This article is written by Mohammad Khurshid Anwar who is pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.

Introduction

Merger and Acquisition (M&A) transactions are large transactions and mostly completed in two stages. First stage is when the parties involved in the transaction reach a definitive agreement, known as signing, the second stage is when the actual transaction occurs, also known as closing. The duration between definitive agreement and closing can vary from few months to few years depending upon the size of target, logistical ease between both acquirer and target, cultural differences, regulatory process involved between transaction, transfer of intellectual patent rights (if any), compliance of representation and warranties, and other operational compliance as required.

Any M&A agreement keeps the agreement open through inclusion of closing conditions in the agreement. These closing conditions list down all the issues which need to be complied or addressed before the closing transaction happens. Any non-compliance to these closing conditions gives a chance to parties for opening re-negotiation due to higher risk exposure or even may lead to termination of agreement.

This article will list down various clauses and mechanisms generally kept in M&A agreement to be compiled until the closing of transaction, corresponding closing conditions and relevant termination clauses in case of non-compliance of closing condition.

Mechanism in M&A Agreement

The most common form of acquisition is purchasing a house, though small in value but it involves all the mechanisms required for merger and acquisition. The mechanism and condition of large mergers and acquisitions can be easily understood with this example. When you desire to purchase a house your do the following: 

• You search for a suitable house and you zeroed down to one house which you expect to be fit for your requirements. – (shortlisting of potential parties)

1. You meet with the owner and go through the property or house after the initial inspection shows your interest in the property.
2. Both parties show intent to sell/purchase the house. – (Intent for agreement is developed)
3. The buyer concentrates on the condition of house and checks physical condition, paper works, previous bill payments etc. whereas seller concentrate on pricing of the property, how the transaction should happen, any of his liabilities need to be transferred to the buyer – this is initial due diligence for entering into an agreement. (a step towards definitive agreement)
4. After initial due diligence both the parties enter into an agreement with certain conditions. Where
   1. Buyer may want to following condition to be complied before payment 
      1. Seller to show no litigation, lien, loan, and any other kind of liability is pending against 
      2. Certain part of house to be repaired, refurbished 
      3. Seller to show all bills against the property and taxes are paid.
   2. Seller may want following conditions to be complied
      1. xxx amount to be paid as advance
      2. After compliance of buyer’s condition 
      3. within xxx days of compliance of buyer’s condition payment should be made.

Both parties may take a few days to comply with each other’s requirements before final payment. In a M&A agreement this final payment is called as closing and these conditions to be complied with before closing is called as Closing Conditions.

In M&A agreement the transaction is large and risks are bigger, therefore the above mechanism of entering into a definitive agreement with closing conditions in place is of utmost importance. It gives the parties an opportunity to carry a proper due diligence and time for statutory/regulatory compliance. 

Above mechanism provides parties a chance to renegotiate the deal or walk out from the deal, in case of non-compliance to any closing condition. Therefore, while drafting a closing condition, care should be taken, compliance to these conditions will form a part of informed decision making. 

Essential components in an M&A agreement content

An M&A agreement generally discuss the following:

1. Price and Payment 
   • Pricing is decided in the early stages of discussion mostly through precontractual agreements like Letter of intent, Term sheet or Head of terms or other suitable agreements. The price payment schedule is also decided what % to be paid upfront and what %age should be paid at the closing.
   • Mode of payment should be decided depending upon the mode of payment various conditions can be carried forward to Closing Conditions. Like in case buyers’ stock is a part of consideration what will happen if price difference is significant between signing and closing; or for promissory note what will happen if buyer is at breach; or is there any limit required for working capital adjustment; or if the part of consideration is earn-out, should it be discussed in closing condition etc. 
2. Escrow/Hold back arrangement: Buyer some time may request for escrow/holdback amount for post-closing indemnification claim.
3. Representation and warranties of seller: representation and warranties by seller helps buyer complete its due diligence, buyer should check the seller’s representation and warranties both at the time of signing and closing. The checking of representation and warranties should be the part of closing conditions in order to avoid any disputes. These representation and warranties can be: 
   • Operational: Completed or Ongoing contracts, supplier agreement status, inventory, seller agreements which need to be transferred with the deal, etc.
   • Financial: asset, liabilities, working capital, stocks, listings, …..
   • Intellectual property: patent owned or used by the seller.
   • Intellectual property infringements: not liability with the use of a certain patent.
   • Sellers liabilities: as applicable other than financial.
   • Legal proceeding pending or completed
   • Others as per type of merger and acquisition nature and business
4. Representation and warranties of buyer: similar to checking of seller representation by buyer, sheller should check buyer’s representation and warranties. Buyer’s representation and warranties can be about:
   • Authorized representative from buyer’s side
   • Financial standing of buyer to pay the full amount
   • Legal issues if getting affected with the deal
   • Others as per type of merger and acquisition nature and business

5. Pre Closing covenants of seller like:

• seller will continue to operate in similar fashion between signing and closing as it was operating prior to signing; 
• restriction on borrowing or lending, encumbering of assets, etc.
• for being reasonable in fulfilling closing conditions
• shareholder/Board approvals for the transaction
• exclusivity in relationship between parties restricting seller for any other alternative deals or even discussing unwanted proposals from third parties

6. Covenants by buyer

• Buyer should make reasonable efforts to complete the transaction and make required regulatory compliance
• Buyer following the closing, will continue to protect the existing company officers and directors under existing indemnification agreements and charter protections
• If private equity buyers are involved, covenants guarantying the funds providing equity capital to guarantee the obligations of the special purpose entity formed to make the acquisition
• Notifying obligations with regards to any material developments that can affect the buyer’s ability to consummate the transaction
• Post-closing tax administration procedures
• Limitations on issuance of press releases or public information on the deal without consent of the seller
• Others as required.

7. Employee Benefits and issues: details regarding retention of seller employee, directors, senior executives and their benefits in terms of perks, stock issues, in case the seller employees required to be re-vested, etc.

8. Closing Conditions: closing conditions are conditions which require to be complied before closing of transaction. It is explained in more detail in the next section.

9. Indemnification provision: in case of breach by seller, misrepresentation, cap on exposure, joint and several liability, exclusion, etc.

10. Allocation of various risks: as applicable e.g. Intellectual Property, material adverse effect.

11. Guarding against fraud.

12. Termination provision: it is closely related with closing condition, along with general condition like with prior notice either party can terminate the deal.

13. Dispute resolution: mention place, dispute resolution method and hierarchy, list down all alternatives in case of separation and penalty.

Closing condition provides the platform for closing of the transaction and is addressed in the next section.

Closing Condition

For drafting a closing condition to M&A agreement, all possible open ends existing before closing of the transaction should be listed under closing condition. Closing conditions can include:

1. Representations and warranties declared by the seller are valid until closing date.
2. Representations and warranties declared by the buyer are valid until the closing date.
3. All pre closing covenants are followed and honored by seller and buyer.
4. All governmental and regulatory approval are in place or when it is intended to be obtained. 
5. Is there any requirement of holding the seller accountable by creation of an escrow account and holding 5 to 15 % of the transaction?
6. Are indemnification is in place in case of post closure breach.
7. Provisions stating warranties and representations have been met by all parties involved
8. All governmental agencies which require information are informed and all necessary permissions are in place. i.e. joint conditions recognizing the transaction is legal
9. Buyer conditions that the seller gets third-party consent, such as from suppliers
10. Joint conditions that no pending legal problems would prevent closing
11. Deal-specific conditions by the buyer that certain issues are addressed before closing

Failure by any party to comply with closing conditions may lead to re-negotiation of a deal or may result in dispute or may lead to termination of agreement, as we can see in the case provided below.

Case of non-compliance of closing condition

Eli Lilly & Co vs Competition Commission of India on 12 March, 2020

This case Eli Lilly & co. was issued as show-cause notice by Competition Commission of India for not informing its acquisition of Novartis Animal Health in India (“NAH India”), a business with sales of only INR 93.0 crores and assets of only INR 36.2 crores.

This is a case of non-compliance of government regulation and against general closing condition criteria of M&A agreement.

Conclusion

There can be various reasons for going for merger or acquisition by a company, some of them are increasing geographical reach, acquiring superior technology, boosting existing operation, taking the competition out from the market and others as the necessity may be. 

Being a high-value transaction, any merger and acquisition transaction carries larger risks. To address the risk involved and obtaining relevant governmental and regulatory bodies approval the transaction takes place in two stages i.e. (i) signing and (ii) closing. Since the transactions are carried out in two stages it gives parties a chance to complete their due diligence properly and at the same time the transaction is affected by market condition, behavior of parties towards the transaction, operational transfer restrictions and other business-specific or financial parameters.  

With so many above mentioned variables operating in any merger and acquisition transaction, drafting and addressing of closing conditions in an M&A agreement becomes very important since it is the last check by both the parties before closing and it also provides the remedy for any change in condition.

References

1. https://www.forbes.com/sites/allbusiness/2017/08/21/18-key-issues-in-negotiating-merger-and-acquisition-agreements-for-technology-companies/
2. https://www.roedl.com/insights/ma-dialog/2020-02/ma-vocabulary-explained-experts-conditions-precedent
3. https://www.lw.com/admin/Upload/Documents/OilAndGasMandA/General%20Concepts/Consolidated_General_Concepts_Part_II_Key_Provisions.pdf
4. https://www.morse.law/news/importance-of-closing-conditions-in-mergers
5. https://www.upcounsel.com/closing-conditions
6. https://www.dlapiperaccelerate.com/knowledge/2017/mergers-and-acquisitions-overview-of-a-transaction.html
7. https://www.divestopedia.com/definition/5786/closing-condition
8. https://www.lexology.com/library/detail.aspx?g=4c8cc8f2-7942-46aa-b936-8dd60e1719da
9. https://indiankanoon.org/doc/68592136/

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