This article has been written by Abhijit Kirtunia, pursuing the Diploma Programme in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.

Introduction: what are covenants?

There is frequently a period of time between the signing of a definitive acquisition agreement and the closing of the acquisition. This is generally required for seeking regulatory approvals, third-party contractual consents, and other conditions that must be satisfied before an acquisition can be completed. It is very important that both the buyer and the seller understand their obligations to the other party during this time. Frequently, the parties will also agree to do (or not do) certain things for a period of time after the acquisition has closed. These pre-closing and post-closing agreements between the buyer and the seller are generally referred to as “covenants” and are usually extensively negotiated by the parties.

A covenant is an undertaking of a party to perform or refrain from performing an action during the period between signing and closing (pre-closing covenants) or for a certain time after closing (post-closing covenants). In M&A transactions, covenants will protect the purchaser’s interests prior to completion (i.e. covenants force a seller and the acquired companies to conduct the business in the ordinary course and to obtain the purchaser’s approval for important or extraordinary matters), as well as its commercial deal after completion in an active sense (i.e. the seller is required to take care of transaction-related interests or to continue to disentangle the acquired business) and in a passive sense (i.e. the seller should refrain from using its knowledge or business relationships to compete with the business it sold).

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Background: the need for covenants – compliance to Anti-Trust regulations

Careful consideration of the processes for diligent planning and integration in any transaction is essential. Failure to comply could result in severe penalties for violating any law, prosecution of public offenses and allegations of co-operation, and termination of basic transactions.

Antitrust landscape in the US

There are three U.S. antitrust laws that regulate the diligence process, transition planning, and overall conduct between parties during deal negotiations and due diligence prior to closing: Section 7A of the Clayton Act (better known as the Hart-Scott-Rodino Antitrust Improvements Act (HSR Act), Section 1 of the Sherman Act, and Section 5 of the Federal Trade Commission Act. There are two binding principles common to these statutes.

First, rivals must remain competitive until after the close. This is based on the acceptance that not everything will be successfully closed. As a result, the distribution of information between competitors throughout the closing period should be carefully monitored and documented to ensure that if the transaction fails to close, market competition is not reduced due to the information learned.

Second, the exercise of beneficial ownership by the buyer over the target prior to the expiration of the HSR Act waiting period is similarly prohibited. Also, competitors must continue to function as competitors until after the close. That means, for example, that a buyer cannot start ordering a target to change certain business methods in anticipation of closure. Instead, the seller must continue to operate freely as if nothing had happened.

CCI lens in India 

In a particular field of competition law, M&A transactions are classified as a combination under review under various provisions of the Competition Act, 2002 (‘the Act’). In this regard, any transaction that is likely to result in an appreciable adverse effect on the competition (‘AAEC’) in India is subject to amendment or approval by the Competition Commission of India (‘CCI’).

In order to evaluate this transaction, all M&A transactions that exceed the threshold need to be notified by the CCI for review. It is worth noting that the framework of the merger competition law is naturally suspicious. It means that the transaction parties must set aside the end of the merger until approved by the CCI.

Significantly, there are two types of gun-jumping acknowledged by the legislation and decisional practice of CCI:

  • Procedural Gun-Jumping: Procedural gun-jumping is the voluntary or involuntary failure to notify a combination. As per Section 6(2) of the Act, the parties involved in a combination must notify CCI within thirty (30) days of execution of any document or other document in terms of Section 5(a) i.e. any document which gives one of the parties the rights to exercise control over the other.
  • Substantial Gun-Jumping: Substantial gun-jumping occurs when parties prematurely put their combination into effect during the waiting period till CCI approves the transaction or before 210 days of filing the notice. This form of gun-jumping is triggered in instances when, inter alia, parties allocate customers among themselves, share confidential information, initiate combined marketing schemes.

The rationale behind the concept of gun-jumping is to ensure that trading teams continue to compete independently in the market until the work is reviewed by the AAEC. In this regard, Section 43A of the Act empowers the CCI to initiate disciplinary action against parties and to impose fines of up to 1% of all their assets or profits, whichever is higher.

  • General Guideline during Antitrust Phase: Parties may ask: (1) whether such provisions are necessary to maintain the transaction; (2) the provisions shall allow the seller to continue competing before closing in the normal course of business or after leaving if the agreement fails to close; and (3) will the restrictions allow for the activities that are often performed by the seller or proposed in the seller’s latest business plans? If so, the advice can probably help to create some kind of agreement that is acceptable to both parties. Limitations on the seller’s ability to make independent pricing, discounts, and bidding/selling decisions before closing, however, are highly suspicious and should be avoided without further consultation with advisers.

It is generally acceptable for parties to enter into agreements in an agreement that prohibits the seller’s activities before closing to protect the profit of the buyer’s transaction. However, it is important that such restrictions, individually or collectively, do not exceed performance control by improperly restricting normal business activities or by restricting a competitor’s ability to compete before closing or disposal if the agreement does not close for some reason. Another way to reduce the risk from operating performance agreements is to rely on standard agreements that simply require the seller to operate the business in a normal course and/or to take actions that may or may not adversely affect the seller’s business.

Few key covenants in transaction agreements

During the period between the signing and closing of the transaction, the business of the acquired companies would continue normally in the normal business. Expected investments (e.g. refurbishment or maintenance of equipment and production installations) may or may not continue as planned. Buyers may want to prepare, re-validate, or expand their business plans for acquired companies. Also, sellers and buyers, contact their business partners to ask for clarification (and assurance of their ongoing position). Some contracts contain a regulatory provision, which may result in a renegotiation of the price or other terms and conditions. As with all things in life, challenges arise in the normal course of business. Because each such issue may affect the number of companies acquired or the inclusion of a business acquired in the consumer’s business, pre-closing agreements will be agreed upon, perhaps with some consumer involvement. Some of the larger ones are below:

Conduct of business pending closing

Under this arrangement, the parties will agree that, until the acquisition is terminated or terminated in accordance with the terms of the fixed acquisition agreement, the seller will continue to conduct business in the normal course of business, in accordance with past practices. The seller will usually agree to take steps to ensure that the business is maintained at this time. The buyer, however, will also require the seller to firmly agree not to engage in specified activities outside the normal course of business, such as amending organizational documents, incurring additional debts, settling significant claims, or altering the compensation of its employees. Teams tend to spend a lot of time discussing these limitations, as the seller wants to maintain flexibility in the business process before closing and the buyer wants to make sure there are no visible changes in the business at this time.

  • Transitional services: Divested/sold companies often rely heavily on the availability of services and resources provided by their holding company. To a lesser extent, this can also apply to services or institutions (if only in certain countries) that are operated by commercial companies to benefit their affiliates. For that purpose, an allocation or purchase agreement will generally contain an interim service agreement that provides for uninterrupted continuity of various services. Common issues to be addressed are the legal entities that are legally entitled (responsible) to the service, the duration of each service (i.e. not all services can be terminated easily), service fees, payment arrangements and invoices, certain service-related information and contacts after closing.
  • No Solicitation – In this arrangement, often referred to as “no shop” provision, the seller agrees not to solicit, provide information, or encourage the negotiation of any transaction with a third party other than the consumer. However, in the sale of a publicly held company, it is customary to put “fiduciary out” without the provision of a solicitation of funds. This exception allows the company to negotiate and complete transactions with a third party if failure to do so would violate directors’ fraudulent activities. In most cases, the fiduciary out requires the merchant board of directors to decide that another proposal is a higher proposal. Agencies often spend a lot of time carefully planning the process of deciding whether another proposal is superior, including whether the buyer has the right to match any proposal before the seller is able to accept the higher proposal.
  • Reasonable Best Efforts – In this provision, the parties will agree to work together to make any necessary filings or obtain any necessary regulatory approvals or third-party consents. 
  • Stockholder Approval- With regard to the sale of a publicly-traded company, this section requires that the seller (and the buyer if the buyer’s shareholder is required to authorize the acquisition) take the necessary steps to hold a shareholders’ meeting to accept a clear purchase agreement and approve the transaction. This section will also cover when to do the items and who pays for the application. In the case of a privately owned company, stock approvals are usually acquired prior to the execution of a fixed acquisition agreement.
  • Access to Information; Confidentiality- This provision ensures that the buyer has access to and is able to continue to do the proper work between signing and closing the acquisition. The seller will want to ensure that this access does not interfere with the seller’s ability to conduct his business and does not interfere with his suppliers, customers, and government agencies having jurisdiction over the intended business, especially if the acquisition is not made public.
  • IP-related matters (if not addressed otherwise)- An undertaking not to enter into, amend or terminate any joint ventures, partnerships, licenses, or important lease agreements.
  • Employees and Employee Benefits Matters- This category will vary depending on the format of the transaction and is often discussed in groups. It usually controls how the buyer will treat the seller’s staff after the work is completed. This provision may require the consumer to continue to employ the seller’s staff for a period of time, retain salary and bonus compensation at the same level for a period of time, provide the same benefits, and/or provide employees with credit under the employee’s employee benefits for the period under which the employee.
  • Directors’ and Officers’ Indemnification and Insurance- This provision assures the seller that directors and their officers will be remunerated after the closure of their actions in the same manner as they would have if the acquisition had not occurred. It also obligates the consumer and the surviving company to adhere to the policy of directors and police insurance (D&O Insurance), purchase another policy that covers the same terms, or acquire what is known as a “tail” policy that provides continuous coverage of the pre-acquisition policy. actions or claims from the director or police action after the meeting. In most cases, this section will also prevent the consumer from changing the provisions of the company’s life cycle for a period of time after the closure.
  • Non-Competition- Depending on the nature of the transaction, it may make sense for the buyer to request a non-competitive agreement from the seller. This provision will prevent the seller from engaging in activities that will compete with the consumer in his or her business performance that he or she acquires after closing. Frequency, limited business description, duration of non-competition, and the scope of the area are widely discussed. This condition may also be extended to cover unsolicited employees.
  • Taxation- Although often referred to in a separate schedule or tax agreement, tax issues obviously require a kind of ‘agreement’ in the context of M&A transactions. liaising with tax authorities and handling any tax-related disputes. And the payment of claims and counter-conduct of any pending cases.
  • Duty to informObviously, between signing and closing, the purchaser wants to be informed of all matters that may affect the number of companies acquired, any incorrect guarantees, and usually any business decisions on acquired companies. It will also need to receive periodic management reports and quarterly or annual financial statements.

Post-closing covenants

All security, guarantee, and security provided by the companies acquired for the benefit of the merchant group and vice versa should be terminated (and replaced). These include financial arrangements of any kind: merger and banking arrangements, securities rights, foreign exchange or financial arrangements, financial commitments and parental guarantees by shareholders, credit providers, and suppliers working for both sold companies and non-retailer services, etc.

  • Non-Competition
    • Geography, duration, and scope;
    • Reasonableness is key;
    • More likely enforced in the context of Stock Purchase Agreement vs. an Employment Agreement.
  • Non-Solicitation of Employees
    • Duration and scope;
    • Employee Benefits.
  • Tax Matters;
  • Stockholder release;
  • Continued confidentiality;
  • Other transition issues.


M&A agreements typically include temporary operating agreements, which require the seller to use the acquired business in a certain way between the time the agreement is signed and the closing time. The purpose of these agreements is to help ensure that the consumer receives the business in the same condition of closure as was the case when due diligence was made and an agreement was signed.

While the nature and scope of covenants may vary from agreement to agreement, but they largely support the seller to

(a) operate the business in the normal course of action; and

(b) maintain relationships with major stakeholders, such as employees, customers, and suppliers – unless otherwise agreed by the consumer or applicable law. In addition to these general requirements, covenants in merger agreements usually include detailed terms that specify certain actions that the seller must take, certain actions that the seller must avoid, and certain actions that the seller must prevent without prior buyer’s consent.

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