In an M&A transaction, there are three stages for which documentation, i.e., legal agreements, is required: Preliminary, principal, and closing documentation.[1]
I. Preliminary Stage of Documentation. Preliminary documentation includes the following agreements:
1. Term Sheet/MoU/Letter of Intent. All of these three documents have a similar effect. Thus, any one may be executed. They are known as “hand-shake agreements” and crystallize the commercial intent of the parties at the negotiation phase when a simple understanding has been reached between the parties;
2. Non-disclosure Agreement. As discussed, NDAs are a security net against prohibited use, misuse, or abuse of the information exchanged between the parties during the due diligence stage. Thus, it is also a type of preliminary documentation; and
3. Exclusivity Agreement. This document states that parties will not enter into counter or secret negotiations with other parties for an M&A deal during this period. Imagine the costs if you don’t have an exclusivity agreement. You would incur losses due to due diligence and negotiation costs of time, money and manpower and at the same time, lose the competitive advantage of the M&A to your rival business. Therefore, all these three documents in the preliminary stage are very important.
II. Principal Documentation: There are some integral documents that form the basis of the M&A transaction. These documents are known as the principal documents. Depending on the industry, structure, and purpose of the transactions, you will need to modify them to suit your needs:
1. Scheme of Arrangement. To execute a merger, amalgamation, or demerger, as per law, a scheme of arrangement must be entered into between the transferor and transferee companies, members and creditors of all the companies.
2. Share Acquisition Agreement. A share acquisition involves a share subscription agreement, for investment in new shares, or a share purchase agreement, for the purchase of existing shares. A shareholders’ agreement is entered into to set out the rights and obligations of the shareholders.
3. Amend Company’s Articles and Memorandum of Association. If Shareholders’ agreements are entered into, the company’s AoA and MoA should also be amended to reflect these agreements and the future business purpose of the merged/acquired entity.
4. Business/Asset Transfer Agreement. An asset or business transfer also requires an asset purchase or a business transfer agreement.
5. Ancillary documents. Other documents may be required depending on the nature and type of transaction, including:
· Employment Agreements;
· Intellectual Property and Immovable Property Transfer Agreements;
· Novation or Assignment of Contracts; and
· Non-Compete and Non-Solicitation Agreements.
Preparing the First Draft
The acquirer(buyer) prepares the first draft. However, if the M&A occurs through a bidding process, it is usually the seller who prepares the draft documents, which are verified and accepted by the acquirer with few modifications.
Contents of an Acquisition Agreement
1. Purchase and Sale Clause. This clause specifies what is being sold and purchased in the case of business or asset transfers, the contours of business or assets being sold and inclusions and exclusions thereto;
2. Payment Clause. This clause deals with the sale, payment mechanism and structure, escrow and holdback arrangements;
3. Pre-Closing Obligations. Each transaction has some pre-closing conditions that need to be fulfilled, as agreed by the parties. They may be in the nature of obtaining licenses and approvals, completing due diligence, etc. It may also include standstill provisions i.e., those conditions which if not fulfilled, bar the execution of the Agreement.
4. Closing Obligations. To specify the closing transaction conditions that need to be fulfilled;
5. Close Structure. The closing mechanism;
6. Conditions Subsequent. Specify the conditions that need to be fulfilled post-closing;
7. Representations and Warranties. The disclaimers regarding the accuracy of the statements made by the parties, including the survival and exceptions to the disclosures made;
8. Indemnity. Where one party promises to make good any loss that occurs and not hold the other party liable;
9. Limited Liability. This clause prescribes limits, in monetary limits, up to which each party agrees to bear the liability incurred if any;
10. Termination Clause. The conditions, events, and procedure for terminating the agreement and the consequences of termination;
11. Dispute Resolution. There are various ways to resolve a dispute such as mediation, negotiation, arbitration and litigation. In this clause, you can choose your preferred method and procedure;
12. Confidentiality. This clause is similar to the NDA that we discussed in the previous chapter, and will contain similar provisions regarding confidentiality;
13. Governing Law and Jurisdiction. To limit the operation of the agreement to certain geographical areas and choose the law and forum governing the contract and disputes, if any; and
14. Boilerplate Clauses. Residual clauses in a standard format.
Contents of a Shareholders’ Agreement
1. Transfer Restrictions. It is important to impose restrictions on the transfer of shares by shareholders. Examples of such clauses are Promoter Lock-in, restriction on transfer to competitors, Right of First Refusal (ROFR), Right of First Offer (ROFO), Tag-along, and Drag-along. These clauses prevent shareholders, investors and promoters from abandoning the new entity and making profits by abandoning the ship;
(i) Promoter Lock-In Period.
The Lock-in period is the term or duration of months or years during which the terms of the agreement cannot be altered or terminated and the promoters and majority shareholders cannot deal with their shares in any manner during this period.
If a party terminates the agreement during the lock-in period or transacts in the shares of the company, it is required to compensate the company and the other shareholders.
The underlying clause in share acquisition or joint venture agreements is that one or more parties may be required not to sell their holding for a particular period of time. You may also have observed that you have to pay a penalty for pre-closure of any loan provided by a bank or financial institution.
A lock-in could be for the entire duration of an agreement or only a part of it. This period actually depends on the respective bargaining powers of the parties. The party with better bargaining powers usually imposes its conditions on the other party. Further, the lock-in may operate against one party or some or all the parties, depending on the nature of the agreement and negotiation among the parties. Example clauses of Lock-In:
(a) The Promoter undertakes not to sell or transfer any shares of the company issued to him under the Share Acquisition Agreement for a period of 3 (years) of such issue.
(b) The Parties agree not to sell, hypothecate, pledge, transfer or otherwise dispose of any shares or other security of the Joint Venture Company to a third party for a period of 2 (two) years from the date of issue thereof except Permitted Transfers under Article 7.1 of this Agreement.
(ii) ROFO.
In a Right of First Offer (ROFO), the holder of the right is entitled to the first offer by the owner of the asset before he offers it to a third party. In a shareholders’ agreement, the asset on which ROFO is given is the shares of the company.
(iii) ROFR.
In a Right of First Refusal (ROFR), the holder of the right is entitled to have the first right to do business with the seller. This means that if any third party requests a deal with the seller, he is obligated to first offer the exact same deal to the ROFR holder.
(iv) Tag-Along Rights.
Tag-along rights give the shareholders the option to either accept or refuse to sell their shares along with the majority shareholders who are entering the deal.
(v) Drag-Along Rights.
If a drag-along clause exists, the other shareholders are dragged into the deal with the majority shareholders and do not have any say. They are offered the same price and rights in the deal as the majority shareholders. This provision is usually included to protect the majority shareholders and make it easy for them to enter M&A deals and agree to sell or exchange the entire share capital of the company if required.
2. Pre-emptive shareholders’ rights. Further issuance of capital by the company;
3. Representation Rights. Right of shareholders to have representation i.e., be appointed as Directors, in the Board of Directors of the new entity on behalf of the majority and minority shareholders;
4. Voting Rights. Affirmative or veto rights for shareholders on certain material actions;
5. Information Rights. Include information such as balance sheets, financial statements, encumbrances, etc. That must be shared with the shareholders;
6. Exit Rights. The right of shareholders to leave the new entity by selling their share either to the company or in the share market in the case of minority investment (e.g., put, tag and initial public offerings); and
7. Resolution of Deadlock. Tie-breaking provisions in case of standstill between shareholders and Board of Directors or if there is a split vote.
Some Suggested Safety Net Documentation to Protect the Deal
1. Confidentiality provisions, including NDA;
2. Exclusivity and non-solicitation clauses;
3. Positive and negative covenants, including standstill provisions, for the period between the agreement and closing dates;
4. Keeping the selling shareholders’ shares in an escrow account until the date of execution; and
5. Break-fee and termination provisions.
III. Closing Documentation
A lot of the documentation at closing consists of compliances such as board resolutions and shareholder resolutions regarding the transfer of shares, amending the memorandum and articles of association, filing the requisite forms with the Registrar of Companies, and receiving the NCLT’s approval for the scheme of arrangement as well as RBI approvals in cross-border transactions.
Supporting documents for the transfer of immovable property such as land, buildings, estates, etc. and intangible property such as goodwill, patents, trademarks, copyrights, technical know-how, designs, etc. are also executed between the parties during this period.[2]
[1] Pooja Mahajan, M&A documentation in India, Lexology, 12 Apr. 2018, https://www.lexology.com/library/detail.aspx?g=cadd0ff2-1437-4216-9be0-4022ef189a0c.
[2] Pooja Mahajan, M&A documentation in India, Lexology, 12 Apr. 2018, https://www.lexology.com/library/detail.aspx?g=cadd0ff2-1437-4216-9be0-4022ef189a0c.
