The (legal) Due Diligence and Sale and Purchase Agreement
Once the initial “pre-contract” agreements as referred to in the first part of our M&A road book have been executed, a next phase of the route of the private M&A transaction starts, namely the due diligence and the sale and purchase agreement.
I. Due diligence
In an M&A transaction, a (legal) due diligence of the target company will be made by the potential purchasers and their advisors.
Besides the legal due diligence review, and depending on the circumstances in the specific case, accounting, financial, operational and business due diligences of the target company are also carried out by the potential purchaser ans its advisors. If the target business is involved in an environmental sensitive business it is not uncommon for a potential purchaser to involve specialist environmental consultants to undertake the environmental due diligence.
The legal due diligence review is conducted based on a data room put together by the seller with assistance of the seller’s lawyers. This data room may be completed with documents requested from time to time by the purchaser's lawyers. During the course of such due diligende, the purchasers and its advisors submit enquiries to the target company.
The data room may be still made up of physical documents but in practice data rooms are nowadays virtual. Of course, in controlled auction processes, with more than one potential purchasers whether or not situated in different countries, virtual data rooms are much more expedient for managing the due diligence.
This public information can be sought after from various public sources and from a large number of Belgian authorities.Certain information on a Belgian target company is publicly available, such as corporate documents in court records (the corporate file is held by the court registry of the competent Commercial Court), financial information contained in annual accounts filed with the NBB, mortgages and (legal) inscriptions mentioned in the certificates delivered by the competent mortgage keeper, etc.
Note that information may be useful in a “pre-due diligence” phase. However, information on shareholdings in a Belgian target company is not publicly available, which is the case in some of our neighbouring countries.
After the (legal) due diligence review, the potential purchaser’s lawyers will furnish their client with a report presenting the findings of their due diligence.
A legal due diligence report may cover e.g. the following with regard to the target company:
Click here to view table.
II. Sale and purchase agreement
Risks identified during the due diligence process may be handled by way of provisions in the sale and purchase agreement (e.g. specific indemnities or reduction of the purchase price). In some cases critical findings during the due diligence process may even constitute “deal breakers” and cause the potential purchaser to withdraw from the negotiations.
Once the seller and the purchaser complete their negotiations, they enter into a share sale and purchase agreement contemplating the sale and purchase of the shares in the target company.
Below certain specific provisions of the typical Belgian share sale and purchase agreement are described (the majority of the provisions are included also in case of a sale and purchase of assets and liabilities).
1. Purchase price mechanism and transfer of shares
Central issues to be governed in the sale and purchase agreement are the purchase price and the transfer of shares in the transaction.
The parties involved may simply opt for payment of the final purchase price in full, at completion, in the form of a cash consideration or e.g. a share swap.
However, a commonly used mechanism for establishing the final purchase price is the use of a “completion accounts” provision. Under such a provision, the preliminary purchase price paid at signing – based for example on a corrected EBITDA, or on the estimated net debt position of the target company and the estimated working capital at the completion date – is then reconciled against the actual corrected EBITDA, and/or net debt position of the target company and its actual working capital at completion. Other measuring criteria are also often used for establishing the purchase price.
An increasingly frequent alternative is a “locked-box” model, fixing the purchase price as per a certain date (based on a balance sheet established on an agreed date) and calculating interest from that date up to completion, but the purchase price being subject to adjustment for unauthorised “leakage”, typically including such matters as dividends, management bonuses, redemption or purchase of shares or payments of liabilities benefiting a seller, eventually corrected with agreed exceptions (e.g., for an agreed amount of dividend to selling shareholder(s) or bonus paid to managers).
Contingent payment depending on the target company’s results, such as “earn-out” structures are sometimes seen in transactions for example where the seller or management of the target company will stay, whether or not retaining part of the shareholdingship.
Numerous other options exist for regulating the purchase price (adjustments) and the payment which may be used in the sale and purchase agreement depending on the circumstances of the specific transaction.
2. Representations and warranties
Representations and warranties typically cover a variety of subjects, including core company law matters (such as due constitution and ownership of shares), operational matters (employment, intellectual property, relations with customers and suppliers, regulatory compliance and others), financial matters, the quality of the assets being sold, if applicable, and tax, in each case addressing general principles and any deal-specific questions identified during due diligence. However, specific risks identified by the purchaser during the due diligence process are not reflected in the representations and warranties. Instead such risks are handled by way of specific indemnities.
Belgian sale and purchase agreements sometimes exclude the remedies provided for by the law, and the remedies under the sale and purchase agreement shall then be the exclusive remedies available to the purchaser. In principle, the seller’s liability for specific indemnities is not limited to the seller’s warranties, nor by the purchaser’s knowledge of the fact that there is an issue in the target company.
3. The liability of the seller
On the Belgian market warranty periods are normally 12 to 24 months.
However, in respect of certain specific areas such as tax and environment considerably longer warranty periods apply.
Claims under tax warranties are in average allowed to be initiated up to a certain amount (e.g. 90) of days after the date upon which the right of the tax authorities or any other competent authority to assess or claim any taxes or social security contributions in respect of the matters giving rise to such a claim is barred by all applicable statutes of limitation.
Environmental warranty periods are usually 5 to 10 years from completion.
With respect to warranty thresholds – “caps” and “baskets” – the purchaser has to be able to claim compensation from the seller for a deficiency under the warranties and the deficiency must satisfy a threshold of a specified amount. Deficiencies that cannot be claimed individually may be aggregated and, if the aggregate deficiency reaches the threshold, the purchaser can claim such aggregate deficiency. A more seller-friendly alternative is of course that claims below the threshold are deducted from the claim. There is also often a limitation that each minor deficiency that shall be taken into account shall itself reach a certain threshold (as so called “de minimis”). A deficiency above thresholds is compensated on a euro for euro basis and is limited by a certain maximum amount, capped at an amount, in most of the cases, equal to the purchase price or a lower specified amount.
Sale and purchase agreements often include provisions specifying that the purchaser may not initiate claims under the warranties based on circumstances which were (or reasonably should have been) known to the purchaser before the agreement was signed, including information disclosed to the purchaser by the seller.
4. The liability of the purchaser
The representations and warranties made by the purchaser are normally very limited, if any. The scope of these representations and warranties is usually limited to corporate existence, authority and necessary approvals for entering into the sale and purchase agreement.
5. Conditions precedent
Conditions precedent refers to one or more conditions for completion of a transaction in situations where “signing” and “completion” occur on separate occasions Common conditions precedent are that the transaction is approved by e.g. relevant competition or financial supervisory authorities and that no material adverse change affecting the target occurs between signing and closing (so called “MAC”-clauses).
6. Non-compete clauses Non-compete clauses are usually included in the sale and purchase agreement as a specific section or as part of the seller’s covenants.
The seller undertakes that neither the seller or any of its affiliates shall directly or indirectly conduct business or have any interest in any business carrying out activities in a specified geographic area that is directly competing with the target company’s business.
The period of time for such non-compete undertakings is 2 to 3 years in average, but highly sector specific.
The non-compete clause is customarily combined with non-solicitation clauses that prohibit the purchaser and any of its affiliates from soliciting or inducing any employees leaving the target company for an employment with the purchaser or any of its affiliates. From a purchaser’s perspective it is desirable to include a liquidated damages (i.e. minimum fixed amount) remedy for breaches of the non-compete clause, to add a deferring effect to the seller’s undertaking. Such a provision also eliminates the problem of proving the actual damage caused to the seller and the target company by a purchaser’s breach of the non-compete undertaking.
7. Confidentiality clauses
Both the seller and the purchaser usually undertake not to disclose the contents of the sale and purchase agreement as well as all information provided in connection therewith. From a purely Belgian perspective, information that is normally excluded from such undertaking is:
- Information known to the general public; - Information that must be disclosed according to the law or any other applicable regulation or that is required for the purposes of any judicial or arbitration proceedings arising out or in connection with the sale and purchase agreement; - Information that needs to be disclosed to professional advisors or financiers; - Any disclosure of information to which the relevant party has given its consent.
Further, both parties often wish to control the public disclosure of the transaction, which is generally not covered by confidentiality clauses in the sale and purchase agreement. Therefore a specific regulation regarding news releases, information stakeholders, etc. may have to be included in the agreement.
8. Dispute resolution
When a Belgian target company is sold, applicable law is usually Belgian law. Disputes arising in connection with the sale and purchase agreement are, in the vast majority of Belgian transactions, agreed to be finally settled by arbitration.
More chapters to come
The next chapter of our M&A road book will amongst others relate to the due execution of the agreement, completion and post-completion actions. This chapter shall be published on our website and in our next newsletter.