Litigation-Ready Caveats For Stock And Asset Purchase Deals
When entering into a stock purchase agreement or asset purchase agreement, both the purchasers and the sellers should be mindful that no matter how straightforward the transaction may seem, it is always possible that a dispute will arise, and they will end up in litigation in the months or years following the closing.
The COVID-19 pandemic has introduced into the marketplace a once-in-a-generation disruption. Buyers and sellers have in many cases found themselves dealing with sometimes catastrophic changes in circumstances following completion of transactions, which have them looking for any advantage possible in post-closing disputes.
In this regard, parties have found that the content, breadth and clarity of certain provisions, discussed below, are paramount.
The Power of Representations and Warranties
The parties should be keenly attuned to the representations and warranties made by both sides in the agreement. Representations and warranties exist so that each party can receive critical assurances about the accuracy of certain claims or circumstances without engaging in their own due diligence to confirm as much.
If the representation or warranty turns out to be incorrect, the party who relied on the truth of the representation or warranty will be indemnified for any damages suffered as a result. Typically, the seller provides more representations and warranties than the purchaser because it is uniquely knowledgeable regarding the corporate structure, financial state and trajectory of the underlying company and its assets, liabilities and relationships.
For instance, a seller often represents and warrants that it is not aware of any events within a certain number of months preceding the effective date that would be materially adverse to the value of the company or its assets. Given the clear value of certain representations and warranties, oftentimes a purchaser will negotiate so that the seller remains liable for a representation and warranty even if the purchaser knew or should have known the falsity thereof.
Post-Closing Purchase Price Adjustments
The stock purchase agreement or asset purchase agreement should set forth a clear and unambiguous protocol for resolving disputes in connection with post-closing purchase price adjustments.
For example, where an agreement contemplates a true-up following the closing to reconcile any differences between the stated and actual accounts receivable or working capital, or any differences between the stated and actual value of any acquired inventory, the agreement should provide a time period for the purchaser to relay the total collected accounts receivable or sold inventory to the seller and for the seller to dispute the accuracy of these totals.
The same is true where an agreement contemplates a purchase price increase or decrease based on the seller’s ability to meet certain key performance indicators in the months or years following the closing.
The agreement should clearly set forth next steps in the event that the seller and the purchaser dispute any price adjustment by requiring that:
- The party seeking to invoke its right to a price adjustment serves a notice on the other party by a certain date and the party receiving the notice serves a responsive notice by a certain date;
- The parties engage in good faith negotiations to resolve any dispute;
- The parties engage an independent accountant to issue a binding decision on any dispute; and
- The parties refer the dispute to mediation or arbitration. The agreement should also clearly set forth who will bear the fees and costs associated with any third party such as an accountant, mediator or arbitrator.
The parties can agree that they must share the costs equally; that the party whose position is farthest from the third party’s determination must pay the full cost; or, that the parties pay a certain percentage of the third party’s cost based on a carefully crafted formula that takes into account the range between the purchaser’s and seller’s proposed numbers and the determined amount.
Where the stock purchase agreement or asset purchase agreement provide that certain disputes thereunder are subject to arbitration, in particular, the agreement should directly and expressly state what disputes are or are not governed by the clause, what happens when a dispute touches on a topic that may be addressed in arbitration and in court, and whether the arbitration clause is to be broadly or narrowly interpreted.
The more precise the clause, the more likely it will provide the parties with certainty so that they can avoid what happened in the 2020 Keystone Food Holdings Ltd. v. Tyson Foods Inc. ruling in the U.S. District Court for the Southern District of New York.
There, the stock purchase agreement provided that all breaches of representations and warranties shall be governed by a court of competent jurisdiction, but all disputes regarding International Financial Reporting Standards compliance shall be determined by Grant Thornton LLP; however, it did not address what happens when a dispute arises concerning a breach of the representation or warranty that the seller’s financial statements were accurate and IFRS-compliant.
Accordingly, when the purchaser contested the seller’s post-closing purchase price adjustments, which increased the indebtedness of the company by changing an improper classification of equipment financing leases, adding a portion of a shareholder loan to a Chinese joint venture, and adding long-term asset-retirement obligations which should have previously reserved, the parties disputed the appropriate forum to resolve their dispute.
The parties were ultimately left to the mercy of the court, which recognized ambiguity in the stock purchase agreement and engaged in its own analysis before determining that all disputes should be in arbitration. Had the parties contemplated the conflict between its arbitration and litigation clauses, they would have been better served.
The Interplay Between Agreements
The purchaser should make sure that any person on the seller side that is critical, in its view, to the continued success of the acquired entity/assets or to the profitability of the transaction, is addressed in the stock purchase agreement, asset purchase agreement or other simultaneously executed contracts. Purchasers and sellers generally contemplate how the owners and shareholders and highest-level executives and officers will be affected by the transaction.
They do not always, however, contemplate how the transaction will affect mid- or lower-level executives, officers and employees and, in certain situations, those mid- or lower-level personnel are critical to the short-term or even long-term functioning of the business.
Baskets and Caps
The purchaser and seller should also consider the confines of any limitation-of-losses provision. The parties can agree that any damages identified by the purchaser are not subject to indemnification by the seller unless and until they exceed a certain threshold amount — i.e., a basket — in order to avoid low-dollar disputes. The parties can also agree, for instance, to limit the seller’s liability with certain exceptions in the case of intentional misrepresentation, willful breach, gross negligence or otherwise.
Finally, the parties should not overlook the value of negotiating boilerplate provisions, such as those addressing:
- Jurisdiction or venue;
- Jury waiver; and
- The prevailing party’s right to attorney fees.
Each of these provisions can be used to a party’s advantage or disadvantage if litigation, or the threat of litigation, arises. In these types of transactions, oftentimes, the purchaser is not located in the same county, state or even country as the seller and, in this regard, if the seller is skeptical that the purchaser will honor any post-purchase price adjustments or otherwise, the seller may find it advantageous to get the purchaser to consent to jurisdiction in its home state.
For example, a seller based in New York’s Hamptons area on Long Island clearly comes out ahead, in one regard, if it is being acquired by a Europe-based purchaser that has a U.S. presence in California and is able to secure the purchaser’s consent to jurisdiction and venue in the Eastern District of New York, Central Islip — about 50 miles from Manhattan, presumably where the purchaser would go to secure counsel if litigation ensures.
The existence or omission of a provision setting forth the prevailing party’s right to fees can also be useful because it can help even the playing field or ensure an uneven playing field if one party has substantially more assets and resources than another. If, for instance, the purchaser is a major U.S. company with deep pockets, it might resist this provision because, after all, a fee-shifting provision won’t have a dramatic effect on its bottom line but it may embolden the sole shareholder who sold his stock or assets to sue if a dispute arises.
Moreover, while jury waivers are common in stock purchase agreements and asset purchase agreements because a judge is well-suited to decide sophisticated commercial matters, likeable sellers who, for instance, sell their small mom-and-pop to a big conglomerate may consider a jury trial.
The authors of this article Brett P. Garver, Corporate Partner and Chair of Moritt Hock & Hamroff’s Secured Lending Practice Group, and Kelly D. Schneid, Counsel at Moritt Hock & Hamroff’s Litigation Group, have been integral to transactions and litigations concerning SPAs and APAs, representing sellers and purchasers alike. Whether you are engaging in the sale of your $25 million, New York-based manufacturing company to an international conglomerate subject to a post-closing earn out price adjustment upon meeting an EBITDA target, engaging in the sale of your startup company and contemplating future employment by the acquiring entity with a graduating purchase price upon meeting key performance indicators, or seeking to purchase and revive the assets of a small family business valued in the six figures, the authors of this article are well-positioned to provide legal counsel.