The Building Blocks of a Mergers and Acquisitions Contract
Every merger or acquisition transaction is unique. Nevertheless, businesses seeking to buy, sell, or merge with, another business will face common contract provisions and structures. The content of these provisions will be different from deal to deal and from company to company. Businesses undertaking a merger or acquisition should work with competent corporate attorneys or M&A attorneys to be sure their contract is comprehensive and protects their interests. A good M&A transaction document will work together internally, and most M&A transactions will contain some version of all the following types of clauses:
This is the very beginning of a contract and sets forth the identities of the parties, the date, and the name of the document. Simply put, very fundamental information about the transaction and the contract itself. Other documents referring to the contract will refer to the information contained in this section.
Background information about the transaction will go here. If the parties are including other transaction documents in the transaction, this section will describe how. For example, if there is a real estate aspect to a merger which is done by a separate real estate document, the recitals will typically describe that document and its relationship to the merger. Other things like prepaid funds, timing, identification of party affiliates, history of the transactions and related matters can all be described in the recitals.
Recitals are important to allow a third party like a judge to understand a contract when reading it for the first time.
Along with the preamble, the recitals will set the tone for the entire transaction. It would be common for the recitals to explain that the buyer is buying the assets in an asset purchase agreement, or that the buyer is buying the stock in a stock purchase agreement, along with a general description of what those assets and stock are. Recitals would also be useful to spell out any special tax or regulatory treatment of a transaction, such as whether a transaction is structured as an IRC Section 368 tax-free reorganization or has special regulatory issues under a state-legal retail cannabis regime.
These may appear at the beginning or at the end of a contract or even in an attached exhibit or schedule. Definitions in a complicated transaction are useful for clarity of meaning, and to avoid typing a long definition each time a certain term is used many times throughout a document. Definitions are critical to avoid ambiguity and for the internal consistency of a document. If the parties to a merger or acquisition don’t agree about what an “Affiliate” is or what “Laws” apply or what the definition of a “Business Day” is, then there can be endless disputes later when the transaction is executed.
Some might say that the purchase price is the only part of a merger or acquisition that matters. The price, how it is paid, when it is paid, and to whom, is a critical aspect of the transaction. This section will spell out details about how money flows, whether escrow is involved in the transaction, cash vs debt vs stock compensation, holdback arrangements, allocation of price for tax purposes, and similar items. When parties are doing complicated transactions in the millions of dollars, the parties need to work with cannabis transaction counsel to fully understand how the price is paid, when the price is paid, to whom the price is paid, and various considerations about what can happen to derail these events.
In any transaction, the parties will agree to undertake certain actions in order to consummate the transaction. Whether that means the filing of applications with regulatory agencies, the cleanup of environmental conditions, the repayment of debts, the establishment of escrow accounts, the assignment of intellectual property like trademarks, or just general cooperation, a merger or acquisition contract will almost always have covenants both for the seller and the buyer. Failure to perform a covenant by any party to a transaction can be a breach of the contract, which could lead to litigation or to the failure of closing.
Representations and Warranties
The parties each promise to each other that certain things are true. These promises are critical! Certain promises are common, such as a promise that a company is in good standing and is authorized to enter into the transaction. Other promises are more customized, such as promises about the filing of tax returns, promises about regulatory status, statements about the status of litigation, promises that no liens exist, and similar items. A party can, by working with transaction counsel, thoughtfully address
what promises to make and how to condition those promises. For example, a party could limit its statements of fact to things in its “actual knowledge.” But the party may want to be sure that “actual knowledge” is defined in the “Definitions” section as mentioned above. Similarly, a promise about a fact can be specific to a certain time. A party cannot necessarily represent that something will be true in the future. A representation and warranty which is false can lead to claims for breach of contract.
Representations and Warranties often come with “disclosure schedules.” These schedules are usually attached to a merger or acquisition transaction and they serve as a way for the parties to make disclosures that restrict or modify the representations and warranties made by that party. For example, a party could represent and warrant that “except as set forth in the tax disclosure schedules, the seller has timely filed its tax returns for all fiscal years ending before the closing.” The disclosure schedule, if
properly completed, could disclose that seller’s prior year tax return is still not filed, under a timely extension. Parties need to work closely with transaction counsel to ensure their disclosure schedules are properly and completely submitted, in order to avoid future claims for breach of contract based on incomplete schedules.
Conditions to Closing
It is typical for buyers and sellers to insist that certain conditions are satisfied before they are obligated to close a merger or a transaction. These conditions could be standard, like “payment of purchase price” or they can be custom, like “seller must deposit funds in escrow sufficient to cover its outstanding PPP loan balance.” With highly-regulated marijuana merger and acquisition transactions, appropriate conditions to close are necessary to ensure the parties obtain sufficient governmental approvals prior to closing. If a condition to close fails, the party who owns that condition to close can rightfully refuse to close the contract. The contract may terminate at that point.
Not every contract closes, unfortunately. A comprehensive merger or acquisition contract will address how the contract terminates and what happens when the contract terminates. A contract can terminate for a variety of reasons: failure to fund, governmental regulatory problems, failure of a condition to close, material change in the buyer’s or the seller’s business, or other termination events as set forth in the contract. The parties should work with experienced transaction counsel to be sure that there are clear instructions for how to terminate a contract and in what situation, and what happens to the parties upon such termination: are the parties’ monies refunded? Is there a break-up fee? What happens to deposits, and are there any covenants like confidentiality that survive termination?
This is always a hot-button issue in a merger or acquisition. Indemnification is a promise by one party to pay for damages suffered by the other party. This is a complex topic with rigorous drafting requirements, and inarticulate drafting of an indemnification provision can cause a party to suffer significant financial losses without recourse. We recommend that parties work with well-qualified attorneys to develop indemnification provisions suitable for their transaction.
Nearly every merger or acquisition contract will contain several boilerplate provisions, usually at the end. While these may seem formulaic or unimportant, they can still be critical. For example, a binding arbitration clause is often contained in boilerplate language. Same with notice provisions, choice of law clauses to set a contract to one state or another, and other material terms that can be quite relevant as a contract is executed and especially when a contract is in dispute. Parties must understand the entirety of the boilerplate, and experienced merger attorneys can help the parties do so.
Because every transaction is so different, it is not easy to take clauses from one transaction and apply them to a new transaction. Parties must work with experienced regulatory and transaction attorneys to develop merger or acquisition contracts that work for their deals. Creating a merger or acquisition transaction that is not internally consistent, that fails to address cannabis-related regulatory issues, or that fails to address one of the critical areas above appropriately, can expose a party to great risk in a merger or acquisition transaction.
Contact our experienced our cannabis attorneys today to discuss your merger or acquisition transactions, or any other business needs.
The views and opinions expressed in the article represent the view of the author and not necessarily the official view of Clark Hill PLC. Nothing in this article constitutes professional legal advice nor is intended to be a substitute for professional legal advice.