Kenadjian Chapter 29

Chapter 29
THE MERGER OR ASSET ACQUISITION CHOICE
AND RELATED ISSUES
Patrick S. Kenadjian
(LN) 98000/800/KENADJIAN/Chapter 29.doc 09/02/11 10:35 AM

Table of Sections
29.1 Scope Note.

29.2 Choosing the Form of the Transaction.
(a) Introduction.
(b) Reasons to Choose a Merger.
(c) Reasons to Choose a Share Sale.
(d) Reasons to Choose an Asset Sale.
29.3 Roles of Various Parties and Advisors.
(a) Introduction.
(b) Management.
(c) In-House Counsel.
(d) Outside Counsel.
(e) Local and Regulatory Counsel.
(f) Financial Advisors.
(g) Auditors.
(h) Others.
(1) Actuaries.
(2) Environmental Consultants.
(3) Public Relations Consultants.
(4) Proxy Solicitors.
29.4 Basic Steps.
(a) Introduction.
(b) Letters of Intent and Other Preliminary Agreements.
(1) Confidentiality and Standstill Agreements.
(2) An Introduction to Letters of Intent.
(3) Binding or Nonbinding Letters.
(4) When to Use a Letter of Intent.
(5) Contents of Letters of Intent.
(c) Due Diligence.
(1) Introduction.
(2) The Data Room.
(3) Basic Information and Background.
(4) Material Transactions and Contracts.
(5) Government Regulation.
(6) Litigation.
(7) Assets.
(8) Employee Matters.
(9) Environmental Matters.
(10) Tax Matters and Financial Statements.
(11) Intellectual Property.
(12) Insurance.
(13) Securities Laws.
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(d) Drafting and Negotiations.
(1) Mechanics.
(2) Representations and Warranties.
(3) An Introduction to Covenants.
(4) Pre-closing Covenants.
(5) Post-closing Covenants.
(6) Conditions.
(7) Indemnification.
(8) Closing.
(9) Termination and Miscellaneous Provisions.
(e) Regulatory and Third Party Consents.
(1) Regulatory.
(2) Leases and Material Contracts.
(3) Debt.
(f) Special Considerations Concerning Share Sales.
(1) Introduction.
(2) Representations and Warranties.
(3) Indemnification.
(4) Escrows and Hold Backs.
(5) Payments Other than in Cash.
(6) Purchase Price Adjustments.
(7) Miscellaneous.
Appendix A Form of Confidentiality Agreement
Appendix B Form of Documentary Due Diligence Request List
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§ 29.1 Scope Note
This Chapter introduces the three basic ways to sell or purchase a business,
the merger, the share sale and the asset sale, discusses the considerations which
lead to choosing one form or another, the role of the various parties to such
transactions and their advisors and the basic steps in any sale or acquisition of a
business, and compares the key provisions of merger, asset and share purchase
agreements.
Mergers and asset and share purchases are discussed more fully in
Chapters 31 and 32. This Chapter and Chapter 30 concentrate on common issues
for all such transactions.
There are three basic ways to sell or purchase a business: a merger

between two companies, a sale or purchase of shares and a sale or purchase of
assets. Mergers are generally reserved for transactions involving publicly held
companies, where the large number of shareholders makes a share sale
impractical, or for reorganizations within corporate groups, often tax driven,
although they are also used in other transactions intended to be tax free or to
qualify as poolings of interests for accounting purposes, where it is important to
limit the amount of non-stock consideration used in the transaction. Share
transactions are the most frequently used form of sale and purchase for a business,
in view of their relative simplicity, although there may be tax or other reasons
(often related to excess assets or unwanted liabilities, or to the desire to
renegotiate collective bargaining agreements of the target company) for choosing
to sell or purchase assets.
The broad outlines of share and asset purchase agreements are very similar,
with the main differences being in the definition of what is being transferred and
(in the case of an asset sale) what is being retained, the mechanics of the
transaction and in the tax provisions. Merger agreements involving the sale and
purchase of publicly held corporations will usually contain fewer representations
and warranties, will rarely include purchase price adjustments (although
occasionally “contingent value rights” will be distributed which have the effect of
an “earn-out” provision) and will not provide indemnification of the purchaser by
the selling shareholders.
Mergers and acquisitions often require pulling together large teams of

professionals to assist the principals in their evaluation and examination of the
business and in negotiating and documenting their transaction. While it is usual
for the project team leader on each side to be a businessman, it is also usual for
legal counsel to have the primary responsibility for organizing each step of the
transaction, including knowing when to bring in various other advisors. The
second part of the Chapter focuses on the role of the various advisors and offers a
few reflections on the choice of the principal negotiators as well.
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The last part of the Chapter focuses on the major phases of the transaction,
including essential and optional preliminary documentation, the due diligence
process, the common parts of merger and asset and share purchase agreements,
and concludes with a few observations on regulatory and third party consents.
This part of the Chapter should be read in conjunction with Chapter 31 as to
merger agreements and Chapter 32 as to asset sales, which discuss in more detail
specific provisions of the agreements particular to those transactions. Appendix
A to Chapter 32 includes a Form of Asset Purchase Agreement (the “Standard
Form”) to which reference is made in the course of the discussion of certain
common clauses of asset and share purchase agreements. Appendix A to this
Chapter is a Form of Confidentiality Agreement which can be used as a starting
point for negotiating a preliminary confidentiality agreement in any acquisition
transaction. Appendix B to this Chapter is a Form of Documentary Due Diligence
Request List which can serve as a starting point for a buyer’s legal due diligence
request to a seller.
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§ 29.2 Choosing the Form of the Transaction
(a) Introduction
There are three basic ways to sell or purchase a business: by merger, by

selling or buying its shares or by selling or buying its assets. Some transactions
will combine both a sale of shares of one or more subsidiaries with a direct sale of
assets. The agreements will then be hybrids between share purchase and asset
purchase agreements.
(b) Reasons to Choose a Merger
Mergers are usually reserved for transactions between companies that

have too many shareholders for a share acquisition to be practical or for
transactions within a corporate group, and the exact structure is often tax driven.
They are also often used in stock for stock transactions, especially in so-called
“mergers of equals” where it is contemplated that the shareholders of each of the
constituent companies will continue to own the combined businesses after the
transaction, and in transactions which are expected to be accounted for as
poolings of interests or to involve a tax free stock for stock exchange. Chapter 30
discusses the relevant tax and accounting issues in detail. Mergers can also
provide an interesting alternative for transactions in which the company to be sold
has a minority of shareholders who are not in favor of selling or when there are
lost stock certificates which render a share purchase somewhat risky from the
buyer’s point of view, but where both sellers and buyer favor a share over an asset
based transaction.
The basic advantage of mergers over other forms of selling a business is

their relative simplicity. As discussed in more detail in Chapter 31, a shareholder
vote is required, followed by the filing of a certificate of merger with the secretary
of state of the state or states which chartered the constituent corporations and the
transaction is complete by operation of law. All shares of the acquired
corporation automatically cease to represent an ownership share in the merged
entity, but instead represent the stated merger consideration, which could be cash,
securities or a combination of both. Dissenting shareholders in some cases may
assert the right to a different form or amount of consideration, but they are no
longer owners of the acquired corporation.
The advantages of a merger in the case of a publicly held company are

obvious. Conventional wisdom has it that even the most generous of tender offers
for a publicly held company will not garner an acceptance rate above the 95-98%
level. There are always shareholders who do not respond to the offer because
they are on vacation, or do not know they own the stock or have died. Thus it is
customary, even where the first step of the sale of a publicly held company has
been a public tender offer conducted under the Williams Act, that the acquiror
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will follow up with a so-called “second step” merger in which the company to be
sold is merged with a wholly-owned subsidiary of the purchaser.
A merger may also be useful where the purchaser wants to acquire the
company to be sold as a whole, and not just its assets, but where there is a small
minority of shareholders who oppose the transaction. If that minority is small
enough that the shareholders who favor the sale have the votes to approve a
merger, then a merger could be an alternative for the majority to deliver the
company as a whole to the purchaser. However, if this is the motive for choosing
a merger, careful attention will have to be given to the issue of dissenters’ rights
under the relevant corporate law.
As discussed more fully in Chapter 31, most state corporation law statutes
grant shareholders who dissent from the vote to approve the merger the right to
have the value of their shares appraised and that value paid to them in cash.
Purchasers generally do not like taking the risk of a large number of dissenters
since it is not always clear what valuation a court may put on their shares. While
the generally accepted view is that courts have been conservative rather than
overly generous in the formulas they have applied in putting a value on such
shares, and the procedure for dissent is technical, relatively complicated and
relatively expensive, so that most shareholders will not pursue it unless they have
a large shareholding, most purchasers do not want to take the risk of
consummating a merger if there is a possibility of dissenters’ rights exceeding a
given threshold, usually 10% of outstanding shares. This is a particularly
important concern where the transaction is intended to be accounted for as a
pooling or to be tax free, since the relevant rules have limitations on the amount
of cash consideration that may be paid. A merger agreement will therefore
normally contain a condition requiring not only the shareholder approval but also
one allowing the buyer not to close if dissenters’ rights are exercised with respect
to more than a specified number of shares.
(c) Reasons to Choose a Share Sale
Share sales can be slightly more complex than mergers in that they require
the active consent of each shareholder of the company to be sold and the actual
individual transfer of their shares. Section 29.4(f) describes some of the
complications which may have to be dealt with when there is more than one
selling shareholder. On the other hand, where there are few selling shareholders,
the share sale avoids the need for filings of merger certificates with one or more
secretaries of state to close the transaction, which can occasionally be difficult to
coordinate if companies from two different states are to be merged, and in general
involves fewer formalities. However, where there are numerous owners or where
some owners (or their shares) either cannot be found, or are subject to any of a
variety of disabilities or require special procedures to sell their shares (minors,
trusts, estates or other entities under court administration), a share acquisition may
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not be a practical alternative. Otherwise, in the case of a purchase from a single
corporate owner or a small number of shareholders, a share sale is probably the
most frequently used form of selling a business. In this sense it is the “default
solution” for a sale or purchase of a business when there are no pressing reasons
to choose another form.
However, as further discussed in Chapter 30, there can be important tax

reasons for choosing a share sale over an asset sale.
(d) Reasons to Choose an Asset Sale
Asset purchases are more complex transactions in that every single asset
and liability of the business which is to be acquired or assumed must be
sufficiently identified, either by means of an appropriate schedule to the asset
purchase agreement or by laboriously negotiated definitions, and then properly
conveyed. Where assets are located in different states or countries the
conveyancing issues can be complex and where real estate is involved,
conveyancing can also be costly. Furthermore, asset transfers generally require
more consents than a share purchase or a merger: leases, contracts and many other
forms of property rights cannot be transferred without the consent of the landlord,
other contracting party or property owner.
However, despite their complexity, asset transactions are a frequent

alternative to share purchases, especially where the business to be acquired either
is not separately incorporated, so that the various assets and liabilities which
constitute the business must be plucked one by one from a larger entity, or where
the corporate entity either contains unwanted assets (for example excess real
estate) or undesired liabilities. In these cases, an asset purchase may be the only
alternative that can bring the parties together on price and other terms. There may
be a further reason to choose an asset purchase transaction if the seller’s business
is partly or wholly unionized and the purchaser wants maximum flexibility in
renegotiating terms and conditions of employment. As discussed more fully in
Section 32.2(d), in a share purchase or a merger, the purchaser is required to
assume existing collective bargaining agreements, while a purchaser of assets
may be able to renegotiate union contracts.
There can also be a further, and more mundane, reason to choose an asset
sale. The simple fact of the matter is that share certificates do get lost. If a
shareholder cannot find them, he or she can of course get substitute certificates
issued, usually against an undertaking to indemnify the issuing company against
any claims from third parties asserting ownership of the shares represented by the
lost certificates. This is standard procedure for large publicly held companies
where a few shares more or less will not generally result in a big problem.
However, in a family held company with relatively few shares outstanding each
share may be proportionately much more valuable and a purchaser may not be
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ready to take the risk that, for example, a now deceased founder did not alienate
the shares for which the certificates are now lost prior to his or her death.
Indemnification by individual heirs is usually unsatisfactory in such cases.
Individuals may well have few assets other than the proceeds they are to receive
in the sale, and which they may plan to spend promptly. Also, unlike other kinds
of problems covered by indemnification it is not clear when this one can be
considered definitively resolved, so that a temporary hold back or escrow of a
portion of the purchase price may not be an adequate solution either. A purchaser
in this case may have a very strong preference for an asset purchase.
Another reason for choosing an asset sale or purchase relates to the issue
of unwanted liabilities of the business to be transferred or of the corporate entity
which holds that business. As discussed more fully in Section 32.2(b), an asset
sale gives the parties more scope to choose which liabilities as well as which
assets will be transferred than do share sales or mergers. However, as also
discussed in that section, the agreement of the parties in this area may not be
respected if this would have the effect of depriving third parties of remedies for
certain kinds of claims. This possibility does not necessarily argue in favor of
disregarding this ground for choosing an asset purchase, but only for caution in
certain circumstances.
Finally, as discussed more fully in Chapter 30, there can be significant tax
reasons for a purchaser to want to buy assets, especially where the book value of
the business’s assets is significantly below their fair market value and the
purchaser sees significant scope for stepping up their basis for tax purposes.
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§ 29.3 Roles of Various Parties and Advisors
(a) Introduction
Sales and purchases of businesses often require pulling together large

teams of professionals to assist the principals in the various stages of the
transaction: due diligence and valuation of the business, the negotiation of the
various agreements required to document it, and the closing of the transaction.
The principal and the project team leader are usually businessmen, but it is
usually left to legal counsel to organize and coordinate the various steps, and to
advise on when to bring in various other advisors.
If there is a financial advisor in the transaction, that advisor may well play
the key coordinating role in the early stages of the transaction, including the
valuation process and certain stages of the negotiations, but that advisor will still
usually leave large parts of the due diligence and negotiation stages, most of the
documentation and almost all of the closing to the lawyer to organize.
This section introduces the roles of the various advisors and offers a few
suggestions for organizing their cooperation and making the most of the often
very short time allocated to each of the tasks to be accomplished to get the
transaction done.
(b) Management
The project team leader and chief negotiator on both sides is likely to be a
businessman. Sometimes it is an owner, but often it is the managements of the
businesses involved rather than the owners who do most of the negotiating. There
are of course exceptions. If the founder of a business is still active at the time of
the sale, he or she will most likely handle the negotiations in person and if there is
a dominant shareholder that shareholder may well intervene personally as well.
However, many businesses are sold at a time when the founder’s family is no
longer directly involved in the business and there the chief negotiator on the sell
side is likely to be an executive rather than an owner. Where the buyer is a
publicly held company the negotiators for the buy side will also almost always be
executives rather than the owners.
That this can lead to conflicts of interest between the owners and the
management which is negotiating on their behalf is obvious. This can put the
lawyer representing the buyer or the seller in an awkward position if his or her
engagement does not make clear whose interests he or she is to represent in case
of a conflict. Thus, a seller who is not going to participate directly in the
negotiations may at least want to have a role in selection of counsel to the
transaction and establish lines of communication and a set of priorities with that
counsel.
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Some conflicts are pretty obvious, as when it comes to negotiating the
continued employment or compensation of management after the sale and there,
very often, separate counsel is brought in to negotiate this part of the transaction.
Other conflicts are more subtle, but the owner of the business to be sold must take
into consideration in choosing the sell side negotiating team that, as soon as the
decision to sell the business has been made, management in a sense is no longer
working for the old owner but for the new owner and that leaving the negotiation
of the sale to this management may not be entirely wise.
This principle applies to sales of subsidiaries or divisions as well as to

sales of whole companies. Of course, in the sale of a subsidiary or division, the
parent’s management usually conducts the negotiations. However, parent
company management is often handicapped by a lack of detailed knowledge of
the business being sold. The subsidiary or division to be sold not infrequently is
based in a location remote from corporate headquarters, is engaged in a separate
line of business and is often a corporate step child, so that there is no one at
headquarters who knows enough about its business to judge whether specific
representations and warranties should be given about its business or where there
are particular problems or even, occasionally, undervalued assets.
Thus, paradoxically, very often the prospective purchaser knows more

about the business to be sold, including its true value and where the bodies are
buried, than does anyone at the seller’s headquarters. This is particularly true
where the purchaser is a competitor, as is frequently the case in “trade sales” of
subsidiaries and divisions. As noted above, the same situation almost always
holds true in the case of family owned businesses being sold by second or third
generation owners: the family has relied upon professional managers to run the
business and is thus not in a position to make the most informed judgment on
either price or conditions of the sale. The remedies to this asymmetry in
information differ as between sales by families and sales of corporate subsidiaries
and divisions. For the family the best solution may be to hire professional
advisors, both financial and legal, making clear whose interests the advisors are to
serve. A corporate seller has other alternatives.
The smartest thing I have seen a corporate seller do was seconding a

young and extremely bright member of the headquarters controller’s staff to a
large division which was to be sold several months before the planned sale. By
the time it came to negotiate the sale, he was the best informed person in the room
when it came to understanding how the business of the division worked and his
assistance in negotiating the representations and warranties and transition
arrangements for the seller was invaluable. Relying on the executives of the
subsidiary or of the division to negotiate their own sale is not advisable unless it is
clear that the executives involved will have a future with the seller rather than the
buyer. This is frequently not the case, either because their skills are specific to
the business or because they are so valuable to the business being sold that the
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buyer makes their staying on a condition of the sale. Relying on headquarters
executives to negotiate the sale is then the only alternative, but the seller must
then recognize that it is likely to be operating at an informational disadvantage to
the buyer and that it makes sense to enlist other allies, including counsel, financial
advisors and auditors.
The corollary of all of this for a purchaser, of course, is that the employees
of the business to be sold are often your best friends. They can be excellent
sources of information as to potential problems with the business and of
suggestions as to how it might be run better. Sellers typically try to limit access
of potential purchasers to the business’ facilities and personnel, often for very
legitimate reasons, such as the fear of the negative effects on employee morale of
a long parade of potential new owners and the hope to keep the whole project as
confidential as possible, in case a buyer cannot be found. An additional reason
for wanting to limit those contacts is to limit the extent of “extracurricular” due
diligence that can be done through ex parte contacts with employees of the
business.
(c) In-House Counsel
Sellers and purchasers both often rely on in-house headquarters counsel to

handle dispositions or purchases of subsidiaries or divisions. Whether this is the
right alternative depends on whether the legal department in question often deals
with acquisitions and sales of business, on the relationship between resources it
can bring to bear on the transaction and the size and complexity of the transaction
(including its geographical scope and regulatory aspects) and the speed with
which the transaction must be done. A company selling operations in a dozen
different countries around the world under severe time pressure is likely to want
to call upon a law firm with international offices and extensive M&A experience
to provide the manpower and expertise to execute the transaction. The decision
may also turn on who is representing the other side. If the purchaser has called
upon a specialized M&A firm, the seller may feel obliged to respond in kind,
especially if it only rarely buys or sells businesses itself. In that case, as noted
below in respect of outside counsel, a specialized firm can contribute its detailed
knowledge of substantive legal points and current concerns in the area.
In any event, in-house counsel will have an important role to play on both
sides of the transaction. On the sell side they are likely to be the best informed
sources as to legal problems of the business to be sold, and the legal steps which
must be taken under the seller’s or the target company’s existing debt, contracts,
permits, licenses, corporate charter and by-laws, to get the transaction done. On
the buy side, they are also likely to be the best informed sources as to corporate
policy on legal matters and the legal steps that must be taken under the buyer’s
existing debt, etc. to get the transaction done.
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The observations made in Section 29.3(b) above concerning the conflicts
of interest of divisional and subsidiary management do not necessarily apply
equally to divisional and subsidiary in-house counsel, depending on how the legal
department is organized, but here again the seller should understand that if it is
clear that divisional or subsidiary counsel has no future with the seller, his or her
interests will be more closely aligned with those of the buyer than with those of
the seller, so that the legal work on the disposition cannot be left entirely to be
done at that level.
(d) Outside Counsel
Outside counsel in M&A transactions come in two basic forms, on the one
hand local and regulatory counsel, discussed in Section 29.3(e) below, and on the
other hand transaction counsel. Transaction counsel is often expected to provide
“turnkey” services to sellers or purchasers. This is not always a realistic
expectation, unless counsel has often handled comparable transactions for this
client. In that case, counsel can be counted upon to know the client’s priorities,
special policies and thresholds of pain on certain issues and thus can negotiate
most standard provisions alone. However, in the case of a first assignment for a
client, the client should consider how much to delegate and what role to play
directly. Transaction counsel can provide manpower, a wealth of comparable
deal experience (including a “reality check” for assertions by the other side that
something is “absolutely standard”), experts in tax law, securities regulation,
employee benefits, environmental protection and other specialized areas of the
law. They can manage the transaction from preliminary negotiations through due
diligence and on to closing. Given a term sheet and some time to ask questions,
they can produce a professional looking first draft agreement.
It is then up to the client to decide whether to allow transaction counsel to

negotiate alone and to make business decisions for the principals. Especially in
the case of a first assignment, the client may want to provide counsel with
direction and instruction from, and frequent consultation with, a chief business
negotiator. Without a sense of his or her client’s priorities or, on the sell side, a
detailed knowledge of the business to be sold, outside counsel may often be more
inflexible and argue every point which could conceivably be important, and thus
be less constructive than the client might wish. On the other hand, uninstructed
counsel may also not realize the particular importance that a standard concession
might have for this client in this deal.
Outside counsel should also be given as clear a brief as possible

concerning which aspects of the transaction beyond the drafting and negotiation
of the purchase or merger agreement they are responsible for and which will be
handled in-house. The tasks to be allocated between in-house and transaction
counsel will usually include most or all of the following areas:
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• preparation and negotiation of confidentiality agreements
• negotiation of arrangements with financial advisors
• negotiation of any letter of intent, term sheet or heads of agreement
• reviewing any press releases relating to the transaction before they

are issued
• advising on transaction structure issues, tax planning issues and

securities law disclosure issues
• documentary due diligence (seller’s counsel will participate in the

selection and organization of documents and the preparation of any rules on data
room access; buyer’s counsel will review most documents but will rely on experts
in some areas) (See Section 29.4(c) infra for a more thorough discussion of the
role of counsel in the due diligence process)
• for seller’s counsel, reviewing laws and regulations and company

documents (permits, licenses, contracts, debt instruments, etc.) to determine what
filings, consents and approvals are needed and to support any opinions to be
delivered
• drafting or commenting on the acquisition agreement and

participating in negotiations
• assisting in the preparation or review of disclosure schedules and

negotiating any changes
• preparing or reviewing term sheets and drafts of ancillary

agreements
• preparing any necessary regulatory filings and, in the case of

seller’s counsel, developing a plan of action for obtaining third party consents
• determining what corporate approvals are required, preparing or

reviewing the appropriate resolutions, and preparing the proxy statement if a
shareholders meeting is necessary
• co-ordinating the closing, preparing or reviewing all

documentation, including legal opinions delivered by other counsel and delivering
a legal opinion
Transaction counsel will usually be in a position to take on most, if not all,

of the foregoing tasks, if that is desirable, or they can collaborate in many areas
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with in-house counsel, but they should be instructed as clearly as possible as to
the areas for which they will be primarily responsible. Cost, available manpower
and expertise will need to be taken into consideration, as well as human elements,
such as the expectations of the general counsel and in-house staff. In this
connection, it should be made clear what the relationship of transaction counsel to
in-house counsel is meant to be. Do they report to the general counsel or to the
business side? Some degree of overlap will probably be inevitable, but clear lines
of responsibility and reporting can help reduce the potential for friction and the
likelihood that some assignments will fall through the cracks, as well as to keep
costs in check.
(e) Local and Regulatory Counsel
Where the sale involves assets in multiple jurisdictions that must be

transferred or where the business is highly regulated, local and regulatory counsel
may play a key role. This is usually more of a concern for the purchaser, if it is
new to the location or to the industry, than for the seller who presumably has the
required local and regulatory counsel. However, it may turn out that the seller has
owned the real property or the foreign assets for so long that there is no active
relationship with competent local counsel, and that most of the regulatory work is
routine and done in-house by non-lawyers whose legal knowledge and regulatory
contacts may not be most appropriately suited to an M&A context.
Additional reasons to retain local or regulatory counsel include the

likelihood that the purchaser will require legal opinions as to conveyancing of real
estate in asset sales and, more generally, as to any important regulatory issues.
The seller’s general counsel may not feel competent to give such opinions without
local back-up as to conveyancing matters or the purchaser may specifically want
recognized outside counsel to opine as to regulatory issues. Outside counsel
retained to run the transaction may or may not have the expertise required to
opine on all such matters. Local counsel may be particularly needed for all of
these reasons where operations outside the United States are part of the business
to be transferred.
If local and regulatory counsel will be needed, it is never too early to

check on their availability and to take their advice on the amount of time
conveyancing and regulatory procedures crucial to the transfer may take, as well
as to inquire of them what pitfalls they anticipate in the planned transaction. This
is particularly the case if foreign jurisdictions are involved where there may be
only a handful of lawyers used to dealing with American purchasers and sellers,
their concerns, their deadlines and their need for written legal opinions. In many
foreign countries law firms are small by U.S. standards and not used to prompt
turn-arounds of documents and answers. Also, written legal opinions have often
traditionally not been required in transactions, either because local civil codes
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provide a level of specificity and certainty lacking in the U.S. outside the UCC
area or because opinion practice is simply not as developed.
The original inquiry with local or regulatory counsel should be conducted

by counsel, rather than being left to management, especially at the subsidiary or
division level. While in-house subsidiary or divisional counsel may well be
knowledgeable, counsel in charge of the sale should, at the very least, decide what
questions need to be asked and review the answers given.
The advisability of the purchaser retaining special local and regulatory

counsel will depend on whether it is entering a new geographical area or line of
business. A bank buying another in-state bank is likely to have all the legal
expertise either in-house or in the person of outside counsel in charge of the
acquisition. On the other hand, the same bank buying a state chartered bank in
another state will likely need local regulatory counsel. Similarly, in an asset
transaction, local real estate counsel, patent and trademark counsel and
environmental counsel may be needed, as well as counsel knowledgeable in areas
such as government contracting. Obviously, not every issue or asset will merit
the hiring of an expert and an important part of the role of counsel in charge of an
M&A transaction is to advise the client which parts require the input of an outside
expert and which can be handled more routinely.
(f) Financial Advisors
It has become standard in transactions involving the purchase and sale of

publicly traded companies to retain independent financial advisors to advise on
the fairness of the transaction to the selling shareholders or to the shareholders of
the merged corporation from a financial point of view. Additionally, in
transactions where both parties are publicly held, especially those which involve a
public tender offer, purchasers also retain a financial advisor to handle the
mechanics of the tender offer as dealer manager and to help value the target and
negotiate the transaction. Finally, owners often engage a financial advisor to help
value the business to be sold and then handle the sale through a “controlled
auction” process. Each of these roles is somewhat different.
The role of the financial advisor to the target of a tender offer is often an
extremely important one. In order to fulfill its fiduciary responsibilities under
state law to its shareholders, a board of directors virtually always engages an
independent financial advisor to help evaluate the acquiror’s bid and to render a
so-called “fairness” opinion if a transaction has been agreed to with the bidder.
These opinions follow a set pattern, reciting the factors which the advisor, usually
an investment bank, has taken into consideration and concluding that the price
offered is “fair to the shareholders of the company from a financial point of view”.
The concept of a fair price is an imprecise one. It does not mean the best price
that could be obtained for the company, but one within a “range of fairness”. This
16
range is determined by means of a number of standard analyses, including
discounted cash flow, comparable transactions and various other standard
financial measures.
To the layman, the need for a financial advisor to fulfill this task may
seem less than obvious, especially given that fees for fairness opinions can run
into the millions of dollars. Do these bankers really know more about the
company’s value than do its officers and directors? The answer is perhaps not,
but their involvement has both practical and legal grounds. On the practical side,
they bring access to a data base of comparable transactions, potential other
partners, sophisticated financial analysis and strategic know-how which, until
recently, was not widely available outside their profession, and their opinion
provides a form of insurance policy to management and the board that they are
not selling out too cheaply. On the legal side, following the seminal Smith v. van
Gorkom decision in Delaware, which held that a board of directors had not
fulfilled its fiduciary duty of care in informing itself about the value of their
company because, among other things, they had not sought advice of an
independent financial advisor, it is a rare board of directors that will risk itself to
accept an offer without seeking such advice.
The bidder for a publicly held company will usually engage an investment
bank, both to confirm its valuation of the target and to act as dealer manager for
the tender offer. The valuation function brings into play the same analysis and
data base which the target company’s financial advisor will use in analyzing the
fairness of the transaction for the target. Access to such data bases is becoming
more widespread so that this portion of the banker’s function is perhaps becoming
less crucial, but if the initial approach to the company may not be entirely friendly,
the advice of an investment bank with extensive M&A experience can be
extremely valuable.
A seller may also engage a financial advisor to help value, properly

present and market a division or subsidiary to be sold. The financial advisor will
typically conduct a preliminary valuation of the business to be sold, produce a
confidential information memorandum describing the business and conduct a
“controlled auction”. This process will involve a preliminary screening of
potential purchasers who are sent the information memorandum after signing a
confidentiality agreement. These potential purchasers will be invited to express
preliminary interest, allowed (sometimes after having given a non-binding
indication of a range of value they see in the business) to progress to due
diligence on the target company, and required to produce binding or non-binding
price indications, after which one potential purchaser may finally progress to the
negotiation of a purchase agreement, based on a draft furnished by the seller.
The foregoing process presents a number of advantages to the seller. It

generally sets a realistic range of expectations on the value which can be realized
17
on the business to be sold, keeps the process of selling the business relatively
confidential until the very end and gives the seller the opportunity to propose the
initial terms of the share or asset purchase agreement to potential purchasers as
part of the competitive bidding process.
For their services in each of these capacities the financial advisor will
expect adequate, often handsome, compensation (often linked to the size of the
transaction), plus indemnification from its client for any liabilities the advisor
may incur as a result of the engagement, other than those attributable to its
negligence (or gross negligence) or willful misconduct, and protection against
being dismissed after having done most of the work but before its fee is fully
earned.
(g) Auditors
Auditors play important roles for both sellers and purchasers. If the
business to be sold is a division rather than a subsidiary, it will often have only
so-called “management accounts” rather than full financial statements. Even
subsidiaries may have financial statements which do not reflect their profitability
as stand-alone businesses. For example, the allocation of parent company
overhead and other expenses, such as debt incurred to support subsidiary
operations, may differ substantially from the costs the subsidiary would incur for
its own MIS or legal department or if it had to borrow at its own cost of funds.
The absence of historical financial statements presented in accordance with U.S.
generally accepted financial principles (“GAAP”) is a negative factor in the
evaluation of any business by a potential purchaser, since it deprives the
purchaser of reliable data on the past earnings history of what is being sold. It can
thus be expected to lead to more conservative valuation of the future earnings
potential of the business, as well as to a requirement for more due diligence.
Where the purchaser is a publicly held company and the purchase would
result in an obligation to file with the SEC separate financial statements for the
acquired company as part of the purchaser’s own SEC filings, the absence of
audited financial statements may be a “show stopper”. However, even when that
is not the case, if there are no audited financial statements, normally either the
purchaser will expect the seller to have its auditors produce audited historical
statements for a subsidiary or a form of pro forma statements for a division. If not,
the purchaser will likely send in its own auditors to take a rough cut at producing
a stand alone balance sheet and income statement for the business involved.
Even if there are audited historical financial statements, the purchaser will
expect its auditors to participate in the business due diligence investigation
discussed more fully below. The seller’s auditors will generally be expected to
cooperate fully in the process, including making available their work papers
relating to the relevant audits to the purchaser’s auditors.
18
Finally, also as part of the due diligence process, in particular
circumstances auditors may be asked to prepare a special report on specific
aspects of the business to be sold. This goes beyond the ambit of the usual
“business audit” and involves carrying out specified agreed upon procedures to
items whose value is either particularly disputed or particularly crucial to the
valuation of the business. What auditors can and cannot agree to do in these
circumstances is spelled out in SAS 35. Special reports can be time consuming to
prepare and intrusive for the seller’s business. Often what they cover can be
covered in a closing date audit, discussed below, if one is to be carried out to set
or adjust the final purchase price. On the other hand a special report is cheaper
and quicker to conduct then a complete audit and if only one or two items are
contentious, a special report may be the preferable alternative. Also, it may be
possible to get auditors to prepare a special report, applying agreed upon
procedures, to items which would not normally be part of the audit, such as order
backlog, which may be very important to the earnings prospects of the business to
be acquired.
Beyond these preliminary, due diligence related roles, the seller’s auditors
may also play a key role with respect to the purchase price, which may be
adjusted based on a closing date balance sheet. As discussed more fully in the
discussion of the setting of purchase prices below, the purchase price may be
adjusted based on a number of items, including the levels of inventory or
receivables at the closing date or net sales or profits since the last regular audited
balance sheet date.
If a closing date balance sheet is to be prepared, the purchaser’s auditors

will generally be involved either in preparing it or in checking it, with the right to
challenge the results. In the absence of agreement between the two sets of
auditors, the purchase agreement may provide for the disputed items to be
referred to a third accounting firm. It is possible that a purchaser may want a
closing date audit irrespective of any purchase price adjustments, just to have a
more precise idea of what it has bought and to bring the acquired business’
accounting procedures into line with its own, so that it can be confident that the
earnings reported by the new subsidiary or division are consistent with those
reported by other parts of its business, and that the balance sheet values of the
acquiree can be incorporated into its own consolidated balance sheet without
running the risk of substantial year-end adjustments when the first consolidated
audit including the new business are prepared.
As noted above, this concern can be particularly important where the

purchaser is a publicly held company and the acquisition is material enough that
under the SEC’s accounting rules the purchaser will be required to prepare pro
forma financial statements to reflect the acquisition and include separate financial
statements for the acquired business in its SEC filings. It can also be important
where, as frequently happens, purchaser and seller use different auditing firms
19
and purchaser wants to replace the old auditors with its own auditors. Given the
latitude which GAAP allows in the accounting for certain aspects of a business,
whether in the valuation of inventory or in the setting of allowances for doubtful
receivables, quite apart from the possibility of the two companies having applied
different accounting principles, a purchaser may well wish to have an audit
conducted that will bring the acquired business’ accounts into conformity with the
purchaser’s own accounting principles from day one, rather than waiting for the
first regular audit cycle. This can also avoid later problems for publicly held
companies in needing to get consents from the prior auditors of an acquired
company to the inclusion of statements they have audited in SEC filings made by
the purchaser.
Each of the foregoing roles is important, but the most crucial may be that
played by the purchaser’s auditors as part of the initial due diligence process,
often referred to as a “business audit”, where their role is to spot obvious
weaknesses in the target’s financial statements, as well as to visit plants and other
facilities, discuss accounting issues with the seller’s auditors and accounting
department and, if other specialists such as tax counsel or actuaries, are not or not
yet involved, examine related areas such as tax and pension liability issues. Since
this examination takes place before the price is fixed and the purchase agreement
is signed, it can have the maximum impact on the acquisition process, either in
allowing a more realistic valuation of the financial position or earnings potential
of the business or in identifying specific weak spots in the business for further due
diligence examination and possible correction before the transaction is
consummated.
(h) Others
(1) Actuaries
Of the other advisors involved in acquisitions, perhaps none are

more important than the actuaries. As discussed more fully in Section 32.2(c), the
valuation of pension and retirement plans cannot be undertaken without the
assistance of qualified actuaries. Since the related liabilities can be a very
significant factor in the valuation of a business, the assistance of actuaries in the
acquisition of any business employing more than a few employees can be crucial.
Especially if the business to be acquired had been downsized so that the current
number of active employees is smaller than the historical levels of employment, it
is important to evaluate exactly the level of commitments to retired and former
employees which may bear no obvious or reasonable relationship to current labor
costs.
The process of actuarial evaluation, requiring the analysis of a

large amount of computerized data, can take some time, which should be built
into the due diligence and negotiation process.
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(2) Environmental Consultants
In view of the extent and often draconian consequences of U.S.

environmental laws discussed more fully in Section 32.2(e), there are few
acquisitions in which the potential for environmental liabilities can be eliminated
confidently enough not to warrant at least a preliminary investigation. In the case
of acquisitions of most industrial businesses, the potential will be important
enough to warrant the retention of a firm of specialized environmental consultants
to conduct at least a so-called “level one” audit.
Section 32.2(e) discusses the U.S. and state environmental laws

more fully, as well as the various levels of environmental investigation which
may be conducted in the course of an acquisition transaction. In addition to the
investigation a purchaser will normally want to conduct, a seller may want to have
its own consultants conduct its own environmental inquiry. This may be the case
where there are acknowledged environmental risks and the seller wants either to
preempt the issue or simply to get a better idea of the value of the business by
factoring in an expert’s views of costs of remediation. In such cases the report
can be part of the data made available to prospective purchasers.
(3) Public Relations Consultants
Outside public relations consultants are usually found in large

public transactions, especially where the initial negotiations may not be entirely
friendly, and where media reporting may play an important role in influencing
shareholder, employee and community attitudes towards the proposed transaction.
In the acquisition of privately held companies, divisions or subsidiaries, public
relations work is usually done by the public relations or media departments of the
companies involved unless the acquisition raises particularly sensitive issues of
local or political concern. This could be the case, for example, if the purchaser is
a foreign company or if the acquisition is to be accompanied by a reduction in
work force or by the move of corporate headquarters of the business to be
acquired.
If the parties to the transaction are publicly held, so that their press
announcements may have an impact on the price of their publicly traded shares,
counsel should review carefully whatever material is prepared by PR
professionals for possible consequences under Federal and state securities laws.
(4) Proxy Solicitors
If a shareholder vote is required to approve the transaction at a

company with a broadly distributed shareholding, a proxy solicitation firm may be
engaged to help reach the shareholders. See Chapter 31.
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§ 29.4 Basic Steps
(a) Introduction
This section summarizes three basic stages of the acquisition process: the
negotiation of preliminary agreements, including confidentiality agreements; the
due diligence process; and the drafting and negotiation of definitive agreements.
It omits a discussion on the final steps: closing and post-closing issues, which are
discussed in more detail as to each kind of transaction in Chapters 31 and 32. See
Sections 32.3(c) and (d). The treatment of drafting and negotiation focuses on the
sections common to all acquisition agreements and leaves the detailed discussion
of provisions particular to mergers or asset transactions to Chapters 31 and 32.
Commencement of serious discussions of an acquisition is almost always

preceded by the signature of a confidentiality agreement, designed to protect the
information the seller will have to share about the business from misuse by the
potential purchaser. This is normally followed by a period of due diligence by the
purchaser which leads to an offer to purchase the business. Most sellers like to
see a written offer, preferably binding, but it is not always necessary to document
this phase of the process and it may be possible to pass directly to the negotiation
and signature of a definitive purchase agreement. In some transactions,
particularly those involving the acquisition of a publicly traded company, it may
in fact be advisable to move directly to a definitive agreement, as discussed more
fully in Section 29.4(b)(4) below. This section discusses the issues which arise in
confidentiality letters, the pros and cons of letters of intent and the areas normally
covered in due diligence, before moving to an overview of acquisition agreements.
We talk of acquisition agreements because they are almost always drafted

by the purchaser and from its point of view. This is not always the case. In so-
called “controlled auctions”, the seller will usually include a form of definitive
agreement in the bidding materials and seek to start the negotiations from that
document. Many bidders will play along; however, a bidder willing to submit a
high (sometimes called “pre-emptive”) bid may well decide to ignore the seller’s
draft on the theory that “top dollar” will win and that it will then be entitled to
exercise the usual “buyer’s prerogative” of controlling the drafting.
There is often much debate as to this so-called “prerogative”. It is true

that it is customary for the purchaser to draft the acquisition agreement, but it is
also true that experienced transaction counsel can work off of the other side’s
draft to add all the representations and warranties the seller omitted from the first
draft and to strip out all the limitations on indemnification (assuming seller
remembered to include an indemnification clause). This procedure will usually
simply take longer and run up more legal fees, but except when time is truly of
the essence, it will rarely confer a decisive advantage on the seller where the
buyer is represented by experienced transaction counsel.
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(b) Letters of Intent and Other Preliminary Agreements
(1) Confidentiality and Standstill Agreements
Before letting a stranger in the door, especially if that stranger is,

as often happens, a competitor, a seller will want to have a potential purchaser
sign a confidentiality agreement. This agreement usually takes the form of a short
letter between seller and purchaser pursuant to which purchaser agrees to use any
confidential information received from the seller only for the purposes of
evaluating the acquisition, to keep it confidential for a period of time, subject to a
number of relatively standard exceptions and, if the transaction does not take
place, either to return or destroy the information and all copies. In addition, the
purchaser may be asked during a specified period not to make any offers to
purchase the business other than with the prior consent of the seller’s board of
directors. The purchaser may also be asked to refrain from making offers of
employment to the employees of the business. Finally, the letter will include an
agreement that the seller may obtain injunctive relief in the case of violation.
While these agreements are quite standard, they raise a number of questions
which need to be resolved on a case by case basis.
The first question concerns the definition of confidential

information. The Form of Confidentiality Agreement attached to this Chapter as
Appendix A contains a fairly standard formulation, which does not generally
present problems for most purchasers. However, direct competitors of the
business to be acquired may have some problems, especially if the confidential
information may concern, say, research and development on products which both
firms are pursuing. No potential purchaser wants to run the risk of being locked
out of a new product field because it has looked at, and then passed on, an
acquisition target.
This is often more of a theoretical than of a real concern, since at

least the preliminary information given to a potential purchaser rarely includes the
“really good stuff”, whether it is new product research and development or the
kind of financial data that would allow it to calculate a competitor’s margins.
This kind of information is usually only released at a very late stage in the process,
when the parties feel close to agreement on price and other terms. Should a
purchaser get that far and still fear the deal may fall through after the information
has been shared, the best way to deal with this sort of problem is often to control
strictly who within the purchaser’s organization has access to the information and
to limit that on a “need to know” basis to persons not directly connected to the
purchaser’s own research and development efforts in the same area. This sort of
“Chinese wall” may be more difficult to implement effectively where the
information contains financial margins rather than new products, but then the
possibility of there being a subsequent claim of misuse of such information is also
likely to be lower than in the case of a new product.
23
Where concerns about this sort of problem are particularly acute
and the actual contents of what information was shared and who had access to it
are particularly important, potential purchasers may want to do two things. The
first is to change the form of confidentiality agreement to provide that one copy of
all documents furnished to the purchaser may be retained by purchaser’s outside
counsel, subject to continuing confidentiality obligations, so that the purchaser
can prove exactly what it was given. The second step is to maintain the
information at a central location (e.g., the purchaser’s own data room) and to keep
a log of who exactly had access to what information, to help prove that access to
sensitive information was in fact limited. In particular sensitive cases, the
purchaser might also commission an outside expert to evaluate some of the
information and report on it to the purchaser’s board.
As a general matter it is standard procedure to limit access to any

information furnished by a seller on a strictly need to know basis and to agree to
destroy or return it, without keeping copies of it. The chances of later misuse of
information if it is too widely spread out within an organization and distributed to
its advisors grows geometrically in proportion to the number of people who have
access to it. Purchasers should note that they are also responsible for the
confidential treatment of the information they pass on to their advisors, including
counsel, financial advisors and auditors. Thus, while it may seem unnecessary to
have all such persons actually sign a confidentiality agreement, if the deal does
not go through the purchaser must then remember that it is responsible for getting
back or having destroyed all copies of the documents it has distributed.
There is occasionally an issue concerning what must be done with

analyses made by the purchaser and its advisors on the basis of information
furnished by the seller. Corporate counsel not infrequently feels that if the
analysis went to the purchaser’s board it must be preserved as part of the board’s
records to prove the board acted on an informed basis. There is certainly a basis
for arguing that analyses prepared by the purchaser and its advisors are
proprietary and confidential information of the purchaser and in no case are to be
turned over to the seller. However, this argument is not necessarily incompatible
with agreeing to destroy these analyses. This is sometimes easier said than done
when directors have taken their copies home with them; for this reason it is often
advisable that all briefing books containing information subject to a
confidentiality agreement be collected at the end of the board meeting and kept
under lock and key by the corporate secretary. Eventually destroying this data if
the deal does not go through may not present serious risks to the board since,
absent exceptional circumstances, corporate boards are rarely sued for decisions
not to buy a business.
The seller will often require purchasers to keep confidential not

only the contents of information but also the fact that a transaction is being
discussed. This can be justifiable for several reasons. First, if the business to be
24
sold is publicly traded, the fact of negotiations may in and of itself constitute
material inside information whose disclosure could have a serious impact on the
stock price. Even where the business is a subsidiary or a division, if it is large
enough, the same stock market price concerns can apply. Second, premature
disclosure can be damaging to the business to be sold, in terms of customer
confidence and employee morale, especially of preliminary negotiations, which
may go on for a while and may collapse. Competitors are sure to use the
uncertainty as to who the future owner will be and what effects a change in
ownership may have on the direction of the business to try to influence customers
and potential customers to change over to them and to hire away key employees
of the business. Also, if the fact of the negotiations becomes known, but they are
broken off, for whatever reason, the seller is likely to be stuck with “damaged
goods” which will be more difficult to sell next time around.
A publicly held bidder will need an exception to the obligation to

keep confidential the existence of the negotiations should its own public
disclosure obligations require it to make disclosure. There are a number of ways
of dealing with this. Often sellers will want to see an opinion of counsel that
disclosure is necessary. In practice this may prove difficult because of the need to
make prompt disclosure in fast moving securities markets. It may thus be more
practical to require prior consultation and, where time permits, prior agreement on
the contents of the disclosure.
Privately held companies and foreign sellers are often suspicious

of the motives of publicly held potential purchasers, especially U.S. purchasers.
The fear is often that the public disclosure exception can be manipulated by the
purchaser to swallow up the rule, thus allowing the purchaser to force disclosure
that negotiations are taking place to put pressure on the seller to reach a definitive
decision prematurely. Dealing with these sensitivities often requires a good deal
of tact and persuasiveness on the part of counsel for the purchaser, but this
exception is crucial for the publicly traded purchaser if the transaction could be
viewed as material. Counsel for the purchaser should remember that materiality
will be judged in retrospect, based on whether the purchaser’s stock price moved
in response to the announcement of the transaction. Thus, if that is a possibility,
the agreement should include the public disclosure exception. Where both
purchaser and seller are publicly traded, both parties will want the provision,
drafted to require reciprocal consultation to the extent possible.
Where the business to be sold is not a subsidiary or a division, and

thus where a frustrated bidder retains the option to go over the heads of the board
of directors directly to the shareholders of the target company to make them an
offer to purchase their shares, the seller’s board will normally require that the
confidentiality agreement also include a so-called “standstill” provision pursuant
to which the potential purchaser agrees not to make an offer for the business for a
specified period of time without the prior consent of the board of directors. It is
25
occasionally argued that where the business to be sold is a publicly held company
this provision may not actually be strictly necessary since, if the information
received by the purchaser is in fact both confidential and material, the purchaser
will not be able to make a tender offer to the company’s shareholders without
disclosing it and thus violating the confidentiality obligation, running the risk of
an injunction against its offer. That line of argument assumes that a court would
find that the information was in fact material non-public information, which it
may or may not be, and that the board of directors was not violating its fiduciary
duty to its shareholders in attempting to suppress the bid and that therefore the
correct remedy is to enjoin the offer rather than to allow the offer to go forward
after corrective disclosure is made and ordering the target to make the same
information available to other bidders. Suffice it to say that both outcomes are
conceivable and that a publicly held target will usually insist on including a
standstill provision, recognizing that its effect may be more in terrorem or an
appeal to the given word than a watertight legal protection, given that a board
engaging in an auction may have difficulty after the Revlon case excluding any
willing bidder from an auction.
It should also be recognized that a standstill provision can also be

useful in the context of a “controlled auction” where the seller wants to be able to
keep control of the bidding process by eliminating bidders at certain points and,
ultimately, usually granting to the high bidder a period of exclusivity to negotiate
a definitive purchase agreement. Having an eliminated former low bidder come
back in late in the process can be a disturbing factor, with the board needing to
consider whether its fiduciary duty requires it to consider the revised bid and thus
run the risk of upsetting an almost certain deal with the favored bidder. The
bidding conditions in a controlled auction will usually spell out that the seller
reserves the right to break off negotiations at any time and to sell to someone who
is not the high bidder, etc. However, it is still useful to have the commitment
directly from the bidder.
Courts do not intervene lightly in civil contractual disputes by

injunction or impose specific performance where money damages may arguably
suffice to compensate an injured party. Consequently, it is essential to specify
that the potential purchaser acknowledges that money damages would not be
sufficient to compensate seller for a breach by purchaser of the letter agreement
and that specific performance and injunctive relief will be available to seller in
such an event.
(2) An Introduction to Letters of Intent
To document or not to document, that is the question.

Businessmen are generally keen to capture what has been agreed to date, even
though a number of key points remain open, to avoid the risk of having the other
side go back on something they thought had been agreed to. Lawyers are more
26
likely to be sensitive to the risk that an incomplete preliminary document, not
intended to be binding, may be read by a court as sufficiently complete to warrant
holding that a transaction has been agreed to, although a few blanks may have to
be filled in. This of course assumes that the initial letter of intent will be just that,
a statement of intent, meant to serve as the basis for a more complete and binding,
agreement, but not itself meant to be binding. This does not have to be the case,
but it most often is.
A seller will generally be in favor of a letter of intent because, even

if the letter makes clear that it is intended to be non-binding (generally with an
important exception discussed below), as a practical matter an executive is much
more likely to be concerned about backing out of a deal once he or she has signed
his or her name to a letter of intent than if there is no such document. A purchaser
may be influenced by the desirability of the transaction: if the assets or the
opportunity are unique, then the flexibility of being able to back out may later
may weigh much less heavily than getting a “lock”, even a non-binding one, on
the deal now. Cultural factors may also play a role, where a foreign purchaser or
seller is involved. They may be much more used to signing such letters and may
in fact expect the parties to be bound once they are signed. They may be
correspondingly put off by the inclusion of language such as that discussed in
Section 29.4(b)(3) below intended to make the letter non-binding.
(3) Binding or Nonbinding Letters
A number of courts have considered the question of whether, and

when, negotiating parties create a binding contract prior to the execution of a
formal agreement. In Winston v. Mediafare Entertainment Corporation, the U.S.
Court of Appeals for the Second Circuit, applying New York law, articulated
“several factors that help determine whether the parties intended to be bound in
the absence of a document executed by both sides.” These factors were (1)
whether there has been an express reservation of the right not to be bound in the
absence of a writing; (2) whether there has been partial performance of the
contract; (3) whether all of the terms of the alleged contract have been agreed
upon; and (4) whether the agreement at issue is the type of contract that is usually
committed to writing.
Of the decisions applying these factors to situations where

negotiations have broken off just prior to the execution of a formal agreement, the
decision of the Court of Appeals of Texas in Texaco, Inc. v. Pennzoil, Co. has
certainly done the most to heighten sensitivity of practitioners with regard to
when a binding contract is formed. In Texaco, a Texas jury had found that,
although they had not executed a formal merger agreement, under New York law
Getty Oil and certain of its shareholders had formed a binding agreement to
accept Pennzoil’s merger offer, only to renege in favor of Texaco; the jury found
27
that Texaco had tortiously interfered with the contract between Getty and
Pennzoil and famously awarded Pennzoil a huge sum.
Required upon appeal to view the evidence in the light most

favorable to the jury’s verdict, the court found that there was sufficient evidence
to support the finding that a binding contract had been formed when the Getty
board of directors approved, with higher price terms, the “memorandum of
agreement” between certain of its shareholders and Pennzoil (which had expired
by its terms).
The court discussed the application of the four-factor test in detail.

As to the first factor, the court focused on the language in the parties’ identical
press releases and (unsigned) draft agreements, and found that the parties had not
expressly reserved the right to be bound only by a formal signed writing. As to
the press release, it found that neither use of the term “agreement in principle,”
nor the statement that “the transaction is subject to execution of a definitive
merger agreement,” were conclusive evidence of an intent not to be bound. It
found that references in the press release to the need for shareholder approval
were “technical requirements of little consequence.” The court also pointed out
that the release was “worded in indicative terms (e.g., “shareholders will receive
$110 per share. . .”), not in subjunctive or hypothetical ones.” Finally, it found
that the draft merger agreement did not explicitly state that formal execution was
required before the contract became binding; rather it used the term “after the
execution and delivery of the Agreement,” in the court’s view, “chiefly to indicate
the timing of various acts.“
The court also found that there was sufficient evidence that the
memorandum of agreement supplied agreement on all essential terms (the third
factor), with only mechanics and details left to be worked out. The court
appeared to concede that the second and fourth factors (partial performance and
complexity of the transaction) tended to favor’s Texaco’s position, but found that
the evidence was inconclusive and that in any case neither was determinative.
The Texaco decision suggests that once a certain quantum of detail

is reached in negotiating an agreement, the intent of the parties becomes of
paramount importance in determining whether the parties are bound. Indeed, this
view is supported by the fact that there is some authority under New York law
that suggests that language in the letter of intent may, in and of itself, negate any
inference that the preliminary understanding embodied in the letter of intent binds
the parties to the transaction. In Dunhill Securities Corporation v. Microthermal
Applications, Inc., the court held that the parties were not bound by a letter of
intent regarding a possible underwriting where the letter quite explicitly
disclaimed any intent to be bound by either party; the court reasoned that “here
being no ambiguity as to the meaning of the present parties, the court is not called
upon to ascertain their intent from sources external to the written document.“
28
In any case, the Winston/Texaco line of cases would certainly be
relevant in analyzing the intent of the parties to a letter of intent that does not
explicitly state that it is nonbinding; more importantly, Texaco graphically
underscores the dangers of not clearly stating the parties’ intent not to be bound
until a final, formal agreement is reached as plainly as possible in the letter of
intent. In that regard, it is worth examining the language of the letter of intent at
issue in Dunhill, which the court described as stating the intent not to be bound
“in the clearest possible terms.” As reproduced in that decision, the language read:
“Since this instrument consists only of an expression of our

mutual intent, it is expressly understood that no liability or obligation of any
nature whatsoever is intended to be created as between any of the parties hereto.
This letter is not intended to constitute a binding agreement to consummate the
financing outlined herein, nor an agreement to enter into an Underwriting
Agreement. . . . [A]ny legal obligations between the parties shall be only those set
forth in the executed Underwriting Agreement.”
As clear as that language is, it could conceivably be improved upon by, for
instance, explicitly enumerating all the conditions that are precedent to the
parties’ obligations. Moreover, given the possibility that the parties’ actions
could negate the letter’s explicit language, the parties should avoid loose language
in press releases and avoid announcements that an “agreement in principle” has
been reached.
(4) When to Use a Letter of Intent
There are very few hard and fast rules as to whether or not to sign
a letter of intent, except where the business to be sold is publicly held. In buying
a publicly held company, letters of intent are a waste of time and, worse, an
invitation for some third party to come in and break up the deal by making an
offer over the heads of both boards of directors to the target’s shareholders. The
parties have just put out a “for sale” sign on the business and dared anyone who
fancies it to come in and bid for it. If the seller is serious about the transaction
with this purchaser, it should insist on going directly to a definitive merger
agreement with an obligation on the purchaser to commence a tender offer for its
shares within a few days. If the purchaser is equally serious about the transaction,
its interests are also best served by proceeding with the utmost speed. The
signing of a letter of intent will require the target’s board to make an immediate
press release and from that point on the parties will be negotiating in a fish bowl,
with every possible alternative buyer on notice that the company is for sale at the
price just announced and that neither party has an enforceable agreement to do the
deal.
If the business to be sold is a subsidiary or a division, a letter of

intent may make sense. As noted above, a seller will often be interested in getting
29
as much down on paper as soon as possible while a purchaser may be more
hesitant. One advantage of a letter of intent from a purchaser’s point of view is
that it can contain one crucial, enforceable provision: the seller’s agreement to a
period of exclusivity for the due diligence process and the negotiation of a
definitive purchase agreement. Especially where the acquisition has great
strategic importance to the purchaser, the exclusivity may be worth the risk of
being unwittingly trapped into a transaction the purchaser no longer wants to
complete.
Where the transaction may be particularly complex, for example

where a business is part of a larger group and dependent on goods and services
provided by other parts of the group, so that supply agreements on specific terms
are needed for the transaction to make sense to the purchaser, the purchaser may
also have an interest in getting all the necessary elements of the transaction
mapped out in writing before the lawyers are let loose drafting multiple
agreements. However, in such a case one or more detailed term sheets
(sometimes called “heads of agreement”) could be sufficient for the purpose of
instructing the lawyers without running the risks which may be inherent in a
countersigned letter of intent.
There is one form of transaction in which the prospective

purchaser will rarely be able to escape a letter of intent, which deserves special
mention. That is the “controlled auction”. There, the seller will usually require a
binding indication of a purchase price, often accompanied by comments on a form
of purchase agreement previously furnished to the bidders, in the final round of
bidding, in an effort to get a letter of intent out of the favored bidder, as a
condition to engaging in final negotiations with that bidder. Put in such a position,
the bidder has little choice but to sign and to add provisions indicating that the
letter is subject to negotiation of a definitive purchase agreement and to as many
other conditions as it thinks it can get away with inserting without damaging its
bid. What happens next on the seller’s side is usually a tug of war between
business people and financial advisors on one side and lawyers on the other, as
the former focus primarily on the price and any financing conditions, while the
latter focus on the other conditions and the comments or lack of comments on the
proposed purchase agreement. Normally the former win.
(5) Contents of Letters of Intent
If the parties are intent on signing such a letter, it should cover a

number of basic points. These include price (including amount, kind of
consideration, escrows, hold-backs and earn-outs, if any, as well as any financial
conditions to be met, e.g., net earnings of a certain amount), structure (asset or
share sale or merger), an enumeration of any specific non-financial conditions
(due diligence, key regulatory and third party consents, financing, board of
directors approval, etc.), a reference to the need to negotiate a definitive
30
agreement containing representations and warranties and indemnification
“customary in transactions of this kind” and, if the intention is not to be bound
except by a definitive agreement, the clearest possible expression of that intention
along the lines set forth in the Dunhill case cited above.
The kinds of conditions that are often inserted in letters of intent

generally fall into two categories: those which are deal specific (need for board
approval or financing, for further due diligence or for key regulatory or third party
consents) and those which are intended to reinforce the provision that says that
the letter is not intended to constitute a binding commitment of the purchaser.
The seller is likely to examine each of these conditions very closely, since each
represents an additional element of uncertainty. Especially in an auction context,
the seller may weigh the seriousness of bids that are close in dollar terms by the
number of arguably frivolous or boiler plate conditions they contain. In any event,
a seller will attempt to reduce the conditions which can legitimately still be
inserted by purchaser to a minimum.
Obviously, a definitive purchase agreement will have to be

negotiated, but a seller could legitimately set a relatively short time frame for the
negotiations, recognizing that if the period is too short it may simply lose the
benefit of having signed this bidder. It could also legitimately require a potential
purchaser to have obtained its own board approval, though this can sometimes be
explained away as largely an unavoidable formality (“our board likes to feel it’s
important”). It could theoretically also argue that the purchaser should either
have lined up its financing or take the risk of being in default on its obligations if
there turns out to be a problem with financing later on, but this is not always the
best course of action where the potential purchaser really needs financing (rather
than just looking for the most favorable form of financing). What the seller wants
is a more secure deal, not one which may fall apart at the last minute and leave it
with only a breach of contract claim against a buyer. The better course may be to
allow the financing condition in the letter of intent but to insist it be dropped in
the final agreement. Whether the need to conduct further due diligence will be a
legitimate condition will be a fact driven issue: if the seller has been withholding
key confidential data because it is too sensitive to be shared with more than
hopefully one bidder, it obviously will have to live with the consequences of that
initial decision. Regulatory approvals can be expedited but not ignored.
(c) Due Diligence
(1) Introduction
The term “due diligence” is borrowed from the federal securities

laws. There it describes the process of reasonable investigation conducted by
underwriters to verify the contents of a registration statement or a prospectus. If
properly conducted, the process provides the underwriters with a defense against
31
liability to purchasers of securities in the event there turn out to be material
misstatements or omissions in the disclosure document in question. In the M&A
context, due diligence refers to a similar process of investigation of the business
to be acquired, but the object is different. Its object is to enable the buyer to learn
enough about the business to value it correctly, identify problems which can be
solved before closing and provide for foreseeable contingencies after closing.
Also, in an acquisition there are no prizes for having been diligent, but not finding
a problem. In a share or asset purchase agreement (though not in most merger
agreements), there is of course usually an indemnification clause, which may
cover material undisclosed liabilities. However, between various limitations,
exceptions and caps on indemnification, difficulties of proof and delays in
payment, not to mention some problems for which money damages may simply
not be sufficient compensation, there is no substitute for a thorough investigation
before signing up.
The process may also benefit the seller in that problems discovered
and disclosed can become not only reasons to lower the purchase price, but also
exceptions to the obligation to indemnify the buyer after closing, so the chance of
actually getting to keep all the agreed upon purchase price may in fact go up as a
result of the due diligence process. It is also possible that certain problems
discovered early enough may be solved prior to the closing.
Finally, in a “controlled auction” the seller and its financial advisor

may in fact conduct their own preliminary due diligence in collecting information
for the confidential offering memorandum and the data room. However, this
discussion will focus on the process as seen from the buyer’s point of view.
The due diligence process is generally divided into two separate

albeit by two overlapping main parts, business and legal, whereby the business
portion can be described as focusing on the commercial aspects of the business to
be acquired (how, in normal circumstances, it makes or loses money, what its
financial needs, prospects and business plans are, etc.), whereas the legal portion
can be described as focusing on the potential for unexpected loss (whether from
litigation, from unusual contractual clauses, from defects in legal title to assets,
etc.) or impediments to closing as well as the routine checking of all important
legal aspects of the business.
The buyer generally sets up two due diligence teams, but the legal
and the business side need to work together. For example, the business side will
identify all the important client relationships so that the legal side can check the
relevant contracts for unusual provisions; the legal side will alert the business side
to potential contractual or regulatory problems to be discussed with the seller and
eventually, if necessary, to be factored into the pricing decision. However, the
two parts often are conducted on separate tracks, at least initially, with the
lawyers given access to a data room full of documents one week and the business
32
people given access to management another week. This puts a premium on
continued coordination within the buyer’s team, so that both groups can make full
use of the other’s increasing knowledge.
While this section will focus on legal due diligence, one last point
should be made about the difference between business and legal due diligence.
While it is usual to delegate much of the legal investigation to outside counsel and
other advisors, and while certain aspects of business due diligence (e.g. those
relating to accounting or actuarial matters) also require the help of outside
advisors, it is usually in the buyer’s best interest to involve its own personnel as
thoroughly as possible in the business review process rather than leaving that
investigation primarily to counsel, investment bankers and accountants. Once the
transaction is completed, outside advisors and their accumulated knowledge will
move on to other deals and the buyer must be in a position to know enough about
the business to run it alone. The success of a deal may depend critically on the
success of the transition period, for which due diligence is a chance to prepare.
The process is also an opportunity to become familiar with the organization, the
operating procedures and the personnel of the business to be acquired.
Some of the same considerations also apply to who should read

documents in the legal investigation of the due diligence process, but usually the
legal investigation will leave a more durable paper trail of its work in the form of
written analyses and filled out checklists. In any event, the press of time will
often dictate that outside counsel be brought in order to assimilate the mass of
materials to be read in the time allotted, regardless of the buyer’s preferences.
Once the teams required to conduct due diligence have been

identified and the time frame proposed by the seller is known, the most important
threshold question is how extensive a request for information should be made to
the seller. A buyer will normally want to get its hands on every available piece of
information about the business and may think that a large working group and a
detailed request speak well for its seriousness. A seller’s perception is often
different.
In a situation where there are several potential buyers, for example,

an extensive due diligence request list from a given buyer and the involvement of
a large team may be perceived by the seller as an indication that the buyer is
merely on a “fishing expedition” or, at the very least, will be slow to decide,
which may make other bidders more appealing. Sellers may also be initially
somewhat unrealistic as to what they must disclose in order to sell a business, and
it may be difficult to put pressure on them early in the process to come up with
every last document a buyer or its counsel may wish to see. It may thus be better
to start off with a relatively general document request which can later be
expanded as it becomes clear what portions of the business merit particular
concern, so long as the client understands the strategy being pursued.
33
Once the purpose and scope of the review have been discussed
with the seller, unless a data room (discussed in Section 29.4(c)(2) below) has
already been prepared by the seller, buyer’s counsel will generally begin the legal
due diligence process by sending a document request list to counsel to the seller.
Appendix B to this Chapter contains a sample Documentary Due Diligence
Request List typical of the documents generally initially requested in an
acquisition, but this will of course need to be specifically tailored to the business
to be acquired and even the initially customized list will likely need to be
modified and updated as the buyer and its advisors become more familiar with
that business. Sellers occasionally try to limit the amount of documents they have
to provide or to object to updated and follow-up requests. While this is
understandable from a human point of view, it is generally self defeating in the
long run. Except in the context of a “controlled auction” where numerous bidders
need to be kept on an equal footing, or in the context of an acquisition of a
publicly held company where time may be too short, in most cases either a buyer
will get to see what it wants, or it will go away, or it will assume the worst and
bid more conservatively than it would have had it gotten full access.
Although this discussion focuses on document review, it should be

kept in mind that inquiry and discussion of various points with the appropriate
person at the business to be acquired or with an outside advisor for the seller are a
continuous part of the process. The same procedures should be followed with
respect to any significant subsidiaries, including confirmation of ownership of
subsidiary shares. Any partnership or joint venture affiliations of the business to
be acquired or any of its subsidiaries should be reviewed in a fashion similar to
the examination of subsidiaries.
(2) The Data Room
Frequently the seller or its legal and financial advisors will

organize a data room for documentary due diligence. Copies of all of the
documents to be reviewed are collected and organized in some systematic fashion.
A data room is useful when a business is to be sold by competitive bidding, since
it is important that all bidders be treated fairly and have access to the same
information. A data room may also be useful in maintaining confidentiality and
avoiding disturbance. By using an off-premises data room, it may be possible to
isolate the process from most of the seller’s employees, which may be critical if
the transaction is not yet public. Moreover, it will be clearer which outsiders have
had access to what information if documents are catalogued and organized in a
data room, and this will help prevent the dissemination or misuse of confidential
information about the business. The index to data room documents will also be
useful later in the process when it comes time to prepare disclosure schedules for
the purchase agreement.
34
When given access to a data room, it is important to use one’s time
and resources wisely and efficiently to analyze the materials that are there and
determine what additional materials are necessary to complete the review. Many
data room users are tempted to spend their time trying to copy as many documents
as possible, or to obtain additional documents, or to get the organizers to change
the rules. Usually copying will be prohibited or severely restricted for
confidentiality reasons if multiple parties will be using the materials. Likewise, if
materials have been excluded, it may be difficult to obtain them on the spot
although the seller may be receptive to a request at a later stage. For one, the
materials may be hard to locate, especially on short notice. For another, it may
have been determined that they are too sensitive to disclose so long as more than
one bidder is in the running. Finally, if given to one team, they will have to be
given to all. Hence it is best simply to identify the gaps for later discussion and
spend the time one is granted access to the data room looking at what is there. A
buyer should assume that a data room will almost never contain all the
information it wants to have about the business to be sold, but that the time will
come to obtain more later. For example, when the time comes to negotiate the
representations and warranties of the seller, all those holes in the data room will
come back to haunt the seller unless it is then willing to produce the missing data
to provide appropriate support for or exceptions to what it represents and warrants
in the purchase agreement as to the business.
Especially when due diligence is conducted using a data room, the

participation of an experienced lawyer with a good grasp of the business and the
client’s objectives and concerns is important. Too often due diligence is
delegated to junior lawyers because it is so time consuming and so much of it is
routine. In the data room context, the need for conscientious supervision and
involvement by more experienced lawyers is even greater than usual.
(3) Basic Information and Background
Counsel will review basic corporate documents such as the

certificate or articles of incorporation, by-laws, and the corporate minute books of
the target company to determine that it is “duly organized,” “validly existing,”
“duly incorporated,” in “good standing”, qualified to do business in the
appropriate jurisdictions, and generally to determine whether such documents
contain any provisions which would prohibit or impede the planned transaction.
“Due incorporation”, in its most narrow sense, relates only to

whether the certificate or articles of incorporation were properly filed in
accordance with applicable state law, permitting the creation of a corporate entity,
whereas “due organization” refers to matters statutorily required for doing
business as a corporate entity, such as election of initial directors, adoption of by-
laws, elections of required officers and the authorization and issuance of shares.
Although there are differences in meaning between the phrases “validly existing”
35
and “good standing,” confirmation that no problems have arisen with respect to
either phrase may be obtained by examining the minute books of the target
company, the certificate or articles of incorporation, a “long-form” good standing
certificate from the applicable state agency, and a franchise tax certificate stating
that the corporation is current on its state franchise tax obligations.
Counsel will also study the stock transfer records of the target
company to ensure that all outstanding shares are duly authorized, validly issued,
fully paid and non-assessable and generally to determine that the seller has good
title to all the company’s stock. In a share purchase counsel also must identify the
selling shareholders; examine the authority of each to execute, deliver and
perform his or her obligations under the stock purchase agreement; and deal with
any special issues presented by minor, incompetent or deceased shareholders,
shares held in trust or subject to voting trusts, or other special voting agreements
or arrangements. It is important to review the terms of any preferred shares of the
target company to determine their voting rights and any preemptive rights, as well
as any shareholder agreements that may limit the rights of the company to issue
shares.
(4) Material Transactions and Contracts
This category includes the debt obligations and any related security
agreements of the business to be acquired as well as material agreements such as
supply contracts, sales contracts, joint venture agreements, leases and any sale-
leaseback arrangements, and purchase agreements relating to prior acquisitions,
restructurings or dispositions by the seller or the business to be acquired. The
latter may contain covenants which still impose obligations on the business, such
as indemnification rights or liability for environmental clean-up with respect to
assets that are no longer part of the business.
As noted above, review of the contracts relating to the business

requires coordination between the buyer’s counsel and the business due diligence
team of the buyer. Counsel should point out to the business team contractual
provisions that are out of the ordinary for transactions in the target company’s
lines of business. In certain areas, such as intellectual property law or the law of
particular classes of contracts (e.g., franchise, government procurement contracts),
this analysis may have to be done by specialists. Current drafts of contracts in
negotiation should also be reviewed.
Contractual provisions to be brought to the buyer’s attention would

include any quantity performance obligations and any exclusivity granted to or by
the business. Particular attention (including review of correspondence,
memoranda and other documentation) should be given to any contracts in which a
contracting party may be in breach and to any contracts the buyer may consider
discontinuing because they are unprofitable or may overlap with other aspects of
36
the buyer’s business. The business’s product distribution system may be a source
of antitrust problems relating to the ability of the business to compete in certain
product lines or geographical areas, or of contractual problems relating to the
target’s rights to terminate existing arrangements to conform to the buyer’s
distribution system.
Counsel should identify contracts under which consents or

approvals will be required in order to consummate the transaction or which will
be subject to modification or acceleration as a result of it. If the buyer expects
that certain of the company’s existing financing arrangements will remain in place,
counsel should review such agreements to determine whether consents are
required for their assignment (in the case of an asset purchase), whether the
acquisition would trigger any right of cancellation or renegotiation by the lender
and whether the company will remain in compliance with all covenants after the
acquisition.
(5) Government Regulation
In this area, counsel should identify federal, state, local or foreign

government licenses or permits required to carry out any material aspects of the
business. These may range from occupational health and safety clearances to
licenses specific to certain industries, such as broadcasting, banking or
transportation. Buyer’s counsel may also need to review, or to consult local
counsel regarding, the principal state and local statutes applicable to the operation
of the business to be acquired, including zoning regulations, franchise laws and
state laws regulating commerce in particular lines of business. Counsel should
identify governmental notifications or approvals required for the proposed
acquisition.
If the industry is highly concentrated, has high entry barriers or if

either the buyer or the seller has a leading position in the industry, counsel should
consider the applicability of federal antitrust law as discussed in Chapter 30. This
would include in particular a review of antitrust files, including complaints and
litigation threats from suppliers, customers and competitors, trade association files,
marketing and comparative studies, as well as a detailed examination of the
business’s distributorship agreements and licensing agreements involving patents
or other proprietary information. If the acquisition involves a foreign buyer,
attention should be given to the applicability of the Exon-Florio Amendment
relating to national security, which is discussed in Chapter 30.
(6) Litigation
In a share purchase, the current and threatened litigation of the

company can have a direct impact upon the value of the acquired business; any
uncertainty regarding the outcome of litigation presents the buyer with a strong
37
argument for a reduction of the purchase price, a specific indemnification or an
escrow arrangement. However, even in an asset purchase agreement where there
is only a selective assumption of the seller’s liabilities, and where liability for
existing litigation is intended to remain with the seller, an analysis of this
litigation is relevant both for an understanding of the litigation exposure inherent
in the business and for assessing the risk that the buyer may become liable for
claims relating to the seller’s conduct of the business prior to the asset purchase
under the various theories of successor liability. (See Section 32.2(b).
Generally counsel will request and review a list of all litigation or

of all litigation which meets some minimum threshold or relates to a specific
subject matter (such as product liability), but will not review actual litigation files
unless the amount in controversy is substantial or there are issues that may have a
lasting impact on the business, such as potential class actions, injunctions or
future claims. The extent of counsel’s review of litigation will be the product of a
cost-benefit analysis by the buyer and its counsel in each case and often a
thorough discussion with the in-house or outside counsel handling the litigation
will suffice. However, it is counsel’s responsibility to know enough about the
litigation to provide the buyer with an accurate understanding of the likelihood
and implications of a judgment against the company. If counsel and buyer
determine that the amount in controversy or the subject matter of the suit merit a
detailed review, buyer’s counsel should request and review in particular pleadings,
deposition transcripts and documents, any correspondence between seller’s
counsel and counsel representing adverse parties, seller’s counsel’s response to
auditors’ requests for information, and information as to any rights of
indemnification or contribution available to the company.
If the seller or the target company is the subject of an outstanding

material judgment, decree, or settlement agreement relating to the business to be
acquired, counsel should confirm that compliance is appropriately performed and
that any such judgment or settlement agreement would not prohibit, or require a
consent for, consummation of the acquisition, and should provide information to
the buyer about the extent to which the decree limits the company’s activities.
The buyer’s counsel should review the judgment or agreement and any
administrative or judicial opinion or finding of facts that may be relevant thereto
and may also want to check the case or proceeding docket with respect to the
judgment, post-judgment filings made by the seller or the company and references
to the judgment in the seller’s or the company’s SEC or other agency filings and
financial statements.
Buyer’s counsel also has numerous other sources of information

concerning litigation, such as Nexis or other similar computer-based publication
libraries, searches of judgment indexes and plaintiff/defendant indexes, searches
of agency dockets, or Freedom of Information Act requests, which can be
accessed outside the scope of document requests to the seller. The most important
38
aspect of a search may be knowing when to stop looking, since the search costs
time and money. This decision will always be a matter of informed judgment
based on experience, sensitivity to the client’s objectives, thoughtful analysis and
common sense.
(7) Assets
Counsel will identify the real and personal property to be acquired

by using the lists and descriptions supplied in response to the document request
and by discussions with target company personnel. Counsel needs to verify the
target company’s title to at least material assets. This is done primarily through
examination of title reports, the underlying title documents and UCC lien searches.
The reviewing lawyer is seeking to identify the title to or right to use any material
properties and any encumbrances on the property, whether use of the properties is
in compliance with applicable laws and regulations, and what steps must be taken
to ensure that good title to the assets is retained (or acquired) after the acquisition.
The buyer and its counsel will also verify the condition of any material property
through inspections, surveys and appraisals.
Regarding real property, the lawyer will need to obtain copies of

all deeds, title opinions, title policies and title abstracts in the possession of the
seller or the target company. The title policies and title abstracts for each parcel
of real property should be updated to determine that the seller possesses
unencumbered title through the closing date. In an asset purchase, in particular,
copies of any appraisals and any existing surveys of all owned and leased real
property are useful to determine value, the desirability of an updated appraisal,
whether the property has access to all necessary public utilities and whether there
are conditions that might interfere with the operation of the property, such as
zoning or noise regulations. In addition, any material pending contracts for
building construction or renovation should be examined. The buyer will normally
require title insurance (both lender’s policy and owner’s policy) for each parcel to
be mortgaged as security for financing in connection with the acquisition, and the
buyer should consider whether to increase existing coverage under title policies
for other parcels.
Regarding leases and sub-leases, the investigating lawyer should

note in particular short terms and under-market rates and should determine
whether the continuation of a lease or sublease may be affected by the acquisition
and, if so, whether the consent of the lessor is necessary.
Mortgages, deeds of trust and fixture filings encumbering the real

property owned or leased by the target company should be examined, especially
for provisions imposing prepayment penalties or allowing the lender to call the
loan prior to maturity. The buyer may, if the property is particularly important,
require an estoppel letter from the lender confirming the essential terms of the
39
indebtedness and agreeing that the sale of the business to the buyer will not result
in a default or a modification of the terms of the loan.
State and local, rather than federal, laws generally govern

ownership, transfer, zoning, building codes, property taxes and use of real
property. As discussed above in Section 29.3(e), the services of local counsel
may be required to examine compliance with the statutes, regulations and
ordinances of the specific jurisdiction in which the property is located. The seller
can be asked to provide a certificate from the appropriate zoning offices that
property owned or leased by the business is not affected by any special exceptions,
variances or conditional uses, and that the present or contemplated use of the
property by the business constitutes a permitted use. The city or county building
inspector may not be willing to certify that a building is currently in compliance
with applicable building codes but should be willing to certify that there are no
reported building code violations and that the building was in compliance at the
time the certificate of occupancy was issued. Buyer’s counsel should confirm that
all property taxes for prior years have been paid.
As for personal property, in an asset purchase the buyer should

obtain a complete list of material personal property owned or leased, identified by
asset type, location and book value, together with any security interests or
encumbrances thereon. With respect to intangible assets, counsel should request a
list of any trademarks, trade names, copyrights, patents, service marks and
applications therefor used by the business as well as a description of any related
claims or litigation. The buyer’s lawyer should initiate searches in the filing
locations indicated by Section 9-401 of the Uniform Commercial Code to
determine whether the personal property used in the business is subject to any
recorded security interest. A search for federal tax liens against the company’s
personal property may also be advisable.
40
(8) Employee Matters
The buyer’s counsel, human resources and labor relations staff

should obtain complete information relating to principal employees, copies of
employment contracts, employee benefit plans and arrangements and their funded
status, collective bargaining agreements, personnel manuals and policies, hiring
and severance policies, training programs, vacation and holiday policies, as well
as the status of any discrimination, sexual harassment, or occupational safety and
health matters and labor disputes. The legal issues include compliance with
ERISA, the Internal Revenue Code, and other federal, state and local labor laws
relating to collective bargaining and unfair labor practices, notice of plant closings
or layoffs, equal employment opportunity, unemployment and worker’s
compensation, noncompetition and nondisclosure of proprietary information,
substance abuse and testing and immigration.
As discussed more fully in Section 32.2(c), liabilities for employee

benefits and the extent to which accrued liabilities are funded can affect the
purchase price of an acquisition. Consequently, a review of employee benefits,
plans and other arrangements should take place as early as possible in the
acquisition review process. This is another area of the acquisition review process
that is best conducted with the assistance of experts, as the laws and regulations
affecting employee benefits have become highly technical. The help of
accountants and actuaries is also required to evaluate the amounts of funded and
unfunded liabilities for accrued and future employee benefits. Nonqualified
health and welfare plans should also be reviewed, including liabilities to retirees
for health care benefits.
The review process should also include executive compensation

and stock option plans to determine the effect of the acquisition on the plans.
Change in control provisions may vest benefits or trigger future benefits that are
contingent and difficult to evaluate.
(9) Environmental Matters
Environmental issues have become increasingly important to

purchasers of assets. Expanded civil and criminal liability and the potential for
significant costs associated with environmental cleanups, as discussed more fully
in Section 32.2.(e), make it essential that the purchaser understand the extent of its
exposure to environmental liability.
Environmental due diligence, which generally includes the review

of internal target company documents such as indemnity agreements, permits,
litigation documents and previously conducted environmental audits and
discussions with the seller, is the first step in assessing the environmental
liabilities associated with an asset purchase. In addition to such reviews and
41
discussions, an independent environmental audit of the properties to be purchased
is typically conducted by environmental consultants retained by the purchaser.
This due diligence process, which is discussed in the asset sale context in further
detail in Section 32.2(e), will assist the purchaser in assessing the extent and
nature of potential environmental liabilities associated with the transaction. Once
this determination has been made, the parties may be able to allocate these
environmental liabilities by the terms of the acquisition agreement or by adjusting
the purchase price.
(10) Tax Matters and Financial Statements
In addition to permitting the buyer to ascertain the target

company’s compliance with applicable federal, state, local and foreign tax
obligations and the appropriateness of its accounting practices and tax return
preparation, the tax review may be useful to the buyer in the early stages of
negotiation because it may help identify certain issues that should be taken into
account in structuring the transaction. It is particularly important to have good
coordination and communication among the lawyers, accountants and financial
personnel on the acquisition team to evaluate properly the information obtained.
Since the federal income tax aspects of corporate acquisitions are

complex, buyer’s counsel will generally include a tax specialist. (The tax aspects
of an acquisition are discussed in Chapter 30). Depending on the target company
and the scope of the review, in addition to the items on the Due Diligence Request
List attached as Appendix B, counsel may also wish to request current good
standing certificates from each state in which the company conducts any material
business (to verify that state taxes have been paid), copies of tax elections filed by
the company (to determine the potential impact on future tax reporting), revenue
rulings requested or received, copies of legal and accounting tax opinions
received by the seller or the company from outside advisors, an explanation for
any change in accountants in the last five years, information relating to any
dispute concerning local income, sales or use, property franchise or other taxes.
The financial statements of the business to be acquired are among

the most important disclosure documents of the seller. While counsel will not
normally be primarily responsible for reviewing them, they may contain
important information concerning items on the legal due diligence list, such as the
existence and certain terms of indebtedness, employee benefit plans, stock options,
warrants, authorized and unissued capital, as well as material contingencies.
Close collaboration between the buyer’s legal and accounting advisors will better
ensure that the implications of the financial statements are properly understood by
the buyer’s acquisition team.
(11) Intellectual Property
42
The seller will generally furnish to the buyer a schedule of
trademarks, patents, copyrights and licenses, including their dates of validity and
any pending applications. Buyer’s counsel will discuss the status of intellectual
property assets with the appropriate in-house specialist of the seller, ascertain
from the business team which rights or licenses are significant to the buyer and
ensure that such intellectual property is being properly assigned or transferred in
the acquisition. It is also important to notify the buyer of the absence of
intellectual property rights, such as know-how or technology that is not legally
protectable and of any infringement claims brought by or against the seller or the
company.
If intellectual property is a significant asset, buyer’s counsel will

usually undertake further investigation. In the case of trademarks, counsel will
seek to determine whether the marks have been registered to the extent allowed
by law and whether sufficient policing of infringement laws has been undertaken
to prevent abandonment of the marks. In the case of patents, counsel will seek to
evaluate the strength and enforceability of the patents and applications and
whether any patents exist that may preclude the use of the technology (as
evidenced by complaints or litigation claiming infringement). The ownership of
any important computer software (pursuant to a written agreement or creation by
the seller’s or the company’s employees) should be ascertained as well as the
protection of such software by patent, copyright or other means. The status of
confidentiality agreements relating to trade secrets should also be reviewed.
(12) Insurance
Buyer’s counsel will review at least a schedule of insurance

policies indicating the type, coverage and amount of insurance policies (general
liability, product liability, fire or casualty, director’s or officer’s liability, workers
compensation, employee life insurance and environmental) and buyer will make
arrangements for the continuation or replacement of such policies. An insurance
professional, who may be the buyer’s risk manager or an outside insurance broker,
will be needed to assess the adequacy of coverage and whether historical
insurance costs are representative of future premiums, as well as to identify any
potential gaps in coverage that may leave potential liabilities uncovered.
Issues to note include any recurring loss or liability experience,

significant deductibles, whether the insurance is on an “occurrence” basis
(occurrence during the policy period) or a “claims-made” basis (covers only
claims asserted during the policy period), any auditor’s assessment of insurance
coverage and any self-insurance. When examining the claims experience, if the
company has deferred giving notice of a claim, the buyer should consider whether
such notice should be given before the acquisition, in particular if the policy is to
be discontinued.
43
(13) Securities Laws
Where the target company is publicly held, counsel will also need
to investigate the possibility that it may have continuing liabilities for violations
of federal or state securities laws. Such liability may have arisen in connection
with prior issuances of securities, with its compliance with ongoing reporting
obligations under the Securities Exchange Act of 1934 or with statements made or
not made in connection with the sale transaction itself.
Counsel should review the prospectuses or other disclosure

documents used in connection with any recent securities issuances and the
compliance with state securities or “blue sky” laws in connection therewith,
together with any correspondence with the Securities and Exchange Commission
(“SEC”) and state securities commissions relating thereto. Likewise, counsel
should review recent SEC filings by the company on Forms 10-K, 10-Q and 8-K,
as well as the latest proxy statements and any SEC comments thereon. Finally,
counsel should review any press releases put out by the company relating to
material events which caused the company’s stock price to move upwards or
downwards, as well as the timing of the underlying events, any known purchases
or sales of the company’s shares shortly before or after the announcements, and
any inquiries received by the company from stock exchange or regulatory
authorities with respect thereto.
(d) Drafting and Negotiations
Drafting and negotiating an acquisition agreement can last

anywhere from a few days to a few months. Typically merger agreements, which
tend to be used most often for the acquisition of public companies, are the
simplest and fastest to negotiate. Asset purchase agreements are generally the
most complex and take longest. The main differences will be described here
briefly, followed by a few practical remarks on the elements that are common to
more than one form of acquisition agreement.
(1) Mechanics
In an asset purchase, the seller agrees to sell, and the buyer agrees
to buy, a variety of assets that usually comprises a business or somewhat coherent
portion of a business, but which are seldom all of the assets and liabilities of one
or more distinct corporate entities. It is thus necessary to work out, in the process
of drafting and negotiating the agreement, whether and how each asset or liability
(or each class of assets or liabilities) will be conveyed. While the “whether” part
can be quite complex and controversial, the “how” part generally is not, although
a variety of legal instruments are needed whereas in a stock purchase there is only
one. It may also be the case that some assets are transferred separately after the
44
closing, perhaps because of a delay in obtaining consent, and thus the asset
purchase agreement must make provisions for this too.
In a stock purchase, the basic mechanics of the transaction are

simple. Shares in certificated form can be conveyed by endorsement or delivery
of stock powers. The buyer, once it has control of the corporation’s stock book,
can then cancel the old certificate(s) and issue itself a new one in its own name.
Title questions are relatively straightforward (although there may be problems if
there are lost certificates) and a legal opinion can generally be delivered which
gives the buyer comfort that it is getting good title to the shares.
A merger is procedurally more complex since it requires corporate

action, although this may be the simplest method when there are numerous
shareholders or difficulties in locating all of the stock certificates. The merger
agreement will require the target corporation to convene a shareholder meeting
and solicit proxies in favor of approving the plan of merger. The merger is made
effective by the filing of a certificate of merger, which includes a plan of merger
specifying what consideration the shareholders of the target corporation are
entitled to receive upon submission of their shares. If the acquisition vehicle is
not the surviving corporation, the plan of merger will also specify how its shares
will be converted into shares of the target corporation. The merger agreement
will provide for the consummation of the merger by the filing of the certificate of
merger upon fulfillment or waiver of the conditions and payment of the purchase
price, typically to an agent who will then distribute it to the shareholders of the
target as they surrender their old stock certificates.
(2) Representations and Warranties
All agreements for the acquisition of a business will have at least a

minimum set of representations and warranties from the seller(s). Their
negotiation often takes up the bulk of the time devoted to the definitive share or
asset purchase agreement. One commentator has referred to them as a “nit-
picker’s paradise” and there is certainly scope for hair-splitting in every line, but
they perform an essential function in the purchase process. Together with the
conditions and, in the case of the acquisition of a private company,
indemnification provisions, the representations work to give the buyer a reliable
picture of what it is that it is buying and a measure of recourse after the closing,
should that picture prove to have been false. There will also be some
representations made by the buyer to the seller, although their role is considerably
less significant, since the seller mostly is concerned only whether the buyer can
perform its obligations under the contract, i.e. principally come up with the
purchase price at closing. When part of the purchase price is securities, however,
the buyer’s representations will be more comprehensive since in effect the seller
is making an investment in the buyer at the same time it is selling the business, so
there will usually be more parallelism between the two sets of representations.
45
The standard representations include the corporate existence of the
parties and authorization to enter into the agreement and consummate the
transactions it contemplates. There will be further representations covering any
regulatory authorization requirements and non-contravention of the charter and
by-laws and third party agreements. These representations will serve to clarify
for each party what corporate procedures and what legal and regulatory risks and
hurdles must be met in order to consummate the transaction.
Then, a group of representations will cover certain basic facts

about the business, including financial statements and filings with the Securities
and Exchange Commission (if applicable), capitalization and subsidiaries (if one
or more corporations are being acquired), material adverse changes since the last
date as of which more or less complete financial statements are available for the
business, litigation, tax and ERISA matters and compliance with environmental
and other laws. Particularly in acquisitions of large public companies that are in
sound financial condition and have a meaningful operating history, some of these
representations may be negotiated away in reliance upon the representation as to
the accuracy of the company’s SEC filings and financial statements. In certain
industries, especially those which are heavily regulated, such as banking,
broadcasting, insurance or transportation, there may on the other hand be other
additional representations that are appropriate to add even in such cases. It can be
helpful to examine precedents for acquisitions in the same industry, and for public
transactions these would be retrievable from the Securities and Exchange
Commission’s files directly or through a disclosure service. The representations
and warranties included in the Form of Asset Purchase Agreement attached as
Appendix A to Chapter 32 (the “Standard Form”) can be used as a starting point
for a sale of assets or a sale of shares of a private company.
If the seller needs shareholder approval, there will also usually be a

representation on the accuracy of its proxy statement.
The first and foremost function of representations is to assure the

buyer on entering into the agreement that it has been fully informed of all matters
that are material to its decision
to enter into the agreement and determination of the value of the business
being bought. The representations will also form the basis of one of the most
essential conditions, which will require some or all of them to be brought down to
the closing, meaning in other words to be in effect repeated on the closing date. If
the seller is unable to make the representations again on the closing date (with
such exceptions and materiality qualifications as may be agreed), the buyer will
not be obligated to close. Finally, in acquisitions of businesses that are not
publicly held, the representations will form the basis for post-closing claims for
breach of representation or indemnification if they were untrue when made or
deemed made by virtue of the closing bring down.
46
The parties will negotiate not only what subjects are necessary or
appropriate to cover in the representations but also what exceptions are necessary.
The representations play a role in bringing to the surface important facts that may
not be uncovered by the buyer in documentary or management due diligence.
Frequently a buyer will propose extensive representations in an early draft as
much to learn why the seller is unwilling to give them as in any expectation that
they will still be in the agreement by the time it is signed. Where a business is
relatively simple or small, the simplest way for a seller to build in exceptions to
representations is by reference to a schedule of exceptions. Buyers cannot really
object to specific exceptions based on the facts of the business to be sold and the
seller is thus protected against post-closing liability to the extent all problems
have been scheduled.
However, especially where the business being sold is large and

complicated, this scheduling procedure can be extremely inefficient for both sides
and the seller will usually want to take many exceptions for materiality and
knowledge in order to avoid the burden of itemizing every possibly exception, the
risk of omitting something and the adverse psychological effect a lengthy list
might have on the buyer. The buyer may agree that it does not want to be
overwhelmed by a mass of information in which the truly important could easily
get lost. However, from the buyer’s perspective, the insertion of appropriate
thresholds of materiality is usually a more acceptable alternative than a
knowledge qualification. The knowledge qualification raises two main concerns.
It may encourage the seller not to do as much due diligence of its own in
connection with making the representation than it would do if it had to make the
representation “flat”, i.e. without the qualification, thus bringing fewer potential
areas of concern to light before the agreement is signed. Moreover, if after the
closing the buyer discovers a problem and seeks recovery, it will have to prove
not only that the problem existed when the representation was made, but also that
the seller knew about it, which is often a more difficult task.
In some circumstances a knowledge exception, at least on the part

of certain sellers, such as family members who are shareholders but not actively
involved in the business (See Section 29.4(f)(2) below), may have to be accepted,
but a purchaser is usually reluctant to have no seller “on the hook” for a particular
representation. If a knowledge qualification is to be accepted from a corporate
seller, there will often be a further discussion about whose knowledge — since
companies can be large organizations with large numbers of people — and to
what extent there is a duty to inquire. Most buyers will insist on a duty to make
“due inquiry” or something of the kind, while sellers are often concerned that they
do not know what that might mean to a court, e.g. something on the order of due
diligence under the federal securities laws, which may go far beyond the
expenditure of time and effort they had in mind.
47
Materiality qualifications can save the seller a large amount of
work in investigating and cataloguing minor exceptions. The number of ways in
which the word “material” or a surrogate therefor (such as a minimum dollar
amount for contracts or litigation) can be added into a representation may be very
high, and each may have more or less serious implications depending on one’s
perspective. Many materiality limitations will be perfectly acceptable from the
buyer’s perspective. The important thing is for a buyer to consider carefully what
the implications of any such limitations are for its due diligence, for the closing
conditions and for its possible remedies.
(3) An Introduction to Covenants
An acquisition agreement will contain covenants which cover the

period between signing and closing and may also contain a certain number of
covenants that survive the closing for some period of time. The pre-closing
covenants “close the loop” between the representations, which give the buyer
assurances about the state of the business and the steps needed to permit the
transaction to close, and the conditions to closing, which permit the buyer not to
close if the representations are no longer accurate and if the pre-closing steps have
not been accomplished. The covenants give the buyer a remedy if the agreed-
upon steps are not taken or if the seller in its conduct of the business should
willfully do or fail to prevent something to detract from its value. The ultimate
performance of some of these covenants may coincide with the closing if they
involve actions that must be prepared in advance but which one or both parties
would not want to complete unless the transaction closes. For example, when
stock is to be sold, there will typically also be a covenant to procure the
resignation of some or all directors at the closing.
For the pre-closing period, there are three key areas of concern: (i)
preserving the value of the business as a going concern; (ii) protecting the buyer’s
rights to withdraw by making sure that it has the information needed to determine
if the conditions will not be met or if a termination event has occurred; and (iii)
requiring the parties to take the steps necessary to assure the closing of the sale.
The individual covenants will be analyzed individually below. The typical post-
closing covenants concern non-competition, intellectual property, seller’s access
to the business to the extent necessary for its accounting, tax or other regulatory
purposes and, particularly in an asset acquisition, a further assurances covenant.
(Sections 5.04, 5.05, 6.02 and 7.01, respectively, of the Standard Form) Where
there are complicated issues relating to competition and intellectual property,
these areas may be treated by ancillary agreements entered into at the closing. A
discussion of covenants relating to employee matters is contained in Section
32.2(c) infra.
(4) Pre-closing Covenants
48
The main pre-closing covenant, meant to address the preservation
of the value of the business, is the conduct of the business covenant, which is
Section 5.01 of the Standard Form. The acquisition agreement may also contain a
confidentiality covenant that supersedes any confidentiality agreement the parties
have already entered and protects both the business and the parties against
unwanted disclosures that may damage their interests. See Sections 6.01 and 7.03
of the Standard Form. The confidentiality agreement signed at an early stage of
negotiation is unlikely to address the buyer’s confidentiality concerns once the
closing has taken place, and the acquisition agreement may need to place
confidentiality restrictions on the seller after closing. See Section 5.02(b) of the
Standard Form.
The buyer’s rights to withdraw are protected by covenants on access to the

business and notice of certain events. (Sections 5.02(a) and 5.03 of the Standard
Form) These enable the buyer to verify whether the representations are indeed
accurate and give it the right to be informed about developments that might have
an impact on whether and when the various conditions of closing are likely to be
fulfilled or whether any grounds for termination of the agreement exist.
The main covenant that addresses the steps necessary to insure the
closing of the transaction is the best efforts covenant. (Section 7.01(a) of the
Standard Form) There will also usually be a covenant relating to filings and
regulatory approvals. (Section 7.02) Where the transaction has a financing
condition, there will often be a covenant setting forth the steps the buyer will take
to secure financing. This can be a complicated area and the parties’ positions will
depend heavily on the facts and circumstances of the transaction. The seller,
however, will normally be quite concerned that the financing condition does not
give the buyer an easy way out from closing the transaction. This is usually
phrased, often somewhat combatively, in terms of the purchase agreement being a
binding agreement and not an “option” to purchase. The buyer will seek
maximum protection by way of a detailed covenant obligating the buyer to take
certain steps. This covenant, if appropriate, will have to be negotiated based on
the status of the buyer’s financing efforts when the acquisition agreement is
signed. Often the seller will insist on seeing financing commitment letters or
“highly confident” letters before accepting a financing condition, and any
covenant will normally take these letters as a starting point. There may be further
covenants covering preparatory steps specific to a given transaction if, for
example, certain important contracts must be renegotiated or terminated.
Conduct of the business (Section 5.01). In this covenant the seller

commits to conduct the business in the ordinary course consistent with past
practice and agrees to specific prohibited and, where appropriate, permitted or
required actions. The list of prohibited actions can be quite long, but is in general
intended to require the consent of the buyer to any substantial changes in the
conduct of the business and, in a stock purchase or merger, to prevent the seller
49
from withdrawing cash and other assets from the business between signature and
closing. Where the corporate entity is being acquired and not merely its assets
and specified liabilities, there will also be detailed prohibitions on charter and by-
law amendments and changes to the capital structure that would have an impact
on what the buyer is to acquire. The appropriate degree of detail will also depend
on a variety of factors, such as the length of time expected to elapse before
closing, whether management is staying with the business and whether the deal
includes other incentives (such as an earn-out) or penalties (such as a price
adjustment based on equity or working capital at closing) that would influence the
seller’s behavior or provide alternative forms of protection. There is therefore no
generally correct or standard way of drafting this type of covenant, and the
clauses should be thought through in the context of the various terms of the deal.
Exceptions to some of the prohibited actions may be appropriate in

stock sales or merger transactions where some assets or liabilities must be shifted
around to the right corporate owner prior to closing.
The conduct of business covenant may also prohibit the seller from
taking or failing to take actions that would render the representations inaccurate.
This clause is helpful to the buyer since facts might arise after signing that would
make the representations untrue if brought down as of the closing date, and the
buyer, having contracted to buy the business, would rather avoid this than be put
in a position where all it can do later is point out that a closing condition has not
been met.
Negotiation of this covenant can be difficult, particularly when it is

expected that it will take a long time to close or the deal is subject to a serious
legal hurdle, such as a court or governmental approval that may be difficult to
obtain. Seller’s concerns about being prevented from running the business (which
it, after all, still owns) in a sensible manner must be balanced somehow with
buyer’s newly acquired proprietary feelings towards the business and its concerns
that the seller may be tempted to reward past loyalty by passing out raises,
extending sweetheart contracts and otherwise frittering away the substance of the
business during the transition period. Where the businesses are competing, there
may be less scope for an overly restrictive covenant, since it may be viewed as
conferring de facto control on the buyer before the waiting period under the Hart-
Scott-Rodino Act (discussed in more detail in Chapter 30) expires or as a contract
that places an unreasonable restraint on trade.
Buyer’s access to information (Section 5.02). As noted above, this

covenant may help the buyer to protect its right to withdraw by allowing it to
continue its due diligence investigation. The right to further access may also be
critical if the buyer plans to finance the acquisition, since lenders or underwriters
will need to conduct some due diligence of their own as well and buyer’s auditors
may need to conduct an audit for such purposes. Another important role of the
50
covenant is to facilitate the transition. Access and information are essential for
the buyer’s planning.
Notice of certain events (Section 5.03). The notice covenant goes

a step beyond the access covenant in that it imposes an affirmative obligation on
the seller to disclose certain subsequent events. These might be material
developments that would make the representations untrue if they had to be
brought down to a later date, or they might be communications from regulators or
third parties that some consent is required in order to consummate the transaction.
This covenant may be supplemented by a covenant to update the disclosure
schedules. However, allowing disclosure schedules to be updated may be
equivalent to allowing the seller to change its representations and warranties after
signing the agreement, and the buyer may want protection against the
consequences of this, for example in the form of a right to back out of the
transaction if it finds the contents of the updated schedules unacceptable.
Updating may, as a practical matter, be inevitable if there is a particularly long
period between signature and closing, but it is often the occasion for significant
Angst for both parties.
Best efforts (Section 7.01). This covenant is critical, since there

will almost always be consents to obtain and other hurdles to overcome before the
transaction can be closed. While this clause most often will not be controversial,
it may give rise to controversy in situations where the parties perceive serious
obstacles to consummating the deal, even though they are hopeful enough to enter
into the agreement. Where there may be some doubt as to whether a particular
regulatory or essential third party consent can be obtained, the parties may want to
reach a more precise understanding concerning the scope of their commitment
before approaching the regulator or the third party. There may be some hesitation
to set this understanding down in writing even when the parties are able to agree
in substance on what they would or would not be willing to do. For example, if
the buyer would be prepared to commit to make certain divestitures as a condition
of receiving antitrust clearance, it would probably not want to commit that
understanding to writing since that would amount to an invitation to the antitrust
authorities (who will have an opportunity to examine the transaction agreements)
to make the divestiture a condition for approving the acquisition.
Even where the parties have no specific obstacles in mind, there

may be some dispute over whether the appropriate standard is “best efforts”,
“reasonable efforts” or something in between. It can be very difficult to predict
both what efforts might conceivably be required to obtain some approval or
consent and how a court, if asked, would interpret these various standards. It is
generally thought that best efforts would require the expenditure of money.
Which standard is chosen in any given acquisition agreement may ultimately
depend on nothing more than the persistence of one or the other party or on
simple bargaining leverage.
51
Certain Filings (Section 7.02). Related to the best efforts covenant
is a covenant that the parties will cooperate in determining whether any filings,
consents or approvals are required and in taking whatever actions are necessary to
obtain them. Negotiation of this covenant is rarely the occasion of much dispute
between the parties.
(5) Post-closing Covenants
Apart from the covenants on post-closing confidentiality and

access to the business, the key post-closing covenants will most likely cover non-
competition and intellectual property. The appropriateness and scope of any non-
competition agreement will vary from transaction to transaction. In addition to
the obvious issues of whether the covenant is necessary to protect the value of the
business to be acquired (i.e. could the seller reenter the business on the day after
the closing and regain all of its old customers, thus leaving the buyer with an
empty shell for its purchase price) and what the implications might be for the
seller to agree to it (i.e. for an individual, would it deprive him of all means to
earn a livelihood or, for a corporation, would it constitute a restraint of trade), the
buyer may be concerned with the tax benefits of the covenant. The buyer may be
able to amortize the portion of the purchase price allocated to the covenant for tax
purposes, thereby reducing its income tax liability.
In addition to the normal questions under the U.S. federal antitrust

laws, discussed in Chapter 30, there may be a real question under New York law
on the enforceability of a non-compete covenant, particularly as it may affect the
ability of individuals to choose their employment. Under New York law, a
covenant not to compete made in connection with the sale of a business is
enforceable if it is reasonable, which means that it is “not more extensive in terms
of time and space than is reasonably necessary to the buyer for the protection of
his legitimate interest in the enjoyment of the asset bought”. Purchasing Assoc. v.
Weitz, 246 N.Y.S.2d 600 (N.Y. 1963). “Whether a covenant is reasonable
depends on the circumstances of each case,” and a particular restriction in a
covenant may be “pared or severed and the covenant in its corrected form can be
enforced”. Town Line Repairs, Inc., et al. v. Anderson 455 N.Y.S. 2d 28 (N.Y.
1982) The reasonableness test in this context requires that the activity prohibited
be “generally limited to that of the business sold”. See John T. Stanley Co. v.
Lagomarsino, 53 F. 2d 112 (S.D.N.Y. 1931). Uncertainty about the enforceability
may justify counsel in taking an exception regarding the clause in its legal opinion.
The key questions on intellectual property will often concern the

duration of any transition period during which certain trademarks and trade names
may continue to be used by the business and the scope of any restrictions.
(Section 5.05) While the parties may argue about what is standard, there will
52
probably be no substitute for careful investigation of the facts and circumstances
specific to the transaction at hand.
Additional covenants will be appropriate in transactions where

shareholder approval is required or where stock is being purchased or being used
as part of the consideration for payment of the purchase price. These may include
a registration covenant where the buyer is paying for the acquisition in whole or
in part by issuing its own capital stock, a “no-shop” covenant where the seller
might be under some fiduciary obligation to consider competing offers (seller
may consider offers which come to it, but may not “shop” this deal in search of a
better one) and various types of “bust-up” and expense reimbursement provisions
that are designed to inhibit competing offers by adding an incremental cost
(within carefully prescribed limits). See Chapter 31 infra.
(6) Conditions
An acquisition agreement will normally have three groups of

conditions: those benefiting both parties, those benefiting the seller and those
benefiting the buyer. In negotiating the agreement, each party should be careful
not to assume that it will have the benefit of the other’s conditions since the other
party in most cases may be free to waive them. Also, each party should try to
view the conditions in relation to the transaction as a whole, since the same clause
in one agreement may have a different effect than in another. The impact of a
bring down condition, for example, plainly depends on the language of the
representations or covenants to be brought down. A litigation condition will also
be written differently for a public than for a private deal.
The most common mutual conditions are those that deal with the
legality of the transaction. Agreements for the acquisition of relatively large
business will contain as a condition the expiration or termination of the Hart-
Scott-Rodino Act waiting period, since both parties are subject to notification and
waiting period requirements in a consensual transaction. Certain licenses to
operate various types of business which cannot be transferred without
governmental consent may also fall into the same category. It is also quite
standard to have mutual conditions that (i) no provisions of law or regulation or
judgment or other order either prohibits the closing or restrains, prohibits or
otherwise materially interferes with the buyer’s operation of all or a material
portion of the business and (ii) no proceeding challenging the agreement or
seeking to prevent, alter or delay the transaction shall be pending or, in some
cases, threatened. Sellers will usually resist the inclusion of threatened litigation
as too imprecise. What may constitute a threat for a suddenly reluctant buyer may
be viewed as much less serious by a seller anxious to close. Particularly in more
complex transactions these provisions may be varied to a greater or lesser extent.
Sometimes one party (usually the buyer) will successfully argue that two different
standards should apply, depending on who is at risk with respect to a particular
53
possible event. Where the potential adverse impact is on the business, the buyer
will have a greater stake than the seller and will argue that the buyer and not the
seller should have the right not to close under such circumstances. The mutual
conditions may also include the execution and delivery of the various ancillary
agreements that may have been negotiated concerning matters that concern both
parties, such as supply contracts and subleases. Other ancillary agreements
covering areas such as non-competition, employment of certain individuals and
licensing of intellectual property where buyer’s sensitivities are typically greater
than seller’s may be required only as a condition to buyer’s obligations, or may be
included in another part of the acquisition agreement rather than as conditions.
Each of the seller and the buyer will usually have conditions
requiring (i) that the other has performed in all material respects its obligations
under the acquisition agreement, (ii) that the other’s representations are true in all
material respects, (iii) that the other has delivered a certificate of an appropriate
officer confirming (i) and (ii) above, (iv) that it shall have received appropriate
documentation covering the other’s existence and authority and (v) that the other
causes appropriate opinions of counsel to be delivered. When the price is being
paid all in cash at closing, the buyer may argue that the seller must close if the
cash is tendered and the transaction is not illegal, i.e., that the seller need not have
the benefit of most of these protections. Nonetheless, these conditions are
typically much simpler for the buyer to fulfill than for the seller, since the
representations that are to be brought down are far less detailed and the likely
subjects for legal opinions are also likely to be more circumscribed. Finally, the
almost universal human striving for symmetry usually wins out and the seller
generally gets these conditions as well.
The purpose of the officer’s certificate is a mystery to many

practitioners. On one level, it serves as an extra assurance to the buyer that
somebody in a position to know the facts has ascertained that the representations
are correct and that the seller’s obligations have been performed. If the seller is
unable to deliver the certificate, the buyer’s position is much clearer than if the
buyer simply asserts that a condition has not been met and refuses to close. The
certificate is no substitute for the bring down condition, however, since opinions
may differ as to whether, for example, a certain event represents a material
adverse change in the business, and the buyer would not want to be bound by the
seller’s subjective view of the facts. The delivery of the certificate may also serve
to clarify whether the parties believed the conditions have been fulfilled or waived.
This issue may be critical if indemnification is later sought, since the knowing
waiver of a closing condition most likely amounts to a waiver of indemnification
rights, unless these rights are explicitly reserved. It should be noted that often the
seller’s counsel seeks to protect the officer signing the certificate from personal
liability by asking for a knowledge qualification. Since this qualification may
have the effect of calling into question the buyer’s indemnification rights with
respect to a representation which was not originally so qualified, the buyer might
54
insist, before accepting such a qualification, that the certificate also provide that
the qualification shall have no effect on such rights. Alternatively, the buyer
might propose, instead of the qualification, that the certificate state clearly that the
officer is certifying in his or her official capacity rather than as an individual.
The inability to deliver the officer’s certificate because the

representations are no longer true will not create liability for the seller, but only
give the buyer the right not to close. On the other hand, there may be liability if
the reason the certificate cannot be given is that there has been a breach of a
covenant. If the officer’s certificate is inaccurate, however, there may be recourse
for fraud or under the indemnification.
Frequently the obtaining of material consents and approvals is

made a condition only to the buyer’s obligations, on the theory that so long as
seller is paid the purchase price, the buyer should be free to work out the
consequences of closing without any particular consent or approval if it decides to
proceed on that basis.
The bring down of representations to the closing date may be fairly

controversial in negotiations, especially where the seller’s representations are
comprehensive and the time between signing and closing is expected to be long.
The parties may agree, for example, that only certain representations must be
brought down. As a drafting matter, this can be accomplished either by excluding
particular representations from the bring down condition, or by phrasing the
particular representation to speak only as of the date it is made. The latter
approach may be more protective of the buyer than totally carving out the
representation, since if it was inaccurate when made, it may still provide a basis
for later indemnification. Sellers often argue that it is appropriate for the bring
down to include a global materiality qualification. If the buyer has already agreed
to specific materiality exceptions in the representations themselves, the buyer will
not want to undermine the results of that negotiation by reopening the issue once
again in the conditions. The buyer may also fear that the materiality exceptions
will “compound” themselves, leaving it with little protection at all vis-à-vis those
representations which are already limited by materiality. The buyer may also
argue that it is more appropriate to weigh the representations together than
separately, since a number of almost material inaccuracies may add up to a very
serious problem. Including the bracketed language in Section 10.02(a)(i) of the
Standard Form would have the effect of weighing the impact of all exceptions
collectively rather than separately for each assertion in the representations that has
a materiality exception. While much effort may be expended debating the “right”
way to measure materiality, it is usually worthwhile to think as concretely as
possible about the potential threats to the deal and to the business. If the buyer
has specific concerns, it may be best to negotiate specific conditions to deal with
them. Although the bring down is a useful tool, the materiality tests that tend to
55
turn up in them are not very precise and the buyer will wish he had more to point
too if something does go wrong.
Another common condition to the buyer’s obligations, particularly

where real estate is involved, will be the receipt of a satisfactory environmental
audit, although in certain circumstances the seller may argue that this is
unnecessary. Some special conditions apply when real estate is being transferred
in Connecticut or New Jersey owing to their particular environmental statutes.
See Section 32.2(e) infra. In asset transactions, title insurance may also be
required. Buyer may also require a financing condition.
Litigation is also an important concern when it comes to closing

the transaction. It may be dealt with as part of the general bring down of
representations, but it is often subject to a different standard. Where there is
already serious litigation pending at the time the acquisition agreement is signed,
the parties may have the opportunity to factor this element into the price and shift
the risk to the buyer or to negotiate some special indemnity provision to keep all
or part of the risk with the seller. It will probably be carved out of the
representation and thus not dealt with in the bring down. As for new litigation,
however, the seller will not want to be in a position where it is unable to meet the
bring down condition so it will probably argue for a different standard.
There are numerous possible standards that can be set, which vary
in terms of the level of exposure, whether threatened litigation is included, the
likelihood of an adverse outcome and whether the standard must be met
objectively or subjectively. A more sensitive test may be agreed for claims or
actions by governmental entities and for litigation that might impinge on the
buyer’s ability to operate the business than for private party litigation that might
be considered routine and characteristic of the business.
A variety of other conditions may be appropriate depending on the

context. If the transaction requires shareholder approval, this will be stated
explicitly as a condition. Where dissenters’ appraisal rights exist, there may be a
condition that these have not been exercised with respect to more than an agreed
percentage of the shares. Where the buyer is issuing securities publicly, there will
be conditions relating to the effectiveness of the registration statement for the
securities under the Securities Act of 1933, as well as other ancillary matters such
as stock exchange listing and accountants’ comfort letters. Where the
transaction’s feasibility is dependent on special tax or accounting treatment, an
appropriate condition may also be included.
A condition that sellers would prefer to avoid but may in rare

situations be forced to accept is a due diligence condition. The fear, as with the
financing condition discussed above, is that this condition is wholly in the control
of the buyer and that including it is tantamount to granting the buyer an option to
56
buy the business. If the acquisition agreement contains adequate representations
and schedules have been prepared in time for signature, the buyer should not
ordinarily need such a condition unless information has been deliberately
withheld in due diligence for confidentiality reasons. If the buyer is not in a
position to complete its due diligence but the parties still want to show their
commitment to the deal, usually the better approach for seller would be to reach
an agreement in principle or letter of intent as a preliminary step. The failure of
the parties to enter into a definitive agreement after reaching an agreement in
principle is not as harmful to the seller as terminating an acquisition agreement on
the basis of a due diligence condition, which is tantamount to announcing to the
world that there is a major problem with the business. There are, however, also
certain pitfalls to this approach, and it may not always be a viable alternative. See
supra Section 29.4(b)(4).
Occasionally a seller may be under great time pressure to sign up a

definitive sale agreement before it can complete the required disclosure schedules,
for example where another transaction it is entering into is dependant on “signing
up” the sale. In such a case the seller may have to agree to what amounts to a
modified due diligence condition. This usually takes the form of giving the buyer
a limited period of time after delivery of the schedules to object with specificity to
their content and, if seller cannot fix the problem, allowing the buyer to terminate
the transaction. This can be a high risk strategy unless the business is “clean” or
the buyer certifiably “hungry” to buy it.
(7) Indemnification
Whenever the business being sold is not itself a public company,

the acquisition agreement will almost certainly include provisions for
indemnification. These will usually cover breaches of representation and
covenants, and may also cover a variety of other areas. While these provisions
are typically drafted to look mutual at least in part, they are mainly intended to
benefit the buyer, since the buyer has usually completely performed by closing
and has given very few representations and warranties that could give rise to
indemnification claims. The basic purpose of indemnification from a buyer’s
point of view is to put it in the position it would have been in if the business had
been as represented and the seller had done all it had agreed to do. In a merger or
a share purchase, where all the liabilities associated with the past conduct of the
business follow it to its new owner, a buyer’s major fear is likely to be of the
undisclosed liability which was not factored into the purchase price and which
severely diminishes the value of its investment, and indemnification will tend to
focus on these issues. In an asset transaction where, absent the operation of some
special doctrine (See Section 32.2(b) infra), typically only such liabilities are
assumed as are expressly provided for in the agreement, each side usually will
also agree to indemnify the other against liabilities that are purportedly assumed
57
(or retained) by the other, since the assumption (or retention) may not be effective
as against third parties by operation of law.
In the sale of public companies, indemnification is rare since the

sellers are numerous and dispersed and, in an all cash transaction, there is no
practical way of collecting. It is not inconceivable that part of the consideration
be paid on a delayed basis so that indemnification claims could be offset (or even
be paid in the form of debt of the buyer, the principal amount of which could in
theory be reduced to the extent indemnification claims are made), although such
arrangements can be expected to be difficult for boards of directors to evaluate
and recommend to shareholders.
One of the most important questions relating to indemnification

will be the survival period, which may vary anywhere from a few months to a few
years. Typically the buyer will insist on the completion of at least one full audit
cycle, since the exercise of preparing audited financial statements is likely to turn
up any serious breaches of representations that may thus far have been missed.
Problems with certain representations, such as those concerning the collectability
of receivables or the salability of inventory, may well become obvious to a careful
buyer considerably sooner and the buyer may be willing to agree to a shorter
period as to those items, if pressed by the seller. The bid and the ask generally
range between six months and three to five years on normal matters, while some
of the special indemnification provisions relating to tax and environmental
matters will normally have longer or even indefinite survival periods. A well
drafted survival provision will also postpone the expiration of the indemnity if the
indemnified party has given timely notice of the claimed breach. It should also be
noted that if the survival clause does not specifically mention the indemnification
provisions as well as the representations and agreements, there is a risk that a
court will find that indemnification survives until the statute of limitations runs
out. The clause would thus cut off misrepresentation claims, but not
indemnification for an inaccurate representation.
Absent a survival clause, normal principles of contract law will

apply to the determination of whether any given representation was meant to
survive the closing. Given the major role played by the parties’ intent in
interpreting a contract, the outcome may actually be quite fact dependent and
difficult to predict.
The most standard indemnification in an acquisition agreement is

for misrepresentation or breach of warranty or breach of covenants.
Typically indemnification will cover not just damages but also

legal expenses and the expenses of any investigation. Sellers will often request a
basket or threshold amount of damages and a cap, or maximum amount that may
be recovered. It is often hard for a buyer to argue against a cap which is equal to
58
the full purchase price paid. However, where the buyer has also required an
escrow or a hold back of a portion of the purchase price, it should expect the
seller to insist that the cap be set at the amount of the escrow or hold back. Where
there is a basket amount of losses and expenses (i.e., a deductible), the buyer may
argue that any materiality qualifications should be ignored initially since the two
provisions serve somewhat overlapping purposes. On the other hand, the use of a
basket is not necessarily a justification for omitting the materiality qualifications.
Even when the agreement is constructed so that there would be no remedy for
immaterial breaches of representations, most people would not want to sign a
contract that includes representations which they are not confident are accurate as
written.
Environmental and tax indemnification, which are quite typical, is

discussed in Section 32.2(e). Beyond these, an acquisition agreement may also
contain special indemnification covering particular risks that have been identified
in due diligence and that the buyer is unwilling to assume.
Indemnification provisions in acquisition agreements usually

contain quite simple procedural provisions, and may also provide that they are the
exclusive remedy for breaches of most of the representations and covenants in the
agreement. The procedural provisions deal with such subjects as notice and
control of third party litigation. An exclusivity clause may make it more difficult
to base a claim on some other theory such as misrepresentation or fraud or
violation of some federal or state statute. Perhaps more importantly from the
seller’s point of view, it will make sure that any agreed upon limitations on
indemnification such as caps and baskets are not circumvented.
The acquisition agreement may also include an escrow or, if part of

the purchase price is to be paid on a deferred basis, some right of set-off. Such
provisions are more common where the sellers are individuals or there is
otherwise some uncertainty regarding collectability. Even when there is no such
issue, the use of an escrow or set-off rights may have an important impact on the
parties’ bargaining power should any controversy arise with respect to possible
indemnification.
When the acquisition agreement includes some mechanism for a

price adjustment, whether based on earnings, equity or one or more components
of working capital, the indemnification provision should be drafted to preclude
providing an additional recovery for a condition which already gave rise to a
purchase price adjustment.
Sellers often argue that effect should be given to any insurance

proceeds or tax benefit relating to the indemnified loss and that they should only
have to pay “net” of those benefits. In practice it is often extremely difficult to
determine what factors should be taken into consideration in ascertaining the
59
value of the tax benefit, which may not always have an immediately fully
realizable value and most attempts to draft such provisions end up being only
comprehensible to tax specialists, leaving the principals baffled as to whether they
have achieved their goal. Indemnification for a loss covered by insurance may be
double recovery, although in some situations claims experience may have an
impact on future premiums and thus some compensation may still be appropriate.
(8) Closing
At the closing, payment is made and ownership of the business

passes to the buyer. In a merger, this is effected by filing the certificate of merger.
In a stock purchase, the endorsed stock certificates or stock powers are delivered.
In an asset transaction, numerous instruments must be delivered in order to
convey ownership of the various properties and rights, and additional levels of
complexity are added when deeds must be recorded or other filings are necessary,
and when pledged or mortgaged assets must be released and sometimes re-
pledged or re-mortgaged to the new lenders. In addition to the payment and
conveyance, the conditions calling for delivery of opinions, certificates and other
documents must be fulfilled. Especially in an asset transaction, it is possible that
a large amount of paper will pass over the table. The particular issues and
problems of closing mergers and asset sales are discussed in more detail in
Chapters 31 and 32.
(9) Termination and Miscellaneous Provisions
An acquisition agreement will ordinarily contain a termination

provision. It is standard that the parties agree that they can terminate the
agreement by mutual agreement (although this is of course possible even if not
expressly stated in the agreement) or if the transaction is not consummated before
a certain “break-up date”. Sellers are usually anxious to get the deal closed once
it has been announced: they would like their money and to be rid of the business.
Buyers will usually also be anxious to start running the business, but their
impatience will be tempered in that they will want enough time to tie up all loose
ends, arrange financing, obtain consents and so often favor a longer time period.
Thus it is not unusual for the parties to have diverging views of how long it
should take to close the transaction and how long they wish to be bound. As a
general rule, more time must be allowed when regulatory approvals are needed.
Also, given the relatively large number of consents to obtain and conveyancing
documents to prepare for the closing of an asset transaction, usually an asset
agreement will provide for a substantial delay between signing and closing. This
is a fact intensive area and there are no “standard” a priori answers.
Another typical termination event is the adoption of any law or

regulation or nonappealable final order or judgment that makes the transaction
illegal. Where the transaction is multijurisdictional, however, the parties may
60
agree that illegality in a minor jurisdiction is not grounds for termination. The
acquisition agreement may also provide for termination by one party if the other
is in material breach of the agreement or for termination by the buyer if there has
been a material adverse change in the business to be acquired. The same buyer
that has just argued for a nine month period until the break-up date will often
argue that there is no reason for it to remain bound if it is clear that the conditions
can no longer be met, whereas the same seller that has just argued that two
months ought to be enough to close, will usually object to an early unilateral
release.
Merger agreements will typically have further termination events

relating to the failure to obtain shareholder approval and similar matters.
The “boilerplate” provisions of acquisition agreements do not

differ much from those included in other major business contracts. Typical
provisions cover notices, amendments and waivers, expenses, successors and
assigns, choice of law, counterparts and effectiveness, absence of third party
beneficiaries and headings. The agreement will also usually provide that it
supersedes all other written or oral agreements. Care must be taken to exclude
any agreements which are intended to survive, and also to make sure that the
various provisions are not inconsistent with the results intended by the parties. Of
these miscellaneous provisions, the expense provisions often receive the most
attention, particularly in the context of mergers and leveraged buyouts. In other
acquisition transactions, it is customary for each side to bear its own expenses.
(e) Regulatory and Third Party Consents
Acquisitions are subject to many legal constraints, both public and

private, that protect interests beyond those of buyer and seller and their respective
owners. Antitrust and other types of regulation may seek to safeguard
competition or the public interest with respect to a particular industry that is
subject to special regulation. Parties who enter agreements of all sorts with
companies also often seek to protect themselves from potential adverse changes
such as a decline in creditworthiness that may occur as a result of an acquisition.
Almost all acquisitions of any significant size will therefore require on the one
hand filings with or consents or approvals by certain regulators and on the other
hand consents of third parties.
(1) Regulatory
Antitrust Regulation. Among the various regulatory aspects of an

acquisition transaction, the antitrust laws are probably the most ubiquitous.
Subject to more complete treatment in Chapter 30, they will be touched on only
very briefly here. The main statute of concern is the Hart-Scott-Rodino Antitrust
Improvement Act of 1976 (the “HSR Act”), which requires pre-closing
61
notification to the Federal Trade Commission and Justice Department of
acquisitions exceeding specified thresholds. The tests of whether the HSR Act
applies to any particular transaction are themselves quite complex and are
described more fully in Chapter 30, but the key areas of concern are the total
assets and net sales of the buyer and of the business being bought — if buyer or
the business has over U.S.$ 10 million net sales or total assets and the other over
U.S.$ 100 million the test may be met — and whether at least 15% of the voting
securities of the target or U.S. $15 million of voting securities or assets will be
held as a result of the acquisition.
If filing is required — and it should be noted that there are

numerous exceptions — it must be determined when to file, who the appropriate
filing parties are and how long the process will take from beginning to end. For
first time filers, preparation of the application may take a considerable amount of
time. In negotiated acquisitions, the waiting period for regulatory review is
ordinarily 30 days, subject to early termination where no serious issues arise.
Early termination must be requested, and will be published in the Federal Register.
Filings may not be made until there is at least a signed letter of intent. Before the
expiration of the initial waiting period, either the Federal Trade Commission or
the Department of Justice may request additional information. Such requests can
be extremely comprehensive, and the waiting period is tolled until all persons
requested have complied. It may take weeks or months to comply if the requests
cover many areas and if the parties are large and complex companies. Because of
the delay involved, it is always sensible to study quite carefully the substantive
antitrust implications of a transaction before getting too deeply involved to
ascertain whether a so-called second request is likely and whether the parties
would be willing to go through the entire process.
Once the second request has been complied with, the investigating
regulator has 20 days to take action. If it does not take legal action within that
period, the parties are free to conclude their transaction. In complicated cases, an
extension may be negotiated. Where areas of concern arise, it is not uncommon
for the buyer to agree to make certain divestitures as a condition of approval and
to hold separate the various pieces of the business until these are concluded.
Other Regulations. Changes of control may in particular industries

may be subject to further regulation under particular state or federal statutes.
Many businesses also are required to be licensed by federal or state agencies, and
the assignment of such licenses may involve a fairly complicated procedure. The
most important relevant federal statutes are the Atomic Energy Act (nuclear
power), the Bank Holding Company Act and the Change in Bank Control Act
(banking), the Federal Aviation Act (air carriers), the Federal Communications
Act (mainly broadcast licenses), the Federal Power Act (public utilities) and the
Interstate Commerce Act (rail and truck transportation), the Public Utility
Holding Company Act (electric utilities and gas distribution). At the state level,
62
insurance regulation is very important, and if there are liquor licenses there may
be requirements applicable to assignments and change in ownership. The criteria
for determining whether there has been a change in control, the filing or notice
requirements and the standards and procedures for determining whether to allow
the transaction differ from field to field, and it is in most cases advisable to retain
special regulatory counsel for the transaction (who may be the client’s regular
outside counsel for regulatory matters) to advise on how to comply with or avoid
being subject to the requirements of the relevant statute.
Further restrictions may apply when the acquiring party is a

foreign entity. The Exon-Florio Amendment to the Defense Production Act of
1950 authorizes the President or his designee (The Committee on Foreign
Investment in the United States) to investigate the impact on national security of
acquisitions which could result in foreign control of persons engaged in interstate
commerce. The Amendment allows the President to block a transaction in the
interests of national security. Since the notice requirements of the Amendment
are voluntary, the parties to a transaction must decide whether they think it applies
and whether to give notice, after which there are specified periods during which a
decision to investigate must be made and the investigation carried out. The total
process can take up to 90 days, and once concluded is final. If a transaction is not
notified, however, it is subject to investigation under the Amendment indefinitely.
Unfortunately neither the Amendment nor the related regulations provide much
guidance on when notification is appropriate.
Many of the regulatory regimes mentioned above have additional

limitations on foreign acquirors, which in each case deserve careful study. In
many areas various creative techniques such as the use of voting trusts or non-
voting securities have been developed for compliance. In addition to these areas,
it should be noted that in the defense area, many contracts require various security
clearances that may be more difficult for foreign owned companies to obtain.
These clearances may also have an impact on the due diligence and valuation
process for acquisitions in such industries.
(2) Leases and Material Contracts
The need for consents under leases and material contracts is likely
to be highest in an asset transaction, where they are to be assigned to the buyer.
Ordinarily a consent will be necessary to avoid a default under these agreements.
It is also possible that some leases and contracts will include change of control
provisions that could be triggered by a stock purchase or merger. In a merger
where the target is not the surviving entity, however, it may also be necessary to
consider whether the merger constitutes an assignment under the state law of both
the target’s jurisdiction and of the state where the property is located or which
governs the agreement.
63
Anti-assignment provisions may give the third party different
levels of discretion to withhold its consent. Once the parties have determined that
they do want to attempt to assign a particular agreement that requires consent,
they will need to assess what legal or economic bargaining power they have and
then agree on a strategy for dealing with the third party. It should be noted that in
some cases it may be more practical for the buyer to either enter into its own
arrangements with the third party or to use some sort of subcontracting or
subleasing arrangement if the agreement cannot be assigned.
(3) Debt
Debt agreements are the most likely to contain change of control

provisions, particularly when they represent bank debt or privately placed debt.
When there is a change of control, the buyer will often want to replace the
financing arrangements anyway and these provisions may not present any
problem, although having to refinance the business simultaneously with the
closing does add tremendous complexity to the transaction, especially when either
the old or new financing is on a secured basis. In some situations, the buyer will
want to keep the existing financing arrangements in place, in which case
negotiations will have to be entered with lenders at an appropriate time. In
situations where credit is being provided locally to various operating companies,
these negotiations may be a fairly straightforward matter if the creditors are
comfortable with the new owner and the situation has not materially changed
from their perspective. The larger and more complex the financing, the more
likely it may be that a substantial amount of energy will have to be devoted to
obtaining the necessary waivers and amendments so that the debt may be assumed.
(f) Special Considerations Concerning Share Sales
(1) Introduction
As noted in Section 29.4(d) above, share purchase agreements

usually follow quite closely the format of asset purchase agreements. The
mechanics of transfer of ownership at closing will of course differ, as will some
of the representations and warranties. The differences in the representations and
warranties will include not only what they cover (and in what detail) but also who
makes them (and subject to what qualifications).
However, share purchases may also differ in several other respects

as well, most importantly where individual shareholders (rather than a single
corporate shareholder) is concerned, in the need for mechanics to assure that all
the share certificates have been accounted for and will be available for transfer at
closing, and in the prevalence of escrows and hold backs of a portion of the
purchase price. Certain kinds of purchase price adjustments, in particular
adjustments of the purchase price based on net earnings or shareholders’ equity
64
and earn-outs, and forms of consideration, in particular promissory notes of the
purchaser (or, in transactions meant to be treated for tax purposes as tax free
exchanges or to be accounted for as poolings of interests, common stock of the
purchaser) tend to be more frequent in share purchase transactions. The major
issues raised by these differences are discussed in this Section.
(2) Representations and Warranties
As noted in Section 29.4(d)(2), the representations and warranties

in share purchase and asset purchase agreements tend to be cut mostly from the
same cloth. Although in a share purchase there may not be the same need to
schedule every last asset and liability, since they will move with the ownership of
the company to the new owner, a buyer still has an interest in using the
representations and warranties in a share purchase to flesh out as much
information about the business as possible. However, if audited financial
statements for the business exist, then it may be more acceptable to make a
number of representations and warranties (such as the typical “no undisclosed
material liabilities” representation) by reference to the balance sheet and the
footnotes than it would be in an asset purchase agreement.
However, the most significant difference in the representations

area where there are individual shareholders is in the extent of the representations
and warranties given by those individuals and in the related issue of whether they
indemnify the purchaser for those representations. Of course, each shareholder
will be expected to represent and indemnify with respect to ownership of the
shares to be transferred, the right to enter into the share purchase agreement and
to transfer them, non-contravention and the conveyance of title to the shares free
and clear to the buyer. However, when it comes to representations as to the
business itself, a distinction may be made among shareholders if there are some
who are actively engaged in the conduct of the business and others who are not.
Depending on the respective percentages held by these two groups and the
willingness of the shareholders involved in the business to take on
disproportionate liability, the parties may agree to divide the shareholders into
two groups, those who represent (and indemnify) and those who either do not
represent or do so only with a broad knowledge exception (and who may or may
not indemnify).
(3) Indemnification
Indemnification from individuals raises practical questions since in

many cases their personal assets are not sufficient (or at least insufficiently liquid),
independently of the portion of the purchase price they will receive, to ensure that
they will be “good for” their pro rata share of the indemnification of the purchaser.
This problem can be solved in several ways. The first is to escrow or hold back a
portion of the purchase price sufficient to satisfy likely indemnification claims.
65
The second is to divide the shareholders up into the non-indemnifying small
holders and the indemnifying large holders. While it may seem inequitable and
illogical to do this, in some family owned enterprises the dominant shareholder
may be the head of the family and willing to cover indemnification out of his or
her share. Since an escrow of a portion of the purchase price only insures that
that portion of the price will be available to satisfy indemnification claims in any
event, the buyer may be relatively indifferent as to whether it is recouping the
same percentage from all or only some of the shareholders. The key question for
the buyer may be whether the indemnifying shareholders are willing to indemnify
for more than their pro rata share of the purchase price or whether the buyer is
confident that their pro rata share or the lower proportion put into escrow, will
suffice to cover its possible indemnification claims. There is, of course, no reason
not to use an escrow or a hold back mechanism here, too. Where no distinctions
are made in the indemnification provided by the sellers, the buyer usually
suggests that it be provided on a joint and several basis by the sellers so that it
does not have to pursue all of the sellers.
(4) Escrows and Hold Backs
An escrow arrangement sounds like the perfect solution to the

problem of recouping indemnification claims from individual shareholders. The
problem for the buyer is that it is often difficult to escrow more than 20 or 25% of
the purchase price before the sellers start to lose interest in the transaction, and
that even this amount may have to be released before all of the survival periods
for representations and indemnification have expired under the share purchase
agreement. Also, as noted in Section 29.4(d)(7) above, the suggestion of an
escrow usually results in the counter suggestion that the indemnification
obligation of the sellers be capped at that amount. Thus an escrow will involve a
number of trade offs on the buyer’s side.
It will also involve another party to the transaction and one more
agreement, since where there is an escrow, there will be a need for an escrow
agreement and an escrow agent. The agent is usually a commercial bank and its
main concerns will be to insure that it is properly indemnified for its action or
inaction under the agreement, that the instructions as to what it is to do are as
simple and as clear as possible, and that it gets paid for its services.
The agreement will cover the investment of the funds to be

escrowed (including what they may be invested in - very often limited to U.S.
government securities - and who decides on the investment), the entitlement to the
interest or other gains on investment (usually to the benefit of the sellers unless
required to satisfy the indemnification obligations of the sellers), the
circumstances under which funds may be released to either the sellers or the
purchaser (this is the part the bank wants to keep simple), who pays the bank for
its services (the sellers normally think it should be the buyer since the
66
arrangement is entirely for its benefit from the sellers’ point of view, the buyer
usually favors sharing the fees equally) and the termination date for the escrow
(usually keyed to the survival period for some of the representations and
warranties).
The mechanics will generally provide that the buyer may deliver a
notice of claim to the bank and to the sellers (usually they will have appointed one
of their number or their counsel to act as their agent) and that if the sellers have
not objected to the claim within a stated period, the bank is to pay it. If there is an
objection, the bank does nothing until it receives a joint instruction from sellers
and buyer. Where the parties cannot agree on the amount of the claim, then a
dispute resolution mechanism is needed, perhaps arbitration, perhaps referral to an
accounting firm or other expert.
When the initial expiration period of the escrow arrives, if no

claims are then outstanding, the bank pays the contents of the escrow account
over to the sellers. If there are outstanding claims, at least a portion of the
account sufficient to satisfy the maximum amount claimed is normally held back
by the escrow agent until the claim is resolved, and any remaining amount in the
account paid to the sellers. The agreement can also provide for phased releases of
the funds, as certain deadlines for survival of representations and indemnification
pass.
This can get quite complicated and the parties then often wonder
why they do not rather agree to a hold back, equivalent to a payment of the
purchase price in installments, or to the payment of a portion of the price in
promissory notes of the buyer. The price remaining to be paid or the principal
amount of the notes can be adjusted as needed if there are indemnification
payments to be made and the procedures spelled out in the indemnification
provisions of the share purchase agreement are usually sufficient to deal with the
mechanics.
(5) Payments Other than in Cash
Payment by way of promissory notes or in common shares of the

purchaser raise a number of complex questions, not the least of which is whether
these securities will hold their value and how the sellers may realize upon them.
Promissory notes, especially where they are issued largely as a substitute for an
escrow or other hold back arrangement, present fewer questions than equity. An
appropriate interest rate should be sufficient to allow them to hold their value over
the short term, although if the buyer’s financial stability is an issue sellers may
want to consider either a guarantee or some security arrangement to ensure the
payment of their claims. The terms of the notes themselves will need to provide
that they are non-negotiable (so that they cannot find their way into the hands of a
third party purchaser) and that their principal amount may be reduced if
67
indemnification claims arise. They may also provide for an extension of their
final maturity date if there are unresolved claims for indemnification outstanding
at the time. As noted above in Section 29.4(d)(2), the buyer is also likely to have
to make additional representations about its business and financial condition if it
intends to issue securities as part of the purchase price and may even need to
provide certain covenants concerning its business. Many sellers also object to
becoming forced investors in the buyer, even for a short time, when their goal was
to exit the business and be free of its risks. Where the sellers include trusts,
minors or financially unsophisticated persons, the use of securities may be
difficult and inadvisable for both the buyer and the sellers.
Where shares of common stock of the buyer are issued, the reason
is usually not related to indemnification issues but to the desire for a specific tax
or accounting result. These issues and the question of how to protect sellers
against a drop in value of these shares, as well as the circumstances under which
they may be sold are dealt with more fully in Chapters 30 and 31.
(6) Purchase Price Adjustments
More often than not, an acquisition agreement for a business that is

not publicly held will contain some provision for adjusting the purchase price
based on one or more factors. The parties will have agreed upon a price based on
the business’ financial situation at a certain point in time and the purchase price
will not be paid until some time later. On the one hand, the seller will want to
earn something on its investment for the interim period, and if it is at risk, it will
usually believe it is entitled to the profits rather than merely interest. On the other
hand, the buyer will want to protect itself against possible losses, especially when
these are not substantial enough to make it desirable or justifiable to exercise a
material adverse change provision and may or may not be appropriate triggers for
a later indemnification claim. There may also be a mutual desire to price off of an
audited set of financial statements rather than based on management estimates of
how the business has done since the last audit was conducted.
What formula is appropriate will depend on the form of the

transaction, the nature of the business and the relationship between the business
and seller. The most common type of adjustment in a stock purchase is probably
a dollar-for-dollar purchase price adjustment based on shareholder’s equity at
closing versus some earlier agreed-upon date. The parties might also agree to a
one-way adjustment, or to a cap or collar, or to an adjustment at some multiple of
the change in equity. When the value of the transaction for the buyer is primarily
the acquisition of assets or market share, other more specialized tests may be
more appropriate, such as the number of subscribers for periodicals or cable
television stations or measures of the customer base for financial services
companies. In asset acquisitions, an equity based adjustment may be less
appropriate since the buyer may be acquiring something other than an entire
68
business. Adjustments based on particular balance sheet items are more typical.
See Section 32.3(d)(2) infra.
Whenever there is a possibility for adjusting the purchase price,

there will also have to be a mechanism agreed for establishing the amount of the
adjustment, the resolution of any disputes that may arise and the timing and
manner of payment. The appropriate level of complexity for the procedures may
depend on how much is likely to be at stake. On the simpler end, the parties may
be prepared to refer the calculation automatically to an independent auditor and
agree to be bound by the results. They may, however, prefer that one party make
a proposal (perhaps in conjunction with the delivery of audited financial
statements) and that the other specify its objections, if any, and then that a second
(and possibly third) auditor be engaged if there is not resolution within specified
time periods. In drafting the agreement it is important to consult with the auditors
in advance to make sure that they can do whatever may be asked of them, and to
examine with the principals the economic implications of whatever mechanism
may be agreed. Any particular accounting conventions that are to be observed
should be identified. There ordinarily should be some risk or cost imposed on the
party making a challenge in order to deter frivolous challenges.
It is also possible that the only way the buyer and seller can come
to terms on price is by agreeing that a portion of the price will be contingent on
the future performance of the business. The parties’ divergent forecasts may have
led them to irreconcilable valuations. The buyer may persuade the seller to accept
a lower up front price by offering a portion of earnings over some future period.
While earn-outs are often proposed, they are frequently discarded once the parties
have examined the numerous questions they raise for which there are often no
good answers. Fair formulas are hard to write, since the buyer may make new
investments in the business, or dispose of part of it, or combine it with some of its
own operations. Unless the buyer plans to continue to conduct the business just
as the seller has, there may just be no good way to measure future performance.
Furthermore, calculation of the formula can be severely affected by

changes in accounting principles or inconsistent application of the same principles.
A buyer may not wish to commit to stand still on accounting issues or may be
forced to change by either industry, SEC or accounting profession initiatives.
While the buyer’s accountants could of course do two calculations, one the old
way to calculate the earn-out and one the new way, they will not be able to certify
the results calculated the old way if accounting principles have changed and a
certified result may be called for by the formula. Also, a seller will normally
want to have access to the company’s books and records, either directly or
through its accountants, to verify that the principles have not changed and that all
relevant factors have been taking into consideration. This may be unacceptable to
a buyer, especially where buyer and seller may be competitors. The formula may
69
also require the exclusion of non-recurring or extraordinary items, which may be
a matter of interpretation.
(7) Miscellaneous
Where the selling shareholders are numerous or include non-

corporate legal entities, the buyer has two sets of concerns: how can it be sure
they will all agree to sell and will all the share certificates have been rounded up
for transfer at closing. To deal with the first issue the buyer can ask the main
shareholder to procure a power of attorney to represent as many of the other
shareholders as possible (hopefully 100%) in the negotiations and even to sign the
share purchase agreement on their behalf. This may not be feasible if among the
shareholders there are trusts or minors. To deal with the second issue, the buyer
may ask that the sellers deposit their shares with an agent upon signing the share
purchase agreement or within a certain period thereafter. In such situations, it
might also be useful for them to grant the agent a power of attorney authorizing
him to take such further action as are necessary to consummate the transaction.
70
Appendix A
FORM OF CONFIDENTIALITY AGREEMENT
[Letterhead of Purchaser]
Address of Target
Gentlemen:
We understand that Target Corporation (“Target”) is prepared to furnish

Purchaser (the “Company”) with certain information to assist the Company in
evaluating the possible acquisition of Target. As a condition to Target furnishing
such information to the Company, we agree, as set forth below, to treat
confidentially such information and any other information you or your agents
furnish to us, whether furnished before or after the date of this letter, together with
analyses, compilations, studies or other documents or records prepared by us, our
directors, officers, employees or representatives, which contain or otherwise
reflect or are generated from such information (collectively, the “Material”).
We agree that the Material will not be used other than in connection with
the purpose described above and that such information will be kept confidential
by the Company and its agents; provided, however, that (1) any of such
information may be disclosed to directors, officers, employees and representatives
(collectively, “representatives”) of the Company who need to know such
information for the purpose described above (it being understood that (a) such
representatives shall be informed by the Company of the confidential nature of
such information [and, except for directors, shall execute an agreement with the
Company, substantially in the form of this Agreement, pursuant to which they]
shall agree to treat such information confidentially; and (b) that, in any event, the
Company shall be responsible for any breach of this Agreement by any of its
representatives), and (2) any disclosure of such information may be made to
which Target consents in advance in writing. The Company will make all
reasonable efforts to safeguard the Material from disclosure to anyone other than
as permitted hereby.
Without prior written consent of Target, the Company will not, and will
direct its representatives not to, disclose to any person the fact that the Material
has been made available to the Company or that the Company has inspected any
portion of the Material, the fact that the Company is considering an acquisition of
Target or any fact with respect to these discussions, including the status thereof,
except that the Company may make such disclosure (after making reasonable
efforts to both avoid such disclosure and advise Target of its intention to do so)
which its counsel advises should be made under the securities laws or New York
Stock Exchange rules. The term “person” as used in this letter shall be broadly
71
interpreted to include without limitation any corporation, company, partnership
and individual.
In the event that the Company or any of its representatives is requested or

required (by oral question or request for information or documents in legal
proceedings, interrogatories, subpoena, Civil Investigative Demand or similar
process) to disclose any information supplied to the Company in the course of its
dealing with Target or its representatives, it is agreed that the Company will
provide Target with prompt notice of any request or requirement so that either or
both of them may seek an appropriate protective order, and/or by mutual written
agreement waive the Company’s compliance with the provisions of this
Agreement. It is further agreed that, if in the absence of a protective order or the
receipt of a waiver hereunder the Company or any of its representatives is
nonetheless, in the reasonable written opinion of its counsel, compelled to
disclose information concerning Target to any tribunal or else stand liable for
contempt or suffer other censure or significant penalty, the Company or such
representative may disclose such information to the tribunal hereunder. The
Company or such representative shall not be liable for the disclosure unless such
disclosure to such tribunal was caused or resulted from a previous disclosure by
the Company or any of its representatives not permitted by this Agreement.
In addition, we hereby acknowledge that we are aware (and that our

representatives who are apprised of this matter have been advised) that the United
States securities laws prohibit any person who has material nonpublic information
about a company from purchasing or selling securities of such company.
In view of the fact that the Material consists of confidential and other
nonpublic information, the Company agrees that for a period of [two] years from
the date of this Agreement neither it nor any of its affiliates will, directly or
indirectly, in any manner acquire or make any proposal to acquire any securities
or property of Target, except pursuant to a transaction approved by Target’s
Board of Directors. You also agree that Target shall be entitled to equitable relief,
including injunction, in the event of any breach of the provisions of this paragraph.
The term “Material” does not include information which (i) becomes
generally available to the public other than as a result of a disclosure by the
Company or its representatives, (ii) was available to the Company on a non-
confidential basis from a source other than Target or its representatives, or (iii)
becomes generally available to the Company on a non-confidential basis from
sources other than Target or its representatives, provided that such source is not
known by the Company or its representatives to be prohibited from transmitting
the information to the Company by a contractual, legal or fiduciary obligation.
The fact that information included in the Material is or becomes otherwise
available to the Company and its representatives under clauses (ii) or (iii) above
72
shall not relieve the Company and its representatives of the prohibitions of the
preceding paragraph.
The Company will promptly upon the request of Target deliver to Target
all documents furnished by Target or its agents to the Company or its
representatives constituting Material, without retaining any copy thereof. In the
event of such request, all other documents constituting Material will be destroyed
or, if not possible, held by the Company subject to this Agreement.
Although we understand that you have endeavored to include in the

Material information known to you which you believe to be relevant for the
purpose of our investigation, we further understand that you do not make any
representation or warranty as to the accuracy or completeness of the Material. We
agree that neither Target nor any of its officers, directors, employees or
representatives shall have any liability to us or any of our representatives resulting
from the use of the Material by us or our representatives.
It is further understood and agreed that no failure or delay in exercising

any right, power or privilege hereunder shall operate as a waiver thereof, and no
single or partial exercise thereof shall preclude any other or further exercise
thereof or the exercise of any right, power or privilege hereunder.
It is further understood and agreed that money damages would not be a

sufficient remedy for any breach of this Agreement by the Company and that
Target shall be entitled to specific performance and injunctive relief as remedies
for any such breach. Such remedies shall not be deemed to be the exclusive
remedies for the Company’s breach of this Agreement but shall be in addition to
all other remedies available at law or equity to Target.
The Company agrees and consents to personal jurisdiction in any action

brought in any court, federal and state, within the State of New York having
subject matter jurisdiction, in connection with any matter arising under this
Agreement.
The provisions relating to confidentiality in this Agreement shall terminate

[four] years from the date hereof. In any event, this Agreement shall terminate
upon the consummation of a merger of Target with the Company or one of the
Company’s subsidiaries or the sale of substantially all the assets of Target to the
Company or one of the Company’s subsidiaries.
73
This Agreement shall be governed and construed in accordance with the
laws of the State of New York applicable to agreements made and to be
performed within such State.
Very truly yours,
By:
__________________
Name:
Title:
Agreed to and Accepted:

TARGET CORPORATION
By:
__________________
Name:
Title:
74
Section 29.4(b)
Appendix B
[Company]
Legal Documentary Due Diligence Request List
A. Basic Information and Background
1. Copies of charter and bylaws or other organizational documents of

[Company] (the “Company”), [names of material subsidiaries] and other
subsidiaries of the Company.
2. Board of directors, committee and shareholder minute books of the

Company and its subsidiaries for the last [5] years.
3. Stock transfer records of the Company [, including list of all stockholders

and number of shares held].
4. Jurisdictions in which qualified to do business.
5. Stockholders Agreement, including amendments, Shareholder Voting

Agreement and any other arrangements among stockholders.
B. Material Transactions
1. Copies of any material agreements or arrangements. [Specify]
2. Copies of any other documentation relating to any acquisitions,

restructurings, reorganizations or dispositions.
3. Copies of other partnership, joint venture or other similar contracts or

arrangements.
C. Contracts
1. Debt, security, guarantee or similar instruments of the Company and its

subsidiaries, including:
a. [specify identified credit agreements, indentures, certificates of

designation, warrant agreements, etc.]
2. Contractual approvals and consents. Identify any contracts under which

consents or approvals will be required in order to consummate the
75
transaction or which will be subject to modification or acceleration as a
result of the proposed transaction.
3. Capital leases, contracts for the deferred purchase price of property and
sale-leaseback arrangements, if any.
4. Any agreement or arrangement that substantially limits the ability of the

Company or any Subsidiary to compete in any line or business, with any
person or in any particular area.
5. Other material contracts or arrangements, including intercompany

contracts or arrangements.
D. Government Regulation
1. Identify any material federal, state, local or foreign governmental licenses

or permits.
2. Any governmental notifications or approvals required for the proposed

acquisition.
3. Review of principal statutes and regulations to which the Company is

subject, and of correspondence with or reports to any federal, state or
foreign regulatory authority.
E. Litigation
1. List of all pending or threatened litigation and governmental investigations

identifying the parties to such litigation or investigations, the nature of the
claim, and the amount at issue.
a. Copies of any litigation letters to accountants delivered in past [3]

years.
F. Assets
1. List of real property owned (now or sold in the last [5] years) by the
Company, its subsidiaries and any predecessors.
2. List of real property leased by the Company and its subsidiaries, together
with (a) location and brief description, (b) lease agreements and (c) if
available, a summary of date, term and termination rights, assignability,
renewal rights and rent.
3. List of material personal property owned, together with any security

interests or encumbrances thereon.
76
4. List of material personal property leased, together with (a) lease
agreements and (b) if available, a summary of date, term and termination
rights, assignability, renewal rights and rent.
5. Intangibles, if any. List of any trademarks, trade names, copyrights,

patents, service marks and applications therefor used by the Company
(and any related claims or litigation).
G. Employee Matters
1. Organizational chart indicating functions and reporting responsibilities.
2. List of principal employees showing all actuarial data, including: name,

age, starting date, responsibilities, compensation, prior service/experience.
3. Copies of employment and severance contracts and other agreements with

employees.
4. Union contracts/collective bargaining agreements in place at the Company,

if any.
5. List of labor and other employee-related disputes, grievances, arbitrations,

unfair labor practices and litigation.
6. Personnel manuals and policies. Policies regarding vacation, severance,

disability benefits, supplemental unemployment benefits, pre- and post-
retirement health and medical benefits, transfer and other material
personnel matters.
7. Company severance policies.
8. Equal employment, age, discrimination, sexual harassment and

occupational safety and health matters. Include descriptive list of all
material disputes, complaints, investigations and other proceedings.
9. Copies of all written pension and welfare benefit plans and arrangements
of the Company and any ERISA affiliates, together with all trust
agreements and any amendments and written interpretations thereof.
Annual Form 5500 reports for last two years relating to benefit plans of
the Company and its affiliates; the most recent actuarial valuation report
prepared in connection with any such plan; IRS determination letters
received with respect to any such plan; and summary plan descriptions and
registration statements on Form S-8 relating to any such plan.
10. Description of all other employee plans or arrangements and description of

funding arrangements.
77
11. Summaries of employee benefit plan and deferred compensation
arrangement account balances for each employee of the Company,
including savings and profit sharing plans, as well as information as to
outstanding employee stock options, stock appreciation rights, restricted
stock and other forms of stock based compensation.
H. Environmental Matters
1. List and description of past and current investigations, proceedings,

violations and lawsuits, if any. Description of conditions or activities
forming the basis for any current or potential claim or proceeding with
respect to environmental matters, including any potential “clean-up” sites.
2. List and description of environmental permits and authorizations, if any.
3. Information regarding any sites previously owned or leased by the

Company (or predecessor) that had known environmental problems or
where operations were conducted that were likely to give rise to
contamination.
4. Copies of all environmental reports, audits, sampling, testing, analyses and

investigations conducted by or for the Company or independent
environmental auditors.
5. Copies of any environmental indemnification agreements.
I. Tax Matters
1. Copies of each tax sharing agreement binding the Company or any of its
subsidiaries; copies of any tax indemnity agreement or similar
arrangement binding the Company or any of its subsidiaries. Copies of
any partnership agreement binding or relating to the Company or any of its
subsidiaries.
2. Current and past three year’s consolidated financial statements of the

Company and its subsidiaries; details concerning amounts included in
reserves or accruals for taxes (including deferred taxes).
3. Copies of all federal, and materials state and local tax returns (including
all attachments, schedules, work papers, etc.) filed or relating to all open
years; list of all open years (federal, state or local) and applicable waivers.
4. Description of current audit issues and related correspondence (federal,

state, local or foreign).
78
5. Copies of latest revenue agent’s or similar reports (federal, state, local or
foreign).
6. Description of significant transactions (intercompany or otherwise)

undertaken in the last 5 years.
7. Details concerning any net operating loss carry forwards; excess loss
accounts; deferred intercompany gains.
8. Description of significant ordinary losses claimed on any return within the

last 5 years.
9. Details concerning any investment tax credits and carry forward amounts.
10. Present tax basis of the Company.
J. Insurance
1. Copies and descriptions (including cost) of existing insurance policies,

including liability retention limits or self-insurance.
2. Summary of claims experience under insurance policies for last 5 years.
K. Miscellaneous
1. Accountant’s letters to management for the last [3] fiscal years, and
related responses.
79

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Chapter 29

THE MERGER OR ASSET ACQUISITION CHOICE

AND RELATED ISSUES

(LN) 98000/800/KENADJIAN/Chapter 29.doc 09/02/11 10:35 AM

29.1 Scope Note.

Appendix A Form of Confidentiality Agreement

Appendix B Form of Documentary Due Diligence Request List

There are three basic ways to sell or purchase a business: a merger

Mergers and acquisitions often require pulling together large teams of

There are three basic ways to sell or purchase a business: by merger, by

(b) Reasons to Choose a Merger

Mergers are usually reserved for transactions between companies that

The basic advantage of mergers over other forms of selling a business is

The advantages of a merger in the case of a publicly held company are

(c) Reasons to Choose a Share Sale

However, as further discussed in Chapter 30, there can be important tax

(d) Reasons to Choose an Asset Sale

However, despite their complexity, asset transactions are a frequent

Sales and purchases of businesses often require pulling together large

This principle applies to sales of subsidiaries or divisions as well as to

Thus, paradoxically, very often the prospective purchaser knows more

The smartest thing I have seen a corporate seller do was seconding a

(c) In-House Counsel

Sellers and purchasers both often rely on in-house headquarters counsel to

(d) Outside Counsel

It is then up to the client to decide whether to allow transaction counsel to

Outside counsel should also be given as clear a brief as possible

• negotiation of arrangements with financial advisors

• negotiation of any letter of intent, term sheet or heads of agreement

• reviewing any press releases relating to the transaction before they

• advising on transaction structure issues, tax planning issues and

• documentary due diligence (seller’s counsel will participate in the

• for seller’s counsel, reviewing laws and regulations and company

• drafting or commenting on the acquisition agreement and

• assisting in the preparation or review of disclosure schedules and

• preparing or reviewing term sheets and drafts of ancillary

• preparing any necessary regulatory filings and, in the case of

• determining what corporate approvals are required, preparing or

• co-ordinating the closing, preparing or reviewing all

Transaction counsel will usually be in a position to take on most, if not all,

(e) Local and Regulatory Counsel

Where the sale involves assets in multiple jurisdictions that must be

Additional reasons to retain local or regulatory counsel include the

If local and regulatory counsel will be needed, it is never too early to

The original inquiry with local or regulatory counsel should be conducted

The advisability of the purchaser retaining special local and regulatory

(f) Financial Advisors

It has become standard in transactions involving the purchase and sale of

A seller may also engage a financial advisor to help value, properly

The foregoing process presents a number of advantages to the seller. It

If a closing date balance sheet is to be prepared, the purchaser’s auditors

As noted above, this concern can be particularly important where the

Of the other advisors involved in acquisitions, perhaps none are

The process of actuarial evaluation, requiring the analysis of a

In view of the extent and often draconian consequences of U.S.

Section 32.2(e) discusses the U.S. and state environmental laws

(3) Public Relations Consultants

Outside public relations consultants are usually found in large

(4) Proxy Solicitors

If a shareholder vote is required to approve the transaction at a

Commencement of serious discussions of an acquisition is almost always

We talk of acquisition agreements because they are almost always drafted

There is often much debate as to this so-called “prerogative”. It is true