The year 2015 showed a record-high dollar volume of mergers and acquisitions, with US companies announcing more than $2 trillion in transactions (as reported by The Wall Street Journal).
The year 2016 has experienced an increase in the volume of withdrawn deals which can be attributed at least in part to antitrust and other regulatory activity. Examples of recently derailed deals include the failed $28 billion merger of Halliburton and Baker Hughes, which the parties allowed to expire in May 2016 following scrutiny from antitrust regulators, and the $6 billion merger of Staples and Office Depot, which was halted when a US district court granted the Federal Trade Commission’s request preliminarily to enjoin the deal.
Have any significant economic or political developments affected the M&A market in your jurisdiction over the past 12 months?
Among other things, tax inversions – which are accomplished through shifting profits to low-tax jurisdictions by a process known as ‘earnings stripping’ – has been a hot topic in the business community. For more details on the subject and recent regulatory changes, see the summary of Proposals for Legal Reform.
Among other things, tax inversions – which are accomplished through shifting profits to low-tax jurisdictions by a process known as ‘earnings stripping’ – has been a hot topic in the business community. For more details on the subject and recent regulatory changes, see the summary of Proposals for Legal Reform.
In addition, the impact of activist investors and money managers has been significant over the past year. A number of large publicly announced deals have been driven by activists and activist investors continue to make headlines.
Are any sectors experiencing significant M&A activity?
According to Mergermarket, the following sectors represented more than 75% of the deals announced in North America in the first quarter of 2016:
According to Mergermarket, the following sectors represented more than 75% of the deals announced in North America in the first quarter of 2016:
- pharmaceuticals/biotechnology (21.8%, in part as a result of challenges in the initial public offering markets);
- energy (20.5%);
- industrials/chemicals (16.8%);
- technology (9.6%); and
- consumer products (7.6%).
Many practitioners expect:
- these sectors to continue to experience the most overall M&A activity in 2016; and
- an increase in smaller spin-off deals, divestitures and general middle market activity.
Are there any proposals for legal reform in your jurisdiction?
Numerous reforms are proposed from time to time. One recent example is the new regulations, issued by the Treasury Department in April 2016, which restrict corporate inversions and transactions undertaken by multinational companies that shift profits to low-tax jurisdictions commonly known as ‘earnings stripping’.
Numerous reforms are proposed from time to time. One recent example is the new regulations, issued by the Treasury Department in April 2016, which restrict corporate inversions and transactions undertaken by multinational companies that shift profits to low-tax jurisdictions commonly known as ‘earnings stripping’.
The new regulations, which are expected to have a chilling effect on such transactions, have already contributed to the termination of Pfizer and Allergan’s proposed $160 billion merger (which sought to reincorporate Pfizer in Ireland). The new regulations include a mix of final regulations, temporary regulations (which have the immediate effect of law but must be issued in final form by April 2019) and proposed regulations which were open to public comment until July 2016.
Practitioners anticipate further development in this area of US federal income tax law in the coming months and years.
Legal framework
Legislation
What legislation governs M&A in your jurisdiction?
A mixture of state and federal law governs M&A transactions in the United States. In particular, corporate governance rules (which are driven by, among other things, an entity’s jurisdiction of incorporation/formation and its organisational documents), tax law, executive compensation rules, antitrust law and state and federal securities laws often drive deal structuring decisions and negotiations, as dealmakers seek tax efficiency, securities law compliance and necessary third-party approvals.
What legislation governs M&A in your jurisdiction?
A mixture of state and federal law governs M&A transactions in the United States. In particular, corporate governance rules (which are driven by, among other things, an entity’s jurisdiction of incorporation/formation and its organisational documents), tax law, executive compensation rules, antitrust law and state and federal securities laws often drive deal structuring decisions and negotiations, as dealmakers seek tax efficiency, securities law compliance and necessary third-party approvals.
The applicable state law(s) in an M&A transaction typically depend on the jurisdiction of incorporation and the entities’ principal place of business. Applicable state laws (when read together with the entities’ organisational documents) typically address corporate governance and M&A issues, such as ‘blue sky’ securities laws, board and stockholder voting requirements, fiduciary duties and various filing requirements.
Federal laws and regulations that may apply in M&A matters include the following (and related regulations):
- the Internal Revenue Code of 1986;
- the Hart-Scott-Rodino Antitrust Improvements Act of 1976;
- the Securities Act of 1933;
- the Securities Exchange Act of 1934;
- the Investment Companies Act of 1940;
- the Committee on Foreign Investment in the United States; and
- industry or sector-specific laws.
Stock exchange rules may also be implicated in transactions involving public companies.
Regulation
How is the M&A market regulated?
The M&A market is regulated through a series of laws and regulations, the applicability of which will depend on:
How is the M&A market regulated?
The M&A market is regulated through a series of laws and regulations, the applicability of which will depend on:
- the nature of the transaction (including its structure and size);
- the parties; and
- the types of asset involved (including whether the target is a public company – that is, a company traded or listed on a public exchange).
While exchanges play less of a role in regulating M&A in the United States than in other jurisdictions, they impose requirements that may have implications on the mechanics of M&A for public companies.
One of the key regulatory agencies is the Securities and Exchange Commission (SEC). The SEC supervises and oversees numerous participants in the US publicly traded securities markets. Its primary role is to protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation.
Are there specific rules for particular sectors?
Yes – for example, transactions dealing with companies in the healthcare, telecommunications, hazardous waste, aerospace and defence, investment management, communications and transportation industries – just to name a few – may be subject to specific federal and state regulations.
Yes – for example, transactions dealing with companies in the healthcare, telecommunications, hazardous waste, aerospace and defence, investment management, communications and transportation industries – just to name a few – may be subject to specific federal and state regulations.
Types of acquisition
What are the different ways to acquire a company in your jurisdiction?
In a deal involving private companies (ie, companies not traded or listed on a public exchange), three common acquisition structures are as follows:
What are the different ways to acquire a company in your jurisdiction?
In a deal involving private companies (ie, companies not traded or listed on a public exchange), three common acquisition structures are as follows:
- Stock (or equity) purchases – the buyer acquires the equity interests of the target.
- Asset purchases – the buyer acquires certain assets and assumes certain liabilities of the target.
- Mergers – a merger of one company into another (which may be accomplished in several ways).
In an acquisition of a public company, the transaction is often structured as a merger or tender offer.
The foregoing list is not exhaustive. Deal dynamics will often drive how an acquisition is structured.
Key structuring considerations include:
- tax;
- the necessity of certain consents, notifications and approvals;
- the nature of assets and liabilities of the target;
- the type of consideration;
- the target’s stockholder base; and
- timing.
Preparation
Due diligence requirements
What due diligence is necessary for buyers?
Diligence is not mandated, but buyers typically conduct extensive due diligence before executing a definitive agreement. Diligence typically covers business, accounting, tax and legal review.
What due diligence is necessary for buyers?
Diligence is not mandated, but buyers typically conduct extensive due diligence before executing a definitive agreement. Diligence typically covers business, accounting, tax and legal review.
The depth and breadth of diligence can vary greatly among buyers and transactions and depends on numerous factors, including factors related to a buyer’s appetite for risk, timing and costs.
Information
What information is available to buyers?
The information available to the buyer typically depends on whether the seller is a private or public company.
What information is available to buyers?
The information available to the buyer typically depends on whether the seller is a private or public company.
For private companies, publicly accessible data is often limited. Therefore, information is typically supplied by a seller in response to a diligence request list prepared by the buyer’s counsel.
Public companies must disclose various categories of information to the public. Therefore, certain documents of a public company can be obtained via the Securities and Exchange Commission’s (SEC) website (edgar.gov), including:
- financial reports;
- organisational documents;
- certain shareholder information; and
- material agreements and events.
What information can and cannot be disclosed when dealing with a public company?
US securities laws generally prohibit a public company from intentionally disclosing material non-public information. Any material non-public information that is unintentionally disclosed must be publicly disclosed promptly. One exception is that a company may provide such information to persons who expressly agree to keep the disclosed information confidential.
US securities laws generally prohibit a public company from intentionally disclosing material non-public information. Any material non-public information that is unintentionally disclosed must be publicly disclosed promptly. One exception is that a company may provide such information to persons who expressly agree to keep the disclosed information confidential.
In addition, under US securities laws, individuals are generally prohibited from trading on material non-public information.
Accordingly, targets will typically require buyers to execute a confidentiality agreement which, in the public company context, will often include a standstill that prevents a potential buyer from acquiring target securities, other than in a transaction approved by the target’s board of directors. It is usually only in this context that public targets will provide information to potential buyers.
Stakebuilding
How is stakebuilding regulated?
Stakebuilding is regulated through a combination of state and federal laws. Acquisitions of more than 5% of any class of a target’s equity securities that are registered with the SEC must be disclosed through the SEC within 10 days of acquisition. Some of the applicable rules also require disclosure updates on certain changes in investment intent.
How is stakebuilding regulated?
Stakebuilding is regulated through a combination of state and federal laws. Acquisitions of more than 5% of any class of a target’s equity securities that are registered with the SEC must be disclosed through the SEC within 10 days of acquisition. Some of the applicable rules also require disclosure updates on certain changes in investment intent.
Moreover, acquisitions resulting in holdings exceeding certain dollar thresholds may require both the buyer and the target to make antitrust filings with the federal government. Further, generally, all transactions undertaken by the bidder in a public company’s securities that occur during the 60-day period before the commencement of a tender offer must be disclosed through the SEC.
State statutes may also affect a buyer’s ability to stakebuild. For example, the Delaware General Corporation Law, subject to certain exceptions (which in a negotiated transaction are usually easy to comply with), prohibits an owner of 15% or more of the outstanding voting stock of a corporation from engaging in a business combination for three years after acquiring the 15% stake.
In addition, stakebuilding in certain industries – such as banking, insurance and gaming – may require regulatory approval.
Documentation
Preliminary agreements
What preliminary agreements are commonly drafted?
Among the most common preliminary agreements are confidentiality agreements and letters of intent.
What preliminary agreements are commonly drafted?
Among the most common preliminary agreements are confidentiality agreements and letters of intent.
Confidentiality agreements
A confidentiality agreement is usually entered by the parties in the first stages of the negotiations to protect sensitive information that will be exchanged between them in connection with structuring the transaction and conducting due diligence. In the case of a public target, confidentiality agreements often include standstill provisions.
A confidentiality agreement is usually entered by the parties in the first stages of the negotiations to protect sensitive information that will be exchanged between them in connection with structuring the transaction and conducting due diligence. In the case of a public target, confidentiality agreements often include standstill provisions.
Letters of intent
A letter of intent typically contains basic terms pertaining to the proposed transaction and often lays the groundwork for commencing negotiations before drafting the definitive agreements. Generally, a letter of intent contains a number of non-binding clauses (eg, proposed structure of the transaction and process) and a few binding clauses (eg, exclusivity, confidentiality, standstill and dispute resolution).
A letter of intent typically contains basic terms pertaining to the proposed transaction and often lays the groundwork for commencing negotiations before drafting the definitive agreements. Generally, a letter of intent contains a number of non-binding clauses (eg, proposed structure of the transaction and process) and a few binding clauses (eg, exclusivity, confidentiality, standstill and dispute resolution).
Letters of intent are generally not used in connection with the acquisition of public companies because of the desire to avoid triggering disclosure requirements.
Principal documentation
What documents are required?
The documents required for an M&A transaction depends on the nature and structure of the transaction. Such documents may include:
What documents are required?
The documents required for an M&A transaction depends on the nature and structure of the transaction. Such documents may include:
- an acquisition agreement;
- in the case of a public transaction, certain disclosure based documentation (eg, a proxy statement or Schedule TO);
- a shareholder, investor rights or joint venture agreement;
- a transition services agreement;
- employment agreements; and
- other ancillary agreements (eg, escrow agreements, paying agent agreements, bills of sale, assignment agreements, letters of transmittal and stock powers).
Which side normally prepares the first drafts?
The buyer often prepares the first drafts, except in an auction context.
The buyer often prepares the first drafts, except in an auction context.
What are the substantive clauses that comprise an acquisition agreement?
Generally the substantive clauses that comprise a private M&A acquisition agreement include:
Generally the substantive clauses that comprise a private M&A acquisition agreement include:
- transaction mechanics (eg, asset purchases, stock purchases and mergers);
- purchase price and other related provisions (eg, adjustments to purchase price, purchase price allocations, method and timing of payment, earn-outs and escrow arrangements);
- representations and warranties;
- covenants (interim and post-closing);
- closing conditions;
- indemnification (in private M&A deals);
- termination (which may be coupled with break fees); and
- general provisions relating to notices, confidentiality, assignment, expenses, governing law and dispute resolution.
What provisions are made for deal protection?
In transactions where the target is a public company, common deal protections include:
In transactions where the target is a public company, common deal protections include:
- no-shops (frequently with a fiduciary out);
- matching rights;
- force-the-vote provisions;
- support agreements;
- top-up options (unless unnecessary as a result of legislation); and
- break fees.
Private targets are typically subject to exclusivity. These deals sometimes contain break fees, but other deal protections noted above typically do not apply.
State laws differ on the enforceability of deal protection devices, and the context is critical.
Closing documentation
What documents are normally executed at signing and closing?
The specifics of what is executed (and timing) varies from deal-to-deal and may depend on specific circumstances.
What documents are normally executed at signing and closing?
The specifics of what is executed (and timing) varies from deal-to-deal and may depend on specific circumstances.
Documents often executed at signing include:
- the principal transaction agreement, including:
- certain exhibits; and
- disclosure schedules in final form (potentially subject to update); and
- written consents and resolutions approving the transaction and related documentation.
Documents often executed at closing include:
- certain exhibits – applicable ancillary agreements vary, but can include documents such as:
- escrow agreements;
- warrants;
- notes;
- registration rights agreements;
- restrictive covenant agreements; and
- employment agreements;
- ‘bringdown’ certificates – these certify that the representations and warranties made by such party are true and correct as of the closing date and that the certifying party has complied with all its covenants and performed its obligations; and
- officer’s certificates – these typically certify the accuracy and effectiveness of the resolutions of the certifying party, as well as its organisational documents.
Are there formalities for the execution of documents by foreign companies?
Generally there are no required formalities imposed by US federal or state laws for the execution of documents by foreign companies simply as a result of such party being outside the United States.
Generally there are no required formalities imposed by US federal or state laws for the execution of documents by foreign companies simply as a result of such party being outside the United States.
Are digital signatures binding and enforceable?
Digital signatures are generally binding and enforceable. The two primary laws governing digital signatures are the Electronic Signatures in Global and National Commerce Act, a federal law, and the Uniform Electronic Transactions Act, a uniform act adopted by most US states. A minority of US states use non-Uniform Electronic Transactions Act statutes or common law to govern the validity of digital signatures.
Digital signatures are generally binding and enforceable. The two primary laws governing digital signatures are the Electronic Signatures in Global and National Commerce Act, a federal law, and the Uniform Electronic Transactions Act, a uniform act adopted by most US states. A minority of US states use non-Uniform Electronic Transactions Act statutes or common law to govern the validity of digital signatures.
There are some transactions where original ‘wet ink’ signature pages may be required by a particular party or are generally preferred, such as in certain financing and real estate transactions.
Foreign law and ownership
Foreign law
Can agreements provide for a foreign governing law?
In general, parties are typically free to choose the law that will govern their agreements. However, the applicable governance requirements imposed by the jurisdiction of the organisation will continue to govern the transaction. For example, Delaware corporate law will likely apply (regardless of the parties’ selected governing law) to the merger mechanics between a Delaware target and a buyer.
Can agreements provide for a foreign governing law?
In general, parties are typically free to choose the law that will govern their agreements. However, the applicable governance requirements imposed by the jurisdiction of the organisation will continue to govern the transaction. For example, Delaware corporate law will likely apply (regardless of the parties’ selected governing law) to the merger mechanics between a Delaware target and a buyer.
To be enforceable, a sufficient nexus to such jurisdiction must typically exist. Moreover, the enforcement of foreign judgments will be subject to rules of comity and public policy considerations.
Foreign ownership
What provisions and/or restrictions are there for foreign ownership?
Subject to certain industry-specific restrictions and state law exceptions (eg, certain restrictions sometimes seen with respect to foreign investments in agricultural real property) federal and state law generally do not restrict foreign ownership of, or investment in, US companies. However, such acquisitions may be subject to review by the Committee on Foreign Investment in the United States (CFIUS). If CFIUS determines that a transaction raises national security concerns, it can impose a range of mitigation measures on the parties (which may include requiring the certain information regarding sensitive US government activities to be shielded from the non-US investor, or even unwinding the transaction if concerns cannot be addresses through other measures).
What provisions and/or restrictions are there for foreign ownership?
Subject to certain industry-specific restrictions and state law exceptions (eg, certain restrictions sometimes seen with respect to foreign investments in agricultural real property) federal and state law generally do not restrict foreign ownership of, or investment in, US companies. However, such acquisitions may be subject to review by the Committee on Foreign Investment in the United States (CFIUS). If CFIUS determines that a transaction raises national security concerns, it can impose a range of mitigation measures on the parties (which may include requiring the certain information regarding sensitive US government activities to be shielded from the non-US investor, or even unwinding the transaction if concerns cannot be addresses through other measures).
In addition, the Commerce Department’s Bureau of Economic Affairs may require US companies to submit a report (the Survey of New Foreign Direct Investment in the United States (Form BE-13)) if a foreign person acquires 10% or more of the voting securities of the US company.
Valuation and consideration
Valuation
How are companies valued?
Three common valuation methodologies are as follows:
How are companies valued?
Three common valuation methodologies are as follows:
- Income-based (or discounted cash flow) – net present value of its future income calculated by dividing the net income (or a similar measure of income, such as earnings before interest, taxes, depreciation and amortisation) of the company by an estimated capitalisation rate (or investor’s rate of return).
- Market-based – based on the market value of comparable companies (including premiums).
- Asset-based – market value of assets minus the market value of liabilities. Revenue is not considered. Accordingly, when a company is profitable, the asset-based approach generally will result in the lowest valuation of the three approaches.
Other considerations commonly factored into the valuation of companies include:
- the financial health and financial trends of the company’s business;
- the company’s relationships with its key customers, suppliers and employees;
- industry and macroeconomic trends;
- synergies to be gained by combining companies; and
- tax attributes, including net operating losses and transaction-related tax deductions (in the case of a corporate target) and upward adjustments to tax basis (in the case of an asset acquisition or certain acquisitions of non-corporate (eg, partnership) targets).
Consideration
What types of consideration can be offered?
While there are generally no restrictions on the type of consideration, cash and shares are fairly common forms of consideration offered. While less frequent, other forms of consideration can include items such as promissory notes, warrants and personal property.
What types of consideration can be offered?
While there are generally no restrictions on the type of consideration, cash and shares are fairly common forms of consideration offered. While less frequent, other forms of consideration can include items such as promissory notes, warrants and personal property.
Strategy
General tips
What issues must be considered when preparing a company for sale?
Issues to consider when preparing a company for sale include:
What issues must be considered when preparing a company for sale?
Issues to consider when preparing a company for sale include:
- the team – consider who (internal and external) should be part of the sales process;
- internal check-ups – address compliance issues before alerting others that the company is for sale. Some common steps include:
- ensuring that the organisational documents are up to date;
- maintaining permits and licenses, material contracts and insurance;
- cataloguing (and reducing exposure to) litigation;
- documenting (and remedying) environmental issues; and
- collecting material contracts; and
- the end game – identify any steps that are necessary to close the deal (eg, approvals and consents).
What tips would you give when negotiating a deal?
- Knowledge – know the industry and regulatory landscape and the counterparty’s business and culture.
- Objectives – keep you and your counterparty’s goals in mind – what issues are deal breakers? Where might there be flexibility?
- Preparation – know what is required to close the deal and have a plan to accomplish it.
- Creativity – be creative in bridging gaps and solving problems.
- Leverage – have alternatives in place.
Hostile takeovers
Are hostile takeovers permitted and what are the possible strategies for the target?
Yes – hostile takeovers are permitted.
Are hostile takeovers permitted and what are the possible strategies for the target?
Yes – hostile takeovers are permitted.
There are various defensive tactics that targets may employ; however, a host of governance issues may affect hostile takeovers. Subject to the foregoing, measures available to a target include:
- a poison pill;
- a share buy-back plan;
- a staggered board (which requires a shareholder vote and oftentimes cannot be implicated as an 11th hour strategy); and
- amendments to limit the shareholders’ ability to call a meeting or remove board members (eg, for cause only) or increase the voting threshold to approve a merger.
In addition, such targets may seek:
- to add debt, sell or acquire assets;
- to acquire the hostile bidder or another target;
- a favourable buyer; or
- a favourable investor who will purchase new equity.
The courts will likely scrutinise the use of such defensive measures, and states differ over whether use of such tactics are permissible.
Warranties and indemnities
Scope of warranties
What do warranties and indemnities typically cover and how should they be negotiated?
Representations and warranties are often vigorously negotiated and typically cover topics concerning parties themselves, the transaction and the business being sold. The scope and coverage depend on the target and its industry, the type and nature of the transaction, the diligence performed and the allocation of risk between the parties. The subject matter of representations and warranties commonly given include:
What do warranties and indemnities typically cover and how should they be negotiated?
Representations and warranties are often vigorously negotiated and typically cover topics concerning parties themselves, the transaction and the business being sold. The scope and coverage depend on the target and its industry, the type and nature of the transaction, the diligence performed and the allocation of risk between the parties. The subject matter of representations and warranties commonly given include:
- corporate organisational matters;
- tax;
- contracts;
- undisclosed liabilities;
- financial matters;
- environmental matters;
- real property;
- litigation;
- employee benefits; and
- IP rights.
Limitations and remedies
Are there limitations on warranties?
Limitations can be found in the representations and warranties themselves (through disclosure schedules and qualifiers with respect to knowledge, materiality and time), in the closing conditions (eg, in the so-called ‘rep bring-down’), in the indemnification provision(s) and in survival periods.
Are there limitations on warranties?
Limitations can be found in the representations and warranties themselves (through disclosure schedules and qualifiers with respect to knowledge, materiality and time), in the closing conditions (eg, in the so-called ‘rep bring-down’), in the indemnification provision(s) and in survival periods.
- Disclosure schedules contain exceptions to the representations and warranties.
- Knowledge qualifiers limit representations and warranties to the extent that specified parties had knowledge of the particular subject matter.
- Materiality qualifiers establish a level of materiality that must exist before a representation and warranty will be deemed inaccurate or breached.
- Making a representation and warranty for a specific period typically limits the scope of such representation and warranty to that specified period only.
- As a closing condition, representations and warranties made at signing are often tested at closing. Such closing condition is often limited by some level of materiality qualification.
- Recourse for breach of representations and warranties may also be limited by survival periods (after which claims are time-barred), as well as other limitations such as caps and baskets.
What are the remedies for a breach of warranty?
There are generally two types of remedy for the non-breaching party:
There are generally two types of remedy for the non-breaching party:
- to forego closing; or
- to bring a post-closing claim for losses.
An increasingly common post-closing remedy is representation and warranty insurance. Such policies may be structured in ways that allow sellers to have limited exposure for representation and warranty breaches (other than in instances of fraud) and may provide buyers with certain indemnity enhancements.
In public M&A transactions, there is frequently little or no post-closing opportunity to obtain recovery for breaches of representations as warranties.
Are there time limits or restrictions for bringing claims under warranties?
Indemnification provisions may include time limits for giving notice of a claim for breaches of representations and warranties. In addition, survival periods for representations and warranties also serve as time limits after which a claim cannot be brought. Survival periods for representations and warranties are typically heavily negotiated; however, in general, most survive for one to three years, with certain fundamental representations surviving for longer period(s). The survival periods under a representation and warranty insurance policy are typically longer than the survival period for general representations in a purchase agreement.
Indemnification provisions may include time limits for giving notice of a claim for breaches of representations and warranties. In addition, survival periods for representations and warranties also serve as time limits after which a claim cannot be brought. Survival periods for representations and warranties are typically heavily negotiated; however, in general, most survive for one to three years, with certain fundamental representations surviving for longer period(s). The survival periods under a representation and warranty insurance policy are typically longer than the survival period for general representations in a purchase agreement.
Tax and fees
Considerations and rates
What are the tax considerations (including any applicable rates)?
One tax consideration is the recognition of taxable income. Generally, a US seller will be taxed at capital gains rates on the excess of amounts received (whether cash or other property) over the seller’s tax basis in the transferred property.
What are the tax considerations (including any applicable rates)?
One tax consideration is the recognition of taxable income. Generally, a US seller will be taxed at capital gains rates on the excess of amounts received (whether cash or other property) over the seller’s tax basis in the transferred property.
The maximum tax rate on capital gains is 23.8% for individuals (for long-term capital gains, inclusive of the 3.8% tax imposed on net investment income) and 35% for corporations (plus, additional state and local taxes), although individuals may be subject to higher rates in certain situations. Certain non-corporate entities (eg, partnerships) are not subject to tax at the entity level; as such, the entity’s beneficial owners will be subject to tax on any gain in their individual or corporate capacities, as applicable, and such gains may be subject to special rules. Certain types of merger and other transactions may allow a seller to receive consideration without the current recognition of taxable income.
A US buyer’s tax considerations may include, but should not be limited to:
- how to structure the ownership of the acquiring entity and, to the extent possible, the target’s business going forward for tax efficiency;
- whether such entities will be treated as corporations or non-corporate entities for tax purposes;
- whether to structure the transaction in a manner that results in an adjustment to the tax basis in the assets of the business, which can result in increased value in the form of deductions going forward; and
- whether the acquisition structure will provide for a tax efficient disposition of the business (particularly a consideration for private equity funds, venture capital funds or similar buyers).
Exemptions and mitigation
Are any tax exemptions or reliefs available?
Opportunities for relief include, in the case of non-corporate US sellers, a special exemption from tax for a portion (generally 50%) of gain from the sale of stock issued directly to the seller from a corporation with a qualified small business (generally, a corporation with assets having an aggregate value no greater than $50 million at the time of the stock’s issuance and substantially all of the assets of which are used in certain active lines of business).
Are any tax exemptions or reliefs available?
Opportunities for relief include, in the case of non-corporate US sellers, a special exemption from tax for a portion (generally 50%) of gain from the sale of stock issued directly to the seller from a corporation with a qualified small business (generally, a corporation with assets having an aggregate value no greater than $50 million at the time of the stock’s issuance and substantially all of the assets of which are used in certain active lines of business).
In addition, corporate sellers (and, in certain limited circumstances, individuals) may be able to apply historic or existing tax credits and losses to offset taxable gain from sale transactions, subject to various limitations.
What are the common methods used to mitigate tax liability?
In certain situations, US sellers of corporate stock may take advantage of the reorganisation provisions under the Internal Revenue Code. If the transaction meets all of the requirements, the gain may be deferred.
In certain situations, US sellers of corporate stock may take advantage of the reorganisation provisions under the Internal Revenue Code. If the transaction meets all of the requirements, the gain may be deferred.
In addition, if a transaction is taxable, a US seller may seek to defer payments to subsequent years, which may also result in the deferral of the obligation to pay the associated tax (although certain interest and similar charges may apply).
Fees
What fees are likely to be involved?
Among other types of fee and charge, stock transfer taxes, real property transfer taxes and sales taxes may be imposed by state and local jurisdictions in connection with transfers of stock, real property and assets. Real property taxes may apply if real property is transferred indirectly (ie, if the owner of the property is an entity and is transferred). Some jurisdictions have exemptions from sales taxes for occasional or casual sales. US sellers and buyers may also be subject to non-US stamp duties, while US sellers may be subject to withholding taxes, in each case to the extent the transaction includes non-US transferred property.
What fees are likely to be involved?
Among other types of fee and charge, stock transfer taxes, real property transfer taxes and sales taxes may be imposed by state and local jurisdictions in connection with transfers of stock, real property and assets. Real property taxes may apply if real property is transferred indirectly (ie, if the owner of the property is an entity and is transferred). Some jurisdictions have exemptions from sales taxes for occasional or casual sales. US sellers and buyers may also be subject to non-US stamp duties, while US sellers may be subject to withholding taxes, in each case to the extent the transaction includes non-US transferred property.
Management and directors
Management buy-outs
What are the rules on management buy-outs?
The rules on management buy-outs are generally governed by:
What are the rules on management buy-outs?
The rules on management buy-outs are generally governed by:
- the management’s fiduciary duties (if any) under state law; and
- the disclosure obligations (in the public company context – ie, a going-private transaction) under federal securities law.
State law fiduciary duties
Officers may have fiduciary duties, but such duties vary widely by jurisdiction and entity form (eg, corporate law as opposed to laws governing other business entities – such as LLCs and partnerships – typically provide for a more limited ability to disclaim fiduciary duties).
Officers may have fiduciary duties, but such duties vary widely by jurisdiction and entity form (eg, corporate law as opposed to laws governing other business entities – such as LLCs and partnerships – typically provide for a more limited ability to disclaim fiduciary duties).
Notwithstanding wide variations in applicable rules across the country, this summary focuses on Delaware corporate law, given Delaware’s popularity as a common jurisdiction of incorporation for public companies.
Under Delaware corporate law, officers must act in the best interests of the corporation and its shareholders. Accordingly, officers owe both:
- a duty of care (to act on an informed basis); and
- a duty of loyalty (to act in good faith and be both disinterested and independent when considering a transaction).
In a management buyout, officers generally have economic interests that conflict with those of the shareholders. As such, officers may be required to demonstrate that the transaction is “entirely fair” to the corporation and its shareholders, both in terms of process and price. This is a higher standard than the business judgment rule, which presumes that the officers acted on an informed basis and were motivated to act in the best interest of the corporation.
Federal securities law disclosure requirements
Federal securities laws generally address conflict of interest concerns relating to management buyouts in a going-private context by imposing disclosure requirements. For example, Section 13(e)-3 of the Securities Exchange Act 1934 may require certain information to be filed with the Securities and Exchange Commission relating to (among other things):
Federal securities laws generally address conflict of interest concerns relating to management buyouts in a going-private context by imposing disclosure requirements. For example, Section 13(e)-3 of the Securities Exchange Act 1934 may require certain information to be filed with the Securities and Exchange Commission relating to (among other things):
- the transaction’s purpose;
- the basis on which management has drawn its conclusions on whether the transaction is fair to the target’s unaffiliated shareholders; and
- any fairness opinion received from the target’s financial adviser.
Directors’ duties
What duties do directors have in relation to M&A?
The duties of directors of US companies with respect to M&A (and otherwise) will vary widely based on the specific facts and circumstances of each deal and the nature of the entities involved. While directors in the corporate context generally owe fiduciary duties to the corporation and its shareholders, in other contexts, such as in the case of a limited liability company or partnership, fiduciary duties may be disclaimable. Such fiduciary duties are primarily regulated by:
What duties do directors have in relation to M&A?
The duties of directors of US companies with respect to M&A (and otherwise) will vary widely based on the specific facts and circumstances of each deal and the nature of the entities involved. While directors in the corporate context generally owe fiduciary duties to the corporation and its shareholders, in other contexts, such as in the case of a limited liability company or partnership, fiduciary duties may be disclaimable. Such fiduciary duties are primarily regulated by:
- the statutory law of the state in which the company is incorporated;
- common law (ie, case law established by court opinions); and
- a company’s incorporation and governance documents.
The following summary of director duties in the M&A context focuses primarily on the duties of directors of corporations incorporated in Delaware (a significant state in the M&A context for several reasons):
If directors authorise the sale of control of the corporation, they must seek the highest value reasonably available.
When taking action in response to a perceived threat of takeover of the corporation, directors generally must:
When taking action in response to a perceived threat of takeover of the corporation, directors generally must:
- show reasonable grounds for believing there is a danger to corporate policy and effectiveness;
- launch a reasonable investigation to determine a takeover threat; and
- show that the action taken was reasonable in relation to the threat posed.
If directors have economic interests that are in material conflict with those of the shareholders, they may be required to demonstrate that the transaction is entirely fair to the corporation and its shareholders.
An action taken without shareholder approval, with the sole or primary purpose of thwarting a shareholder vote or disenfranchising shareholders, generally will be upheld only if the directors can show a compelling justification.
An action taken without shareholder approval, with the sole or primary purpose of thwarting a shareholder vote or disenfranchising shareholders, generally will be upheld only if the directors can show a compelling justification.
Employees
Consultation and transfer
How are employees involved in the process?
Unless the workforce is unionised – which is not the case in the majority of workplaces in the United States – rank-and-file employees generally have little involvement in the process.
How are employees involved in the process?
Unless the workforce is unionised – which is not the case in the majority of workplaces in the United States – rank-and-file employees generally have little involvement in the process.
If the workforce is unionised, labour unions may have certain rights in connection with a change of control transaction.
It is also common for certain key employees to receive transaction bonuses or be required to enter into employment agreements as a condition to closing a transaction.
What rules govern the transfer of employees to a buyer?
The structure of the deal determines whether employees of a target automatically transfer to the buyer:
The structure of the deal determines whether employees of a target automatically transfer to the buyer:
- In a stock sale or merger, where the employing entity remains the same but has new ownership, employees remain employees of the target following the closing.
- In an asset sale, employees do not automatically transfer to the buyer, and the buyer will usually make employment offers to those employees that it wishes to retain following the closing.
In either case, in the absence of contractual or other obligations to the contrary, employees are generally employed at will and their employment can be terminated at any time for any lawful reason.
If the buyer plans to terminate the employment of many employees on or following the closing, the federal Worker Adjustment and Retraining Notification Act, and similar state or local laws, may require that certain advance notices be issued.
Pensions
What are the rules in relation to company pension rights in the event of an acquisition?
Pension rights and obligations vary based on the type of acquisition and type of pension (defined contribution versus defined benefit). Certain common high-level considerations regarding US tax-qualified retirement plans are addressed below.
What are the rules in relation to company pension rights in the event of an acquisition?
Pension rights and obligations vary based on the type of acquisition and type of pension (defined contribution versus defined benefit). Certain common high-level considerations regarding US tax-qualified retirement plans are addressed below.
Asset purchase
In an asset transaction, the buyer will have the option of either assuming the seller’s pension assets and liabilities, or causing the seller to retain those assets and liabilities. Because the assets of defined contribution plans (ie, a 401(k) plan) equal the liabilities for plan benefits, the buyers that assume these types of plan generally focus on whether the plan complies with all relevant laws. This should be addressed through diligence and representations and warranties.
In an asset transaction, the buyer will have the option of either assuming the seller’s pension assets and liabilities, or causing the seller to retain those assets and liabilities. Because the assets of defined contribution plans (ie, a 401(k) plan) equal the liabilities for plan benefits, the buyers that assume these types of plan generally focus on whether the plan complies with all relevant laws. This should be addressed through diligence and representations and warranties.
Defined benefit plans, on the other hand, could be significantly underfunded. Therefore, buyers that assume these plans often engage an actuary to determine the existing and future liabilities under the plan. Such buyers often require the sellers to make a contribution to the plan that fully funds the liability, or reduce the purchase price by the funding shortfall (if any).
Notably, a buyer may be treated as a successor employer and be responsible for defined benefit plan liabilities, even if the transaction agreement provides that they are excluded liabilities. To protect itself against this risk, a buyer may include provisions in the transaction agreement requiring the seller to fund the plan fully before closing and to then purchase annuities to satisfy all plan liabilities.
Stock purchase
In a stock transaction, all plans maintained by a target generally will continue to be maintained by the target following closing.
In a stock transaction, all plans maintained by a target generally will continue to be maintained by the target following closing.
With respect to defined contribution plans, a buyer with a pre-existing defined contribution plan should consider requiring the seller to terminate its defined contribution plan before closing – otherwise, the seller’s plan cannot be terminated following closing until all participants have elected to withdraw their money from the plan. Termination may require at least 30 days advanced notice to plan participants if the seller’s defined contribution plan is operated as a safe harbour plan. The benefit of a pre-closing termination is that multiple audits, testing reports and governmental filings will not be required on an on-going basis (as is the case when more than one plan is maintained by the buyer and its subsidiaries).
With respect to defined benefit plans, the same issues that arise in an asset sale if the plan is assumed must be addressed – specifically, how the buyer will be compensated for any funding shortfall.
Other relevant considerations
Competition
What legislation governs competition issues relating to M&A?
The primary antitrust/competition law statute governing M&A is Section 7 of the Clayton Act of 1914, which prohibits transactions which “may substantially lessen competition, or to tend to create a monopoly.”
What legislation governs competition issues relating to M&A?
The primary antitrust/competition law statute governing M&A is Section 7 of the Clayton Act of 1914, which prohibits transactions which “may substantially lessen competition, or to tend to create a monopoly.”
Section 7 of the Clayton Act is primarily enforced by the Federal Trade Commission (FTC) and the Department of Justice (DOJ). The DOJ and FTC may seek an injunction to block a prospective transaction from closing, and can force divestiture of assets in already consummated transactions. The DOJ and FTC can also seek disgorgement of profits when challenging consummated transactions.
Private plaintiffs can also bring a suit to challenge a transaction under Section 7 of the Clayton Act. Further, state attorneys general can bring a parens patriae action on behalf of the state’s citizens. Private plaintiffs and state attorneys generals can seek treble damages for actual injuries suffered as a result of the loss in competition caused by a consummated merger.
The Hart-Scott-Rodino Antitrust Improvements Act of 1976 enables the DOJ and FTC to review certain transactions before they are consummated. Under the act, parties proposing to acquire holdings of voting securities, assets or non-corporate interests in excess of certain dollar thresholds must file a formal notification and may not close their transaction until the applicable waiting period expires.
Anti-bribery
Are any anti-bribery provisions in force?
The Foreign Corrupt Practices Act prohibits covered persons – including US-incorporated companies, US citizens/legal permanent residents, companies traded on US stock exchanges, persons physically located in the United States and any other person acting on behalf of such persons – from corruptly paying or offering to pay, directly or indirectly, money or anything else of value to a foreign official for purposes of influencing any act or decision of such official to obtain or retain business.
Are any anti-bribery provisions in force?
The Foreign Corrupt Practices Act prohibits covered persons – including US-incorporated companies, US citizens/legal permanent residents, companies traded on US stock exchanges, persons physically located in the United States and any other person acting on behalf of such persons – from corruptly paying or offering to pay, directly or indirectly, money or anything else of value to a foreign official for purposes of influencing any act or decision of such official to obtain or retain business.
The term ‘foreign official’ is defined broadly to include not only officials of non-US government agencies, but also any employees of state-owned enterprises, officials of non-US political parties and any other person acting in an official capacity on behalf of such persons.
There are certain exceptions and affirmative defences to these requirements, including with respect to legitimate hospitality expenses and facilitation payments. However, these exceptions have been construed narrowly by US enforcement authorities, which continue aggressively to pursue companies and individuals for violations of the Foreign Corrupt Practices Act.
Anti-bribery enforcement actions also can involve bribery of non-foreign officials through charges of violations of the Travel Act and other US laws.
Receivership/bankruptcy
What happens if the company being bought is in receivership or bankrupt?
Most often, if a company files for bankruptcy, it does so under Chapter 11 of the Bankruptcy Code, which is the federal provision governing restructurings. If the company being bought is in Chapter 11 bankruptcy, it must maximise value for all stakeholders. An auction and sale pursuant to Section 363 of the Bankruptcy Code is a common way for the debtor to meet its fiduciary obligations.
What happens if the company being bought is in receivership or bankrupt?
Most often, if a company files for bankruptcy, it does so under Chapter 11 of the Bankruptcy Code, which is the federal provision governing restructurings. If the company being bought is in Chapter 11 bankruptcy, it must maximise value for all stakeholders. An auction and sale pursuant to Section 363 of the Bankruptcy Code is a common way for the debtor to meet its fiduciary obligations.
One benefit of purchasing a company in Chapter 11 bankruptcy is that the buyer can acquire the assets free and clear of all previous liens and claims. One possible deterrent is that the terms of the sale are made public. If a buyer wanted to avoid the auction process, it may seek to purchase the assets via the debtor’s reorganisation plan. The plan process, just like the Section 363 sale process, is subject to court approval.
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