Page 24 - M & A Disputes

Negative covenants are designed to protect the buyer by precluding the seller from taking certain actions
that could impact the target company between the execution of the acquisition agreement and the closing
date. Such negative covenants may include not altering accounting methodologies or tax-filing positions,
not entering into contractual obligations outside the ordinary course of business, not declaring or distrib-
uting dividends or distributions to members, and not acquiring or divesting assets outside the ordinary
course of business. Ultimately, the preclosing covenants are meant to ensure that the seller runs the op-
erations of the target in the ordinary course of business until it is turned over to the buyer at the closing
date.

Conditions to Closing

The acquisition agreement customarily outlines actions and obligations of both the buyer and seller that
are necessary in order for the transaction to close. Absent the performance of such actions and obliga-
tions, a potential opportunity exists for a party to walk away from the transaction prior to the closing
date. Customarily, the agreement will address conditions and obligations relating to the accuracy of the
representations made by both parties, the attainment of appropriate consents and approvals, the process
for due diligence and document access, and the ability to obtain financing for the transaction. In addi-
tion, the conditions to closing may be subject to a materiality qualification. This provision prohibits a
party from attempting to terminate the transaction by relying upon an inconsequential breach of the rep-
resentations.

Indemnity Clause

Most agreements include an indemnity clause that intends to protect the buyer from loss associated with
the seller’s failure to perform in certain respects, as described in the Acquisition Agreement. For exam-
ple, the indemnity clause typically protects the buyer against breaches by the seller of covenants, repre-
sentations, or warranties (for example, the failure to operate the business in the normal course, the fail-
ure to disclose material information, or a misrepresentation of a material fact) that were undisclosed by
the seller and discovered subsequent to the closing date by the buyer. The indemnity clause may also
provide a mechanism for recovery related to matters for which the seller agrees to retain responsibility
postclosing (for example, pending litigation or an environmental liability). The indemnity clause may
include provisions protecting the seller from claims for indemnification regarding matters that were dis-
closed to the buyer pursuant to the acquisition agreement’s representations and warranties prior to the
closing date.

Typically, the period for making certain claims under the indemnity clause will be for a defined time pe-
riod negotiated and agreed upon by the parties. Exceptions to the time limit may exist related to certain
matters, including environmental matters, fraud, and tax-related issues. In addition to a time period, the
indemnification clause may include language for a cap, "basket," or deductible. In the case of a cap, a
maximum amount of liability to which seller can be exposed by entering the transaction is contractually
established. This cap limits the potential amount that may be claimed by the buyer under the indemnity
clause.

In acquisition agreements reflecting "basket" or deductible amounts, the buyer’s damage or losses
claimed must meet or exceed a certain threshold before the seller is liable for any such items. In the case
of a "basket," the seller becomes liable for the total amount of losses claimed once the "basket" thresh-
old amount is met or exceeded. Alternatively, when a deductible exists, the seller will become liable for
indemnity losses only to the extent that such losses exceed an agreed-upon deductible amount.

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