“Public companies” in the U.S. fall into two general categories: companies that are required to file reports in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) applicable to U.S. domestic companies (which can include some companies incorporated outside the U.S.) and companies that qualify for certain reporting accommodations as “foreign private issuers.” The following discussion in connection with acquisitions of public companies relates principally to acquisitions of companies that report to the SEC in accordance with the domestic U.S. disclosure requirements. The SEC has rules relating to cross-border acquisitions that allow acquisitions of foreign companies with U.S. ownership below a certain threshold to proceed without full SEC registration or extensive disclosure, provided certain conditions are met.
Acquisitions of U.S. public companies (“public targets”) involve a number of U.S. securities law and other considerations that are not generally involved in private company transactions. Because of these differences, public company acquisitions may take a number of forms, including:
Acquisitions of public targets can be either cooperative, in which the board of directors of the public target negotiates an acquisition or merger agreement with the acquiror, or hostile, in which the acquiror seeks to acquire the public target without the cooperation, and in some cases involving the active opposition of public targets, by the public target.
Acquisitions may be more complicated if the target has put into place certain anti-takeover measures, such as classified boards (where board member terms are staggered over a period of years) or “poison pill” provisions in the target’s governing documents. In addition, some states have control share acquisition statutes that restrict the ability of an acquiror to acquire shares of a target unless the provisions of the statute are complied with. Generally, public targets have the ability to waive the application of such statutes in their certificates of incorporation or pursuant to negotiations with a potential acquiror. The purpose of anti-takeover provisions is not to entrench management, but rather to provide the public target board a greater opportunity to negotiate a transaction in the best interests of the shareholders of the public target with less possibilities for removals of directors, given the staggering of terms.
In a transaction involving the acquisition of a private company (“private target”), the parties typically negotiate and enter into an acquisition or merger or only certain assets. In some transactions, the acquiror may want to purchase the assets rather than the stock of the private target, among other things, in order to avoid certain corporate-level liabilities. In other transactions, the acquiror may seek to obtain control of the private target through the acquisition of a controlling share interest. Although private companies do not generally have the anti-takeover devices typically put into place by public companies, such companies may have shareholder agreements with provisions that would need to be complied with in structuring an acquisition.
The U.S. does not have a national company law. Instead, the rights and obligations of corporations and their shareholders are principally governed by the laws of the state of the United States where the target is incorporated, and there can be considerable variation in the statutory provisions from state to state.
Finally, acquisitions of non-corporate entities, such as limited liability companies, may involve tax and other considerations that may dictate the optimal structure.
In a negotiated (non-hostile) acquisition of a public target, there will generally be a merger or business combination agreement reflecting securities law, stock exchange, approval thresholds and other requirements. The principal transaction agreements would generally also contain, among other terms, the form and amount of consideration deliverable to target or its shareholders, representations, warranties and covenants of the parties, and closing conditions applicable to the transaction. Interim operating provisions would apply if the definitive agreement is not being executed simultaneously with the consummation of the transaction (as is generally the case with public targets); provisions related to financing of the transaction will also be reflected in the definitive agreements. Additionally, in consideration of the time and effort being devoted to pursuing the transaction, the parties often agree to exclusivity terms restricting the ability of the public target to pursue alternative or competing transactions, sometimes with negotiated exceptions. Before entering into the principal definitive agreements, the parties may negotiate and execute a binding or non-binding term sheet and the acquiror (and the public target) will carry out due diligence after entering into a non-disclosure or confidentiality agreement to facilitate the exchange of information. Often, a virtual data room will be created as a repository of public target-related information, particularly if there may be third parties, such as investment bankers or prospective investors that will require access to certain information regarding the public target.
The public target will generally need to notice and hold a shareholder meeting to approve the transaction, which will involve the preparation of a proxy statement subject to review and comment by the SEC. SEC rules prescribe the information that will need to be included in the proxy statement. In addition, the acquiror will generally need to file a registration statement under the Securities Act with the SEC if the public target shareholders will receive securities in the transaction. If the acquisition involves a tender offer, a Schedule TO will be required to be filed with the SEC and disseminated to shareholders. Other forms may also be required to be filed with the SEC, such as a Schedule 13D if the acquiror beneficially owns more than 5% of the public target’s shares. The board of a public target may also determine to engage an independent and appropriately qualified firm to render a fairness opinion pursuant to a negotiated engagement letter, and the parties will need to engage accountants to prepare the financial statements of target to be included in the SEC filings (another engagement letter). Both public and private targets will require legal counsel, , officers and secretary’s certificates, and other closing documents. If any financing transactions are to be evaluated or consummated in connection with the acquisition, additional documents will be required, including non-disclosure agreements (or, in some instances, equivalent “over the wall” confidentiality procedures and protocols, usually carried out by experienced financial advisors), investor disclosure materials, and investor agreements such as subscription agreements or other documents setting forth the terms of the investment. Parties may engage determine to engage one or more placement agents or financing advisors to assist with a financing process pursuant to engagement agreements generally proposed by the placement agent or other advisory firm.
In addition to the principal transaction agreement, there may be a relatively large number of other documents involved in a U.S.-style acquisition transaction, which may include:
Both a private transaction and a public transaction will require a series of representations and warranties by the parties to be set forth in the merger agreement. These generally go to financial statements and related matters, litigations and regulatory matters, governance, information regarding material contracts and material real and personal property, intellectual property, required third party consents (including governmental and regulatory consents), and, in many cases, exchange listing-related conditions. There would also be fundamental representations and warranties related to capitalization, authority, ownership and absence of conflicts, among others, as well as industry or transaction-specific representations, covenants and closing conditions. In addition, if the target is a public company, or is private but would constitute a material acquisition by the acquiror, SEC filings would be required that entail specific public disclosures that would not be required in other transactions. In the case of a transaction with a public company, the proxy rules promulgated under the U.S. Securities Exchange Act of 1934, as amended (“Exchange Act”), and rules governing registration of securities, or both, would dictate applicable disclosure requirements. Additionally, other U.S. Securities Act of 1933, as amended, and Exchange Act rules apply to communications in the context of a public company merger transaction. In a transaction involving issuances of securities of a private company, information about the transaction and the parties involved also needs to be prepared and disseminated to investors and shareholders, often in the form of an information statement or offering memorandum.
Although mandatory tender offers pursuant to company law are applicable to certain acquisitions of securities in many non-US jurisdictions, they are not present in the US. Acquirors of US companies may acquire securities in privately negotiated transactions without needing to extend the offer to other securityholders. There are, however, some additional considerations. First, offers to more than a specified number of securityholders of US public companies may trigger the SEC’s tender offer rules, requiring filings and compliance with certain procedural requirements. Second, some private companies have shareholder agreements that include tag-along and drag-along rights, giving shareholders the right or the obligation to participate in sales of securities.
Parties to U.S. acquisition transactions can employ a variety of transaction structures. In addition to corporate law considerations, the structure may be dictated by tax and regulatory considerations and other factors, such as required third-party consents and approval requirements.
In addition, as mentioned, some state laws permit short-form mergers, without a shareholder vote, if the shareholder holds a specified percentage (generally about 90% or more) of the target’s shares. Short-form mergers can take place following negotiated share acquisitions with a limited number of large shareholders, or more commonly, pursuant to a tender offer where fewer than all the outstanding shares are acquired. There are some exceptions to requiring this large percentage. For example, if the target is a Delaware corporation with shares listed on a national securities exchange or if its shares are held of record by more than 2,000 holders immediately prior to the execution of the merger agreement, then the target will have the right to opt into using Section 251(h) of the Delaware General Corporation Law. If the parties opt into Section 251(h) and the number of shares accepted in the tender offer would be sufficient to approve a merger (in most cases a majority of the outstanding shares), then the merger can be consummated without a vote of the target stockholders (and without having to obtain to 90% of outstanding shares in order to effect a short form merger).
Although some transactions, often involving private targets (including nonmaterial subsidiaries of public companies can be closed simultaneously with the entry into the acquisition agreement, many transactions require a period of time between signing and closing to, for example, obtain necessary shareholder, regulatory or third-party consents, disseminate information to investors in connection with shareholder meetings or consents, or for other closing conditions, including obtaining financing.
There are a range of price structures used in U.S. M&A transactions, some of which can become complex if, for instance, there are intricate adjustment mechanisms applicable at or after closing and depending also on the type or types of consideration being offered (cash and securities), among other factors. Fixed price acquisitions are generally simpler, but there are many transactions where a “base” amount of consideration is negotiated, subject to adjustment at or after closing, based on a variety of possible metrics, such as cash or assets on the balance sheet at the closing date, working capital or net indebtedness, all of which could be formulated as a comparison to earlier-delivered financial information or, for instance, negotiated “normalized” amounts, with associated true-up or other mechanisms. In such instances, the parties would need to negotiate the terms and mechanics of the adjustment provisions (and allocation of responsibilities for stub periods until the final purchase price determinations are reached), as well as the definitions incorporated into such provisions, usually requiring the parties to, for instance, outline with specificity the relevant metrics and methodology to be used in carrying out comparative calculations. It is important to include dispute resolution mechanisms in acquisition agreements, in the event the parties do not agree on the amounts of any closing or post-closing adjustments. These provisions may sometimes provide for a third party accounting or other firm to assess and render an independent determination in the event the parties cannot reach agreement. Sometimes, the parties agree to have the acquiror withhold a portion of the consideration deliverable at closing to cover potential adjustments, to provide a source of recovery for indemnification claims, or both. Even in a fixed price acquisition, the parties may provide for a post-closing earn-out based on the post-merger performance of the target. This is sometimes the case if the seller believes that the value of the acquired business is greater than the buyer is willing to pay at the closing.
There may be a range of notification, filing and regulatory approval matters associated with an acquisition. In the U.S., larger transactions may require pre-merger notifications (and sometime clearance) from the Department of Justice and the Federal Trade Commission (or the expiration of associated waiting periods). In addition, acquisitions in certain industries, such as broadcasting, airlines, gaming, and power or infrastructure activities, may require special governmental approvals as well as special permits and licensing. Finally, acquisitions involving national security or similar concerns may involve additional forms of governmental review and approval. Acquisitions involving public targets generally require the filing of proxy statements or registration statements, as well as other documents, with the SEC, and the SEC’s review of such documents. Additionally, transactions involving securities issuances by national exchange-listed companies require adherence to exchange requirements and often submission of applications to list the newly-issued securities. If the target has non-US operations, foreign regulatory approvals may be required. In addition to regulatory filings and consents, approvals to an acquisition transaction may require consents by lenders and other contractual counterparties to the target. Counsel to the parties will need to be aware of contractual change-in-control provisions, as well as debt covenants that may require debt redemptions or other actions by the obligor.
There may also be other regulatory matters to consider. If the target does business in jurisdictions or with parties identified on the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) lists, continuing to do business with such entities may result in sanctions against the company. Finally, doing business in certain jurisdictions may involve heightened review by the SEC or national securities exchanges.
Material adverse change (“MAC”) or material adverse event (“MAE”) provisions are customary, to enable the acquiror to terminate the transaction if unanticipated adverse matters may arise prior to the closing of a transaction. These can involve adverse changes involving the operations or performance of the target’s business, or extrinsic matters, such as the commencement of armed hostilities in areas where the target has facilities or does business, or new statutory or regulatory changes that will materially affect the target. These provisions may be highly negotiated, however, because MAC and MAE concepts are interpreted very narrowly in current jurisprudence, transaction parties also tend to also include other standards with lower “thresholds” for breaches of acquisition agreements, to apportion risk between the acquiror and target, as further described below.
Acquisition agreements for transactions that do not sign and close simultaneously usually include exclusivity or “no shop” terms, sometimes subject to negotiated exceptions.
Break-up fees are conventional in some transactions; if the transaction is terminated due to certain breaches by the target (or in some cases (so-called reverse break-up fees), the acquiror), or if, pursuant to a fiduciary out provision, the target is sold to another acquiror. Break-up fees may be triggered by a range of circumstances, including the inability of the acquiror to obtain financing, or the failure of the transaction to obtain required regulatory approvals.
A fact is material for US securities law purposes if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision. In the case of an omission, it is material if a reasonable investor would view its disclosure as having significantly altered the “total mix” of information available.
Parties to acquisition transactions are able to identify their own materiality metrics. For example, a purchaser may have the ability not to proceed with a transaction if the target has experienced specified adverse changes. Some material adverse changes may affect the ability of the parties to consummate the transaction (such as a legal injunction), while others may give a party the ability to terminate the agreement unless the parties can renegotiate certain terms.
In many acquisitions, certain representations and warranties are qualified by knowledge provisions. In these instances, it is conventional to identify the persons whose knowledge is subject to the provisions, typically the senior leadership of the target and the heads of certain business segments.
In transactions involving a delay between the signing of an acquisition agreement and the closing (as is generally the case with public targets, and sometimes with private targets), bring-down provisions are common, though certain representations and warranties may be excluded and the parties may negotiate modifications to materiality qualifiers for bring-downs.. Bring-downs may involve updated disclosure schedules, updated legal opinions and negative assurance letters from lawyers and updated comfort letters from auditors, as well as updated officer’s and secretary’s certificates.
Sandbagging (or anti-sandbagging) provisions are generally legal, and would be reflected in the acquisition agreement..
Often in the acquisition of private targets companies, or of subsidiaries of public targets the principal shareholders of the target will guarantee the accuracy of the target’s representations and warranties and compliance with specified covenants. If there are multiple guarantors, the guarantees can be joint and several (where each guarantor is responsible for the full amount of the guaranty), or only several (where each guarantor is responsible for a portion of the obligations up to certain limits).
By contrast with private-transactions, it is sometimes the case that acquisitions of public targets do not have post-closing indemnification provisions. By proceeding to closing, the acquiror will accept the risk of breaches of representations or warranties. Acquirors of public companies have the advantage of being able to review the prior SEC filings by those companies, including audit reports, and generally engage lawyers, bankers or others to perform extensive due diligence. Also, once the shareholders of a public target receive the merger consideration, it may not be practicable to seek indemnity. For this reason, in some transactions, a percentage of the purchase price may be deposited into an escrow account to serve as an initial source of indemnification payments should the need arise.
Indemnification provisions typically include a de minimis provision for individual items, and an overall basket before an indemnification claim may be brought. There may be separate indemnifications for specified items, such as taxes. Unlike acquisitions outside the U..S, where it may be customary to have indemnity cap equal to or less than the purchase price, some U.S. transactions do not have indemnification limitations or may have capped exposure in certain areas and unlimited indemnification for other areas, such as breaches of fundamental representations or involving instances of fraud or gross negligence. In any agreement involving indemnification, there may be a need for guarantors to agree to indemnification, in case the principal obligor may not have adequate liquidity to meet its indemnity obligations. Some agreements contain “anti-sandbagging” provisions, which may limit the ability of a party to assert claims based on breaches of representations and warranties if the party was aware of (or put on notice of) such breaches prior to the closing.
The principal liability associated with indemnification in U.S. acquisition transactions is the inability of the indemnitor to fund its indemnity obligations. For this reason, parties to a transaction will sometimes require a guarantor and/or procure “representation and warranty insurance” from an insurance company. Although state law statutes of limitation may limit the ability of a party to assert claims based on breaches of representations or warranties (either based on when the breach occurred or when the party claiming the breach became aware of it), the parties can, in the acquisition agreement, agree to a shorter contractual period or, in some cases, to a longer period. The acquisition agreement may have differentiated periods in which to bring claims based on the subject matter of the claim (e.g., ownership of securities, tax matters). Representation and warranty insurance is less common in U.S. public company transactions, relative to which reps and warranties survive transaction closing.
The applicability of foreign law to U.S. transactions may vary widely based on the jurisdictions involved and the nature of matters to which foreign law considerations are applicable. If the public target is a U.S.-incorporated entity, the choice of law is often based on the laws of a particular state in the U.S., with appropriate consent to jurisdiction and waiver of forum non convenience. That said, U.S. public targets with operations outside the U.S. may be subject to specific laws regarding changes of control of the non-U.S. operations.
Although acquisition agreements relating to public targets may provide for arbitration, arbitration is more common in private transactions. Arbitration may also be more common in connection with disputes relating to technical or specialized matters, such as those involving inventory valuation, earn-out provisions, etc. The principal benefit of arbitration is that it can sometimes resolve disputes more quickly and efficiently than a court proceeding (though this is not always the case). The downside is that the parties may not have the same discovery rights, and there is a risk that an arbitrator’s determination may be less informed than a determination made following a court proceeding. Unlike a court proceeding, where the parties may have the right to appeal an adverse decision to an appellate court, challenges to an arbitration award are more limited, for example to matters such as fraud, corruption, evident partiality of an arbitrator, or the arbitrator exceeding his or her powers.
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