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State snapshot

Trends and climate

What is the current state of the M&A market in your jurisdiction?

According to Thomson Reuters, during the first nine months of 2018, there were 9,251 announced deals in the United States, totalling $1.3 trillion in aggregate deal value. This represents an approximate 6% decrease in the number of deals for the same period in 2017, but a 44% increase in dollar value. In 2017 the volume of announced deals was 9,853, totalling $901.09 billion.

The 2018 results buck a trend that has held since 2015 of decreasing total values of M&A deals and increasing numbers of deals:

  • In 2015 there were 9,962 deals totalling $2.34 trillion.
  • In 2016 there were 11,061 deals totalling $1.67 trillion.
  • In 2017 there were 13,069 deals totalling $1.42 trillion.

Further, the pace of transactions is accelerating, and the M&A market is currently seller friendly.

Have any significant economic or political developments affected the M&A market in your jurisdiction over the past 12 months?

The 2017 federal income tax reform:

  • reduced the highest federal corporate income tax rate from 35% to 21%;
  • reduced the highest marginal federal income tax rate of non-corporate taxpayers from 39.6% to 37% (plus a 3.8% tax on investment income) or, in certain circumstances, to 29.6% (plus a 3.8% tax on investment income); and
  • imposed limitations on the deductibility of interest and the use of net operating loss carryforwards. 

While the impact of these changes on M&A transactions is still developing, buyers have become more inclined to take the form of corporate entities, while the tax benefits of borrowing to finance acquisitions (ie, generating tax-deductible interest expense) have been reduced. Growth in the economy has increased buyers’ willingness to acquire companies, but rising interest rates may slow some of the M&A market activity. Buyers frequently obtain financing in connection with acquisitions, and as the cost of borrowing money increases, obtaining such financing will grow more expensive.

Are any sectors experiencing significant M&A activity?

Rather than a particular sector being particularly active compared with other sectors, the status of the buyer and seller is the distinction, with private equity buyers and sellers being particularly active in the current market.

Are there any proposals for legal reform in your jurisdiction?

The most significant recent proposal was the new tax legislation that was enacted in late 2017 and affected numerous sectors. Tax reform had been the subject of discussion for several years prior to the legislation’s enactment and its effects, and potential additional changes, continue to garner attention.

Legal framework

Legislation

What legislation governs M&A in your jurisdiction?

In general, private M&A transactions (ie, transactions not involving a company whose stock is publicly traded) in the United States are governed by state law. The vast majority of US businesses are incorporated or otherwise formed under Delaware law. The well-developed case law of Delaware’s Court of Chancery and its specialised bar of practitioners give rise to a legal landscape that is perceived as steady and predictable. As a result, M&A law in the United States is governed predominantly by Delaware law (however, acquisition finance transactions are often governed by New York law).

Federal securities laws and regulations require public companies (generally, companies whose securities have been offered to the investing public) to make certain disclosures and follow special rules with respect to M&A transactions.

Federal and certain state antitrust laws and regulations (ie, competition laws), such as the Hart-Scott-Rodino (HSR) Act, also govern M&A transactions involving both public and private companies in the United States.

Regulation

How is the M&A market regulated?

The Securities Act of 1933 regulates the offer and sale of securities (eg, stock for a corporation and membership interests for a limited liability company) in the United States. Transactions involving the offer and sale of securities must be registered with the Securities and Exchange Commission or be exempted from these registration and related disclosure requirements. Some exemptions include sales not involving a public offering or those of limited size.

 

The M&A market is also regulated by the HSR Act. Its purpose is to prevent anti-competitive M&A transactions. Transactions that exceed a certain size (currently $84.4 million) are typically subject to filing requirements with the Federal Trade Commission and the Antitrust Division of the Department of Justice to determine the impact (if any) that they may have on competition.

Are there specific rules for particular sectors?

There are numerous regulated sectors, and specific rules apply to any entity that operates a regulated business (ie, a company for which regulations are central to its business). For example, compliance is crucial for banks’ and investment management businesses’ operations and value. Certain deal terms in an M&A transaction are also specific to certain sectors. Other regulated sectors include healthcare and insurance.

Types of acquisition

What are the different ways to acquire a company in your jurisdiction?

There are three principal ways to structure the acquisition of a company:

  • purchase and sale of the target’s equity securities (eg, stock for a corporation or membership interests for a limited liability company) – the purchaser acquires the equity securities directly from the target’s equity holders;
  • purchase and sale of the target’s assets – the purchaser acquires assets directly from the target (and does not accede to the target’s liabilities); and
  • merger of the target and an entity affiliated with the acquirer (often, its subsidiary) – the resulting surviving company is then wholly owned and controlled by the acquirer.

Tax treatment is often instrumental in determining how an acquisition is structured. If the target is a corporation (or has elected to be taxed as a corporation), the transaction is typically structured as a purchase of stock. An asset sale would generally subject the target to corporate level income tax on any gain, while a stock sale would not. A merger of a newly formed subsidiary of the purchaser into the target in which the target is the surviving corporation is treated as a purchase of stock for these purposes. This calculus may change if the target has significant loss carryforwards that can offset the gain or if it is a Sub-chapter S corporation or a subsidiary member of a consolidated group. In these situations, an asset sale (or merger of the target corporation into the purchaser or a purchaser subsidiary) would not generally materially increase the income tax cost of the transaction, while the purchaser would benefit from obtaining a fair market value tax basis in the target corporation’s assets. 

In addition, if the target is a Sub-chapter S corporation or a subsidiary member of a consolidated group, the transaction can be structured as an acquisition of stock, but the parties can elect to treat the transaction as an asset purchase for income tax purposes. Such an election can achieve the tax benefits of an asset sale for the purchaser while potentially avoiding state and local transfer taxes that could arise from an asset sale. If the target is not a corporation (and has not elected to be taxed as a corporation), the form of the transaction would not generally matter from an income tax perspective.

Preparation

Due diligence requirements

What due diligence is necessary for buyers?

The level of due diligence that a buyer wishes to undertake will depend on a variety of factors, including:

  • the target’s size, industry, ownership composition and financial health;
  • whether the buyer is a strategic acquirer or a financial sponsor;
  • the buyer’s risk tolerance; and
  • the context of the transaction (eg, an auction process).

Buyers will often undertake a preliminary due diligence review of a target based on its financial statements and recent financial and operational performance. If a buyer decides to move forward, it will engage outside advisers (eg, financial advisers, tax accountants and lawyers) for an expanded diligence process, involving:

  • ownership and governance;
  • customer and vendor relationships;
  • legal and regulatory compliance;
  • real estate;
  • labour and employment;
  • intellectual property and information technology;
  • litigation;
  • environmental;
  • tax; and
  • employee benefit plans.

An outside adviser to a buyer will typically summarise its findings from the diligence process in a written report. This work product becomes particularly important where there are other market participants involved in the proposed transaction that rely on the buyer and its advisers to perform an adequate level of due diligence. For instance, a buyer’s lender or insurer (where applicable) will be entitled to review diligence reports prepared by the buyer’s outside advisers in the ordinary course.

Information

What information is available to buyers?

Buyers may search public records at the state and county levels to:

  • gather information concerning current and past liens perfected against a target’s assets;
  • obtain copies of the target’s organisational documents; and
  • confirm the target’s good standing status (ie, that all state franchise taxes have been paid).

If a public company is the target, filings and documents relating to its ongoing public reporting and disclosure obligations (including materials relating to past M&A and financing transactions) may be accessed through the Securities and Exchange Commission’s (SEC’s) website.

In the early stages of an M&A transaction, the information available to a buyer is typically limited to a confidential information memorandum or management presentation (summarising the target’s operations, business plan and financial forecast for potential buyers) and a virtual data room populated with basic background materials on the target.

As the transaction progresses (including, in the auction context, once a buyer’s bid has been accepted and the buyer has won exclusivity), the buyer’s counsel typically has the opportunity to deliver a more formal due diligence request list, listing information buyer’s counsel wishes to review in connection with due diligence.

The buyer’s counsel may also schedule due diligence calls with relevant management personnel from the target (and target’s counsel) on certain topics with respect to which due diligence is more easily conducted live.

What information can and cannot be disclosed when dealing with a public company?

Generally, when a public company is involved in an M&A transaction, selective disclosures are prohibited. Regulation Fair Disclosure requires that confidentiality commitments be obtained prior to making a selective disclosure. If a selective disclosure is made and trading in the company’s stock occurs as a result, the persons involved may be civilly or criminally liable on a theory of tipping.

Practical considerations also discourage premature disclosures regarding deals involving public companies. If a premature disclosure occurs before a deal is publicly announced, the price of the company’s stock will mostly like increase, which negatively affects the buyer and reflects poorly on the company’s board.

Stakebuilding

How is stakebuilding regulated?

Under US securities law, the SEC regulates stakebuilding in public companies. Disclosure requirements are imposed based on the amount of ownership. For example, any person or group that controls more than a 5% beneficial ownership interest in a public company is subject to additional disclosure requirements with the SEC. Under the Securities Exchange Act, if an acquirer exceeds 10% of share ownership in a public company, any subsequent acquisition will be subject to additional disclosure requirements.

Documentation

Preliminary agreements

What preliminary agreements are commonly drafted?

Most buyers enter into a non-disclosure or confidentiality agreement prior to engaging in due diligence in order to protect confidential information. In this context, the buyer will agree to use the information to which it gains access strictly in connection with the transaction. Once the earliest stages of due diligence are complete, the parties may execute a letter of intent, memorandum of understanding or term sheet. This preliminary agreement is typically not binding except with respect to specific provisions concerning, for example, confidentiality, exclusivity and dispute resolution. The letter of intent or similar agreement sets out the parties’ agreement on general terms, which customarily includes:

  • the form of transaction;
  • the purchase price;
  • the proposed transaction timeline;
  • a summary of any required internal or material anticipated third-party consents; and
  • to the extent applicable, indemnification and management arrangements and restrictive covenants.

Principal documentation

What documents are required?

The form of the main transaction document depends on the structure of the transaction (ie, a merger agreement, a stock purchase agreement or an asset purchase agreement). Other documents that may be required include a non-disclosure agreement (or similar type of confidentiality agreement such as a letter of intent, memorandum of understanding or, if the transaction commences with an auction, a process letter). There may also be a management presentation or confidential information memorandum. Other documents associated with the transaction may include:

  • disclosure schedules;
  • escrow agreements;
  • employment agreements;
  • restrictive covenant agreements;
  • management equity arrangements; and
  • ancillary agreements relating to the transfer of securities or assets.

In addition, third-party or governmental consents and regulatory filings may be required.

Which side normally prepares the first drafts?

A buyer normally prepares the first drafts of the principal documentation in an M&A transaction.

However, in the context of an auction process, counsel representing the target and/or the sellers normally prepares an auction draft of the principal documentation that is made available to prospective buyers. Customarily, each buyer is then required to include, as part of its bid to acquire the target, a full mark-up of the auction draft.

What are the substantive clauses that comprise an acquisition agreement?

While the substantive clauses vary from deal to deal depending on the specific structure of the transaction, the following terms appear in most definitive transaction documents:

  • the purchase price and any adjustments to the purchase price or earn-outs;
  • representations and warranties;
  • covenants;
  • conditions to closing the transaction;
  • provisions relating to indemnification and survival of representations, warranties and covenants;
  • specific provisions detailing tax matters; and
  • miscellaneous provisions including those relating to choice of law and venue for resolution of disputes.

What provisions are made for deal protection?

Buyers and sellers have a number of mechanisms at their disposal to protect a deal during the period between signing and closing:

  • Termination fees – if a seller fails to satisfy its obligations required for closing and the transaction is terminated, it may be required to pay the buyer a fee.
  • Reverse termination fees – if a buyer fails to satisfy its obligations required for closing and the transaction is terminated, it may be required to pay the seller a fee.
  • ‘No-shop’ provisions – these provisions prohibit the seller from soliciting alternative offers after a deal has been signed. There may be exceptions given the fiduciary duties of the target’s directors.
  • Specific performance – the definitive transaction agreement may include a provision enabling one party to compel the other to specifically perform and close the transaction if the conditions to closing have been satisfied or waived.
  • Matching rights – when there are multiple bidders to acquire a company, matching rights grant the beneficiary of such rights the opportunity to match a competing bidder’s offer.
  • Stockholder agreements – these agreements may be entered into with a significant stakeholder, or stakeholders representing a high percentage of the voting power of the target company, to obligate such stakeholders to vote in favour of the transaction or cooperate with the buyer or to agree not to sell their shares to a different buyer prior to closing.
  • Force the vote – if a company’s board has initially recommended that the company enter into a transaction but subsequently withdraws such recommendation, Delaware corporate law nevertheless permits the directors to submit the transaction to the equity holders for approval. Accordingly, definitive transaction agreements may include a buyer-friendly provision requiring the target company’s directors to submit a transaction to a vote in such circumstances.

Closing documentation

What documents are normally executed at signing and closing?

In a customary transaction with a ‘split’ signing and closing structure, the parties sign the definitive transaction document on the signing date. In the private equity context (ie, where the buyer is normally a newly formed special purpose vehicle without assets), the buyer customarily delivers an equity commitment letter evidencing the commitment of fund entities sponsoring the purchase to fund all or a portion of the purchase price at closing. If any third-party debt financing is contemplated, the buyer will also deliver a signed debt commitment letter evidencing the lender’s commitment to fund a portion of the purchase price at closing. Fund entities sponsoring the purchase may also deliver a limited guaranty, wherein such sponsor guarantees payment of the buyer’s obligations in the event the agreement is terminated and the transaction is abandoned (including a reverse termination fee (if applicable) and the buyer’s share of deal expenses).

At closing, each other transaction document will be executed and exchanged, including but not limited to employment arrangements, escrow arrangements and other ancillary agreements, such as bring-down certificates and authorising resolutions.

Are there formalities for the execution of documents by foreign companies?

Signatories with respect to the transaction documents must be appropriately authorised by the foreign company to execute documents on the company’s behalf. Frequently, there are notarisation or other formal requirements intended to ensure that the executed document is enforceable against such company. The requirements for such authority vary by jurisdiction and transaction document; therefore, the domestic entity will typically engage local counsel in the relevant foreign jurisdiction to obtain comfort that the document will be enforceable against such company.

Are digital signatures binding and enforceable?

Two sets of legislation address electronic signatures in the United States:

·         the Uniform Electronic Transactions Act, which is a model state law that most states (including Delaware) have adopted; and

·         the Electronic Signatures in Global and National Commerce Act, which is federal law.

The Electronic Signatures in Global and National Commerce Act applies when federal law governs a given matter and will pre-empt inconsistent state law unless a state has adopted the Uniform Electronic Transactions Act. Under both the Uniform Electronic Transactions Act and the Electronic Signatures in Global and National Commerce Act, an electronic signature is generally binding and enforceable as long as it is signed with the appropriate intent. Both acts provide that electronic signatures are not enforceable in the case of documents relating to certain domestic and family law, estate planning and Uniform Commercial Code matters.

Foreign law and ownership

Foreign law

Can agreements provide for a foreign governing law?

In the United States, parties have freedom of contract and may include contract provisions of their preference. If the target is a domestic entity, it would be difficult and generally impractical for a party to argue that a foreign jurisdiction’s law should govern the terms of the agreement. Many provisions in a typical purchase agreement are grounded in US law regardless (eg, regulatory areas like employment, tax, employee benefits and intellectual property). In general, an agreement cannot provide that US law applies – a particular state must be specified. Common choices are Delaware, New York and California.

If the target is organised in a non-US jurisdiction, foreign law will commonly apply to the transaction. Notably, considerations relating to choice of law and dispute resolution are distinct subjects. For dispute resolution, in some cases the parties may submit to use arbitration, for which there is frequently broad discretion with respect to the applicable law.

Foreign ownership

What provisions and/or restrictions are there for foreign ownership?

There are generally no restrictions on foreign ownership of US interests. However, certain restrictions and expanded oversight apply if a US target owns sensitive technology or other assets that are considered to implicate national security concerns. The Committee on Foreign Investment in the United States screens certain transactions involving foreign investment in companies that, for example, produce, design or develop critical technology or work with critical infrastructure.

Valuation and consideration

Valuation

How are companies valued?

In the M&A context, companies are valued using basic banking methodologies, including analyses of comparable companies and transactions, multiples and discounted cash-flow analysis. For strategic investments, companies may also be valued based on the value of certain assets or relationships and anticipated synergies.

Consideration

What types of consideration can be offered?

Generally, consideration can be offered in the form of cash, debt and equity, on absolute and contingent bases (including earn-outs).

Strategy

General tips

What issues must be considered when preparing a company for sale?

Prior to entering into a sale process, sellers and the target’s management should consider who is serving as the company’s auditors and whether an eventual buyer would be comfortable relying on those auditors. If the target is in a regulated industry, the sellers and the target’s management should consider the relevant compliance culture. If regulatory matters are central to the target’s value, buyers will pay close attention to such matters, and the company should be prepared to be responsive to the buyer’s diligence process. Other issues that should be considered include whether the target’s current management expects to continue to manage the company after a sale. If members of management also hold ownership interests in the target, the company should have an understanding of whether they are prepared to roll some portion of the cash proceeds received into equity interests in the buyer.

What tips would you give when negotiating a deal?

At the outset of a sale process, if the target is of a sizable value, the sellers should engage an investment bank. A skilled investment bank will generate a competitive auction process, which creates a favourable environment for the target and its sellers. In an auction process, it is also beneficial for the company to fix as many deal terms as possible prior to giving one particular buyer exclusivity with respect to the transaction. In addition, the parties’ counsel should each be aware of their respective client’s key deal terms, and flexibility (or lack thereof) with respect to certain terms.

Hostile takeovers

Are hostile takeovers permitted and what are the possible strategies for the target?

Hostile takeovers are permitted. A target may respond to an unsolicited takeover proposal by rejecting the proposal. Under Delaware law, a target’s board can “just say no” if it reaches a good faith belief after reasonable investigation that the unsolicited takeover proposal posed a legally cognisable threat to the company (eg, substantive coercion by the bidder).

A target may adopt takeover defences to improve its ability to control the process following an unsolicited takeover proposal. Such defences may include:

  • shareholder rights plans (also known as poison pills);
  • defensive provisions in a target’s organisation documents that provide its board with additional control or time in the event of an unsolicited takeover proposal; or
  • change of control provisions in the target’s contracts or debt instruments that would trigger default, payment, termination or other rights in the event of an acquisition, thereby making one more difficult or costly.

A target can also pursue a sale of the company or other strategic alternatives in response to an unsolicited takeover proposal. In pursuing a sale, a target can try to negotiate with the bidder to improve its proposal or attempt to solicit alternative acquisition proposals. Alternatives may include divestitures, restructurings, recapitalisations, acquisitions, joint ventures or new investments by a friendly shareholder.

Warranties and indemnities

Scope of warranties

What do warranties and indemnities typically cover and how should they be negotiated?

Representations and warranties typically cover a wide range of issues relating to the target’s business, ownership and contracts, with the specific tailoring of the representations and warranties largely dependent on the particular target. The representations and warranties will almost always:

  • address the target’s formation, organisation, good standing or status, authorisation to enter into the transaction and transaction agreements, financial statements, contracts (eg, with customers and vendors), real and personal property, insurance and litigation history; and
  • include representations that no consents will be triggered or required as a result of the transaction.

The target’s representations and warranties also customarily encompass statutory matters, such as tax, employment, employee benefits and intellectual property.

The market standard varies when the companies involved in the transaction are public and the negotiation of representations and warranties is further limited. The target’s public status means that information about the target is readily available. As a result, the representations and warranties in the definitive transaction agreement do not serve a diligence function to the same degree as they might in a transaction between private companies.

Limitations and remedies

Are there limitations on warranties?

Customary limitations on warranties include qualifiers for knowledge, materiality and material adverse effect.

What are the remedies for a breach of warranty?

Absent fraud, the typical remedy for a breach of warranty is an indemnification claim, which is governed by the applicable provisions of the acquisition agreement and may be subject to certain limitations. These limitations include specifying the source of recovery to holdback amounts or escrow accounts or permitting direct recourse against the sellers or representations and warranties insurance policies, if applicable. However, the parties may retain the ability to pursue claims for breach of contract and fraudulent misrepresentation in applicable cases.

Are there time limits or restrictions for bringing claims under warranties?

Many contracts will contain provisions that delineate the applicable survival periods for different representations and warranties. Representations and warranties made in a definitive transaction agreement are customarily divided into fundamental (ie, concerning the validity of the underlying transaction itself) and non-fundamental (ie, concerning the target’s business). In the case of non-fundamental representations and warranties, the survival period typically ranges from zero to 24 months, while the period for fundamental representations and warranties tends to be approximately six years (ie, the default statute of limitations for a breach of contract claim), with some surviving indefinitely. The survival period for breaches of certain representations and warranties (eg, those relating to taxes and employee benefits) are normally tied to the applicable statute of limitations (plus a grace period of, for example, 60 days).

Other restrictions on survival may include exclusions for de minimis amounts, a tipping basket or true deductible, and caps on recovery. Caps for breaches of fundamental representations and warranties may be as high as the full purchase price while caps for breaches of non-fundamental representations and warranties are typically lower.

Tax and fees

Considerations and rates

What are the tax considerations (including any applicable rates)?

The highest marginal federal income tax rate on corporations is 21%. For non-corporate taxpayers, the highest marginal federal income tax rate is 37% or, in some instances, 29.6%. In addition, non-corporate taxpayers are subject to an additional 3.8% tax on investment income.

Exemptions and mitigation

Are any tax exemptions or reliefs available?

The target’s equity owners may be able to receive proceeds in the form of equity interests of the purchaser on a tax-free basis depending on the structure of the transaction. While the specific requirements for tax-free treatment are complex, tax-free treatment with respect to purchaser equity is generally possible if the purchaser is a partnership or limited liability company that has not elected to be taxed as a corporation. If the buyer is a corporation (or has elected to be taxed as a corporation), the receipt of buyer stock on a tax-free basis generally requires, among other things, that:

·         the target is a corporation and:

  • at least 40% of the consideration is buyer stock if the transaction is structured as a merger in which the target does not survive; or
  • at least 80% of the consideration is buyer voting stock in other instances; or

·         the target’s owners, together with other transferors, own at least 80% of the purchaser immediately after the transaction.

What are the common methods used to mitigate tax liability?

Parties typically structure transactions in order to mitigate tax liability. Depending on the structure and the parties’ entity classifications, in some cases the target’s equity owners may be able to obtain the purchaser’s equity interests on a tax-free basis. Structuring transactions so that the target’s owners roll their sale proceeds into equity of the buyer often provides beneficial tax deferral to the owners. Further, specific provisions in the US federal tax law provide for tax-free reorganisations if certain requirements are met.

Fees

What fees are likely to be involved?

Fees incurred in a typical M&A transaction generally include:

  • bankers’ or finders’ fee;
  • legal fees;
  • accounting fees;
  • financing fees (associated with arranging debt financing);
  • escrow fees;
  • underwriting fees and premiums (associated with arranging a representations and warranties insurance policy);
  • costs and expenses associated with running public records searches; and
  • other fees and expenses associated with the specific industries within which the buyer and target operate.

Management and directors

Management buy-outs

What are the rules on management buy-outs?

A management buy-out (MBO) is an acquisition of a target by all or some of its current management team, usually with the assistance of external financing. MBO transactions may raise concerns about managers’ conflicts of interest and fiduciary duties. The managers’ interest in buying at a low price may conflict with their duty to act in the company’s best interest.

Federal securities laws and state corporate laws address some conflicts of interest concerns involved in MBOs with public companies. Certain rules under federal securities law require substantial disclosure of information to the shareholders about the purpose of the transaction and its substantive and procedural fairness. Under state corporate laws, MBOs are often subject to the same standards of review as other conflict-of-interest transactions and an independent committee or other similar body is often used in connection with the transaction.

Directors’ duties

What duties do directors have in relation to M&A?

Under Delaware law, directors owe duties of care and loyalty to the company and its shareholders. Within these two primary fiduciary duties are also the subsidiary duties of good faith and disclosure.

The duty of care requires directors to take reasonable steps to fully inform themselves regarding a transaction. Elements evidencing the duty of care include consideration of:

  • the terms of the acquisition;
  • the acquisition’s strategic purpose and fairness; and
  • the deliberative process.

Directors may, in good faith, rely on experts, such as financial and legal advisers. The duty of loyalty requires directors to act in the company’s best interests and restricts them from standing on both sides of a transaction or deriving personal benefit through self-dealing.

The duty of good faith requires directors to promote the company’s value for the benefit of its shareholders. When directors ask shareholders to take actions, the duty of disclosure requires them to disclose all facts that:

  • are material to the directors’ consideration of the transaction; or
  • can reasonably be obtained by the directors.

In evaluating whether directors have fulfilled their fiduciary duties, Delaware case law has established three tiers of review:

  • the business judgment rule – the most deferential to directors;
  • enhanced scrutiny – an intermediate standard of review; and
  • entire fairness –the most onerous of Delaware’s standards of review.

Employees

Consultation and transfer

How are employees involved in the process?

In order to preserve the confidentiality of a pending transaction, buyers and sellers try to limit the number of employees who are involved in due diligence and negotiating deal terms to senior management members and the heads of certain important functional groups (eg, accounting, tax, legal and human resources).

What rules govern the transfer of employees to a buyer?

In an equity purchase, there is no transfer of employees, as they remain employed by the same entity, albeit under new ownership. As a matter of law, the transaction will not automatically cause target employee terminations. However, once the transaction is closed, the buyer may decide whether to terminate any employees.

Where the transaction is structured as a purchase of assets, there is no automatic transfer of employees from the seller to the purchaser. Instead, the buyer must make offers of employment to the employees who it wants to hire. On acceptance, those employees must be ‘on boarded’ as the purchaser’s employees in accordance with the applicable law and the purchaser’s customary practices.

While under US law employees are generally at will and can be terminated at any time, parties to an asset purchase also must take steps to ensure that they comply with the Worker Adjustment and Retraining Act and similar state and local requirements, which prescribe employer responsibilities when conducting certain mass layoffs and plant closings. 

A target’s employees may also be covered by a severance plan or individualised employment agreements which may obligate the employer to provide notice of termination and/or severance pay for a contractually determined period following certain qualifying terminations of employment. Parties may try to amend these arrangements to eliminate these payments prior to closing.

During a transaction, the buyer should also review agreements and plans with key executives of the target to determine:

  • the cost of the agreements, especially any severance or change in control payments that may be triggered by the transaction; and
  • any potential tax concerns raised by the agreements.

The Internal Revenue Code treats different types of compensation differently. Payments to certain individuals that are considered contingent on a change in control may result in a 20% excise tax for the individuals and a corresponding loss of deduction for the company.

Pensions

What are the rules in relation to company pension rights in the event of an acquisition?

Employee benefit plans in the United States, including retirement plans, are governed by complex legal provisions, including the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code.

Treatment of retirement plans, and the potential risks and liabilities associated with such plans, depends on:

  • the type of plan;
  • the type of benefits involved; and
  • the structure of the transaction.

In a stock purchase or merger, the buyer assumes all of the target’s pension and benefit liabilities. In an asset sale, the buyer will assume only specified assets and liabilities. Pension and other benefit plans may be left behind with the selling entity or transferred to the buyer according to the asset purchase agreement. In addition, the parties may choose to transfer specified retirement liabilities to the buyer’s retirement plans in a transfer or spin-off from the seller’s plan.

Even if the buyer does not assume the seller or target’s pension plans, it may be liable for defined benefit plans maintained by the seller or target and the members of their controlled group. As such, it is necessary to determine whether such plans exist, either with respect to the company being purchased or any its controlled group members.

The transaction could also trigger a reportable event notice to the Pension Benefit Guaranty Corporation (PBGC), a federal regulatory body. Failure to file such notice in a timely manner can result in an assessment of penalties by the PBGC. In addition, the PBGC monitors transactions that involve pension plans; if the PBGC determines that the pension plan will be negatively affected by a transaction or event (eg, the transaction increases the risk of plan failure), it may attempt to negotiate additional financial protections. In the case of certain multi-employer plans, there may also be withdrawal liability triggered by the transaction.

Other relevant considerations

Competition

What legislation governs competition issues relating to M&A?

The Clayton Act and the Sherman Act regulate antitrust and competition issues. In general, these laws prohibit M&A that would substantially lessen competition or potentially result in a monopoly or unreasonable restraints of trade. As a result, parties to certain transactions may be required to submit the transaction to government review and clearance before they may close the transaction. There are also antitrust laws at the state level.

Anti-bribery

Are any anti-bribery provisions in force?

The Foreign Corrupt Practices Act of 1977 contains federal anti-bribery provisions. State laws also apply. The act prohibits paying or promising to pay foreign officials in return for business or to influence their decisions. The prohibition is not limited to conduct within the United States.

Receivership/bankruptcy

What happens if the company being bought is in receivership or bankrupt?

Transactions with financially distressed companies are often effectuated through bankruptcy proceedings. Bankruptcy sales are generally structured as asset sales and offer various protections for buyers that would otherwise be unavailable in transactions outside  a bankruptcy process. Sales occurring in the context of a bankruptcy proceeding must generally be approved by the bankruptcy court overseeing the proceeding. As part of that approval process, the buyer can expect:

  • a judicial order authorising the transfer of assets free and clear of any liens, claims or encumbrances; and
  • an injunction prohibiting creditors from taking action against the buyer or the purchased assets.

In addition, a transaction with a distressed seller outside a bankruptcy process carries the risk that the seller’s creditors may challenge the propriety of the transaction later on should the seller ultimately fail; transactions effectuated through a bankruptcy process generally eliminate that risk. Nevertheless, bankruptcy sales generally require transactions to be subject to an open bidding and auction process. As a result, a prospective purchaser may be required to pay a higher price than it otherwise would have had to pay outside an auction process.