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— Analysis —
Whether you're a buyer or a seller, the current economic crisis may have you contemplating the wisdom of closing pending deals under existing merger or purchase agreements. And, even if your company isn't particularly worried about closing a pending transaction, lenders or investors might be. In such turbulent times, anyone who even hints about canceling or postponing a deal may quickly find themselves in court. How can you protect yourself? If you're considering whether to break off, attempt to retrade, or seek to enforce a pending deal, keep the following issues in mind. Course of conduct can be very important. It's common sense -- and a legal obligation -- that any company contemplating its options in a pending transaction should act in good faith. If a buyer's course of dealing with a seller fully suggests that it intends to complete a deal, while at the same time the buyer's personnel are communicating with each other about ways to break the deal, such evidence could be harmful if a dispute ensues. In litigation, virtually all documents (including internal memos, e-mails, digital recordings of voicemail messages, etc.) that employees create are discoverable, with the exception of attorney-client communications. The same goes for oral communications. Ask yourself whether your company's conduct, if subjected to judgment by a court or jury, will be viewed as having been commercially reasonable under the circumstances. Conduct that suggests an ulterior motive or bad faith may come back to haunt you.
Be wary of closing contingencies or MACs. Are there any meaningful conditions to closing stated in your transaction? If your deal includes a specific financing contingency or a particular EBITDA threshold as a precondition to closing, the buyer may be able to invoke such clauses as a reason to be excused from the deal. But, if such contingencies are not precisely worded -- and those that are "boilerplate" are often not -- and if they are susceptible to more than one reasonable meaning, as they often are, litigating the interpretation of the clause can erupt into a lengthy and expensive exercise. In virtually every jurisdiction, the interpretation of contract language results in a court deciding the meaning and effect of disputed language. The only way to guard against such an outcome is to pay careful attention to the drafting of contingency clauses. Many deals are not subject to such specific contingencies, and instead have only generic MAC clauses. MACs often have many "carve-outs" that effectively nullify the clauses as a practical matter. The typical carve-outs include exceptions for changes in general national or global economic conditions, so the current economic crisis probably would not be considered a MAC in most circumstances. Companies, particularly sophisticated ones, should be wary about relying on MAC clauses as the primary basis for a breakup. MAC cases are almost always quite fact-intensive, and the burden of proving the existence of a MAC rests squarely on the shoulders of the company seeking to invoke the clause, usually the buyer or lender. The practical reality is that courts scrutinize MAC claims very carefully, and they rarely rule in favor of buyers seeking to rely on MACs in the context of merger or purchase agreements. Still, a carefully drafted MAC may well provide a viable "escape" for buyers who want to limit carve-outs. Buyers and sellers may benefit from MACs that contain specific and easily determinable financial or other benchmarks. For example, if the acquisition target's business is highly dependent on key customer concentration, consider agreeing that the loss of a particular customer or specified reductions in demand by that customer will constitute a MAC. Similarly, financial thresholds that are objectively quantifiable -- e.g., a trailing 12-month EBIT requirement or some other fact-based financial benchmark -- can lead to a reliable determination of whether a MAC has occurred. Bottom line: Ambiguous and complex language will likely spawn controversy that will not be resolved quickly. Specific performance issues. As a general rule, courts will enforce specific performance clauses, particularly where the determination of monetary damages would be difficult and specific performance is practicable from a commercially reasonable business standpoint. Such clauses can be invoked by sellers and buyers. However, courts may decline to enforce specific performance clauses that do not unambiguously describe the intentions of the parties. If you intend for the specific performance clause to result in a particular outcome -- for example, to compel the parties to close the transaction -- be sure to spell out the desired outcome as clearly and concisely as possible. Buyers contemplating a breakup should analyze whether the seller can compel a closing or some other affirmative conduct. Liquidated damages/damages caps. Liquidated damages provisions generally will be enforced so long as the agreed-upon amount is not so disproportionate to anticipated damages as to constitute a penalty. Penalty provisions generally are void and unenforceable as a matter of public policy. By contrast, an enforceable liquidated damages amount is a sum that objectively represents a fair assessment of the damages that would flow from a breach of the agreement where actual damages would be difficult to ascertain. Rule of thumb: Liquidated damages provisions will be enforced where actual damages are uncertain and the agreed-upon amount is reasonable. Breakup fee provisions, reverse termination fee clauses and the like should be viewed as forms of liquidated damages provisions and may not be mutually exclusive. Companies should be vigilant to ensure that the damages and remedies provisions in their agreements are clear. And everyone, particularly buyers, should ensure their exposure to damages is capped to the greatest possible extent. Agreements often contain exceptions to capped damages and exclusive remedies clauses in the event of intentional breaches or other willful conduct by the breaching party -- avoid such clauses if you can, and understand the consequences of any clauses that may already exist in your agreement. Caps and exclusive remedy provisions can almost always be avoided where the breaching party has engaged in fraud. Consider the Rules of Engagement. Know the basics from a process standpoint in the event that your deal is headed to dispute. Does your agreement mandate arbitration? If so, what are the arbitration rules that will apply? Can you sue or be sued in court? If so, will you end up being required to litigate in an unfriendly venue (e.g., in the seller's home court)? Do you have the right to a jury trial? What state's law will govern your dispute, and how does the law of that state treat the issues that you expect to predominate in your case? How long will it take to achieve a litigated result? What claims or counterclaims do you expect the other side to raise, and do you have viable defenses to such claims? How expensive will it be (i.e., out-of-pocket costs, internal resources, distraction, inconvenience, impact on lender and investor relationships, etc.) to wage the battle? These questions deserve attention on the front end. The current economic crisis has not yet provoked any meaningful changes in the laws that apply to disputes stemming from broken deals. But these difficult times will likely result in a greater number of deals that stall, fall apart, or otherwise end up in dispute, and an increase in litigation seems inevitable. Early consideration of these issues will help your company be better prepared for litigation if it should arise in the context of your deals, and may help to avoid litigation all together. Mark D. Cahill is chair of the litigation department at Choate, Hall & Stewart LLP in Boston. He represents public and private companies and venture capital and private equity firms in complex contract, intellectual property, class action, and financial litigation. |
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