Cross-Border Transactions from a U.S. Perspective

Cross-Border Transactions from a U.S. Perspective

ByS. Martijn Steger

Kegler, Brown, Hill & Ritter

Berlin – 12 September, 2008to

Deutscher Handels-und Gesellschaftsrechtstag

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Index

Slide Numbers

I. Attorney/Client Relation 5 – 13A. Liability cap/restriction 5 – 7B. Contingent fees and other

fee structures 8 - 10C. Billing/time sheets 11 - 13

II. Due Diligence 14 – 16A. Challenges of electronic data

rooms in multijurisdictional transactions 14 - 16

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Index

Slide Numbers:

III. Break-Up Fees 17 – 22

IV. SPA 23 – 60A. Material Adverse Change

Clauses 23 – 30B. De minimis/Basket/Cap 31 – 38C. Locked box 39 – 42D. Limitation periods for Reps &

Warranties in Private Targetdeals 43 - 44

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Index

Slide Numbers

E. Some important reps and warranties 45 – 58F. Selected German law provisions that

US clients have trouble understandingor accepting 59 - 60

Sources 61Legal Advice 62Thank You / Contact Information 63

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I. Attorney/Client Relation

• A. Liability cap/restriction» More common in Europe than the USA» US law firms carefully consider the firm’s

malpractice insurance coverage» Rules of ethics in many US states restrict lawyers

limiting liability to clients

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• A. Liability cap/restriction, cont’d.» Ohio’s Rules of Ethics provide as follows:» “A lawyer shall not … make an agreement

prospectively limiting the lawyer’s liability to a client for malpractice or requiring arbitration of a claim against the lawyer unless the client is independently represented in making the agreement.” Rule 1.8(h)(1).

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• A. Liability cap/restriction, cont’d.» No Ethical restriction on capping liability to third

parties, such as in Closing Opinions» Malpractice Insurance should be checked to

determine scope of coverage for such Opinions» Not aware that excess coverage policies are

available. If available, perhaps could negotiate to pass along to client the cost of the premium

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• B. Contingent fees and other fee structures» Contingent fees are permitted in civil matters,

including M&A deals, so long as they are “reasonable”. Ohio Ethics Rule 1.8(i)(2), which is similar to the rules in many other states

» A key concern is the lawyer’s “independence”» Reasonableness will depend on a number of

factors, including the sophistication of the client» The contingent fee agreement must be in writing in

many states. Good practice anyway

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• B. Contingent fees and other fee structures, cont’d.

» I am not aware of publicly-available data about the percentages for contingent-fee deals in the USA

» My firm’s experience is that contingent-fee deals are unusual.» More common is providing estimates of each stage of the

M&A process» Also, fairly common is a “discount” if the deal does not close

coupled with a “kicker” if the deal does close. Both are normally fairly small – 20% or less

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• B. Contingent fees and other fee structures, cont’d.» The fixed fee is an alternative to hourly and contingent fee

structures» Fixed fees are difficult to set for entire transactions, but easier

for discrete, well-defined stages» Typically, US lawyers give fee estimates in ranges for the

entire transaction

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• C. Billing/time sheets» Content varies depending on the nature of the billing» If hourly rate billing, the typical invoice will include a

detailed time sheet» If contingent fee or fixed fee billing, the detail will be

much less» Most US clients prefer the invoices monthly

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• C. Billing/time sheets, cont’d.» Contents of an hourly fee bill often include the

following:• Identity of the fee earner• Date service performed• Description of the services performed (varies from a few

words to a long paragraph). • Amount of time spent• Cost (time x rate)

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• C. Billing/time sheets, cont’d.» Descriptions of the services performed to which US clients

react negatively:• “Services re M&A transaction”• “Internal conference with attorney Heavy Biller”• “Research re I.R.C. Section 338”

» US clients appreciate invoices that describe the issue and the solution provided

• E.g., “Brief analysis of Seller’s unique Locked Box valuation method and develop rationale for post-completion true up.”

» Most also object to charges for costs that they believe should be included in overhead

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II. Due Diligence

• A. Challenges of electronic data rooms in multijurisdictional transactions» EDRs are commonly used by US clients, especially

in cross-border deals» One major issue: Security of the information.

• User name and password protocols are the minimum• EDR providers might offer additional protections, e.g.,

digital identification certificates • Some clients have their own proprietary systems

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II. Due Diligence• A. Challenges of EDRs in multijurisdictional

transactions, cont’d » Another major issue: How do you determine the

relevance of documents, which cover several jurisdictions, for your due diligence?

• Work with excellent local counsel• Dealing with language issues & determining what to

translate• Due Diligence Reports: “Red Flags” Only?• Have a clear list of your client’s main objectives• Create a well-organized DD Checklist• Require answers imbedded in the DD Checklist

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II. Due Diligence

• A. Challenges of EDRs in multijurisdictional transactions, cont’d» Be aware of the risk (and benefit) that EDRs are

normally transparent – e.g., who reviewed what documents and for how long

» Terms of Use can be an issue:• E.g., modifications to documents, or not?• Normally, electronic deal rooms are separate, because the

SPA & other deal documents are modified during the course of negotiations

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III. Break-Up Fees

• Potential Triggers for Break-Up Fees» Simple or Naked No-Vote Fee» No-Vote after Acquisition Proposal» After Drop Dead date + Acquisition Proposal» Change in Board recommendation » After certain breaches of acquisition agreement» The amount of the fee varies depending on the

trigger

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III. Break-Up Fees

• Simple or Naked No-Vote Fee» Is a trigger in about half of Private Equity Buyer and

about ten percent of Strategic Buyer deals with Public Company Sellers*

» Vast majority of those clauses require reimbursement of expenses as the Break-Up Fee*

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III. Break-Up Fees, cont’d

• No Vote after Acquisition Proposal» Is a trigger in about 85% of both Private Equity

Buyer and Strategic Buyer deals with Public Company Sellers*

» About 90% of the deals required the Break-Up Fee be paid at signing or consummation of the third-party deal *

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• After Drop Dead date + Acquisition Proposal» Is a trigger in about 60% of both Private Equity

Buyer and Strategic Buyer deals with Public Company Sellers*

» Over 90% of the deals required the Break-Up Fee be paid at signing or consummation of the third-party deal *

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• Change in Board recommendation» Is a trigger for payment of a Fee in 97% of both

Private Equity Buyer and Strategic Buyer deals with Public Company Sellers*

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III. Break-Up Fees, cont’d• After Certain Breaches of Acquisition

Agreement» General breach of Reps & Warranties was NOT a

trigger in 97% of both Private Equity Buyer and Strategic Buyer deals with Public Company Sellers*

» Breach of Stockholder Meeting Covenants was NOT a trigger in 80% of both Private Equity Buyer and Strategic Buyer deals with Public Company Sellers*

» Breach of a No-Shop provision was NOT a trigger for a Fee in 80% of Private Equity Buyer deals and 64% of Strategic Buyer deals*

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IV. SPA

• A. Material Adverse Change clauses» Also called MAE – material adverse effect» MAC or MAE clauses conceptually capture “force

majeure” events, but go far beyond them» Critical issues include the definition (or not) of

“materiality”:• Leave it vague?• Make it more precise by defining it as having, e.g., an

impact on EBITDA of X% or more?

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IV. SPA

• A. Material Adverse Change clauses, cont’d» MAC or MAE Clauses are common Conditions to

Closing• 100% of Private Equity Buyer and 99% of Strategic Buyer

deals with Public Company Sellers*• 78% of Private Equity Target Deals included a standard

MAC clause and at least some of the other 22% included a simple “absence of changes” clause or an “accuracy of representations” clause*

• The majority of those standard MAC clauses included “no pending or threatened legal proceedings”*

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IV. SPA

• A. MAC/MAE clauses, cont’d.» Typical Strategic Buyer’s MAC Clause allowing a

“Walk Right”:» “No Material Adverse Change. Since the date of

this Agreement, there has not been any material adverse change in the business, financial condition or results of operations of the Target or its Subsidiaries taken as a whole.”*

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IV. SPA

• A. MAC/MAE clauses, cont’d.» Typical Private Equity Buyer’s MAC Clause allowing

a “Walk Right”:» “No Material Adverse Change. Since the date of

this Agreement, there has not been any material adverse change in the business, financial condition capitalization, assets, liabilities, operations, results of operations [or prospects] of the Target or its Subsidiaries taken as a whole.”*

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IV. SPA

• A. MAC/MAE clauses, cont’d.» Only about 5% of Strategic or Private Equity Buyers’

MAC Clauses contain “prospects”, but do include forward-looking language such as “events that could/would reasonably be expected to result in a MAC/MAE”*

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IV. SPA

• A. MAC/MAE Carveouts include:• “Changes adversely affecting the US economy

(so long as the Target is not disproportionately affected thereby)”.» Over 90% of all Buyers of Public Companies had

that carveout, but about 70% of the Strategic Buyer deals had the “disproportionate” language as compared to nearly 80% of the Private Equity Buyer deals*

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IV. SPA• A. MAC/MAE Carveouts include:• “Changes adversely affecting the industry in

which the Target operates (so long as the Target is not disproportionately affected thereby)”.» Over 75% of all Buyers of Public Companies had

that carveout, but about 85% of the Strategic Buyer deals had the “disproportionate” language as compared to nearly 95% of the Private Equity Buyer deals*

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IV. SPA

• Other Common MAC/MAE Carveouts*» “Announcement or pendency of transactions

contemplated by this Agreement” (~80%)» “Change in accounting principles” (~65%)» “Changes in laws” (~60%)» “War/Terrorism” (~50%)» “Failure to meet analyst projections” (~35%)

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IV. SPA

• B. De minimis/Basket/Cap (as a limitation on indemnification or damages provisions)» De minimis amounts, also called Eligible Claim

Thresholds, only were used in about 20% of Private Target deals with baskets*

» My experience and that of Kegler Brown is the opposite

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IV. SPA

• B. De minimis/Basket/Cap, cont’d.• Baskets were used in about 97% of deals with

Private Targets*:» 54% were Deductible deals, aka “non-tipping

baskets”» 36% were First Dollar deals, aka “tipping baskets”» 7% were a combination (i.e., the Deductible was a

different amount than the basket or threshold)

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IV. SPA

• B. De minimis/Basket/Cap, cont’d.• Baskets as a % of Transaction Value in Private

Target deals*:» 62% were .5% or less» 28% were .5% to 1%» 8% were 1 to 2%» 2% were greater than 2%» The trend, compared to the last study in 2004, is to

smaller baskets.

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IV. SPA

• B. De minimis/Basket/Cap, cont’d.• Baskets covered the following in Private Target

deals*:» Breaches of Reps & Warranties - 100%» Breaches of Covenants - 55%» Other Indemnity Claims - 39%

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IV. SPA

• B. De minimis/Basket/Cap, cont’d.• Significant carveouts from Baskets in Private

Target deals*:» Fraud - 55%» Capitalization - 52%» Due Authority - 47%» Taxes - 42%» Ownership of shares, Intentional Breach of

Seller’s/Target’s Reps & Due Organization - ~30%» These percentages are all up from 2004 study.

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IV. SPA

• B. De minimis/Basket/Cap, cont’d.• Caps in Private Target Deals were used as

follows*:» 88% were less than the Purchase Price and, where

determinable, 44% equaled the Escrow Amount» 7% equaled the Purchase Price» 4% had caps that were in an undeterminable

amount and in 1% the cap amount was silent

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IV. SPA• B. De minimis/Basket/Cap, cont’d.• Cap amounts in Private Target Deals as a % of

Transaction Value*:» 26% were less than 10%» 21% were 10%» 17% were 10 to 15%» Another 17% were 15 to 25%» 5% were 25 to 50%» Another 5% were 50% of the PP up to the PP» 9% were the PP» No clear trend from the 2004 study.

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IV. SPA

• B. De minimis/Basket/Cap, cont’d.• Significant carveouts from Caps in Private

Target deals*:» Fraud - 64% (down from 77% in 2004)» Capitalization - 46% (up from 26%)» Due Authority – 43% (up from 11%)» Taxes - 40% (up from 27%)» Ownership of shares, Intentional Breach of

Seller’s/Target’s Reps & Due Organization - ~30%

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IV. SPA• C. Locked box• An alternative, popular with Sellers, to a post-

completion reconciliation of accounts / “true up” of the Purchase Price

• Will see more of it in “Sellers’ Markets,” such as when more private equity money is chasing deals than quality companies are available for sale

• No statistics on how much it is being used in USA, but seems to be increasing

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IV. SPA

• C. Locked box, cont’d• Concept: The parties agree on the PP for the

Target based on the last audited balance sheet, management’s most recent balance sheet or an agreed pro forma balance sheet.» Critical to Buyer first to perform all necessary DD on

the Target & especially on that balance sheet» Buyer must also make sure Seller does not

manipulate working capital between the time of the agreed balance sheet and completion

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IV. SPA

• C. Locked box, cont’d.• Normally, Seller will covenant that no leakage

will occur during that time, including no dividends, no distributions or other returns of capital and no other payments to Seller or affiliates other than at arm’s length.

• Exceptions could be agreed-upon debt repayments and payments to third parties in the ordinary course of business

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IV. SPA

• C. Locked box, cont’d.• Buyer often will ask for:

» Indemnification to cover any leakage that was not permitted

» Covenant concerning conduct of business between signing and closing

» Warranty of accuracy of the balance sheet» Reps concerning the accuracy of DD information

from Seller

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IV. SPA

• D. Limitation periods for Reps & Warranties in Private Target deals*» Express No survival – 4%» 6 - 12 months – 2%» 12 months – 26%» 12 - 18 months – 9%» 18 months – 34%» 18 – 24 months – 3 %» 24 months – 16%» Greater than 24 months – 5%

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IV. SPA

• D. Major carveouts to limitation periods for Reps & Warranties in Private Target deals*» Taxes – 67% (up from 55% in 2004)» Capitalization – 59% (up from 38%)» Due Authority – 54% (up from 31%)» Ownership of Shares – 42% (up from 21%)» Employee Benefits/ERISA – 39% (vs 31%)» Fraud- 37% (vs 20%)» Due Organization, Environmental & Breach of

Seller’s/Target’s Covenants – 37%

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IV. SPA

• E. Some important reps and warranties• The importance of reps & warranties varies

somewhat from one deal to another – e.g., environmental.

• I will give a few examples of reps & warranties that are normally critical

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IV. SPA

• E. Some important reps and warranties, cont’d• Financial Statements, including “Fair Presentation”

» “The Financial Statements: (i) have been prepared from the books and records of the Company in accordance with US GAAP consistently applied during the periods covered thereby (except as otherwise disclosed therein); (ii) are complete and correct in all material respects; and (iii) fairly present in all material respects the financial position and the results of operations of the Company (on a consolidated basis) as of the dates and during the periods indicated therein…”* [NOTE: Part (iii) is not GAAP qualified.]

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IV. SPA

• E. Some important reps and warranties, cont’d.» 75% of Private Target deals had a “Fairly Presents”

rep that was not GAAP qualified (as versus 84% in 2004)*

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IV. SPA

• E. Some important reps and warranties, cont’d.• Internal Controls / Accuracy & Completeness

» “The Company’s internal controls and procedures are sufficient to ensure that the Latest Financial Statements and the Annual Financial Statements are accurate in all material respects.

» … [All] accounts, books and ledgers related to the business of the Company are properly kept, are accurate and complete in all material respects, and there are no material inaccuracies or discrepancies of any kind contained or reflected therein.”*

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IV. SPA

• E. Some important reps and warranties, cont’d.» 45% of Private Target deals included a Internal

Controls rep and only 31% of them had the “Accurate and Complete” component*

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IV. SPA

• E. Some important reps and warranties, cont’d.• Buyer-favorable version of “No Undisclosed

Liabilities” representation: “Except as set forth in the Disclosure Letter, Target has no Liability except for Liabilities reflected or reserved against in the Balance Sheet or the Interim Balance Sheet and current liabilities incurred in the Ordinary Course of Business of Target since the date of the Interim Balance Sheet.”*

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IV. SPA

• E. Some important reps and warranties, cont’d.• Target-favorable version of No Undisclosed

Liabilities: “Except as set forth in the Disclosure Letter, Target has no liability of the nature required to be disclosed in a balance sheet prepared in accordance with GAAP except for …”*

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IV. SPA

• E. Some important reps and warranties, cont’d.» Some deals used other wording for this “No

Undisclosed Liabilities” rep, but even so*: » 93% of Private Target deals included some form of

the No Undisclosed Liabilities rep, with • 68% Buyer-favorable (“All Liabilities”)• 32% Target-favorable (“GAAP Liabilities”)*

» Even with other formulations of this rep, 83% of them had a “ordinary course since Balance Sheet” qualifier, 44% had a “materiality” qualifier and only 7% had a “knowledge” qualifier.*

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IV. SPA

• E. Some important reps and warranties, cont’d.» A few notes about Disclosure Letters:

• Normally provided on the eve of completion – if so, very frustrating to Buyer’s counsel

• Often much negotiation over whether disclosures made in due diligence (within and outside the EDR) qualify the reps & warranties or whether any qualifications must be stated in either the reps & warranties themselves or the Disclosure Letters

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IV. SPA

• E. Some important reps and warranties, cont’d.• Compliance with Law representation*

» 99% of Private Target deals had it. Of those:» 76% covered past and present» 77% included Notice of Violation» 32% included Notice of Investigation, but» Only 10% were “knowledge” qualified

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IV. SPA

• E. Some important reps and warranties, cont’d.• Compliance with Law representation*

» 22% had NO “materiality” qualifier» 23% were qualified by a defined MAE» 55% were qualified by an undefined use of

“materiality”*

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IV. SPA• E. Some important reps and warranties, cont’d.• “10b-5/Full Disclosure” representation• “10b-5”: “No representation or warranty or

other statement made by Target in this Agreement [or] the Disclosure Letter … in connection with the Contemplated Transactions contains any untrue statement or omits to state a material fact necessary to make any of them, in light of the circumstances in which it was made, not misleading.”*

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IV. SPA

• E. Some important reps and warranties, cont’d.• “Full Disclosure” representation: “Seller does

not have Knowledge of any fact that has specific application to Seller (other than general economic or industry conditions) and that may materially adversely affect the assets, business or results of operations of Seller that has not been set forth in this Agreement or the Disclosure Letter.”*

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IV. SPA

• E. Some important reps and warranties, cont’d.» In Private Target deals*:

• The 10b-5 rep was included in 52%• 10b-5 plus Full Disclosure was included in 10%• No such rep was in 38% of the deals

» In the deals that had a rep, only 26% were “knowledge” qualified*

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IV. SPA

• F. Selected German law provisions that US clients have trouble understanding or accepting» German Labor Laws, including:

• Workers’ Councils• Automatic transfer of employment agreements by law

(para. 613a German Civil Code) in asset deals• Restrictions on and payment for non-compete clauses

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IV. SPA

• F. Selected German law provisions, cont’d.» Other issues include:

• Maintenance of statutory capital and liability of Buyer if Seller paid the statutory capital back

• No certificates for shares in GmbH and thus no “proof” that the sold share exist

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Sources• When the statements are marked with an *, the

information is from one of the following 2007 M&A Deal Point Studies from the ABA:» Strategic Buyer/Public Target» Private Equity Buyer/Public Target» Private Target (v2)» These are projects of the M&A Market Trends

Subcommittee of the Com’te on Negotiated Acquisitions of the American Bar Association’s Section of Business Law

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Legal Advice• This presentation is designed to provide an

overview of a number of legal principles and considerations

• As each legal issue is fact dependent, this presentation should not be used or viewed as legal advice, and your legal counsel should be consulted on the application of your particular factual situation to the current law

• Copyright: 2008 Kegler, Brown, Hill & Ritter

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Thank You / Contact Information

S. Martijn StegerKegler, Brown Hill & Ritter Co., L.P.A.Ste. 1800, 65 E. State St.Columbus, OH 43215Direct Dial: 1 614 462 5495Fax: 1 614 464 2634Email: [email protected]

mailto:[email protected]

Cross-Border Transactions from a U.S. Perspective

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