In Topic 43 we covered the need to have a high-quality experienced transaction attorney. Here is where they earn their compensation.
A business purchase agreement may range from 30 pages to over 100 pages.
Sellers become very myopic when it comes to the actual transaction document. It is far “too long” and “too technical” for their liking and often times their comprehension. They prefer to “leave that technical stuff to the professionals”. There is the first validation factor for why you need an experienced transaction attorney.
Seller's lock in on transaction dates, purchase amounts and payment terms. The following pages are just “legal jargon”. It is not just “legal jargon”. It is every bit as important as the terms that the sellers enjoy reading.
I have literally experienced sellers trying to sign their purchase agreement without even reading the legal jargon? I won't tolerate it nor will a good transaction attorney.
This is not our commitment – it is the sellers.
If you ask many sellers “what are you representing and warranting” you get a blank stare.
If you ask sellers “what are you indemnifying” you get a distant stare.
I have seen agreements that have an indemnity limit up to the purchase price. When I asked the seller if they knew that they were liable to return up to 100% of the purchase price the blood ran out of their face. There absolutely cannot be surprises like this after a deal is signed.
In a purchase agreement, representations and warranties (reps and warranties) are statements of fact and contractual promises made by the parties to each other. The parties place great reliance on these documented legal assertions. They are an official disclosure that allocates post-closing risk between the buyer and the seller.
A representation is a formal statement of past or existing fact that is asserted to be true as of the date designated per the purchase agreement. If untrue, it gives the injured party a claim for misrepresentation.
A warranty is a binding contractual guarantee that a specific assertion of fact is true. If a warranty proves to be false, it is considered "breached," and the breaching party must legally indemnify or compensate the other party for their losses.
Here is where sellers get themselves in a lot of trouble. Especially covert sellers and sellers that are too lazy to perform the diligence that is required for the reporting process.
A key component of a purchase agreement is the accompanying schedules. Each schedule covers a designated topic and the seller is responsible for listing all relevant information related to that topic.
Example – Contingent Liabilities
The seller is required to list (schedule) all known and anticipated potential liabilities of the company. The seller knows that there may be an issue with the Department of Labor but chooses not to list it. When the buyer learns about this unexpected new liability they have legal recourse to file a claim against the seller for the amount involved.
There are many things that sellers have purposely failed to disclose such as environmental issues, labor issues, contractual breaches, lawsuits, warranty exposure and even the future loss of a material contract.
Advice – there is NO CONCEPT of listing (scheduling) too much. If you want to sleep well after your transaction you will want to list every single thing that you know.
If you do not it is a potential ticking bomb that will find you and cost you.
Holdbacks – it is very typical for a buyer to require a holdback of some percentage of the purchase price in escrow. This is a designated reserve that is allocated to fund any claims that the buyer makes over a certain period of time in the future. The dollar amount and time period are fully negotiable.
Basket – this is a minimum amount that may be filed as a claim. It prevents nuisance filings. It might state that the buyer must have a total of 50,000 in claims before they may file.
The seller, M&A advisor and transaction attorney should always be on the exact same page on all of these legal requirements.
I once spent nine months on a large deal only to have the buyer stick in an indemnity clause limit of 100% of the purchase price at the last second. I looked my client in the eye and said “if they won't relent on this, we need to walk away”. With great distress he agreed. I then told the buyer that we were walking if he didn't change it to 25%. I heard the choking in his voice. He already had board approval so I had him right where I wanted him. He relented.
See why you want to have a powerful team on your side?
Once you get your money you should have the peace of mind that it is really yours and you are not at risk of giving it back (as long as you have been ethical and fully disclosing.)
The big risk of post-closing claims is that the buyer can fully “lawyer up” and crush little guys with arbitrary claims. Full disclosure and claim caps can knock down that nonsense before it occurs.
Now do you see why it is so frightful when a seller does not even read what he or she is representing and warranting?
Get an A team and be highly ethical and you will not need to live in fear after you complete your transaction and get your money!