sometimes

undisclosed liabilities, no conflicts, intellectual property

‒ Statute of limitations may be tolled, e.g., until a tax return is filed or an environmental claim is discovered

• Remaining representations survive for an agreed period

‒ Typically 1 to 2 years, with 18 months most common

‒ The period is often chosen to ensure that a full audit cycle is covered

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Survival (continued)

Covenants should not be subject to a limited survival period.

• If mentioned at all, covenants should survive “in accordance with their respective terms”

‒ Pre-closing covenants will expire at closing

‒ Post-closing covenants (e.g., non-competition, confidentiality) should have an express term

Effect of Survival Requirement

• Claims must be brought within the applicable survival period

• If timely brought, claims continue until resolved

• Escrow release typically coincides with expiration of survival period

TIP: When cross-referencing, include the Section name parenthetically after the number, so that numbering changes will not inadvertently change the substance of the agreement

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Limitations on Indemnification Caps

• Maximum amount that a party is liable to indemnify with respect to one or more categories of claims

• Should only apply to indemnification claims based on breaches of reps and warranties, not covenants ‒ Reps and warranties, together with disclosure schedules, constitute a

description of a business, and the cap on indemnification for breaches of reps and warranties recognizes that such a description will always be somewhat inexact; the same argument does not apply to covenants

‒ TIP: Check the cross-reference carefully!

• Based on a recent study published by the ABA, deal caps averaged approximately 20% of the purchase price ‒ 5% of deals were capped at 100% of the price

‒ Almost 50% of deals were capped at 10% or less of the price

‒ Smaller deals tend to be subject to higher percentages

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Limitations on Indemnification (continued)

Baskets / Thresholds / Deductibles • Aggregate claims must exceed this amount before indemnification is

available • Basket / Threshold: Once the specified amount is surpassed, claims are

indemnified from the first dollar ‒ E.g., if a party has aggregate claims of $150 subject to a $100 basket or

threshold, the party may recover $150

• Deductible: Once the specified amount is surpassed, only claims in excess of that amount are indemnified. ‒ E.g., if a party has aggregate claims of $150 subject to a $100 deductible, the

party may recover only $50

• Based on a recent study published by the ABA, baskets/thresholds averaged approximately 1% of the deal value, up to a maximum of 5% ‒ For a given deal, a deductible would generally be lower than a basket or

threshold

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Limitations on Indemnification (continued)

De Minimis Exclusions • Individual claims must exceed this amount before they count

toward a basket / threshold or deductible ‒ E.g., if a party has 100 claims of $50 each, subject to a $100 de

minimis exclusion, the party may not recover any portion of the $5,000 aggregate claim

• Based on a recent ABA study, 23% of deals had such a de minimis exclusion

Third-Party Recoveries • Insurance: The indemnified party may be required to pay over

any insurance recovery it receives for the indemnified loss

• Taxes: An indemnification claim may be subject to reduction based on a tax benefit received by the indemnified party

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Indemnification Procedures Because the indemnifying party is the true party in interest with respect

to monetary claims by third parties, indemnification of such claims is subject to requirements such as: • The indemnified party shall give timely notice of the claim, in reasonable

detail, to the indemnifying party • The indemnifying party may elect to defend the claim with counsel

reasonably acceptable to the indemnified party ‒ When acting as Seller’s counsel, resist any requirement that Seller admit that a claim

is indemnifiable before permitting the Seller to assume the defense

• The indemnified party may participate in the defense with its own counsel at its own expense, subject to the indemnifying party’s right to control the defense

• Absent consent of the indemnified party, the indemnifying party may not agree to the entry of any judgment or any settlement that admits liability or provides for equitable (including injunctive) relief that would bind the indemnified party

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Confidentiality Confidentiality Agreements in Acquisition Transactions

• Why confidentiality agreements or covenants?

• When do parties enter into NDA’s?

• Should an NDA be separate from the LOI or APA?

• Mutual vs. unilateral NDA’s

• What information is protected?

‒ All confidential or proprietary information of the disclosing party

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Confidentiality (continued)

• What information is not protected?

‒ Publicly known

‒ Available on a non-confidential basis

‒ Already in the receiving party’s possession

‒ Available through a third party

‒ Independently developed

• What actions are prohibited?

‒ Prohibition on disclosure

‒ Prohibition on use

‒ Exception: compelled disclosure

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Confidentiality (continued)

• Termination of the confidentiality agreement or covenant

‒ Indefinite term

‒ Return of confidential information

• Additional provisions that may be included

‒ Disclaimer of any representation or warranty

‒ Disclaimer of any license grant

‒ Obligation to inform of unauthorized disclosure

• If the disclosing party is a public company

• If the potential buyer is a competitor

• Limitations on the efficacy of confidentiality provisions

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Jurisdiction and Venue

Governing law

Forum selection/submission to jurisdiction

Jury trial waiver

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Contact Information

Lori Buchanan Goldman Stradley Ronon 215.564.8707

lgoldman@stradley.com

Joshua N. Silverstein Stradley Ronon 856.321.2416

jsilverstein@stradley.com

David Lee Kovacs Moses & Singer

212.554.7847 dkovacs@mosessinger.com

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