Mergers and acquisitions 101 – how specific language can save you if you need to back out of a merger
Most merger and acquisition (“m&a”) transactions follow a fairly well defined course, commencing with a non disclosure agreement and sharing of a small amount of data to verify some key financial information, then moving to a letter of intent (“LOI”), which also can be called a Memorandum of Understanding (or “MOU”).
The LOI/MOU is often specifically non binding, except for confidentiality, a lockup clause, and perhaps certain other specific clauses (like typically that each party bears its own attorneys fees). If the due diligence performed in the LOI/MOU stage pans out, the parties will then proceed to definitive agreements, which are typically signed at a closing. In today’s world, that closing is most often “electronic” – that is to say, the parties exchange electronically signed documents, one of the attorneys assemble the documents, and hold them in an “attorney escrow” and then upon instructions, the escrow is “released” and the documents become “hard.” This is sometimes referred to as a soft closing – in that it can take some time to assemble the various signatures, and other documents that are pre-conditions to the effectiveness of the m&a deal.
An attorney nightmare in these cases occurs when, at the last minute, one of the parties calls off the deal. Often the parties have acted as if the deal will proceed, and have relied on the closing in taking or refraining to take certain actions. If a party fails to release the documents from escrow, and the other party has suffered damages, a lawsuit can ensue. These are somewhat rare cases, but in a recent case, Olympus Managed Health Care, Inc. v. Am. Housecall Physicians, Inc., 853 F. Supp. 2d 559 (W.D.N.C., 2/12/2012), exactly this issue was presented to the court.
M&A deals can be complex, and often involve other issues – such as pre-purchase loans, bridge agreements, options, teaming and distribution agreements, and so on. In the Olympus Managed case above, the merging parties had prior contractual agreements – one party was an exclusive dealer of services of the other party (in the U.S.), and one party had loaned the other party money. The parties had exchanged signature pages in a soft escrow, but the attorneys had not released them when something happened. The purchaser/acquiror had not informed the target that one of its stockholders was disputing rights to its stock, and there was an arbitration proceeding, and right before the merger was to close, the arbitrator had hinted that he might require all of the stock of the acquiror to be put in escrow. Had that occurred, the acquiror could not proceed with a merger (a merger often involves exchange of stock and issuance of new stock to the target). The acquiror called off the closing, one day before the escrow release. Therein ensued this lawsuit, which included every claim imaginable – fraud, breach of contract, breach of fiduciary duty, intentional interference with contract, and so on.
During the course of the negotiations, the lawyer for the acquiror had been careful to include certain language in his emails, letters and in the LOI/MOU. That magic language, was to this effect: the LOI expressly provided that it “does not constitute a binding agreement” and was “[s]ubject to the negotiation of definitive agreements meeting with approval of the parties” and the agreement then repeated a similar qualification three times as it laid out its operative paragraphs: “assuming the due authorization, execution and delivery hereof by [the parties], are, or will be, the valid and binding obligation of each [of them].” Also, most of the communications indicated similarly that any draft submitted was “subject to final execution.”
Under Delaware law, this process has been described as follows:
“Especially when large deals are concluded among corporations and individuals of substance, the usual sequence of events is not that of offer and acceptance; on the contrary, the businessmen who originally conduct the negotiations, often will consciously refrain from ever making a binding offer, realizing as they do that a large deal tends to be complex and that its terms have to be formulated by lawyers before it can be permitted to become a legally enforceable transaction. Thus the original negotiators will merely attempt to ascertain whether they see eye to eye concerning those aspects of the deal which seem to be most important from a business point of view. Once they do, or think they do, the negotiation is then turned over to the lawyers, usually with instructions to produce a document which all participants will be willing to sign. . . .
After a number of drafts have been exchanged and discussed, the lawyers may finally come up with a draft which meets the approval of all of them, and of their clients. It is only then that the parties will proceed to the actual formation of the contract, and often this will be done by way of a formal `closing’ … or in any event by simultaneous execution or delivery in the course of a more or less ceremonial meeting, of the document or documents prepared by the lawyers.”
Leeds v. First Allied Conn. Corp., 521 A.2d 1095, 1102 n.4 (Del. Ch. 1986).
The Olympus Managed case demonstrates that even when a transaction is carefully planned and follows traditional M&A practice, a lawsuit can arise when a closing is aborted, and this risk increases the closer one gets to the closing. In Olympus Managed, the documents had all been signed and were held in an attorney escrow and would have went hard one day after the notice was given to call the deal off. In these cases, the risk of litigation is exceptionally high. In Olympus Managed, however, the jilted suitor turned plaintiff was unable to prove that the M&A deal was “hard” and hence lost on that and most other claims it made.
While it may not be appropriate in every deal (and may be hard to obtain), potential targets are therefore sometimes well advised to seek representations and warranties from the acquiring company in the LOI/MOU, to the effect that the acquiring company has no pending or threatened lawsuit or other action that would impede or impair or otherwise prevent them from completing the deal as proposed. In the Olympus Managed case it is pretty clear that the acquiror knew it had this stockholder case pending, did not inform the target, and then used that as a basis to call the deal off. Even if the target had searched the case records for this case, it would not have found it, because it was a private arbitration. If a representation had been made that nothing impaired its ability to complete the transaction, the acquiror would have been in a much worse position trying to avoid the closing (as the resolution of the stockholder case was not a condition precedent to the deal) . Also, if the agreement was not a “sign and close” deal and instead was a “sign then close” deal, a proper representation of the acquiror in the definitive agreement would have been breached as well.
For more information on these issues, contact Mike Oliver.