SC Lawyer, September 2012, #5. Protecting Buyers in M and A Transactions.

Author:By Melinda Davis Lux

South Carolina BAR Journal


SC Lawyer, September 2012, #5.

Protecting Buyers in M and A Transactions

South Carolina LawyerSeptember 2012Protecting Buyers in MA TransactionsThinking Beyond Indemnification and EscrowsBy Melinda Davis LuxIn an acquisition involving the purchase and sale of a business, seller's indemnification obligations are usually the most heavily negotiated provisions in the purchase agreement, and for good reason. Most purchase agreements provide that indemnification is the buyer's exclusive remedy for seller's breach of representations, warranties and covenants, and for excluded liabilities.

Buyers sometimes negotiate carve-outs from the exclusive remedy provision, such as fraud and intentional misconduct by seller. Those carve-outs, however, are typically very limited. Consequently, the scope of seller's indemnification obligations is critically important. The most common way in which a buyer secures seller's indemnification obligations is by placing a portion of the purchase price in escrow at closing. The escrowed funds are available to the buyer to satisfy seller's indemnification obligations.

The American Bar Association, MA advisory firms and other organizations publish deal studies that summarize deal terms for a selected set of MA transactions. Practitioners often use those studies to argue that certain indemnification and escrow terms-such as time limitations, minimum claim amounts, thresholds and caps-are "market." Unless the acquisition has some unique aspects, many sellers strongly resist terms proposed by buyers that are outside of the "market" terms reflected in recent deal studies. This creates challenges for buyers seeking to obtain customized indemnification protection against deal-specific risk.

Indemnification and escrows are the primary means by which buyers protect themselves against post-closing acquisition risk. Indemnification provisions, however, are becoming more standardized. Consequently, it is increasingly important that buyer's counsel encourage the buyer to explore additional protections outside of indemnification and escrows.

It is easier for sellers to evaluate buyer proposals that are narrowly tailored to address specific business risk. In addition, most sellers are naturally more receptive to buyer proposals outside of the context of indemnification. Consequently, buyers increase their odds of success when they propose protections against deal-specific risk outside of the context of indemnification. This article will explore buyer protections that are often overlooked in M and A transactions. For simplicity, the article assumes that the acquisition is structured as an asset purchase, that the selling entity is a private company, and that a selling entity or other selling parties continue in existence after closing.

Negotiate an accounts receivable repurchase obligation

In many acquisitions, accounts receivable constitute a significant portion of the assets of the acquired business. Buyers often view the col-lectability of aged accounts receivable with more skepticism than sellers. In those situations, buyers can propose an accounts receivable repurchase obligation. An accounts receivable repurchase obligation gives the buyer an option to sell, and requires the seller to repurchase, some or all accounts receivable that remain uncollected after a certain date following the closing.

Sellers can rely on collection history and familiarity with their customers to evaluate collection risk. Sometimes sellers are confident that accounts receivable will be collected. In those cases, a repurchase obligation can reduce the buyer's collection risk without placing a significant burden on the seller.

The buyer and seller can customize a repurchase obligation. A repurchase obligation can apply to all purchased receivables or to a subset of purchased receivables, such as receivables owed by particular customers. The buyer and seller...

To continue reading