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The two legal systems that most often govern cross-border private M&A transactions are US (most commonly Delaware) law and English law. To the untrained eye, acquisition and sale agreements governed under either system may appear very similar, and differences are classified as “form over substance.” There are, however, a handful of material differences in approach and legal ramifications that affect corporate transaction structuring and liability exposure that seasoned M&A practitioners should be familiar with. These include:
- Agreements to agree; deeds: In Delaware, an agreement to agree may be legally binding and enforceable. When parties execute a letter of intent in connection with an acquisition, they enter into a binding agreement to negotiate in good faith the terms set out in the letter. All transaction agreements are executed in a universal way, which does not require witnesses or compliance with special procedures in order to be enforceable. In the UK, an agreement to agree is prima facie not legally binding and unenforceable unless an obligation is sufficiently certain, i.e., if it is possible to ascertain by objective criteria exactly what each party is required to do to comply with the obligation. There is no positive obligation to negotiate in good faith. In addition, certain acquisition documents are usually executed as deeds instead of simple agreements – usually when there is no clear consideration or in order to extend the statute of limitations governing the document from six to 12 years. Importantly, deeds are executed differently to simple agreements. A deed must be executed in the presence of a witness and, if executed electronically, in compliance with the “Mercury rule,” which means that the final version of the deed must be circulated to the signatories (not separately from the signature pages) and the signed signature page(s) must be scanned and returned together with the entire deed in order for the deed to be deemed properly executed.
- Merger vs. SPA structures: Acquisitions of private Delaware corporations are most commonly structured as triangular mergers whereby the acquiring company forms a new acquisition subsidiary that merges with the target company. No individual stockholder of the seller has to be a party to the merger agreement. Such a merger structure does not exist in the UK. Acquisitions of UK private companies are generally structured as share purchases (undertaken by way of a share purchase agreement) whereby the buyer agrees to purchase all of the issued shares of the target company directly from selling shareholders.
- Purchase price adjustment vs. “locked box” mechanism: Acquisition agreements governed by Delaware law often use purchase price adjustment mechanisms in order to “true up” working capital and other financial benchmarks based on estimated financial statements, which are then trued-up following closing based on actual updated financial statements of the target company prepared following closing. Acquisition agreements governed by English law more often contemplate a locked box mechanism where the purchase price is established on the basis of the last set of financial statements (if possible, audited) of the target company and, from the date of such financial statements, the target company is considered to be run for the benefit of the buyer. A “no leakage” pound-for-pound indemnity protects the buyer from cash/assets being transferred from the target company to the sellers or for their benefit (e.g., dividends, distributions, transaction costs) in the period from the date of the financial statements to closing. As a result of this mechanism, the purchase price does not need to be, and is not, adjusted (for working capital or otherwise) at closing.
- Representations & warranties vs. warranties; disclosure: Delaware law agreements do not differentiate between representations and warranties. Both are given on an indemnity basis with no right of rescission arising from breach. In Delaware, representations and warranties are typically qualified by the contents of specific, related disclosure schedules. Matters disclosed as an exception on the disclosure schedule relating to any particular representation or warranty are typically only deemed to be disclosed for purposes of other representations and warranties to the extent the relevance of such disclosure is reasonably apparent on its face. In addition, representations and warranties are typically given both as of signing and as of closing. Subject to a materiality or a material adverse effect standard, the accuracy of the representations and warranties of the other party as of closing is typically a closing condition. The use of the term “representation” is typically avoided in English law to avoid the implication that tortious remedies (such as rescission) may be available based upon claims of misrepresentation. Furthermore, warranties are very often qualified not only by the contents of a related disclosure letter, but also by reference to either a data room or other collection of documents (which documents usually qualify all of the warranties in the agreement). Warranties are also often qualified by “general disclosure,” such as information discoverable by making searches of online public registers, such as those registers kept by Companies House, the Land Registry or the UK Intellectual Property Office. Although the scope of materials qualifying the warranties is very broad, a disclosure will generally only be effective in qualifying the relevant warranty to the extent that sufficient facts and circumstances are fairly disclosed. Where there is a split signing and closing, warranties are usually given as of signing but are often not repeated at closing. Tax liabilities are generally dealt with in a separate tax deed, which provides an indemnity for pre-completion unpaid or unreserved tax liabilities of the target company.
- We note that warranty and indemnity insurance has become increasingly common on both sides of the Atlantic for private M&A transactions, in particular in private equity transactions. Pricing of premiums for these insurance policies may vary in each jurisdiction, being slightly less expensive in the UK, but are more dependent on the risk profile of the transaction and parties involved than the jurisdiction governing the acquisition agreement.
- Title covenants: In Delaware, a representation and warranty relating to share ownership is explicitly stated as nothing is implied. There is no concept of full title guarantee in relation to shares, and there is generally a specific statement that the sellers will sell their shares free and clear from any claims, liens and other encumbrances and that they have full power and authority to transfer such shares. In the UK, sellers give full title or limited title guarantee with respect to their shares, with full title being most common. Full title guarantee implies that the sellers have the right to make a sale, that the sellers will do all they reasonably can to give the title they purport to give, at their own cost, and that the sale is free from all charges, encumbrances and adverse rights, other than any charges, encumbrances or adverse rights that the sellers do not know and could not reasonably be expected to know.
- Sandbagging: Acquisition agreements governed by Delaware law sometimes contain provisions expressly acknowledging that a party’s right to recover for breaches of representations and warranties of the other party is not affected by any knowledge of such breach by such party, whether obtained prior to signing or between signing and closing. This heavily negotiated provision is known as a pro-sandbagging clause. English law governed acquisition agreements often contain provisions that provide that a party does not have a right to recover for a breach of warranty of the other party to the extent the non-breaching party had knowledge of such breach prior to closing. This is known as an anti-sandbagging clause. English case law also suggests that a party generally does not have a right to recover for a breach of warranty of the other party to the extent the non-breaching party had knowledge of such breach prior to closing. The buyer in such a case is deemed not to have relied upon the accuracy of such warranty, or to have no or de minimis damages, as such buyer is presumed to have valued the shares or assets on the basis of its knowledge that the warranty was untrue. Anti-sandbagging clauses typically limit the group of people who are deemed not to have knowledge of breach to the key deal team of the buyer, excluding attributing to them knowledge of outside advisers.
- Indemnification: Except for certain equitable remedies and for causes of action based upon fraud (a definition that is often heavily negotiated), acquisition agreements governed by Delaware law almost always provide that indemnification is the sole and exclusive remedy available to the parties for breaches of the agreement. Indemnification for breach of representations, warranties and covenants is generally on a full indemnity basis, which means all applicable damages and losses incurred may be recovered on a dollar-for-dollar basis, subject to limitations or exclusions set out in the agreement. There is no need to prove a link between breach and a related decline in value of the target company. In the UK, indemnification on a pound-for-pound basis is typically only included for specific known liabilities and contingent liabilities discovered in due diligence or disclosed in the disclosure letter. The parties generally do not have a duty to mitigate losses that are subject to a specific indemnity. Breaches are limited to contractual damages, which are determined on the basis of diminution in value (i.e., by calculating the difference between the amount paid for the shares and the amount which would have been so paid for the shares if the breach had not occurred). Such damages can be higher or lower than damages calculated on a pound-for-pound basis, depending on the facts and circumstances of the loss/damage.
- Best/reasonable efforts vs. best/reasonable endeavours standards: In Delaware, the terms “best efforts” and “reasonable efforts” are most often used in connection with acquisition agreement covenants. Broadly speaking, there is minimal distinction between these concepts as they are both interpreted as requiring a party to act diligently and in good faith, i.e., to take actions that a prudent person would take under the circumstances. In the UK, the usual terms used are “best endeavours” and “reasonable endeavours.” The main difference between these terms is the difference between pursing a commercially reasonable course and no more versus pursuing all reasonable courses. Accordingly, it is more favorable in English law governed acquisition agreements for either party to apply a reasonable endeavours standard in order to ensure compliance with its covenants.
- Bring-down of closing conditions: In Delaware merger agreements, the obligations of the parties to consummate a transaction are typically subject to a number of closing conditions including, among others, (i) the receipt of any required governmental and shareholder approvals, (ii) the continued accuracy of the representations and warranties of the other party and compliance with covenants as of closing (subject to materiality or a material adverse effect standard), (iii) occasionally, a financing condition and (iv) that no material adverse effect or change has occurred with respect to the target company being sold. In the UK, the obligations of the parties to consummate a transaction are typically subject to the receipt of any required governmental and shareholder approvals (including the ability to exercise drag rights); however, agreements do not usually contain closing conditions for the continued accuracy of the warranties and covenants or material adverse change. While the number and subject matter of closing conditions vary for each transaction, acquisition agreements governed by English law generally tend to have fewer closing conditions than Delaware law governed agreements.
- Post-closing covenants: It is customary in Delaware private acquisitions of divisions or product lines for buyers to expect sellers to agree to post-closing covenants to protect the buyer’s interest in the business it is acquiring. Typical covenants include an agreement not to solicit customers, suppliers and employees of the target, a non-compete and a confidentiality provision. Non-solicit covenants are generally given for a one- to two-year period, while a non-compete covenant is often given for a longer period of three to five years. In the UK, buyers expect sellers to agree to similar restrictive non-compete and non-solicitation covenants, with the non-solicitation of employees covenant often limited to key employees only. Furthermore, in the UK it is rare that the non-compete covenant is given for a period longer than three years as such longer term provisions are viewed as too restrictive on competition and hence legally unenforceable.
- At the end of the day, the question of whether to use Delaware or English law to govern an acquisition agreement is often decided, not because of pure legal considerations, but because of more practical factors such as comfort of the parties with their home jurisdiction for dispute resolution, the place of incorporation or operations of the target business, the location of the trusted adviser to the seller/buyer and tax considerations. While it is arguable that the market standard for English law agreements is generally more seller-friendly, by shifting more risk to the buyer and providing the sellers with greater closing certainty, ultimately, the general consensus is that both legal systems afford the parties sufficient clarity and the fair and trusted protection of a well-established common law legal system.
Finally, here are some language differences to look out for in acquisition agreements …
|We say…. (US)||You say… (UK)|
|Bylaws||Articles of association|
|Common stock||Ordinary shares|
|Closing financial statements||Completion accounts|
|Disclosure schedule||Disclosure letter|
|Best/reasonable efforts||Best/reasonable endeavours|
|“-ize” or “-izing” in words like organize, realize and finalize||“-ise” or “-ising” in words like organise, realise and finalise|
|Sections of an agreement||Clauses of an agreement|
|Mail a notice||Post a notice|
|Operating business||Trading business|
|When something is more than a certain number, for example, more than 10%, state “10%<”||…more than 10% is stated as “>10%”|