Buyer Protection Provisions in M&A Agreements: AR Repurchase Obligation, Inventory Audit, Insurance and More

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Buyer Protection Provisions in M&A Agreements: AR Repurchase Obligation, Inventory Audit, Insurance and More Minimizing Buyer's Risk With Deal-Specific Provisions Beyond Indemnification and Escrows THURSDAY, OCTOBER 8, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Dimitry Herman, Founder and Managing Partner, Herman Law, Boston John Marsalek, Partner, Dorsey & Whitney, Minneapolis Reed Sussman, Esq., Senior Vice President, Gallagher WGA, Boston The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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5 Buyer Protection Provisions in M&A Agreements

6 Outline I. Purchase Price Adjustments II. Key Clauses A. Accounts Receivable Repurchase B. Inventory Audit C. Setoff Rights D. Cross-default Provisions III. M&A Transactional Insurance 6

7 I. Purchase Price Adjustments 1. Deals with Purchase Price Adjustments 2. Working Capital 3. Working Capital Mechanics 4. Indemnification 5. Interplay between PPA & Indemnification 6. Alliant Techsystems Inc. v. MidOcean Bushnell Holdings LP 7

8 I. Purchase Price Adjustments 1. Deals with Purchase Price Adjustments (PPA) 85% of deals have a PPA mechanism* 91% of those deals have an adjustment for Working Capital* *Per 2012 ABA Deal Point Study 8

9 I. Purchase Price Adjustments 2. Working Capital Working Capital = Current Assets Current Liabilities What is included in Working Capital? In accordance with GAAP and/or Seller s historical practices? Fluctuates between valuation date and closing date Adjustment seeks to prevent: - Seller from shortchanging Buyer - Buyer receiving a windfall 9

10 I. Purchase Price Adjustments 3. Working Capital Mechanics Parties agree on target Working Capital Seller prepares estimate of Working Capital Buyer prepares final Working Capital Dispute Resolution Independent Accountant 10

11 I. Purchase Price Adjustments 4. Indemnification Types of Claims Procedure Limitations (Time Period, Basket, Cap) Dispute Resolution Courts 11

12 I. Purchase Price Adjustments 5. Interplay between PPA & Indemnification Key Differences - Subject Matter - Time Frame - Limitations - Dispute Resolution Interplay 12

13 I. Purchase Price Adjustments 6. Alliant Techsystems, Inc. v. MidOcean Bushnell Holdings, L.P. (C.A. No.9813-CB) Background: Working Capital to be calculated in accordance with GAAP and otherwise in a manner consistent with the practice and methodologies used in the preparation of certain financial statements of MidOcean. Purchase agreement also contained a representation that MidOcean s financial statements were prepared in accordance with GAAP applied on a consistent basis. Indemnification provisions provided that the sole and exclusive remedy for any claim relating to the transaction was governed and limited by the indemnification provisions, but that nothing in this sentence shall operate to interfere with or impede the operation of the provisions of Section 2.4 [Purchase Price Adjustment section]. 13

14 I. Purchase Price Adjustments ATK Background (continued): Dispute Resolution: Accounting Firm v. Courts Basket: Not on PPAs, but on indemnification claims Cap: Cap on PPA higher than on indemnification claims Exclusive Remedy: Indemnification procedure is subject to the PPA procedure No Double Recovery Provision 14

15 I. Purchase Price Adjustments Dispute: MidOcean delivered an estimate, which was approx. $4M above the WC threshold ATK delivered its calculation, which was approx. $22M below the WC threshold Thus, $26M repayment back to ATK ($4M settled) MidOcean argued that ATK did not perform its calculation using the practices and methodologies used by MidOcean MidOcean refused to submit the disputed items to the Accounting Firm 15

16 I. Purchase Price Adjustments MidOcean s Argument: Discrepancy based on whether certain items were accounted for in accordance with GAAP Based on Financial Statement representation Therefore, dispute should be resolved in accordance with the indemnification provisions Recall: basket and lower cap on indemnification claims 16

17 I. Purchase Price Adjustments ATK s Argument: Compliance with GAAP requirement fell within PPA procedure within scope of Independent Accountant Exclusive Remedy provision gave priority to PPA procedure 17

18 I. Purchase Price Adjustments Decision: 1) Plain terms of the Purchase Agreement Recall: calculated in accordance with GAAP and otherwise in a manner consistent with the practice and methodologies used in the preparation of 2) Exclusive Remedy provision established hierarchy Recall: Indemnification provisions are the sole and exclusive remedy, but that nothing in this sentence shall operate to interfere with or impede the operation of the provisions of Section 2.4 [Purchase Price Adjustment section] 18

19 I. Purchase Price Adjustments Practice Points: 1) Application of GAAP 2) Consistency with Seller s historical practices 3) Items to be Included in Working Capital 4) Double Counting 5) Interplay 19

20 II. Key Clauses A. Accounts Receivable Repurchase B. Inventory Audit C. Setoff Rights D. Cross-default Provisions 20

21 II. Key Clauses A. Accounts Receivable Repurchase Sample Clauses: Buyer shall have the right, upon written notice to Seller at any time after 90 days following the Closing Date, to require Seller to repurchase for cash all of the accounts receivable on the books and records of Seller as of the Closing Date that have not been collected as of such notice date. To the extent Seller indemnifies any Buyer Indemnified Person with regard to any one or more Accounts Receivable, Buyer hereby agrees to assign all of its right, title and interest in and to such Accounts Receivable to Seller including all rights of recovery with regard to such Accounts Receivable. 21

22 II. Key Clauses A. Accounts Receivable Repurchase Variations - Types of accounts receivable to be repurchased - Timing of Buyer Notice Mechanics of Operation - Working Capital - Representation - Indemnification Effect on Customer Relationship 22

23 II. Key Clauses B. Inventory Audit Purchase Price for businesses such as manufacturing, pharma or retail may be heavily based on the value of inventory, which may include raw materials, work in process and finished goods Buyer does not want to overpay for inventory that may be overestimated in amount pay for inventory that is damaged, expired, obsolete or otherwise not usable or saleable 23

24 II. Key Clauses B. Inventory Audit Interplay with Purchase Price Provisions Included as a separate component of the Purchase Price payable after closing, after physical inventory is completed Included as a separate component of the Purchase Price paid based on an estimate at closing and adjusted by final inventory post-closing Not addressed specifically and handled generally via the Post- Closing Adjustment Provisions 24

25 II. Key Clauses B. Inventory Audit Example Clause providing for Separate Component of Purchase Price At the Closing (as defined herein), Buyer shall pay to Seller, in cash, by wire transfer of immediately available funds, each the following amounts (collectively, the Closing Payment ):. (..) US$[**] (the Inventory Payment ), which amount is payable in respect of the Estimated Inventory as set forth on [the Closing Balance Sheet][Schedule XXX] 25

26 II. Key Clauses B. Inventory Audit Definition of Inventory SIMPLE: Inventory means all inventory, finished goods, raw materials, work in progress, supplies, and other inventories of the Business. PHARMA: Inventory means merchandise inventory, pharmacy merchandise (legend, non-legend and generic), supplies, containers, labels, packaging material, maintenance supplies, beverages (alcoholic and non-alcoholic), food and other similar items, whether in broken or unbroken units, which are located in or held for sale at the Store Properties. FOOD: Inventory means all food products, non-alcoholic beverages, alcoholic beverages, keg deposits, paper products used in food sales, and other products sold in the ordinary course of business, excluding (i) any alcoholic beverages at any Restaurant located in State that Buyer is not legally permitted to purchase at Closing and (ii) any obsolete, unusable or other out-of-date or non-current items disallowed by Buyer or Franchisor. 26

27 II. Key Clauses B. Inventory Audit Other Considerations Representations and Warranties on Inventory should be considered in comparison to the post-closing inventory covenants Examples: All Inventory, whether or not reflected in the Trial Balance, consists of a quality and quantity usable and salable in the ordinary course of business consistent with past practice, except for obsolete, damaged, defective or slow-moving items that have been written off or written down to fair market value or for which adequate reserves have been established. All Inventory is owned by Sellers free and clear of all Encumbrances, and no Inventory is held on a consignment basis. The quantities of each item of Inventory (whether raw materials, work-in-process or finished goods) on hand are reasonable and in conformity with the Sellers ordinary course of business consistent with past practice. 27

28 II. Key Clauses B. Inventory Audit Other Considerations Examples cont.: All Inventory is owned exclusively by the Company, free and clear of any Liens, has not been pledged as collateral, is not held by the Company on consignment from others, conforms in all material respects to all standards applicable to its use or sale imposed by any Governmental Authority, is fit for its intended purpose (and, if applicable, is not adulterated, misbranded, mispackaged or mislabeled) and is of a quality that is suitable, usable or (in the case of finished goods and products) saleable in the ordinary course of the Business. Schedule 7.20 lists all Inventory, the location of such Inventory and the approximate values of the amount of Inventory held in each such location as of the date of the Interim Balance Sheet. The quantity of the Inventory on hand, in transit and on order as of the Closing will be at levels substantially customary for the Company for that time of year in which the Closing occurs; such quantity representing Company s good faith estimate of quantity required by the Business to continue to operate in the ordinary course of Business and without interruption. Items of such Inventory which are not of a quality usable and saleable in the ordinary course have been written down to net realizable value. 28

29 II. Key Clauses B. Inventory Audit Example of General Covenant Seller acknowledges that following the Closing Purchaser intends to complete a physical inventory of the Inventory, at [Purchaser s][seller s] expense. Following the Closing, Seller will grant Purchaser [and its representatives] reasonable access to the facilities where the Inventory is located, as well as to all related files, books and records of Seller, as are reasonably necessary to permit Purchaser to complete such physical inventory process. The form, scope and methodology of such inventory process shall be determined by the [Purchaser][the parties] [in its reasonable discretion]. [From the date of the Closing until the completion of such inventory process, Seller shall store and maintain with all reasonable care and caution and in accordance with applicable standards of any insurance and in conformity with applicable laws.] Seller will also make available to Purchaser and its agents, all management and other appropriate personnel during normal business hours, on reasonable prior notice. 29

30 II. Key Clauses B. Inventory Audit Provision from Food Industry Pre-Closing Valuation. Promptly following the close of business on the date immediately prior to the Closing Date, a representative of the Sellers and a representative of Buyer shall count and record all Inventory, inclusive of the Closing Store Cash, at the Restaurants using an inventory count sheet in a form reasonably acceptable to Sellers and Buyer. Each inventory count sheet shall be executed by a representative of the Sellers and a representative of Buyer. The Inventory valuation shall be calculated, without duplication, in accordance with the Accounting Policies (i.e. physical Inventory quantity shown on the executed Inventory count sheets multiplied by the respective Inventory unit cost determined on a first-in first-out Inventory basis using most recent vendor invoices). Accounting Policies means collectively (i) the accounting principles, policies, covenants, methodologies and procedures applied on a consistent basis with the application of such accounting principles, policies, covenants, methodologies and procedures in the Financial Statements and (ii) the specific accounting policies set forth on the attached Accounting Principles Schedule (which specific accounting policies will control in the event of any conflict between such policies and the accounting principles and policies described in clause (i) of this definition). 30

31 II. Key Clauses B. Inventory Audit Example from Food Industry cont. Closing Date Statement. Within 14 days after Closing, Buyer will prepare and deliver to Seller Representative a statement (the Closing Date Statement ) setting forth a calculation by Buyer of the Inventory Valuation. Resolution of Disputes. If Seller Representative and Buyer fail to reach an agreement with respect to all of the matters set forth in the Objection to Inventory Valuation before expiration of the Inventory Valuation Resolution Period, then any amounts remaining in dispute ( Disputed Inventory Valuation Amounts ) shall be submitted for resolution to the office of ***, LLC or, if *** LLC is unable to serve, Buyer and Seller Representative shall appoint by mutual agreement the office of an impartial nationally recognized firm of independent certified public accountants (***, LLC or such firm, the Independent Accountants ) who shall resolve the Disputed Inventory Valuation Amounts only and make any determination as to the Inventory Valuation Settlement. The Independent Accountants shall make a determination as soon as practicable within 30 days (or such other time as the parties hereto shall agree in writing) after their engagement, and their resolution of the Disputed Inventory Valuation Amounts and their adjustments to the Closing Date Statement shall be conclusive and binding upon the parties hereto and the Inventory Valuation Settlement as determined hereby shall be paid by the appropriate party in the manner provided in Section 2.06(d). The Independent Accountants shall only decide the Disputed Inventory Valuation Amounts by the parties, and their decision for each Disputed Inventory Valuation Amount must be within the range of values assigned to each such item in the Closing Date Statement and the Objection to Inventory Valuation, respectively. The fees and expenses of the Independent Accountants shall be paid by Sellers, on the one hand, and Buyer, on the other hand, based upon the percentage that the amount actually contested but not awarded to Sellers or Buyer, respectively, bears to the aggregate amount actually contested by Seller Representative, on behalf of Sellers, and Buyer. For the avoidance of doubt, the fees and disbursements of each party s accountants and other Representatives (other than the Independent Accountants) incurred in connection with the Inventory Valuation Settlement shall be borne in accordance with Section

32 II. Key Clauses B. Inventory Audit Interplay with Remedies Separate dispute resolution mechanics should be considered in connection with the inventory, such part of post-closing adjustment Shortfall in inventory count may not amount to a material difference for purposes of a breach of the representations and warranties Special carveouts to any Basket and Cap should be considered for the inventory adjustments 32

33 II. Key Clauses C. Setoff Rights Another Payment to Seller - Promissory Note - Contingent Payment or Earnout - Supply Agreement (or other commercial agreement) Mechanics of Operation - Additional Protection for Buyer 33

34 II. Key Clauses C. Setoff Rights - Sample Provision #1: Buyer shall have the right to offset from any Contingent Payment then due and payable to Seller for any indemnification claims for Losses pursuant to Article V of this Agreement. Also include: The offset rights of Buyer pursuant to this Section shall be in addition to any other rights of Buyer pursuant to this Agreement. 34

35 II. Key Clauses Beyond Indemnification and Escrows C. Setoff Rights - Sample Provision #2: Upon notice to Sellers Representative specifying in reasonable detail the basis thereof, Buyer may set off any amount to which it claims to be entitled from any Seller, including any amounts that may be owed under this Article or otherwise, against amount otherwise payable under the Promissory note or any provision of this Agreement. The exercise of such right of setoff by Buyer in good faith, whether or not ultimately determined to be justified, will not constitute a default under this Agreement, the Promissory Notes or any instrument securing any of the Promissory Notes, regardless of whether any Seller disputes such setoff claim or whether such setoff claim is for a contingent or an unliquidated amount. 35

36 II. Key Clauses Beyond Indemnification and Escrows C. Setoff Rights - Sample Provision #3: Buyer may offset any amounts to which it reasonably believes itself, in good faith, to be entitled under the terms of this Agreement against amounts otherwise payable by it under this Agreement; provided, however, that if the Securityholders Representative provides written notice to Buyer that the Securityholders Representative, in good faith, objects to the amount claimed by Buyer to be subject to any such exercise of offset rights, the amounts to which such objection notice relates shall be held in a separate account by Buyer pending resolution of such objection notice in accordance with the procedures set forth in Section 5.04 [Indemnification procedures]. 36

37 II. Key Clauses Beyond Indemnification and Escrows D. Cross Default Provisions Buyers may wish to trigger indemnity rights pursuant to a breach of other transaction-related agreements and documents such as: Employment Agreements Noncompetition Agreements Transitional Services Agreements Loan/Financing Documents Other Purchase Agreements (e.g. real estate purchase documents) Strategic/Commercial Agreements (license agreements, supply agreements, etc.) Ancillary documents such as officer certificates, reports, financial statements, etc. delivered in connection with the closing 37

38 II. Key Clauses Beyond Indemnification and Escrows D. Cross Default Provisions Sellers may wish to limit this type of remedy only to the main purchase agreement, merger agreement, etc. To claims against the Company/Seller for its actions and not for breaches by other parties, such as individual stockholders, a stockholder representative or employees/consultants of the Seller that are part of the same transaction 38

39 Representations & Warranties Insurance October 8, 2015 WGA White 2015 ARTHUR J. GALLAGHER & CO. BUSINESS WITHOUT BARRIERS

40 Topics for Discussion R&W Insurance Marketplace R&W Insurance Basics Obtaining R&W Insurance Why do Buyers / Sellers Purchase R&W Insurance WGA White

41 R&W Insurance Marketplace Product introduced in 1998 Increased product awareness, understanding and recognition Growing interest in the product from buyers looking to overcome obstacles to closing, private equity and venture capital firms divesting portfolio companies, financially-distressed companies, and shareholders selling closely-held companies. Law firms and investment banks are considering R&W insurance when structuring transactions for their clients. R&W Insurance Markets: AIG, AWAC, Concord Specialty Risk (managing underwriter), Ambridge Partners (managing underwriter), Lloyd s of London (Beazley and XL), ACE, Ironshore, The Hartford, Montpelier How much coverage is available? Individual carriers can provide up to $50 million in coverage for any one transaction. When additional coverage is required, we will work with several carriers to structure a program consistent with the desired level of coverage. WGA White What transactions are candidates for coverage? The representations and warranties insurance market is currently tailored to transactions where the purchase price for the acquired company or acquired business is generally in the range of $10 million to $1 billion ARTHUR J. GALLAGHER & CO. BUSINESS WITHOUT BARRIERS 41

42 R&W Insurance Basics Provides coverage for breach of representations & warranties / transfers indemnification obligations to insurance carrier Enables parties to more efficiently resolve disagreements regarding: Allocation of specific risks and liabilities Scope of indemnification obligations Security to support indemnification Coverage can be either buyer or seller based Buyer-Side Policy -- Reimburses the buyer for losses resulting from an inaccuracy in the representations and warranties made by the seller about the acquired company or business, thereby enabling the buyer to recover its losses directly from the insurer without having to first locate and then pursue the seller and its assets. Seller-Side Policy -- Reimburses the seller, or pays the buyer on behalf of the seller, for losses resulting from claims made by the buyer for an inaccuracy of the representations and warranties made by the seller about the acquired company or business, thereby protecting the seller from having to return a portion of the purchase price. Coverage can be placed either at, or following, either the signing or closing of the transaction. WGA White 2015 ARTHUR J. GALLAGHER & CO. BUSINESS WITHOUT BARRIERS 42

43 R&W Insurance Basics What does R&W Insurance cover? Breaches of representations and warranties in the Acquisition Agreement Can be drafted to cover all representations and warranties or specifically tailored to cover one or a select number of them What are the typical exclusions? Actual knowledge by specified deal team members of a breach or fact or circumstance that would reasonably be expected to give rise to a breach Covenants, projections, estimates and forward looking statements Fraud (Seller-side policy only) Matters disclosed in the Disclosure Schedules Post-transaction purchase price or net worth adjustments Deal specific exclusions WGA White 2015 ARTHUR J. GALLAGHER & CO. BUSINESS WITHOUT BARRIERS 43

44 R&W Insurance Basics Defense / Settlement of Seller Side Policy Insured has duty to defend / carrier has right to associate with defense Carrier must approve Insured s legal counsel Carrier must consent to any settlement What is the policy term of a R&W Insurance policy? R&W Insurance policies can be written for a duration of up to 6 years WGA White 2015 ARTHUR J. GALLAGHER & CO. BUSINESS WITHOUT BARRIERS 44

45 R&W Insurance Basics How much does R&W Insurance cost? One-time charge typically in the range of 3% - 4% of the amount of coverage purchased. The premium applicable to any particular transaction is a function of several variables, including the type of business being acquired, the form of acquisition agreement (is it pro-buyer, pro-seller, or neutral?), the types of representations and warranties covered, the breadth, depth and quality of the due diligence process, the insurance policy deductible, and the policy period. When Buyer-Side policy is used to eliminate Seller s indemnification obligations, premium range narrows to 3.5% - 4%. Minimum premium is generally around $100,000. Size of deductible? WGA White Carriers generally require a deductible in the range of 1% - 2% of the transaction value (not the insurance limit), depending on similar factors as described above. When Buyer-Side policy is used to eliminate Seller s indemnification obligations, minimum policy deductible is usually closer to 2%. How long does it take to obtain R&W Insurance? Typically 2-3 weeks from the execution of an NDA and the submission of the required documentation. Policies can be placed in less than one week in certain circumstances ARTHUR J. GALLAGHER & CO. BUSINESS WITHOUT BARRIERS 45

46 Obtaining R&W Insurance Execute NDA Provide Submission to Insurer Draft Acquisition Agreement, Target Financial Information, Confidential Information Memo Obtain Free Non-Binding Quote within 3-5 days Select Carrier and Pay Underwriting Fee Typically between $10,000 $50,000 depending on size and complexity of deal; satisfies Carrier s outside counsel fees Underwriting Process: 5-10 days High level audit of due diligence process Access to legal, financial, tax due diligence reports (if Buyer-side) and data room Conference call(s) with deal team and outside advisors Policy Negotiations Concurrent with underwriting process Work closely with outside counsel WGA White 2015 ARTHUR J. GALLAGHER & CO. BUSINESS WITHOUT BARRIERS 46

47 R&W Purchasing Drivers Why Buyers* Request Coverage Enhance Amount/Duration of Indemnity Distinguish Bid in Auction Ameliorate Collection Concerns Protect Key Relationships Protect the Deal Insure Certainty of Purchase Price Address Stakeholder Concerns Why Sellers** Request Coverage Distribute Sale Proceeds Increase Purchase Price Supplement Disclosure Process Protect Passive Sellers Expedite Sale Reduce Contingent Liabilities Address Stakeholder Concerns *For most deals, it s a strategic vs. risk management decision. Buyers may opt to include in bid packages. **Seller may opt to have it baked into the bid package; then flip it to the Buyer. WGA White 2015 ARTHUR J. GALLAGHER & CO. BUSINESS WITHOUT BARRIERS 47

48 Thank you Reed Sussman, Esq. Area Senior Vice President 470 Atlantic Avenue Boston, MA (617) WGA White 2015 ARTHUR J. GALLAGHER & CO. BUSINESS WITHOUT BARRIERS

49 Thank You John Marsalek Dorsey & Whitney 50 South Sixth Street Suite 1500 Minneapolis, MN (612) Dimitry Herman Herman Law LLC 268 Newbury Street Suite 400 Boston, MA (617)