LLC, PARTNERSHIP, LP & PASS-THROUGH MERGERS, PART 1 & PART

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1 LLC, PARTNERSHIP, LP & PASS-THROUGH MERGERS, PART 1 & PART 2 First Run Broadcast: May 16 & 17, 2017 Live Replay: March 21 & 22, :00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00a.m. P.T. (60 minutes each day) As LLCs and other pass-through entities have become the default choices of entity in most business, commercial, and real estate transactions, many mergers or assets sales now involve two or more pass-through entities. The familiar principles that apply to corporate mergers or asset sales do not translate to pass-through transactions. Rather, combinations of LLCs, LPs, partnerships and even S Corps are governed by a non-intuitive mix of jumble of rules which treat the transaction one way for business law purposes and quite another or tax purposes. Indeed, for income tax purposes, transactions following a variety of patterns are deemed to consist of a series of property contributions and distributions and taxed accordingly. Planning for both aspects is a very complex challenge. This program will provide you with a practical guide to planning both the business law and tax law aspects of merging pass-through entities. Day 1: March 21, 2018: Framework of non-tax and tax law for combining pass-through entities, partnerships, LLCs, LPs, and S Corps How transactions are treated for state law purposes v. tax law purposes Tradeoffs between assets v. membership interests/s Corp stock deals Non-tax benefits of entity deals contract assignments, licensing and registration transfers Successor liability issues in asset deals and how to mitigate risk Special considerations involving S Corp mergers triggering hidden taxes, losing S Corp eligibility, structuring restrictions Benefits of treating stock transactions as asset sales under IRC 338(h)(10) Day 1: March 22, 2018: Structural alternatives for combining LLCs and partnerships Framework of special tax issues for mergers involving LLCs and partnerships, including entity- and member-level treatment Treatment of distribution, voting and other rights when membership interests/s Corp stock is transferred Due diligence considerations of merging pass-through entities State and local sales tax issues on transfer of assets in the merger Incentive compensation issues Speakers: Paul Kaplun is a partner in the Washington, D.C. office of Venable, LLP, where he has an extensive corporate and business planning practice, and provides advisory services to emerging growth companies and entrepreneurs in a variety of industries. He formerly served as an Adjunct Professor of Law at Georgetown University Law Center, where he taught business planning.

2 Before entering private practice, he was a Certified Public Accountant with a national accounting firm, specializing in corporate and individual income tax planning and compliance. Mr. Kaplun received his B.S.B.A., magna cum laude, from Georgetown University and J.D. from Georgetown University Law Center. Norman Lencz is a partner in the Baltimore, Maryland office of Venable, LLP, where his practice focuses on a broad range of federal, state, local and international tax matters. He advises clients on tax issues relating to corporations, partnerships, LLCs, joint ventures and real estate transactions. He also has extensive experience with compensation planning in closely held businesses. Mr. Lencz earned his B.S. from the University of Maryland and his J.D. from Columbia University School of Law.

3 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address LLC, Partners, LP & Pass-through Mergers, Part 1 Teleseminar March 21, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER March 14, 2018 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

4 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address LLC, Partners, LP & Pass-through Mergers, Part 2 Teleseminar March 22, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER March 15, 2018 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

5 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: March 21, 2018 Seminar Title: LLC, Partners, LP & Pass-through Mergers, Part 1 Location: Credits: Program Minutes: Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

6 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: March 22, 2018 Seminar Title: LLC, Partners, LP & Pass-through Mergers, Part 2 Location: Credits: Program Minutes: Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

7 PROFESSIONAL EDUCATION BROADCAST NETWORK INTERSPECIES MERGERS Allen Sparkman Sparkman Foote, LLP Houston & Fort Worth, Texas, Denver, Colorado (o) (713)

8 Mr. Sparkman practices law in Denver and Houston as a partner of Sparkman + Foote LLP. Mr. Sparkman s practice includes the areas of business transactions, securities, tax, and professional responsibility. Mr. Sparkman s work includes the preparation of securities disclosure documents for start-up companies in a variety of fields, including offshore oil and gas exploration, foreign mining operations, real estate, and comic book certification. Mr. Sparkman also regularly prepares LLC and partnership documents, and represents buyers and sellers of businesses, including preparing or reviewing all necessary legal documents. Mr. Sparkman began practicing law in Dallas, Texas in 1973 and moved to Denver in In 2008, an opportunity presented itself that resulted in Mr. Sparkman opening an office of his firm in Houston, Texas, where he now spends a substantial portion of his time. Mr. Sparkman earned an A. B. degree in American History from Princeton University in Mr. Sparkman received a J. D. degree with high honors from the University of Texas School of Law in While in law school, Mr. Sparkman was a Vice-Chancellor, member of the law review, and served as a teaching assistant in legal research and writing and appellate advocacy and brief writing. Mr. Sparkman is listed in THE BEST LAWYERS IN AMERICA for both Colorado and Texas and speaks regularly at continuing legal education seminars in Colorado, Texas, and nationally on entity selection, fiduciary duties and governance, mergers and conversion, veil piercing, ethics, series LLCs, and tax planning. Mr. Sparkman has presented more than 100 papers at continuing education programs for the American Bar Association, the Colorado Bar Association, Continuing Legal Education in Colorado, the State Bar of Texas, the University of Texas School of Law, the Professional Education Broadcast Network, the Practicing Law Institute, the National Business Institute, and other continuing education providers. He is the author of numerous articles on choice of business entity and series LLCs. Mr. Sparkman s published articles include Fifth Circuit Misses Opportunity to Bring Clarity to Series LLC Questions, Business Law Today (April 2014), Series LLCs in Interstate Commerce and Tax Aspects of Series LLCs, Business Law Today (February 2013), and The Series LCC: A New Planning Tool by Adrienne Randle Bond and Allen Sparkman, 45 Texas Journal of Business Law (Fall 2012). Mr. Sparkman is a contributing author to William Schmidt Preserving Your Wealth: A Guide to Colorado Probate & Estate Planning (2012), Practitioner s Guide to Colorado 2

9 Business Organizations (Colorado Bar Association, Allen E. F. Rozansky and E. Lee Reichert, Managing Editors), and Guide for Colorado Nonprofit Organizations (Colorado Bar Association, Karen E. Leaffer, Managing Editor). Mr. Sparkman has served several times as an expert witness in Colorado, Texas, and California in cases involving duties of directors, director deadlock, duties of managers, duties of partners, construction of operating agreements, construction of partnership agreements, construction of contracts, veil piercing, and attorney malpractice. Mr. Sparkman has been qualified as an expert witness in the district court for Denver, Colorado. Mr. Sparkman is a member of the American, Colorado, and Houston Bar Associations, the State Bar of Texas, the Texas Center for Legal Ethics, the Center for Professional Responsibility, and the Association of Professional Responsibility Lawyers. For the American Bar Association, Mr. Sparkman is an active member of the Business Law Section and its Committees on Corporate Governance (co-chair, task force on governance of social benefit entities; co-chair, joint committee on governance of Corporate Governance Committee and Nonprofit Committee); LLCs, Partnerships and Unincorporated Associations (chair, task force on model Series LLC operating agreement); Mergers and Acquisitions; Middle Market and Small Business (co-chair, governance subcommittee); Nonprofit Organizations; and Professional Responsibility (chair, subcommittee on state and local liaisons). He is also a member of the American Bar Association Tax Law Section and Real Property, Probate and Trust Law Section. Mr. Sparkman is a member of the Drafting Committee on Series of Unincorporated Business Entities of the National Conference of Commissioners on Uniform State Laws as an ABA Section Advisor, ABA Business Law Section. Mr. Sparkman is a past chair of the Business Law Section of the Colorado Bar Association. Mr. Sparkman is an active member of the Ethics Committee of the Colorado Bar Association, the Colorado Secretary of State s Advisory Committee for Business and Commercial Laws, and the Legislative Drafting Committee of the Business Law Section of the Colorado Bar Association. Mr. Sparkman was the Colorado reporter for State Limited Partnership Laws and State Limited Liability Company Laws while those were published by Aspen Law & Business. 3

10 MERGING DIFFERENT SPECIES OF BUSINESS ENTITIES STATE LAW ISSUES I. State Law Aspects of Mergers. Most state statutes now allow mergers of corporate entities and unincorporated entities. 1 The Revised Model Business Corporation Act ( RMBCA ) provides for such mergers and also provides for share exchanges involving unincorporated entities. 2 The flexibility and ease of use of the limited liability company form has made them very popular in many states and clients often ask about merging an LLC with a corporation or partnership. II. Approval of a Merger in General. A. Typically, the state statute will require the adoption of a plan of merger. For example, Colorado law requires that a plan of merger state: (a) The entity name or, for an entity that has no entity name, the true name, the jurisdiction under the law of which the entity is formed, and the form of entity of each of the merging entities; (b) The entity name or, for an entity that has no entity name, the true name, the jurisdiction under the law of which the entity is formed, and the form of the surviving entity into which the merging entities are to merge; (c) The terms and conditions of the merger, including the manner and basis of changing the owners' interests of each merging entity into owners' interests or obligations of the surviving entity or into money or other property in whole or in part; and (d) Any amendments to the constituent documents of the surviving entity to be effected by the merger. 3 1 E.g., Colo. Rev. Stat ; Texas Business Organizations Code ( TBOC ) ; 8 Del. C (general partnerships), (limited partnerships), (limited liability companies). 2 RMBCA et seq. 3 Colo. Rev. Stat (1). 4

11 B. State law must be consulted for approval requirements. In Colorado, the merger of a corporation must be approved by a majority vote of shareholders unless a greater vote is required by the articles of incorporation. 4 Approval of a merger of an unincorporated entity is based on the entity documents. 5 If the entity documents do not include merger provisions, the Colorado statute looks to the document s amendment provisions. 6 If the entity document is silent with respect to amendment, unanimous approval is required. 7 A Delaware corporation may merge into or consolidate with a partnership or limited liability company by majority vote. 8 The default rule for approval of a merger of a corporation under the RMBCA is majority vote. 9 The Texas default rule for the merger of a corporation is two-thirds approval. 10 In Delaware, the default rule requires unanimous approval for the merger of a partnership; 11 Delaware requires majority approval for the merger of a limited liability company if the LLC agreement does not include provisions for the approval of such transactions and if the LLC agreement doesn t prohibit mergers. 12 If a Delaware limited liability company is the survivor of a merger, the plan of merger may effect any amendment to the LLC agreement or effect the adoption of a new LLC agreement, and the adoption of the amendment or the new LLC agreement will be effective notwithstanding any provision of the LLC agreement relating to amendment or adoption of a new LLC agreement other 4 Colo. Rev. Stat (5). 5 Colo. Rev. Stat (2). 6 Id. 7 Id. 8 8 Del. C. 251 (corporate approval), 263(c) (partnerships) (approval of a shareholder who will become a general partner is required), 264(c) (limited liability companies). 9 MBCA 7.25(c), TBOC Del. C (c) Del. C (b), (h). 5

12 than a provision that by its terms applies to an amendment or adoption in connection with a merger. 13 Texas provides that a plan of merger may include amendments to the governing documents of any surviving entity, but does not have language like Delaware s that allows the plan of merger to override the general amendment provisions of the governing documents. 14 C. All state merger statutes and the RMBCA include greatly relaxed approval requirements for certain subsidiary entities and mergers in which the ownership of the survivor is the same before and after the merger. D. Both the Texas and the Delaware provisions require that all the partners approve the merger of a partnership if the partnership agreement does not contain provisions for approving a merger. Assume a partnership agreement that is silent with respect to mergers, or that contains a provision requiring that a merger be approved by a three-fourth s vote, but permits amendments by a majority vote. Is there a potential problem if, on the eve of approving a plan of merger for the partnership, the partnership agreement is amended by a bare majority vote to add a provision allowing approval of a merger by a majority vote? In Twin Bridges Limited Partnership v. Draper, C.A. No Del. Ch. Sept. 14, 2007, the court applied the step transaction doctrine familiar to tax lawyers to the analysis of the legal consequences of the amendment of a partnership agreement to eliminate a super-majority voting requirement followed by the partners approval (under the amended provision) of the merger of the partnership into a newlyformed limited partnership with a different governing structure. Although the Delaware Chancery court treated the two transactions as one, it upheld the amendment and merger based on its interpretation of the partnership agreement. In Fox v. I-10, LTD., 957 P. 2d 1018 (Colo. 1998), the Colorado Supreme Court upheld the amendment of a limited 13 8 Del. C (f). 14 TBOC (1). 6

13 partnership agreement by majority vote to increase the contribution obligation of a limited partner who voted against the amendment. E. If a person will have personal liability as a result of a merger, the consent of that person may be required. 15 In the case of the merger of a corporation into a partnership with the partnership as the surviving entity, Delaware law requires the consent of any shareholder who will become a general partner. 16 III. Special State Law Issues in Mergers of Corporations with LLCs or Partnerships. A. The merger of a corporation with a limited liability company or partnership raises several state law issues. B. Are shareholders who dissent from the conversion or merger entitled to statutory appraisal rights? 1. Yes in Colorado Yes in Texas Yes in Delaware Yes in RMBCA E.g., ULLCA 1014; TBOC (f) Del. C. 263(c). This rule appears to be applicable even if the resulting partnership is a limited liability partnership. 17 Colo. Rev. Stat (2), Tex. BOC (b), (a)(1)(D), Del. C. 262(b) (corporations); 6 Del. C (limited liability company may provide for appraisal rights by agreement). 20 RMBCA 13.02(a)(7). 7

14 C. How do shareholders become parties to the partnership or operating agreement? Colorado law defines operating agreement as any agreement of all of the members. 21 TBOC (1) defines company agreement as the agreement of the members. Delaware law is the same The TBOC states that: the ownership or membership interests of each organization that is a party to the merger and that are to be converted or exchanged, in whole or part, into ownership or membership interests, obligations, rights to purchase securities, or other securities of one or more of the surviving or new organizations, into cash or other property, including ownership or membership interests, obligations, rights to purchase securities, or other securities of any organization, or into any combination of these, or that are to be canceled, are converted, exchanged, or canceled as provided in the plan of merger, and the former owners or members who held ownership or membership interests of each domestic entity that is a party to the merger are entitled only to the rights provided by the plan of merger or, if applicable, any rights to receive the fair value for the ownership interests provided under Subchapter H A problem may arise if a merger is approved and there are shareholders who vote against the merger but who do not exercise their dissent and appraisal rights. For example, even with respect to shareholders who vote for the merger, the TBOC would only provide that each such shareholder would have a membership interest in the LLC and would be a member of the LLC, or would have a partnership interest in the partnership and would be a partner of the partnership. Presumably, the plan of merger could provide that a shareholder who assented to the plan of merger would also thereby be assenting to the partnership or company agreement that was included in the plan of merger. Query whether the plan of merger could include an enforceable provision that a shareholder who voted against approval of the plan of merger would be deemed to have 21 Colo. Rev. Stat (11)(a) Del. C (7). 23 Tex. BOC (a)(8). 8

15 assented to the terms of the partnership or company agreement if the shareholder did not exercise the shareholder s dissent and appraisal rights. 3. The law may be more precise in other states. For example, Colorado law provides that, unless otherwise provided in the plan of merger, a shareholder who dissents from the merger but who does not elect appraisal rights is statutorily deemed to be a member of the resulting limited liability company or partnership and to be a party to the operating or partnership agreement. 24 Delaware law would appear to permit inclusion of a comparable provision in the plan of merger. Delaware does not require that a partner or member execute a partnership of LLC agreement to be bound thereby. 25 IV. May an Individual Series of a Series LLC Merge on its Own? A. Several states, beginning with Delaware, have added provisions to their LLC statutes allowing an LLC to create series. The idea is that each series, though established by a single juridical LLC, is treated as an enterprise separate from each other and from the LLC itself. Each series has associated with it specified members, assets, and obligations, and due to what have been called internal shields the obligations of one series are not the obligation of any other series or of the LLC. B Similar LLC legislation has now been adopted by Alabama (H.B. 2, Ala. Reg. Sess. 2014, amending Title 10A, Code of Ala. 1975, effective Jan. 1, 2015), Delaware (DEL. CODE ANN. tit. 6, ), the District of Columbia (D.C. CODE ), Kansas ( K.S , 143), Illinois (805 ILCS 180/37-40), Iowa (IOWA CODE ANN ),Missouri (Mo. Rev. Stat ), Nevada (NEV. REV. STAT ), Oklahoma (OKLA. STAT. tit. 18, 2054), Puerto Rico (14 L.P.R. 3967), Tennessee (TENN. CODE ANN ), Texas (TEX. BUS. ORG. CODE ), 24 Colo. Rev. Stat (3) Del. Code (12)(general partnerships), (12)(limited partnerships), (7)(limited liability companies). 9

16 and Utah (UTAH CODE ANN ). In addition, three states have legislation providing for entities known as series LLCs, but the statutes in these states do not provide for internal liability shields: Minnesota (MINN. STAT. 322B.03), North Dakota (N.D. CENT. CODE ), and Wisconsin (WIS. STAT ). Delaware law also provides for series limited partnerships. DEL. CODE ANN. tit. 6, (2007). The District of Columbia, Kansas, Illinois, Iowa, and Missouri Series LLC statutes permit the Series LLC to elect to treat individual series as separate entities. D.C. Code , K.S ,143, 805 ILCS 180/37-40(b), IOWA CODE ANN , and Mo. Rev Stat The District of Columbia, Illinois, and Kansas require the filing of a certificate for each series. C. Except for the District of Columbia, Kansas, Iowa, and Illinois, the state series legislation provides that a series is not a separate entity that on its own can engage in a merger. V. Protecting Your Client. 1. In General. When the owner of a business decides to sell his or her business, the owner primarily wants to be sure that upon agreement with a buyer, the seller is assured of receiving a known price. The seller may also be concerned about a number of other matters, including the seller s ability to compete with the buyer after the sale, the impact of the announcement of the sale on the seller s employees and customers, and whether the seller s employees will be offered employment with the buyer. The buyer is concerned primarily that he or she will get what the seller purports to have, both in assets and historical earnings. The buyer also will be very concerned to have confidence that all seller liabilities have been disclosed and may also be concerned about preventing the seller from competing with the buyer after the sale and whether 10

17 all, or perhaps just certain key, employees of the seller will continue with the buyer. The attorney for the seller or buyer should understand his or her client s goals, wishes, and priorities. The attorney should ask what the client most wants to achieve, what are the next two or three important goals, and what would be nice to achieve but can be ditched if it will help achieve one of the important goals. When an attorney is representing the buyer or seller in the sale of a business, it is helpful if the attorney understands what a purchase and sale agreement typically contains for the protection of the buyer and seller, what the typical negotiating points are, and what contract language may be said to be standard or generally acceptable in the market. The Mergers and Acquisitions Committee of the Business Law Section of the American Bar Association makes available many useful resources. This paper identifies some of those resources and provides and comments on representative contract language. 2. Form of Consideration. One of the basic decisions that has to be made early in the planning process by all parties is what form of consideration is to be used. The use of cash or other assets other than purchaser s stock in a transaction involving corporations generally causes an immediate income tax consequence. The use of the acquirer s common stock opens up more opportunities to avoid or defer income taxes but raises all the investment issues that accompany any large stock investment plus the additional concerns that may arise under federal and state securities laws. Receipt of restricted securities generally involves a required holding period during which the holder is unable to protect himself or herself from a falling market. In addition, compliance by the acquirer with the registration requirements of Section 5 of the federal Securities Act of 1933 may be prohibitively expensive or otherwise unfeasible. The acquirer may only be willing (or able) to use 11

18 cash or to use stock, and the owners of the target may have differing desires and needs. 3. Example Sale Facts. Assume that Janie Seller has been operating a successful lemonade stand at the corner of 34 th and Vine during summers for a number of years. During the cooler months, she has offered hot chocolate after school hours. Although Janie has no legal right to exclusive use of her corner, the other girls in the neighborhood respect her long use and would never think of trying to interfere. Janie wants to become more involved in school sports, and this will make it difficult to continue her business. Susie Buyer is a few years younger than Janie and moved to the neighborhood just a few months ago. She and Janie got to talking when Susie stopped for a lemonade, and Susie agreed to buy Janie out if they could agree on a few things. Janie wants $100 for her lemonade and hot chocolate stand. For $100, she will transfer her stand and all inventory and equipment to Susie. Susie wants Janie to agree to introduce Susie around to all the girls in the neighborhood so they will know Susie is Janie s rightful successor. Susie is also worried about Janie s younger sister, who is too young now to be a threat but may be in a year or two. 4, Agreeing on Final Purchase Price. One of the most important issues in any sale of a business is what procedure the parties will follow to agree on a final purchase price. Here, Janie wants $100, and Susie is willing to pay that if certain conditions are satisfied, including confirmation that Janie s earnings the last 12 months were at least $20. In most private M&A transactions in the United States, the purchase price agreed on at signing is subject to a postclosing adjustment based on the closing date amount of specified financial 12

19 items such as net working capital, net assets, cash, and debt. 26 Commentators label this approach the Completion Accounts method. 27 The Completion Accounts method typically is dispute-prone, permits manipulation by the seller, and requires heavy negotiation of accounting methods and principles. An alternative that has been becoming popular in Europe is the Locked-Box Approach. 28 Under the Locked-Box Approach, the parties do not provide for any purchase price adjustments. Instead, the parties negotiate the purchase price by considering all the balance sheet items as of a date prior to signing and projections of those amounts as of the targeted closing date. 29 The representations, warranties, and covenants buyers rely on in a locked box approach to preserve the value of the target before closing generally are similar to those used in the completion accounts method. However, they are often stricter and carve out typical materiality, basket, and cap qualifiers. Anti-leakage protection may include prohibiting all cash distributions or other dividends, asset transfers, and management fees or other related-party payments. Ordinary course operation also will be required. The completion accounts method allows sellers more flexibility to take cash out or move other assets or liabilities in or out because the contract s adjustment mechanism will take such actions into account in the post-closing adjustments. The primary advantage offered by the locked box approach is greater price certainty at signing and less to quarrel about after closing. The J. P. Morgan 2013 M & A Holdback Escrow Report states that when an escrow account 26 William Lawlor and Eric Siegel, Assessing the Locked Box Approach to Purchase Price Adjustments, Deal Lawyers (March-April 2012) (Executive Press, Inc. Concord, CA.). 27 Id. 28 Id. 29 Id. 13

20 was bifurcated to segregate a portion of the escrowed funds for a specific purpose, purchase price adjustment was the most common reason for bifurcation, accounting for 63% of all secondary accounts. Although purchase price adjustments were only 32% of the claims made in the J. P. Morgan report, of escrow funds paid out to satisfy buyer claims, 52% was paid because of purchase price adjustments. In both the completion accounts method and the lock box approach, the buyer will insist on covenants regarding conduct of the seller s business between signing and closing and limits on distributions, changes in executive compensation, sales of seller s assets not in the ordinary course, and other actions. To monitor compliance with these covenants, the buyer will want a provision allowing it to access the seller s books and records. A typical contract provision might look like this: The Company shall provide Parent and its representatives reasonable access during normal business hours to (a) all of the premises, properties, books, Contracts, documents and records of the Company and Subsidiaries, (b) all other information concerning the business, properties and personnel (subject to restrictions imposed by applicable Law) of the Company and Subsidiaries as Parent may reasonably request, and (c) all employees, customers or suppliers of the Company or any of its Subsidiaries as identified by Parent. The Company shall provide to Parent and its accountants, counsel and other representatives copies of internal financial statements (including Tax Returns and supporting documentation) promptly upon request; provided, however, that no information discovered through the access afforded by this Section shall (x) limit or otherwise affect any remedies available to Parent, (y) constitute an acknowledgment or admission of a breach of this Agreement, or (z) be deemed to amend or supplement the Disclosure Schedule or prevent or cure any misrepresentations, breach of warranty or breach of covenant. Issues raised by the above sample language include: 14

21 Does the seller have reason to restrict the buyer s contacting the seller s customers or suppliers? Will the proviso at the end of the language be enforceable? See the discussion of sandbagging below. Other concerns common to both approaches to determining the purchase price include: Continuing the indemnification rights and benefits of director (or manager) and officer insurance for the benefit of directors, managers, and officers of the seller; Providing for who has the responsibility and authority to determine the content of tax filings for taxable periods of the seller ending before the closing and for any such taxable period that straddles the closing. A representative provision for continuing indemnification and insurance is: Continuing Indemnification; Insurance Policy. Parent and Merger Sub agree that all rights to indemnification (including advancement of expenses) existing on the date hereof in favor of the present or former managers and officers of the Company with respect to actions taken in connection with the Company prior to Closing as provided in the Company s Charter Documents shall survive the Closing and continue in full force and effect for a period of six years following the Closing. Parent shall maintain in effect, or shall cause the Surviving Company to maintain in effect, a managers and officers liability insurance policy covering those persons who are currently covered by the Company s managers and officers liability insurance policy with coverage in amount and scope at least as favorable as the Company s existing coverage; provided, however, that this Section shall be deemed to have been satisfied if a prepaid policy has been obtained by Parent or the Surviving Company which provides such persons with the coverage described in this Section for an aggregate period of not less than six years with respect to claims arising from facts or events that occurred on or before the Closing Date, including with respect to the transactions contemplated by this Agreement. Parent shall bear all costs and expenses associated 15

22 with the policy required to be purchased and maintained pursuant to this Section unless the aggregate annual cost thereof exceeds 150% of the annual cost thereof to the Company immediately prior to the Closing, in which case Parent shall acquire the maximum amount of coverage that can be obtained for a premium not to exceed such 150% amount. The Company and its present and former members, and Management Committee members are hereby expressly made intended third party beneficiaries of this Section, and this Section may be enforced by all or any of them without joinder of any other Person. A representative provision for taxes is: Tax Matters. (a) Parent shall prepare and timely file (taking into account extensions granted), or cause to be prepared and timely filed, any Tax Returns (other than income Tax Returns) for the Company and the Subsidiaries for any period that ends on or prior to the Closing Date that are required to be filed after the Closing Date. All such Tax Returns shall be used in a manner consistent with the Tax Returns of the Company and the Subsidiaries for preceding Tax periods, unless a different treatment is required by Applicable Law. Representative [defined as one of the members of the target Company who is designated to act for all of the members after the closing in certain matters] shall prepare and timely file (taking into account extensions granted), or cause to be prepared and timely filed, any income Tax Returns for the Company and the Subsidiaries for any period that ends on or prior to the Closing Date that are required to be filed after the Closing Date. (b) In the case of Taxes that are payable with respect to any Straddle Period, the portion of any such Tax that is attributable to the portion of the Straddle Period ending on and including the Closing Date shall be: (i) in the case of Taxes that are either (A) based upon or related to income or receipts, or (B) imposed in connection with any sale or other transfer or assignment of property (real or personal, tangible or intangible), deemed equal to the amount that would be payable if the Taxable period of the Company and the Subsidiaries ended with, and included, the Closing Date; and (ii) in the case of Taxes that are imposed on a periodic basis with respect to the assets of the Company and the Subsidiaries, deemed to be the amount of such Taxes for the entire Straddle Period, or, in the case of such Taxes determined on an arrears 16

23 basis, the amount of such Taxes for the immediately preceding period, multiplied by a fraction the numerator of which is the number of calendar days in the portion of the Straddle Period ending on and including the Closing Date and the denominator of which is the number of calendar days in the entire Straddle Period. (c) If Parent or the Surviving Company becomes aware of any assessment, official inquiry, examination or proceeding (a Tax Proceeding ) that could result in an official determination with respect to any Buyer Indemnified Tax, Parent shall promptly so notify the Representative; provided, however, that the failure to so notify the Representative shall not relieve the Unitholders of their obligations with respect to such Buyer Indemnified Tax unless, and only to the extent that, such failure results in actual material prejudice to the Unitholders. If the Representative becomes aware of any Tax Proceeding that could result in an official determination with respect to Taxes related to the Surviving Company or any of the Subsidiaries, the Representative shall promptly so notify Parent; provided, however, that the failure to so notify Parent shall not relieve Parent of its obligation under this Section unless, and only to the extent that, such failure results in actual material prejudice to Parent. (d) Parent shall exercise control over the contest and/or settlement of any issue raised in any Tax Proceeding with respect to Taxes (other than income Taxes for a pre Closing Tax period) related to the Surviving Company or the Subsidiaries; provided, however, that (i) Parent shall keep the Representative informed of all material developments with respect to such Tax Proceeding if it relates to any Buyer Indemnified Taxes. Any reasonable expenses incurred in connection therewith shall be paid by Parent to the extent that such expenses relate to a Tax that is not a Buyer Indemnified Tax. To the extent that expenses incurred in connection to a Tax Proceeding relate to a Tax that is a Buyer Indemnified Tax, Parent shall make a claim for indemnification pursuant to Section and the Escrow Agreement. (e) The Representative and Parent shall provide each other with any information reasonably necessary to prepare and file complete and accurate Tax Returns. (f) Any disputes arising with respect to this Section shall be resolved by the Neutral Firm pursuant to the procedures set forth in Section regarding submission of unresolved items by the Neutral Firm. (g) Allocated Values. Within thirty (30) Business Days after the Closing Date, the Parent will prepare or cause to be prepared and deliver to the Representative a schedule (the Allocation 17

24 Schedule ) in accordance with the provisions of Sections 1060 of the Code and the regulations thereunder (and any similar provision of state, local, or foreign Tax law), which allocates for federal income tax purposes the Total Merger Consideration (and all other capitalized costs) to the assets of the Company. If the Representative has any objections to the Allocation Schedule, Parent and the Representative shall negotiate in good faith to resolve such objection. Neither Parent nor the Unitholders shall take any position on any Tax Return, in any audit or otherwise, that is inconsistent with the Allocation Schedule unless expressly required to do so pursuant to applicable Law. 5. Compliance with Securities Laws. If all or part of the consideration for the sale is securities of the buyer, the buyer typically will want to qualify the offering of securities under Rule 506 of Regulation D. 30 Rule 506 allows offerings in any amount so long as there are no more than 35 non-accredited purchasers, and the non-accredited purchasers meet certain sophistication requirements or are represented by purchaser representatives who do. Regulation D does not require that any particular information be provided to accredited investors, 31 but Regulation D does require that specified information be provided to non-accredited investors. Compliance with these information requirements can be costly and time-consuming. Accordingly, the buyer will need to know whether any of the owners of seller are not accredited investors within the meaning of Regulation D. If there are seller owners who are not accredited investors, the buyer, unless it is willing to provide the additional disclosure that would be required in an offering to nonaccredited investors, will want a contact provision providing that nonaccredited investors will be cashed out: If Parent determines that it is unable to reasonably believe that one or more Unitholders, Warrantholders, or Optionholders is an Accredited Investor, then in lieu of the shares of Parent Common C.F.R Regulation D is at 17 C.F.R However, Regulation D points out that the anti-fraud provisions of the securities laws apply. 18

25 Stock otherwise deliverable to any such holder, such holder shall be paid cash in an amount equal to the amount of Merger Consideration payable to such holder at Closing and in the amount of any Earn-out Consideration that becomes payable to such holder, the amount of such cash in respect of Merger Consideration or Earn-out Consideration, as the case may be, being equal to the product of the number of shares of Parent Common Stock otherwise deliverable in each case to such holder under Section multiplied by the Parent Volume Weighted Average Price; (such aggregate amount of cash deliverable to all such holders being the Unaccredited Cash ). The buyer must also comply with any applicable state securities laws. However, if the transaction qualifies under Rule 506 of Regulation D, the buyer will only have to make a notice filing with any applicable state. Also, many states have exemptions for offerings made only to accredited investors or only to a small number (10-20) of offerees. Often such exemptions require no filing. 6. How Long Will Representations Continue? The parties must negotiate how long the representations of the seller will continue after closing. The seller would prefer that the representations terminate at closing; the buyer would prefer that they continue indefinitely. A typical period is one year: All of the representations and warranties made by each party in this Agreement shall survive the Closing and continue in full force and effect until the date that is 12 months from the Effective Time (the Survival Period Termination Date ); provided, however, that the representations contained in Section [Taxes] shall continue in full force and effect through the expiration of the applicable statute of limitations. All covenants and other agreements contained in this Agreement shall survive the Closing indefinitely unless a specific time period is assigned to them. 7. Remedies and Caps or Baskets. With respect to the seller s representations and warranties, and the seller s obligation to indemnify the buyer, the contract typically will include provisions specifying if indemnification is the exclusive remedy and whether there are any caps or other limits. Sample language might be: 19

26 Exclusive Remedy. From and after the Effective Time, except for the remedy of specific performance, and except in the case of fraud, indemnification under this Article shall be the sole and exclusive remedy for any claim or action related to or arising out of the transactions contemplated by this Agreement or the operating for the Company prior to the Closing, whether such claim or action is based on contract, tort or otherwise. Parent, Merger Sub and the Company each hereby waive any provision of any Applicable Law to the extent that it would limit or restrict the agreement contained in this Section. The indemnification obligations set forth in Section and (other than for breaches of Sections or ) [representations relating to capitalization of the target, authorization, due execution, and binding effect, and taxes] and Section ) [inaccuracy of representations and warranties, certificates, a required spreadsheet, fraud, or intentional or willful breach of a representation or warranty] shall apply only after the aggregate amount of claims for indemnification against the Company under this Agreement exceeds $50,000 (the Deductible ), and thereafter the indemnifying party shall be liable for all indemnification obligations in excess of the Deductible. The aggregate amount of all indemnification obligations of the Effective Time Holders pursuant to Section and shall not exceed the sum of $3,000,000, plus 10% of the product of the number of shares of Parent Common Stock deliverable as Earn-out Consideration times the Parent Volume Weighted Average Price (such sum, the Cap ), provided that the Cap shall not apply to any breach of the representations and warranties contained in Sections [representations relating to capitalization of the target, authorization, due execution, and binding effect, and taxes]or. [nonfulfillment or breach of any covenant, any inaccuracy in the required spreadsheet, or a claim by any person that such person is entitled to any property of, or equity interest in, the target Company]. Except as set forth below, any amounts payable by the Effective Time Holders pursuant to Section 7.2(a)(i) and (ii) shall be satisfied solely and exclusively by (A) the Effective Time Holders surrendering Escrowed Shares in proportion to their Ownership Interest Share in accordance with the terms of the Escrow Agreement, and (B) if and to the extent that a Buyer Indemnified Party is entitled to indemnification in amounts in excess of any then remaining Escrowed Shares, Parent s withholding of the delivery of Earn-out Shares. For the avoidance of doubt, the rights of the Buyer Indemnified Parties to make 20

27 claims against the Escrowed Shares and to withhold Earn-out Shares are the Buyer Indemnified Parties exclusive remedy with respect to indemnification under Section and, other than indemnification for breaches of Sections or [representations relating to capitalization of the target, authorization, due execution, and binding effect, and taxes]. No Effective Time Holder shall be liable for indemnification under Section or for breaches of Sections or [representations relating to capitalization of the target, authorization, due execution, and binding effect, and taxes] or under Section [nonfulfillment or breach of any covenant, any inaccuracy in the required spreadsheet, or a claim by any person that such person is entitled to any property of, or equity interest in, the target Company] in amount in excess of the value of the Total Merger Consideration received by such Effective Time Holder (with the Parent Common Stock received by each Effective Time Holder being deemed to have a value equal to the Parent Volume Weighted Average Price for the purpose of such limitation). A Buyer Indemnified Party entitled to indemnification under Section for breaches of Sections or [representations relating to capitalization of the target, authorization, due execution, and binding effect, and taxes] or under Sections [nonfulfillment or breach of any covenant, any inaccuracy in the required spreadsheet, or a claim by any person that such person is entitled to any property of, or equity interest in, the target Company] shall first seek indemnity from any then remaining Escrowed Shares and, to the extent applicable, from Parent s withholding of the delivery of Earn-out Shares. For the purpose of satisfying any indemnification amounts payable under Section, Escrowed Shares and Earn-out Shares shall be deemed to have a per share value equal to the Parent Volume Weighted Average Price. The aggregate value of any indemnification obligations of Parent shall not exceed the Cap. 8. How are Losses Determined? The purchase and sale agreement should also define how losses are determined for purposes of the indemnification obligation, for example: Losses Defined. For all purposes of and under this Agreement, Losses shall mean (i) any loss, claim, demand, damage (including any consequential, incidental, indirect, special or punitive damages), deficiency, lost profits, liability, judgment, fine, penalty, diminution in value, cost or expense (including 21

28 reasonable attorneys, consultants and experts fees and expenses), (ii) any and all reasonable fees and costs of enforcing an Indemnified Party s rights under this Agreement, and (iii) any and all reasonable fees and costs defending any Third Party Claims. For all purposes under Article, any qualifications in the representations, warranties and covenants with respect to a Material Adverse Effect, materiality, material or similar terms shall be disregarded with respect to the calculation of the amount of any Losses attributable to a breach of any such representation, warranty or covenant. 9. Providing for Termination of Agreement. Although the parties to a purchase and sale agreement ordinarily will want the sale to close and will work toward that end in good faith with no fingers crossed, the agreement should provide for its possible termination, for example: Effect of Termination. Upon termination of this Agreement, this Agreement shall forthwith become null and void and there shall be no Liability on the part of any party hereto, or their respective managers, members, directors, stockholders, officers, employees, agents and Affiliates; provided, however, that nothing herein shall relieve any party from any Liability for any willful breach by such party of any of its representations or warranties or for its breach of any of its covenants or agreements set forth in this Agreement, and all rights and remedies of such nonbreaching party under this Agreement in the case of such a breach, at law or in equity, shall be preserved; provided further that Article [general provisions such as notice, assignment, expenses, and governing law] shall survive any such termination. 10. Should Buyer s Claims be Reduced for Tax Benefits? A common ploy by sellers is to assert that if the seller has to pay a claim made by the buyer, the seller s payment should be reduced by the tax benefit the buyer receives from the payment. The Private Target Mergers and Acquisitions Deal Points Study (hereafter, Deal Points Study ) 32 reports that 52% of deals provided for a reduction in the seller s liability for the tax benefit to the buyer. Moreover, 32 A Project of the M & A Market Trends Subcommittee of the Mergers and Acquisitions Committee of the Business Law Section of the American Bar Association (including transactions completed in 2012) (December 31, 2013). 22