When a public company is contemplating an acquisition, lawyers should consider early in the acquisition process whether the execution of the acquisition agreement and/or the completion of the acquisition may trigger a filing under Item 1.01 or Item 2.01 of Form 8-K.
Item 1.01 of Form 8-K requires disclosure when a registrant enters into a “material definitive agreement” outside of the ordinary course of business. In the context of an acquisition, this in most cases would potentially be triggered by the execution of the definitive acquisition agreement (rather than a letter of intent or term sheet).
The determination of whether the execution of a definitive acquisition agreement triggers Item 1.01 is a subjective determination based on general standards of materiality as defined in SEC rules, judicial decisions and administrative guidance (for example, the Levinson test that defines information as material if “there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision” by significantly altering the mix of information available). There is a relative dearth of SEC authority on the subject of whether an acquisition agreement (or any agreement more generally) should be considered a material definitive agreement for purposes of Item 1.01. However, there are certain guideposts and considerations which an acquiring registrant should take into account when making a determination as to whether an acquisition agreement constitutes a material definitive agreement for purposes of Item 1.01.
A helpful first step in this analysis is whether the acquisition (when completed) will trigger Item 2.01 based on the bright-line quantitative tests thereunder (discussed below). If Item 2.01 of Form 8-K is triggered, then in most cases a registrant will determine that a Form 1.01 Form 8-K will be required in connection with the execution of the definitive agreement.
If an acquisition is significant to a registrant but Item 2.01 is not triggered, then the registrant may have a challenging judgment as to whether the acquisition agreement should trigger a filing under Item 1.01 of Form 8-K. In this regard, relevant factors may include:
- Key income statement metrics of the acquired business compared to the registrant (which may include revenue, operating income, net income and EBITDA)
- The book value of the assets of the acquired business compared to the registrant
- The purchase price paid by the registrant in comparison to the book value of the registrant’s assets
- The purchase price paid by the registrant in comparison to the enterprise value and/or market cap of the registrant
- Whether the acquisition would result in a significant increase in the debt leverage of the registrant and/or would require additional debt or equity financing sources
- Whether the acquired business would give rise to a new product or business line or reporting segment of the registrant or otherwise further any key strategic initiatives or goals of the registrant
- Whether the registrant is particularly acquisitive (if this is the case, this may somewhat move the needle against Item 1.01 being triggered in connection with any particular acquisition)
- Whether any members of the management team of the target company will become executive officers or directors of the registrant
- Whether there are other obligations or benefits (including under ancillary agreements) material to the registrant related to the acquisition
- The past practice of the registrant with respect to whether it has filed acquisition agreements under Item 1.01 (if a similar past acquisition of a registrant has triggered an Item 1.01 filing, this may support the decision to similarly file a subsequent similar acquisition)
With respect to the income statement, assets, and purchase price comparisons referenced in the first three bullets above, a rule of thumb used by some practitioners is that if one or more of these comparisons exceeds 5% or 10% (there are differing views as to which threshold is appropriate, with 5% being more conservative), this may be viewed as an indicia of materiality (recognizing that qualitative factors are also relevant).
If Item 1.01 is triggered, then the registrant will be required to file a Form 8-K setting forth certain information regarding the acquisition agreement (including the material terms and conditions of the agreement) within four business days following the execution of the agreement. In addition, the registrant will be required file the agreement, either as an exhibit to the Form 8-K or as an exhibit to the periodic report covering the period in which the agreement is entered into.
Item 2.01 of Form 8-K provides that, when a registrant has completed the acquisition of a significant amount of assets, other than in the ordinary course of business, the registrant will be required to file a Form 8-K and disclose certain information regarding the acquisition within four business days following the completion of the acquisition. Unlike Item 1.01, the determination of whether the completion of an acquisition triggers Item 2.01 is based on bright-line quantitative tests.
Assuming that an acquisition involves the acquisition of a business, under clause (ii) of Instruction 4. of Form 8-K and Item 11-01(b) of Regulation S-X, an acquisition is significant if one of the three significance tests under Rule 1-02(w) of Regulation S-X is tripped at the 20% level.
It is beyond the scope of this blog to address the significant subsidiary tests under Rule 1-02(w) of Regulation S-X and the associated financial statement filing requirements under Form 8-K, which can be quite complicated. However, at a high level, under Rule 1-02(w) of Regulation S-X, the three tests compare (1) the target company’s assets vs. the registrant’s assets, (2) the purchase price of the acquisition vs. the registrant’s assets, and (3) the target company’s income from continuing operations before income taxes (the “pre-tax income”) vs. the pre-tax income of the registrant (the measuring period for these determinations for the registrant is generally the prior fiscal year of the registrant). If any of these three tests is tripped at the 20% level, a Form 8-K under Item 2.01 is triggered, and the filing of financial statements is required.
If the filing of financial statements is required as noted above, the registrant is generally required to file (1) pro forma financial information reflecting the acquisition for the prior fiscal year plus any interim period, and (2) historical annual audited financial statements of the target company for one, two or three years, depending on the significance level of the acquisition (whether 20%, 40% or 50%) and other considerations. With respect to acquisitions, the deadline for filing required financials (via a Form 8-K/A) is 71 calendar days following the original due date for the 8-K.
Practical Consequences of Triggering a Form 8-K in an Acquisition
The issue of whether an acquisition will trigger an 8-K filing can have a significant impact on the acquisition negotiation and process, including in relation to the following:
- If a determination is made that an acquisition agreement will need to be filed, the acquiring registrant (if a regular acquirer) may have reticence about agreeing to certain deal terms in a publicly-filed agreement which may be used against the registrant in connection with future M&A activity. In this regard, it is not uncommon for M&A lawyers to use publicly-filed acquisition agreement precedent against the registrant in future deal negotiations.
- If a determination is made that an acquisition agreement will need to be filed, the parties will need to consider whether there are confidential or sensitive terms included in the agreement from the perspective of one or both parties (e.g., the parties may be concerned that the existence of a specific indemnity could give rise to an inference or a presumption from the perspective of a plaintiff or a governmental authority that a legal violation has occurred or there otherwise is substantive monetary exposure).
- Taking into account the considerations noted in the first two bullets above, the parties will want to consider whether the registrant intends to file any schedules, annexes or exhibits associated with the acquisition agreement (the recent FAST Act amendments provide that a registrant will no longer have to file schedules or attachments to material contracts unless they contain material information not otherwise disclosed in the contract).
- If Item 2.01 of Form 8-K is triggered such that audited financial statements of the target company will need to be filed by the registrant following the closing, an acquiring registrant may insist that the audited financials be completed before the signing of the definitive acquisition agreement or at least require that such audited financials be completed as a condition to closing.
- In acquisitions with a gap between signing and closing, the determination that the acquisition agreement triggers Item 1.01 (which will require a filing within four business days following execution of the acquisition agreement) may result in public disclosure of the acquisition earlier than the target company and/or the acquirer desire (for example, the target company may not want the customers, suppliers, employee base, etc. of the target company to be aware of the acquisition until after the closing has occurred).