Amid the backdrop of COVID-19 and the changing dynamics of deals, mergers and acquisitions introduce significant potential for litigation at nearly every stage. Disputes can occur from preliminary negotiations to years after the transaction closes.
Whether you’re a buyer or a seller, be aware of these common causes for disputes.
1. Keep It Confidential with a Detailed Nondisclosure Agreement
Disclosing confidential information is an integral part of the M&A process. Potential buyers will need access to proprietary information – including financial reports, profit margins, client lists, trade secrets, etc. – to make an informed decision. As a result, confidentiality agreements, also referred to as nondisclosure agreements or NDAs, are typically the first binding agreement entered into by the parties. Whether a deal flourishes or flounders, confidentiality agreements allow sellers to safeguard their most important intellectual assets.
Given the risks of misappropriation and protracted litigation, a clear and enforceable agreement is paramount. Sellers should tailor agreements to address which materials provided in the course of negotiations must be returned or destroyed when negotiations end. Is there a time limit for how long information must be kept proprietary? Should the nondisclosure agreement extend to the fact that M&A discussions took place and to the terms of the transaction? Do sellers want to limit or prohibit potentials buyers from soliciting employees, customers, or vendors? These are the details which – if left unspecified – can lead to miscommunications and disputes down the road.
An experienced attorney can help tailor the scope of the agreement to a particular transaction – or even on a buyer-by-buyer basis – so sellers can identify what constitutes confidential information in the context of each potential buyer, ensure enforceability and remedies when disputes arise, and set terms that strike a balance between attracting a buyer and protecting valuable, confidential information.
2. Incomplete Disclosure Schedules
Incomplete, inaccurate, and poorly prepared disclosure schedules can expose sellers and shareholders to significant liability.
As one of the most important parts of an M&A transaction, disclosure schedules provide factual documentation that supports each of the seller’s representations (assertion of fact) and warranties (promises about the future). This can include everything from intellectual property and important contracts to outstanding liabilities.
Because problems with disclosure schedules can give rise to litigation or entitle sellers to escrowed funds, buyers must meticulously account for any liability that may arise post-closing. This can include:
- Employee or vendor claims
- OSHA violations or regulatory investigations
- Tax liabilities
- IT security breaches
- Other risks
Buyers should also ensure they use current and accurate information, provide complete financial statements, and supply all information for bank accounts and insurance policies.
Learn more about the importance of disclosure schedules in M&A transactions.
3. Calculation and Timing of Earn-Out Provisions
Earn-out provisions often arise in purchase agreements when buyers and sellers have different opinions about the value and future potential of a business. By striking a compromise where buyers put up a large portion of the purchase price and pay the rest over a period of time, contingent upon the business achieving pre-defined performance targets, both buyer and seller benefit from advancing the transaction.
However, earn-outs can go wrong when parties fail to properly limit risk.
When crafting earn-out provisions to avoid post-closing disputes, parties should:
- Agree on accounting methodology, valuation, and definition of EBITDA
- Clearly define schedules for earn-out payments
- Include the right to access financial statements, and
- Outline the extent of discretion buyers can exercise in operating the business post-closing to limit risks for claims that buyers intentionally frustrated the earn-out.
Although the ultimate goal is to avoid disputes in the first place, earn-out provisions should define the processes for addressing any post-closing disputes that do arise.
4. Breach of Fiduciary Duty
Corporate directors and officers contemplating a sale of their company have an obligation to review all material information prior to making a business decision. While what constitutes material information may vary depending on the transaction, directors’ and officers’ legal, fiduciary duty to act in the best interests of the corporation does not.
When directors fail to uphold these duties, they risk exposure to breach of fiduciary claims. This duty to act in good faith applies not only to reviewing pertinent facts for the deal, but also extends to material information related to the buyer’s contemplated actions that could impact the company’s post-closing solvency. In addition, directors or officers with a familial or financial ties – or even extensive social or professional ties – to the potential buyer should consider whether they need to abstain from the decision-making process.
5. Freeze-Out Mergers
Freeze-out mergers take place when a merger of two entities forces minority shareholder to sell their stock in exchange for a cash buyout, essentially “freezing out” minority shareholders. Recent rulings show courts increasingly scrutinize such transactions. Because fiduciary duties remain intact during mergers, majority shareholders cannot organize a merger for the sole purpose of cashing out minority shareholders. There must be a benefit to the corporation as well.
To avoid litigation, majority owners should ensure fair dealing with minority owners, offer a fair market value for their equity interests, and ensure that the merger advances a corporate interest.
In Texas, minority shareholders may no longer have a cause of action for shareholder oppression, but they do have many other options when facing squeeze-outs and freeze-outs, including claims for breach of contract, breach of fiduciary duty, or fraud, among others.
Comprehensive Counsel for Mergers & Acquisitions
M&A transactions require buyers and sellers to invest not only in due diligence and exploration of the deal, but also the nuts and bolts of essential agreements, disclosures, and provisions that can help them effectively manage risk while preserving the flexibility to achieve durable deals.
At Hendershot Cowart P.C., our business law and litigation team provide comprehensive counsel to entrepreneurs, start-ups, and corporate clients searching for ways to proactively limit risk and establish the foundation for future growth. We represent buyers and sellers across a range of industries, including health care clients looking to facilitate a medical practice set-up or merger.
To speak with an attorney from our Houston office, call or contact us online.