Bowne ma handbook

THE MERGERS
& ACQUISITIONS
HANDBOOK
A Practical Guide to
Negotiated Transactions
First Edition
> DIANE HOLT FRANKLE
STEPHEN A. LANDSMAN
JEFFREY J. GREENE

DLA PIPER

Print Date: November, 2007

This publication is designed to provide accurate and authoritative
information in regard to the subject matter covered. It is published
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professional should be sought.

— From a Declaration of Principles jointly adopted by
a Committee of the American Bar Association and
a Committee of Publishers.

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FIRST EDITION

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throughout Asia, Continental Europe, the Middle East, the United States, and
the United Kingdom. The firm’s global legal practice includes commercial,
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range from multinational, Global 1000 and Fortune 500 enterprises to
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Piper, please visit the firm’s web site at www.dlapiper.com.

i

About the Editors
DIANE HOLT FRANKLE is a partner in the Silicon Valley, California office
of DLA Piper and Co-Chair of the firm’s global Mergers & Acquisitions Group.
Ms. Frankle specializes in mergers and acquisitions, corporate governance,
and antitakeover counseling. She has represented numerous companies, both
buyers and sellers, in asset deals, stock and cash mergers, tender offers,
management buyouts and other complex acquisitions, and in implementing
defensive strategies. Ms. Frankle is a member of the American Bar Associa-
tion’s Committee on Negotiated Acquisitions and Co-Chairs the Committee’s
Task Force on Public Company Acquisitions. She speaks and writes regularly
in programs for both clients and practicing lawyers on mergers and acquisi-
tions, corporate governance, the fiduciary duties of directors, and federal and
state securities laws. She is listed in the Best Lawyers in America, Who’s Who
Legal: The International Who’s Who of Business Lawyers, Chambers Global
Guide and as one of Northern California’s Super Lawyers, for her mergers and
acquisitions practice. Ms. Frankle received her J.D. magna cum laude from
Georgetown University Law Center in 1979. After law school, she served as
law clerk to Senior District Judge R. Dorsey Watkins, Senior District Judge of
the United State District Court for the District of Maryland from 1979 to 1981.
STEPHEN A. LANDSMAN is a partner in the Chicago office of DLA
Piper and is Co-Chair of the firm’s global Mergers & Acquisitions Group. He
engages in a general corporate, business counselling, and tax practice, with
special emphasis in the area of mergers and acquisitions. Mr. Landsman has
extensive in-depth experience in numerous industries as lead counsel
representing both purchasers and sellers in a wide variety of transactions
including public to public, private to public, private to private, leveraged
recapitalization, divisional or asset sales and joint venture/strategic alliance
transactions. Mr. Landsman has been a speaker on various corporate law
matters and has been the author of several published articles in his field. In
2007 the respected English research firm Chambers & Partners cites
Mr. Landsman in Chambers USA: America’s Leading Lawyers for Business.
He has been designated an Illinois Super Lawyer in both 2005 and 2006 and
is also listed in Who’s Who in America and Who’s Who in American Law.
JEFFREY J. GREENE is a partner in the Shanghai office of DLA Piper.
He concentrates his practice in the areas of cross-border mergers and
acquisitions, corporate and securities law. Mr. Greene regularly advises clients
in a wide variety of mergers, acquisitions and change of control transactions,
and has led cross-border M&A deals in Australia, China, Finland, Germany,
India, South Korea and the United Kingdom, among others. Mr. Greene
frequently presents to practicing attorneys on the areas of mergers and
acquisitions. Before relocating to the firm’s Shanghai office, Mr. Greene prac-
ticed in the firm’s Seattle, Washington office where he was named a “Rising
Star” by Washington Law and Politics magazine from 2001 to 2006.
iii

Acknowledgements
Editorial:
Diane Holt Frankle Silicon Valley, California
Steven A. Landsman Chicago, Illinois
Jeffrey J. Greene Shanghai, China
Contributing Authors:
William H. Bromfield Seattle, Washington
Sulee J. Clay Washington, DC
Stephanie M. Decker Shanghai, China
Trenton C. Dykes Seattle, Washington
Francis J. Feeney, Jr. Boston, Massachusetts
Danielle S. Fitzpatrick Seattle, Washington
Diane Holt Frankle Silicon Valley, California
Jeffrey J. Greene Shanghai, China
David M. Hryck New York, New York
Purnima N. King San Francisco, California
Paolo Morante Baltimore, Maryland
Kathryn H. Ness New York, New York
Michelle D. Paterniti Boston, Massachusetts
Thomas B. Reems Washington, DC
Robb Scott San Francisco, California
Jeffrey M. Shohet San Diego, California
Christian Waage San Diego, California
Eric H. Wang Silicon Valley, California
Numerous partners, associates and other colleagues have contributed
to this handbook. Our special thanks to Edward Batts, Joel Ginsberg,
Lawrence Gold, Mark Hoffman, W. Michael Hutchings, Peter Lawrence,
Albert Li, Laura Puckett and David Reitz.

v

PLEASE READ THIS DISCLAIMER: This handbook is intended to
provide a general, informational overview to non-lawyers and is not
intended to provide legal advice as to any particular situation. The laws,
regulations and other rules applicable to each specific variation of the deals
discussed in this handbook are complex and subject to change. Experi-
enced counsel should be involved in every aspect of the planning, struc-
turing and negotiation of any M&A transaction, including the drafting and
execution of all transaction documentation.
Without limiting the generality of the preceeding disclaimer, the
discussion of the basic Internal Revenue Service rules and regula-
tions relating to the taxation of business combinations is intended to
be a summary only. Such rules and regulations are extremely complex
and evolving, and by definition are dependent on the specific facts of
each particular case. Participants to business combinations must
consult their tax advisors early and often when structuring M&A
deals.
The views in this handbook are those of the editorial staff and the
contributing authors only and do not necessarily reflect the views of DLA
Piper.

vi

TABLE OF CONTENTS
Chapter 1 The Mergers and Acquisitions Process . . . . . . . . . . 1
Why Buyers Buy and Sellers Sell. . . . . . . . . . . . . . . . . . . . . . 2
Elements of Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
The Players . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Acquisition Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Time and Responsibility Checklist . . . . . . . . . . . . . . . . . . . . . 6
Leveraging The Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Chapter 2 Letters of Intent & Term Sheets . . . . . . . . . . . . . . . . 9
Letter of Intent Pros and Cons . . . . . . . . . . . . . . . . . . . . . . . . 10
Binding or Non-Binding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Elements of the Letter of Intent . . . . . . . . . . . . . . . . . . . . . . . 11
Chapter 3 The Nondisclosure Agreement . . . . . . . . . . . . . . . . . 13
Understanding the Scope of Confidential Information . . . . . . . 14
Use of Confidential Information . . . . . . . . . . . . . . . . . . . . . . . 15
Non-Disclosure of Discussions. . . . . . . . . . . . . . . . . . . . . . . . 15
Legally Required Disclosures. . . . . . . . . . . . . . . . . . . . . . . . . 16
Return or Destruction of Materials . . . . . . . . . . . . . . . . . . . . . 17
Non-Solicitation/Employment . . . . . . . . . . . . . . . . . . . . . . . . . 17
Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Choice of Law/Forum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Chapter 4 Legal Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . 21
What Is Due Diligence and When Is It Performed? . . . . . . . . 21
What Are the Objectives of Due Diligence? . . . . . . . . . . . . . . 21
Overview of the Due Diligence Process . . . . . . . . . . . . . . . . . 22
Who Is Involved and the Necessity of a Diverse Team of
Experts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Due Diligence Request List . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Response to Due Diligence Request List . . . . . . . . . . . . . . . . 27
Scope and Process of Review . . . . . . . . . . . . . . . . . . . . . . . . 29
Results of Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Chapter 5 Deal Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Principal Deal Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Stock Purchase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Asset Acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Mergers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Considerations in Choosing a Structure . . . . . . . . . . . . . . . . . 39
Chapter 6 Definitive Acquisition Agreement. . . . . . . . . . . . . . . 47
Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
Economic and Structural Provisions . . . . . . . . . . . . . . . . . . . . 48
Representations and Warranties . . . . . . . . . . . . . . . . . . . . . . 52
Interim and Post-Closing Covenants . . . . . . . . . . . . . . . . . . . 59

vii

Employee Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Deal Protection Devices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Conditions to Closing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Miscellaneous Provisions. . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
Chapter 7 Indemnification & Contribution . . . . . . . . . . . . . . . . 69
Why Indemnification? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
Acquisitions of Publicly-Traded Targets . . . . . . . . . . . . . . . . . 70
Types of Indemnified Matters . . . . . . . . . . . . . . . . . . . . . . . . . 71
Definitional Limitations on Indemnification . . . . . . . . . . . . . . . 73
Monetary Limitations on Indemnification . . . . . . . . . . . . . . . . 74
Other Limitations on Indemnification . . . . . . . . . . . . . . . . . . . 76
Sole and Exclusive Remedy. . . . . . . . . . . . . . . . . . . . . . . . . . 77
Indemnification Procedures; Dispute Resolution. . . . . . . . . . . 77
Hold-Backs of the Purchase Price . . . . . . . . . . . . . . . . . . . . . 78
Contribution Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
Chapter 8 Fiduciary Duties of Board of Directors . . . . . . . . . . 81
Overview of Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . 81
Heightened Fiduciary Duty . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
Fiduciary Duty Implications of Certain M&A Transaction
Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
Voting Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
Chapter 9 Stockholder Approvals and Securities
Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
Obtaining Stockholder Approvals . . . . . . . . . . . . . . . . . . . . . . 98
Registration Statements For Buyer’s Securities . . . . . . . . . . . 104
Chapter 10 The Role of Investment Bankers in M&A
Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
The Engagement Letter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
Fairness Opinions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112
Chapter 11 Hart-Scott-Rodino and Related Regulatory
Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
Brief History and Purpose of the Act . . . . . . . . . . . . . . . . . . . 115
HSR Notification Requirements . . . . . . . . . . . . . . . . . . . . . . . 115
Beyond Notification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124
Beyond the HSR Act — Government Challenges Outside the
Statutory Context . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
Beyond the HSR Act — International Pre-Merger Notification
Requirements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
Chapter 12 Tax Considerations . . . . . . . . . . . . . . . . . . . . . . . . . 127
Taxable Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127
Tax-Free Reorganization . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

viii

Annex Section . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-1
Annex 3-A Mutual Nondisclosure Agreement . . . . . . . . . . . . . A-1
General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-1
Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-1
Use of Evaluation Material . . . . . . . . . . . . . . . . . . . . . . . . . . . A-2
Non-Disclosure of Discussions. . . . . . . . . . . . . . . . . . . . . . . . A-2
Legally Required Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . A-2
Return or Destruction of Evaluation Material . . . . . . . . . . . . . A-3
No Solicitation/Employment . . . . . . . . . . . . . . . . . . . . . . . . . . A-3
Standstill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-3
Maintaining Privilege . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-5
Compliance with Securities Laws . . . . . . . . . . . . . . . . . . . . . . A-5
Not a Transaction Agreement . . . . . . . . . . . . . . . . . . . . . . . . A-5
No Representations or Warranties; No Obligation to Disclose . . . A-5
Modifications and Waiver . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-6
Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-6
Legal Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-6
Governing Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-6
Severability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-6
Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-7
Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-7
Entire Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-7
Counterparts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-7
Annex 3-B Summary Checklist . . . . . . . . . . . . . . . . . . . . . . . A-9
Definition of Confidential Information . . . . . . . . . . . . . . . . . . . A-9
Use of Confidential Information . . . . . . . . . . . . . . . . . . . . . . . A-10
Non-Disclosure of Discussions. . . . . . . . . . . . . . . . . . . . . . . . A-10
Legally Required Disclosures. . . . . . . . . . . . . . . . . . . . . . . . . A-11
Return or Destruction of Materials . . . . . . . . . . . . . . . . . . . . . A-11
Non-Solicitation/Employment . . . . . . . . . . . . . . . . . . . . . . . . . A-12
Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-12
Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-13
Miscellaneous Provisions Applicable to Providers and
Recipients . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-13
Annex 4 Sample Due Diligence Checklist . . . . . . . . . . . . . . . A-15
Annex 11 Certain HSR Exempt Transactions . . . . . . . . . . . . . A-41

ix

Preface
The term mergers and acquisitions, or “M&A”, refers generally to a
number of different types of transactions, including mergers, asset acquisitions
and stock purchases. While there may be some degree of overlap among the
various transaction types, each deal and each deal type is its own unique
animal driven by certain practical and business considerations of the parties.
For example, on the sell-side, a company may look to an M&A deal to
provide liquidity to its founders or because it has reached the limits of its
ability to grow organically. A would-be buyer, on the other hand, may be
motivated by the prospect of acquiring strategic technology, expanding
product offerings, adding distribution channels or increasing market share.
Even under ideal circumstances, an M&A transaction will consume man-
agement resources of both the prospective buyer and would-be seller. Conse-
quently, the parties must have realistic expectations of the timing, structuring,
regulatory and other related considerations. Because every transaction is dif-
ferent, it must be approached from the vantage point of the specific facts and
circumstances at hand. In putting this handbook together, we endeavored to
focus on these practical matters and to use them as a backdrop for our
discussion of the legal considerations associated with doing an M&A deal.
This handbook addresses negotiated transactions only. As such, we do
not consider hostile takeovers or other situations where the would-be buyer
and would-be seller have not come together willingly to attempt to do a deal.
With that said, a negotiated transaction is nevertheless an adversarial pro-
ceeding. While all parties to the deal may be keenly interested in getting the
deal to closing, one should never lose sight of the fact that the parties have
different, competing and, generally speaking, conflicting interests.
While much of the information contained in this handbook regarding both
deal structures and principal deal terms applies to transactions involving both
public and private companies on the buy and sell side, certain structural
considerations and deal terms may be significantly affected by whether the
parties involved are publicly traded or privately held. Reference is made to these
distinctions throughout the book only where relevant to a particular discussion.
Finally, although Federal securities and anti-trust laws may come into
play in certain transactions based on the type of deal consideration or the
nature of the parties, an M&A transaction is for the most part driven by the
laws of the particular state(s) in which the constituents are incorporated or
domiciled. Accordingly, this handbook is intended to be agnostic with
respect to particular state laws. However, because it is generally accepted
among practitioners that Delaware law tends to offer the most comprehen-
sive body of M&A and corporations law, and because a considerable
number of the public companies in the United States are incorporated in
Delaware, Delaware law is sometimes discussed for illustrative purposes.
xi

Chapter 1
The Mergers and Acquisitions Process
As we use the term in this handbook, the mergers and acquisitions
(“M&A”) process describes the methods and arrangements by which a
prospective buyer and seller consummate the purchase and sale of a
company. Through this process one party decides to buy and the other
decides to sell at an agreed price and on agreed terms. To make such a
decision, the parties have to reach some level of understanding of under-
lying information. This information almost always includes proprietary infor-
mation which can be obtained only with the consent of the parties.
Moreover, it is the kind of information which the parties will disclose only
after they are relatively confident that a deal will follow. Accordingly, the part
of the process by which the parties exchange information (referred to as
“due diligence”) often parallels to some extent the part of the process by
which the parties arrive at a conceptual price and deal structure (the “letter
of intent” or “term sheet”) and by which the parties finally establish the price,
the allocation of risk and other terms and conditions of the arrangement (the
“definitive agreements”). The overall effort to bring about the transaction is
coordinated with a master checklist (the “time and responsibility checklist”).

This chapter provides an overview of the stages of the acquisition
process with reference to some of the tools that have evolved to manage
each stage. Mergers and acquisitions are generic terms that may refer to a
variety of transactions, including asset purchases, stock purchases, merg-
ers, share exchanges and the like. Except where the context indicates
otherwise, the term “acquisition” is used in the broad sense to encompass
acquisitions and dispositions.

Entering the acquisition process is much like starting a marriage or a
new job or other life altering event in that it involves a major commitment,
and is best embarked upon after carefully considering the long-term goals
of all parties involved. If you make a bad hire or match, you are likely to
regret it for some time, and it is likely to be expensive.

The acquisition process involves a large cast of insiders and consult-
ants, some of whom may have conflicting interests. There are also regu-
latory considerations that are usually routine if addressed in a timely
manner.

There are different kinds of buyers/sellers and different kinds of deals,
and the motivation for doing deals are equally plentiful and varied.
1

The Mergers & Acquisitions Handbook
A Practical Guide to Negotiated Transactions

Why Buyers Buy and Sellers Sell
Competitive Advantage. Although it is unusual, there are times when a
buyer will acquire a company primarily to keep someone else from buying it.
Strategic Considerations. Strategic buyers are the proverbial crown
princes of buyers because, by definition, they pay more. Generally, a
strategic buyer pays what the company is worth to the buyer rather than
what it is worth on its own.
Cheaper to Buy Than Make. There are buyers for whom buying other
companies is an everyday part of their businesses. These include buyers doing
“roll ups,” which are usually companies operating in an industry that is con-
solidating. Generally, these buyers intend to keep and operate the companies
they buy. On the other hand, private equity funds (formerly referred to as
leveraged buyout funds) and merchant banks typically buy companies with the
intention of reselling them or taking them public within some predetermined
period of time. These professional buyers may be opportunistic or strategic,
depending on the circumstances. Generally, they are experienced buyers with
experienced advisors. Historically, they do not overpay, but they also know
what they are doing and do not waste the seller’s time.
Risk Mitigation. There are times when the best way to resolve or avoid
a lawsuit is to buy the other party.

Elements of Value
It can be fairly inferred from the different kinds of buyers and different
kinds of deals that the parties frequently go into the M&A process with
different goals and expectations. These differences often center around the
elements of value. The deal values of the party with the greatest negotiating
strength generally dictate deal structure.
• Price. In a cash deal, the price dynamic reflects common sense.
Setting aside tax considerations, the higher the price, the better for
the seller and the worse for the buyer. However, where the currency
is the stock of a public company, this may not be true if the deal is
large enough to be noticed by the market. Ironically, if the market
thinks the price is too high (not accretive), the value of the market
price of the stock received as the purchase price will fall after the
transaction. Unless the seller has been able to sell or hedge the stock
before this fall takes place, the seller will end up receiving less total
value because the price was set too high at the outset.
• Tax and accounting consequences. Tax and accounting conse-
quences depend on the deal structure. In an acquisition, the buyer
2

Chapter 1 - The Mergers and Acquisitions Process

acquires either the seller’s assets or the seller itself. (To make
matters complicated, there is one kind of deal — under Internal
Revenue Code Section 338(h) — in which the buyer acquires the
seller but the transaction is taxed as if the buyer had acquired
assets.) Generally, the buyer pays for what is acquired either with
its stock, cash, or a combination of both.
It is often possible to structure an acquisition as a tax-free reorga-
nization. If the transaction is taxable, the gain may be taxed as either
capital gain rates or ordinary rates. In addition, there are some
potentially scary tax complications, generally depending on how the
seller has been formed and operated. For example, if the seller is an
S corporation that converted from C corporation status, it may have
“built in gain” that will be taxed. Or if the seller has issued stock
options that vest, or bonuses that are earned upon a sale of the
company, the “excess golden parachute” payment punitive excise
tax must be considered. There may also be a punitive excise tax if
stock options were granted at less than fair market value.
The choices here are complicated and often binary (that is, what is
good for one party is likely to be bad for the other). Just as the seller
wants the highest cash price, the seller also wants to pay as little tax
as possible. A tax-free deal sounds like it would be best for the seller,
but cash is always taxed. If the proceeds are to be taxed, the seller
does not want them double-taxed (at the corporate level and again at
the stockholder level) and for this reason would prefer a stock sale
over an asset sale. The seller would also prefer to be taxed at capital
gain rates. If the buyer is a taxpayer and sensitive to tax conse-
quences, the buyer may want a portion of the purchase price paid in
respect of covenants not to compete, which can be expensed more
quickly than purchase price, but which are taxed to the seller at
ordinary income rates. If the seller is more sensitive to impact or
earnings (e.g., a pre-IPO company), it will not want the more rapid
amortization for non-compete payments.
• Liabilities and the Allocation of Risk. If a buyer buys stock, it is buying
the company rather than the company’s assets. The company brings
with it all of the known and unknown liabilities arising from the oper-
ation of the business. The known liabilities are directly addressed, but
most buyers prefer to buy assets in order to avoid, to the extent
possible, the assumption of the seller’s contingent liabilities.
• Liquidity. The seller’s primary motivation for the sale of a successful
company is typically to convert an illiquid asset (the company) into a
3


liquid asset (cash or the buyer’s publicly traded stock). On the other
hand, depending on the circumstances, many buyers using stock to
make acquisitions are concerned about the potential impact of a big
block of stock coming onto the market. As a consequence, if the
acquisition is paid for with stock, the buyer often wants to restrict the
subsequent transfer or hedging of that stock.

The Players
There is a long list of players potentially involved in helping the parties
reconcile the elements of value applicable to their particular type of deal. In
general, the constituencies include some or all of the following:
• Owners. One way or another, the owners/stockholders always get a
voice in the disposition of a company. However, depending on the
form of transaction, the owners may not get a direct voice in the
decision to acquire a company.
• Management. It is unusual to buy or sell a company without the
cooperation of management.
• Employees. If management and the owners are satisfied, employees
as a group generally have only indirect, if any, influence. The excep-
tions are where the employees are unionized, where the buyer and
seller are relying on the employees to perform during a transitional
period, and where a large number of employees will lose their jobs
(requiring compliance with state and federal plant closure laws).
• Third parties.
m Customers

m Lenders

m Creditors

• Advisors.
m Counsel (corporate, tax, regulatory, intellectual property, etc.)

m Investment bankers

m Valuation experts

m Accountants

m Escrow Agents

m Financial Printers

• Regulators.
m Federal Trade Commission. The Hart-Scott-Rodino Act,
administered by the FTC, applies only to large deals
m Securities Exchange Commission and State Securities Reg-
ulators (in the event stock is part of the purchase price or one of
the companies is publicly held)
4


m Internal Revenue Service and State Tax Regulators
m Industry Specific Regulators

Acquisition Process
The big-picture goal of the acquisition process is to manage the players
so as to allow the proposed transaction to be completed on time and on
budget. Of course, this is easier said than done. In practice, a number of tools
and devices have been developed to manage the constituencies as efficiently
and effectively as possible toward the realization of this goal. For example,
the due diligence (fact-finding) process is generally initiated and managed
with a due diligence checklist. These tools and their purposes are as follows:
Acquisition Tools Purpose
Time and Responsibility Manage the overall effort by
Checklist coordinating the constituencies

Due Diligence Checklist Manage the process by which the
parties exchange information
Letter of Intent (‘‘LOI”) or The part of the process by which the
Term Sheet parties arrive at a conceptual price and
deal structure

Definitive Agreement The part of the process by which the
parties finally establish the price,
allocation of risk, and other terms and
conditions of the arrangement

Earn-Out or Price Contingent purchase price
Adjustment

Representations and Allocation of risk as to underlying facts
Warranties and Schedule
of Exceptions

Conditions to Closing Allocation of risk as to supervening facts

Post-Closing Covenants Obligations of the parties after closing
Indemnities Financial consequence of risk allocation

5


Time and Responsibility Checklist
The Time and Responsibility Checklist provides an overview of the
M&A process. It breaks down the deal into component parts. Responsibility
is then assigned and a schedule set for each part.
A typical Time and Responsibility Checklist includes the following:
• a list of each person who will have responsibility for some part of the deal
(generally, the parties listed above in the discussion of constituencies);
• a list of each document or action required to complete the transac-
tion, organized as described below:
m for each, an assignment of responsibility for drafting and

reviewing that document or action;
m for each, a status report; and

m for each, a due date.

Each document or action is further broken down with reference to the
stage of the process, as follows:
• Actions Taken Prior to Signing Definitive Agreement:
m term sheet

m board approvals

m formation of newco (where an acquisition sub is formed)

m business due diligence

m legal due diligence

• Agreements and Documents to be Delivered at Signing, e.g.:
Asset Purchase Agreement (the Exhibits Differ for a Stock
Purchase Agreement and Merger Agreement)
m assumption agreement

m bill of sale and assignment

m buyer’s closing certificate

m contract assignment

m lease assignment

m seller’s closing certificate

m trademark and patent assignment

m stockholder agreement

m offer letters

• Pre-Closing Actions:
Company Stockholder Written Consent
m Information Statement (provides disclosure to stockholders in

connection with soliciting consent to the transaction)
Third Parties Requiring Notice
Third Parties Requiring Consent
Allocation of Cash Consideration
6


• Agreements and Documents to be Delivered at Closing:
General
m Governmental Approvals

m Company Stockholder Approval for Asset Purchase

Deliverables/Actions; Conditions to Closing
m Assumption Agreement

m Bill of Sale and Assignment

m Contract Assignment

m Lease Assignments

m Buyer’s Closing Certificates

m Seller’s Closing Certificates

m Trademark and Patent Assignment

m All Government Consents Obtained

m Third Party Consents

m Offer Letters

m Good Standing Certificates

The closing is the time when all documents, like consents and permits,
must be delivered and proof of any necessary government filings, good standing
certificates and approvals are required. All ancillary agreements and certificates
must also be delivered at the closing. It is obviously “crunch time.”

Leveraging The Process
While M&A transactions come in a variety of shapes and sizes, and
vary from industry to industry, in negotiated transactions, the overall pro-
cess by which the buyer and the seller look to consummate a transaction is
fairly constant. Both the buyer and the seller should have a firm
understanding of the process, as time, money and ultimately the deal itself
may depend on it.

7


8

Chapter 2
Letters of Intent & Term Sheets
How does a deal begin? Parties known to one another may from time to
time undertake discussions about a potential tie-up. Often these discus-
sions do not end up amounting to much. However, on some occasions the
parties are serious enough about their discussions to want to memorialize
certain key understandings in writing. Such a writing is generally referred to
as a letter of intent — i.e., the parties’ expressed desire to go forward in
some manner.

The terms “letter of intent,” “term sheet,” “memorandum of understand-
ing” and “heads of terms” are generally synonymous in that they essentially
make reference to the same type of document — i.e., an agreement in
principal by a would-be buyer and would-be seller to further consider the
propriety of doing a deal. In some circumstances, a letter of intent and term
sheet will be combined, with the letter of intent portion setting forth a high-
level discussion of the transaction terms which are then set out with greater
particularity in a term sheet (attached as an exhibit to the letter of intent).
This is really a matter of personal preference as the substance of the
document will be the same regardless of the form in which it is presented.
For purposes of this chapter, the term “LOI” or “letter of intent” is used
broadly to encompass all incarnations of such agreements in principal.

In many deals the first statement of deal terms will be in an LOI or term
sheet; however, in some cases the parties may move from a general
discussion of proposed transaction terms straight to negotiation and doc-
umentation of the definitive acquisition agreement.

While there may be compelling reasons for the parties’ decision to
forego a letter of intent, in complex deals the parties are often better served
by taking the extra time to negotiate an LOI. Among other things, a letter of
intent provides the parties with a structure to their discussions and may set
out the parties’ expectations as to how the deal negotiations will proceed.
Moreover, a well-crafted LOI may streamline drafting and negotiation of the
definitive acquisition agreement and as a result actually reduce transaction
time and expense.

While a letter of intent is not intended to function as the definitive acqui-
sition agreement, to the extent the parties do have an LOI, it should not be so
cursory or high level in nature that the parties move forward without having at
least a general understanding of what the deal terms will ultimately look like.
9


Letter of Intent Pros and Cons
Parties sometimes resist using letters of intent because, like the
definitive acquisition agreement, the LOI is a negotiated document. Nego-
tiating and drafting an LOI will invariably involve additional front-end time
and expense for the parties. Often the parties are reluctant to want to take
the “bloom off the rose” so to speak by having to undertake tough nego-
tiations when they are just getting to know one another.
Additionally, either party may be reluctant to enter into an LOI for fear of
conceding a particular point that has not been fully vetted. This may be less
of an issue for the buyer because in all likelihood the buyer will have only
undertaken limited, if any, due diligence up to that point and will typically
reserve its rights to modify certain deal terms based on the results of its due
diligence review.
Often the letter of intent will provide for a limited period of exclusive
negotiation between the buyer and seller. This is disadvantageous for the
seller, but it is one of the primary reasons why buyers often insist that the
parties execute an LOI.

Binding or Non-Binding
Generally, an LOI will be non-binding with respect to all but a few
certain provisions. Typically, the binding provisions in an LOI will involve:
• confidentiality obligations of the parties;
• an exclusivity period (i.e., no shop) running to the benefit of the
buyer; and
• the right of the buyer to receive a termination or break-up fee in the
event the seller walks away from the deal.
If the parties have not previously entered into a confidentiality agree-
ment, it would be prudent for them to do so at the time they undertake
negotiation of an LOI. Once an LOI has been executed, the parties’ focus
generally shifts to the due diligence investigation, timing considerations and
negotiation of the definitive acquisition agreement. It is important not to let
the confidentiality agreement slip through the cracks.
Care should be taken to ensure that the LOI is truly non-binding, except
as noted above, and does not inadvertently create a binding “agreement to
negotiate” definitive terms. In some jurisdictions courts have prescribed so-
10

Chapter 2 - Letters of Intent & Term Sheets

called “magic” language that expressly removes any such implicit duty to
negotiate.

Elements of the Letter of Intent
To some extent, the terms of the LOI will mirror what one would expect
to find in the definitive acquisition agreement, only with less specificity. A
typical LOI will likely address at least the following:
• Assets/Stock — description of the assets (which may simply be
described as “all or substantially all” of the seller’s assets), or capital
stock to be acquired
• Acquisition Consideration — consideration to be paid by the
buyer in respect of the assets or stock of the seller (e.g., cash,
stock, earn-out, etc.)
• Closing Conditions — specifies certain key closing conditions,
such as voting agreements (and proxies), votes/consents required,
required regulatory approvals, and required third party consents
• Closing Date — general timetable for completing the transaction
• Corporate Approvals — whether stockholder consents are
required or whether a stockholder meeting will be called
• Due Diligence — the parties’ respective access to the books and
records of the other party
• Escrow — amount of acquisition consideration to be escrowed or
held-back to backstop indemnification or other post-closing obliga-
tions of the seller
• Governing Law — legal jurisdiction governing the terms of the
transaction, including the LOI
• Representations & Warranties — scope of the seller’s represen-
tations and warranties (Note: because of the abbreviated nature of
the typical LOI, parties often simply provide for “customary” repre-
sentations and warranties, which may set the stage for disagreement
during negotiation of the definitive acquisition agreement)
• Structure — whether the transaction will be structured as a merger,
asset acquisition or stock purchase
• Survival — length of time after closing that the parties’ representa-
tions and warranties will survive
11


A more comprehensive LOI might also address other considerations,
including:
• Board Representation — whether the seller would retain any post-
closing representation on the board of the acquired entity
• Employment Agreements — if the buyer is to retain certain key
members of management, the LOI may condition closing of the deal
on the buyer’s ability to negotiate satisfactory employment agree-
ments with such management members
• Fees and Expenses — any special fee arrangements among the
parties
• Options — treatment of outstanding employee stock options upon
consummation of the transaction (Note: terms of the option plan and
applicable option agreements will need to be considered)
• Publicity — whether either party is permitted to announce the trans-
action (typically the parties will agree to keep the LOI and proposed
transaction confidential)
• Registration Rights — buyer’s obligation to register any of its secu-
rities used as acquisition consideration
• Tax Treatment — whether the parties intend for the transaction to
receive a certain tax treatment (i.e., tax free reorganization)
While there may be strategic or tactical considerations for the parties’
decision to forego an LOI, if thoughtfully considered, a letter of intent may
provide the parties an early indicator of whether there is indeed a deal to be
done.

12

Chapter 3
The Nondisclosure Agreement
The nondisclosure agreement, often referred to as the NDA or con-
fidentiality agreement, is typically one of the first agreements to be entered
into in an M&A transaction. The agreement is designed to protect the
confidentiality of information exchanged in connection with the transaction
and during the course of one party’s due diligence review of the other party.
This chapter outlines a few of the more frequent issues encountered in
negotiating a typical NDA for a merger or acquisition. Generally, the seller
provides the buyer with confidential information. However, as noted above,
the seller may also receive confidential information from the buyer. If the
transaction involves significant equity being issued by the buyer, both
parties may provide confidential information to each other. In such circum-
stances, the concepts discussed below should be considered accordingly.
The NDA is usually prepared by the seller’s counsel or the seller’s
financial advisor. Although the principal focus of the agreement is protecting
confidential information that the seller provides the buyer, the buyer may
also have an interest in maintaining the confidentiality of information pro-
vided during the course of negotiations. For example, the buyer may have
provided confidential information to the seller in order to provide assur-
ances of its ability to pay the consideration for the acquisition. If the buyer is
issuing equity as consideration, the buyer may provide sensitive information
to the seller related to future business plans in order to demonstrate to the
seller that the buyer and the seller make a good business fit, to assure the
seller of its ability to develop the seller’s combined businesses in the future,
or, if the buyer is issuing a substantial percentage of its equity as consid-
eration, to satisfy the seller’s due diligence investigation of the buyer.
If both buyer and seller provide confidential information to each other, a
“mutual” NDA will be needed. If the provision of confidential information is
only contemplated to be from the seller to the buyer, a “unilateral” NDA may
be used. In most instances, however, a mutual NDA will often still be used
because the buyer’s confidential information may be disclosed to the seller
at some point during the discussions, even if it was not originally
contemplated.

13


Practical Tip: Tailoring the NDA to the Specific Deal

Parties will often mistakenly start with an NDA that is designed for
providing information to vendors or with a short-form NDA that is not
tailored for M&A transactions. The parties should be careful to avoid
this mistake, because the NDA for an M&A transaction will contain
specific provisions addressing matters not necessarily present in
other situations. For the same reasons, the parties should avoid
the temptation to rely on an NDA previously used by the parties in
a prior commercial arrangement.

Understanding the Scope of Confidential Information
One of the preliminary matters to review in any NDA is the scope of the
definition of “confidential information.” The seller should carefully examine
whether the definition of confidential information sufficiently covers the
information and materials it will provide to the buyer (and, to the extent
applicable, confidential information that may have been provided to the
buyer before the NDA was signed) to ensure that it does not inadvertently
exclude information or materials intended to be confidential. In addition, the
seller should be wary of “residual” clauses that allow the buyer, in its future
products or services, to use confidential information retained in the “mem-
ory” of the buyer’s employees. On the other hand, the buyer typically
attempts to limit the definition of confidential information so that it does
not include information created or discovered by the buyer prior to, or
independent of, the seller.
If the buyer is a close competitor, the seller may have particular
concerns about providing highly sensitive information to the buyer (e.g.,
pricing information, patent information or source code). Similarly, the buyer
may not want to review such highly sensitive information because it might
expose the buyer to future claims of misuse of proprietary information in
violation of the NDA or pose regulatory concerns. Therefore the parties may
want to consider carving out any subset of information that is extremely
confidential to the seller. These items may be better addressed in a sep-
arate NDA containing careful controls and procedures to limit the distribu-
tion and access of information to those advisors or agreed-upon personnel
of the buyer whom the seller reasonably believes will not exploit the infor-
mation commercially.
Another issue that may arise is how to determine whether information
is confidential. The seller may want to remove any onerous legending
14

Chapter 3 - The Nondisclosure Agreement

requirements that would require the seller to mark written materials “con-
fidential” or to reduce oral statements to writing. The potential pitfall of such
requirements is that the seller may disclose confidential information assum-
ing such information is protected when it is not in fact protected by the NDA
because the seller inadvertently failed to legend the confidential information
or to summarize oral confidential information in writing. The buyer may
agree to waive these requirements, especially since such requirements
often lead to a delay in receipt of due diligence materials due to the seller’s
need to carefully legend each document delivered or desire to limit access
to and control oral diligence discussions.
For evidentiary purposes, the seller should maintain a list or copy of all
the documents provided to the buyer and all persons to whom such doc-
uments were delivered. This will also help the parties to keep track of what
was previously provided so that duplicative requests for information can be
reduced.

Use of Confidential Information
In addition to defining which information is confidential, it is important
that the seller prevent the buyer from using the confidential information
provided by the seller for any purpose other than evaluating the possible
transaction at hand. The seller may want to insist on language in the NDA
stating that the confidential information is to be used solely for the purpose
of evaluating the transaction and that no implied license is being granted to
any of the seller’s intellectual property.
The seller may also want to protect its confidential information by
limiting the distribution of confidential information to a select group of the
buyer’s representatives. The seller may also consider a provision in the
NDA that would allow the seller to hold the buyer liable for any improper use
of confidential information by the buyer’s representatives. Alternatively, if
there are heightened concerns about the sensitivity of the information, the
seller may ask that confidential information be disclosed only to the buyer’s
representatives listed on a separate schedule to the NDA and that such
persons provide an acknowledgement, in writing, that they are bound by the
obligations of the NDA.

Non-Disclosure of Discussions
Both the seller and the buyer often want to keep confidential the fact
that discussions are taking place. Disclosure of such information could
create uncertainty among the seller’s suppliers, customers, vendors, and
15


employees, and if the seller is a publicly-traded company, result in a
dramatic change in the seller’s stock price. The buyer typically has con-
cerns about the confidentiality of discussions for similar reasons, and, in
addition, will want to limit the seller from using the buyer’s interest in the
seller to negotiate a potential sale to another party in order to avoid
competitive bidding or to prevent disclosing the buyer’s potential business
strategy to its competitors. However, in an auction context, the seller may
attempt to retain its ability to disclose the fact that the buyer is a bidder, or, to
the extent possible, to disclose the terms of any bid made by the buyer to
other bidding parties. If the buyer needs financing to complete the trans-
action, the buyer may negotiate an exception allowing it to disclose infor-
mation to its financiers.

Practical Tip: What it Means to Not Disclose Discussions

• May not disclose that evaluation materials have been
exchanged

• May not disclose that discussions or negotiations are taking
place

• May not disclose the terms and conditions of such discussions

Legally Required Disclosures
In some situations, the buyer may be legally required to disclose confi-
dential information to third parties in connection with legal proceedings. To
address this scenario, the seller should request either (i) the right to object to
the disclosure of any confidential information, or (ii) at the very least, the ability
to limit or control the scope of any court-ordered disclosure. The seller should
also insist that the buyer and its representatives notify the seller within a certain
period of time of any legal proceedings that would require the disclosure of
confidential information. The notification period should give the seller enough
time to seek injunctive relief or some other protective order from an appropriate
court. The seller may also want to request that the buyer fully cooperate or use
its reasonable best efforts to cooperate with the seller in obtaining such a court
order. If the seller is unable to obtain such equitable relief, the seller will want
language stating that the buyer will only disclose confidential information that is
legally required to be disclosed, in the opinion of its legal counsel.
16


Return or Destruction of Materials
It is important to the seller that all written confidential information be
returned or destroyed by the buyer, together with all copies and derivative
materials, if the acquisition is not completed. However, the buyer may prefer
to destroy the confidential information, or certify to the seller that it has
destroyed the confidential information because its representatives may have
made written notes on the documents or incorporated the content of those
documents into internal memoranda or business presentations. If the seller
accepts the buyer’s certification alternative, it should consider requesting that
the buyer list the documents that have been destroyed. Some thought should
be given to the destruction of electronic data on the buyer’s computer hard
drives and servers, as well as the tangible copies of confidential information
that the seller supplied. In some circumstances, the buyer may ask that a
copy of what was received be retained for archival/evidentiary purposes to
protect itself from being accused of using disclosed confidential information.
If this is the case, a copy should be kept by outside counsel only.

Non-Solicitation/Employment
A prospective buyer may seek to interview the seller’s employees as it
“kicks the tires” on its potential acquisition. This raises two concerns for the
seller: (i) it may alert the seller’s employees of a potential acquisition,
making it difficult for the seller to continue its normal course of business,
and (ii) it may result in a situation in which the potential buyer decides to
solicit key employees rather than acquiring the entire company. The seller
should request language in the NDA prohibiting the buyer from soliciting or
hiring the seller’s employees for some period of time (typically 6 months to
2 years, one year being fairly common) and from soliciting or hiring former
employees who may depart within some period of time (typically 3 to
6 months). The buyer may resist this prohibition by arguing that it is a
large entity and that keeping track of the solicitation and hiring activities of
its human resources department will be difficult, if not impossible. As a
result, the buyer may ask to limit this provision to only “key” employees or
employees that the seller identifies during the due diligence process.
Furthermore, the buyer may argue that general solicitations not directed
at the seller’s employees should be carved out because the buyer has no
control over whether the seller’s employees receive or respond to general
solicitations that may appear in newspaper publications or on the Internet.
17


Term
The term of the NDA will depend on (i) the strategic value of the
information to the seller, and (ii) how quickly such information may become
obsolete. Some NDAs fail to include a “sunset” provision and are silent as to
the duration of the confidentiality obligations under the NDA. In such cases,
the seller may argue that the confidentiality obligations, especially those
relating to core technology that will not become obsolete, should never
terminate. However, the buyer should attempt to limit the NDA to a specific
period of time (typically 1 to 5 years) because the seller’s proprietary know-
how may become obsolete in several years and the buyer will not want to be
limited by the NDA in making new technological developments. The buyer
may suggest that the NDA terminate upon the earlier of (i) completion of the
transaction or (ii) within a period of time after signing or termination of
negotiations if the transaction fails to close. If the seller is providing software
source code, it should consider asking for a carve-out provision excluding
source code from any time limits on protection.

Practical Tip: Avoiding Inadvertent Termination of the NDA

Generally, a definitive agreement will have a provision that states
that the definitive agreement sets forth the entire understanding of the
parties relating to the subject matter thereof, that it supersedes all
prior understandings, and that all prior agreements are terminated.
Make sure that the NDA is carved out from this provision so that the
NDA is not inadvertently terminated.

Remedies
Another issue to consider in evaluating NDAs is the question of rem-
edies. The seller will want to include some language from the buyer
acknowledging and agreeing that monetary damages are insufficient to
remedy a breach of the NDA and that the seller is entitled to injunctive relief
in addition to any other remedies. The seller may also request that the buyer
pay any legal fees resulting from a breach of the NDA, but a provision
stating that the prevailing party will pay the legal fees may be a more
reasonable compromise.

Choice of Law/Forum
With respect to a one-way NDA, the law and courts of the domicile of
the disclosing party is typically provided for. Where both parties are making
18


disclosures, this issue is frequently contentious. A possible compromise is
to provide that the law and forum of the domicile of the disclosing party will
control with respect to disputes involving that party’s confidential
information.
While the NDA is typically one of the first agreements to be entered into
in an M&A transaction, it is often the most overlooked. When negotiating
and finalizing the NDA, the parties should carefully weigh the desire to
proceed quickly with a transaction against the importance of assuring that
the NDA adequately protects the parties’ interests. A sample form of a
mutual NDA is attached as Annex 3-A and a checklist of items to look for
when reviewing an NDA is attached as Annex 3-B for your reference.

19


20

Chapter 4
Legal Due Diligence
In the context of an M&A transaction, the term “due diligence”
describes the process each of the parties undertakes to investigate the
other before a final decision is made whether to proceed. It can be likened to
dating (or maybe an engagement) before marriage. The parties are still
finding out about each other, and either can back out, though that is likely to
be unpleasant for one or both. Usually the buyer assures its investigation is
critical to permit it to decide to spend its cash or issue its securities to buy
the seller. However, a savvy seller will be equally concerned about the buyer
if the consideration is stock in the buyer or there is some strategic com-
bination contemplated.

What Is Due Diligence and When Is It Performed?
Due diligence is not a formality. It is a critical part of any M&A trans-
action because it allows a buyer or a seller to examine the business, legal
and financial affairs of the other to confirm that it is getting what it thought it
was getting. The results should answer two important questions: (i) “Can or
should we do the deal?” and (ii) “On what price/terms do we want to do the
deal?” Due diligence may expose “deal breakers” (e.g., accounting issues,
litigation, regulatory issues, tax issues, third party consent issues, etc.) that
could materially change the anticipated benefits of the deal. At a minimum,
discoveries can change the price/terms of the deal. At the worst, the
discoveries may prevent the deal from getting done at all.

Due diligence findings are also a critical concern in drafting the defin-
itive transaction documents, in particular, the representations, warranties,
covenants and disclosure schedules. Due diligence allows the parties to
allocate the risks as they move forward.

What Are the Objectives of Due Diligence?
The objectives of due diligence vary depending upon:

• whether a party is the buyer or the seller;

• the buyer’s business purpose for the transaction (i.e. does the buyer
plan to integrate operations following the closing, or will it strip down
the seller’s operations to assets); and

• the proposed deal terms, including the type of consideration that the
seller would receive.
21


For the buyer (or seller if the transaction contemplates a stock-for-
stock exchange, “merger of equals,” or strategic combination), the objec-
tives of due diligence may include the following, among others:
• accumulating sufficient information to validate the proposed valua-
tion and to justify the business reasons for consummating the deal;
• learning more about the seller’s business and operations;
• uncovering and identifying the current and potential issues, prob-
lems, risks and liabilities posed by the transaction;
• determining whether the seller’s business can effectively be inte-
grated into that of the buyer; and
• identifying unused capacity and determining how such capacity can
be effectively utilized to produce synergies.
For a seller receiving cash consideration in the transaction, its focus
during due diligence will be on (i) what stockholder or third-party consents
are required to consummate the transaction; (ii) corporate, business
records, or contract clean-up issues; (iii) compensation, severance, or
personnel matters; and (iv) arrangements where the consummation of
the transaction would cause an undesirable effect on the seller, such as
an event of default, a right of a third party to terminate a material obligation
of the seller, or a trigger of a source code escrow obligation.

Overview of the Due Diligence Process
Due diligence is routinely time consuming and often complex. However,
the process can be manageable and cost-effective if a party spends time in
advance creating a due diligence plan and forming a due diligence team.
The first step in the due diligence process (after, of course, finding a
deal) is for the parties to enter into an NDA or confidentiality agreement.
This agreement protects the subsequent disclosure of information that will
be provided to a buyer or seller in connection with the due diligence review
of the other party. As discussed in greater detail in Chapter 3 (“The
Nondisclosure Agreement”), a well-designed NDA accomplishes the
following:
• sets the ground rules concerning the disclosure and use of any
provided information;
• defines the scope of the documents and materials that will be
reviewed (for example, certain competitive or sensitive information
22

Chapter 4 - Legal Due Diligence

may be initially excluded from the process until the parties progress
further in the negotiations, or may be further subject to explicit
screening procedures);
• may include prohibitions on the solicitation of employees and other
“standstill” provisions; and
• addresses the processes and ongoing obligations of the parties
(including the return or destruction of confidential information) in
case the deal falls through during the due diligence stage.
The next step in the due diligence process is assembling a due
diligence team and assisting the individuals who will actually be performing
the due diligence to understand the type of transaction, the context of the
proposed investigation, and the type of company that is being reviewed. By
developing a general understanding of key features of the deal including its
scope, periods of review, and materiality thresholds common for deals of
these types and in the applicable industry, as well as the expected timing of
the transaction, the due diligence team can prioritize its review and struc-
ture the campaign accordingly.
What information does the recipient need or want? In this step, the
parties should broadly identify the scope of the documents they would like
to review and prepare a list of the requested documents and information
(“due diligence request list”). This list, which also creates a mechanism for
identifying and cataloguing both the information requested and the infor-
mation received, is usually very broad in the beginning of the due diligence
process. Upon finalizing the list of initial documents that the reviewing party
would like to receive, the due diligence request list is presented to the other
side, which then begins to compile, copy, and index the requested
materials.
Because due diligence is an evolutionary process, the review of one
document may prompt an additional line of inquiry or a need for additional
documents on the same subject (e.g., supplemental due diligence requests
concerning intellectual property, export, governmental contract, and envi-
ronmental information matters). These supplemental due diligence
requests are common and an important part of the process.
Once the materials have been prepared and organized, the disclosing
party distributes the documents and materials to the reviewing party’s due
diligence team. Historically, this distribution was made in person by deliv-
ering the documents to a “data” or “war” room at the offices of the disclosing
party’s counsel. In such cases, the reviewing party’s due diligence team
23


would perform its due diligence review in those offices. More recently,
however, parties have begun to copy and mail (or email) due diligence
documents to the reviewing party’s due diligence team and even post the
materials to secure online data rooms.
Once the diligence materials have been made available, the diligence
teams may spend hours or days reviewing such materials and compiling
appropriate work product to memorialize their findings.

Practical Tip: Online Data Rooms

Online data rooms allow the reviewing party’s due diligence team
to review the documents in the comfort of their own offices, which
generally has the effect of decreasing the cost of the due diligence
review (i.e., there is no need to travel to remote locations to carry out
the review). However, convenience and potential cost reduction must
be balanced against any issues that may result from the broader
dissemination of sensitive information.

Who Is Involved and the Necessity of a Diverse Team of
Experts
Every deal is different, and one of the first priorities in the due diligence
process is to assemble a diverse due diligence team. The team’s collective
expertise should cover the various business, legal, technical, and financial
matters unique to the seller and the deal at hand. This means not only
assembling the appropriate legal team, but making sure that the buyer or
seller has designated the appropriate in-house contacts to address ques-
tions that may arise concerning financial, customer, marketing, technical/
engineering, information technology/infrastructure, or personnel matters.
Although the primary lawyers on the deal will conduct much of the legal
diligence review, there are certain areas that will warrant a legal “special-
ist’s” review. These areas include antitrust, corporate and securities, debt
facilities, environmental, executive compensation and employment, gov-
ernment contracts or regulatory agencies, import and export, intellectual
property, litigation, privacy, real estate and real property, and tax. Each
specialist should have an integral role in creating the contents of the due
diligence request list (or responding to the request list), reviewing material
related to the specialist’s subject matter, and drafting, reviewing and mod-
ifying the portions of the definitive transaction documents relevant to the
specialist. In order to make the due diligence review by a specialist cost-
24


effective, the specialist should be briefed on the objectives of the parties as
discussed above.

The due diligence process is a collaborative effort and delegating
responsibility will facilitate a more efficient and effective process, thereby
producing a higher quality result and reducing the probability that key issues
will be overlooked or improperly addressed or negotiated.

Practical Tip: Points of Contact

Consider having one point person each for the seller, its counsel,
the buyer, and its counsel, whose task is fielding and responding to all
requests for additional due diligence material or information.

Due Diligence Request List
The due diligence request list (as prepared by the investigating party)
is an important step in formulating the scope of a due diligence review.
Although some may believe that this list is generic or “boilerplate,” a detailed
and targeted request list can make the due diligence process more efficient,
which may also lead to a more thorough and cost-effective review. In
general, a due diligence request will include all material agreements,
stockholder agreements, capitalization records, financial information, cus-
tomer and supplier information and contracts, employee records, and
benefits plans.

Despite the general nature of the types of information that will be
requested, the list itself should be fairly specific, and tailored to the specific
deal. It is better to make a targeted request for specific materials than it is to
make a general request such as, “Provide us with all material information
about the company.” For example, asking for “all charter documents” or “all
financing documents” is not as helpful or efficient as asking for “the
company’s certificate of incorporation, its bylaws, and all amendments
as now in effect” or “all loan agreements, credit facility documents, security
agreements, indentures, bonds, notes, and other evidences of short-term
or long-term indebtedness, and all amendments, as now in effect.” This is
particularly the case with parties that are not experienced in handling due
diligence requests and may not be familiar with the information generally.
25


Practical Tip: When a Broad Diligence
Request is Appropriate

A broad diligence request list may be appropriate when:
• the timeline is very tight (for example, a deal involving a public
company in a competitive situation or a situation in which the
risks of a leak are high);
• the disclosing party has a large diligence team to respond to the
entire request;
• the recipient has sufficient resources and personnel to handle
and review the information upon receipt; and
• both parties have committed to completing the diligence pro-
cess efficiently and expeditiously.

Whether the request is global or targeted, generic or detailed, it should
be tailored to the particular provider as much as possible. For example, if
the provider is a public company, its SEC filings should be read before the
request is submitted. This will enable the recipient to identify particular
documents (or potential documents) it might not otherwise be in a position
to ask for specifically.
Although this kind of customization is more difficult when the provider is
a private company, it is not impossible. The recipient will likely have some
specific information about the provider (from firsthand knowledge or infor-
mation from a website); and a modest amount of advance teamwork among
those who have this information can help focus the request.

Practical Tip: When the Disclosing Party is Public

Review SEC filings (e.g., forms 10-K, 10-Q and 8-K) before
preparing a diligence request.

Attached as Annex 4 is an example of what a comprehensive due
diligence request list might look like. Please note that this form is merely a
starting point. However, whether the form is used for a single global request
or staged focused requests, it should provide an itemized list of material
documents that are important in any due diligence review. The form may be
used by provider and recipient alike as an inventory of documents
requested and provided.
26


Response to Due Diligence Request List
Once the team has been assembled, the due diligence request list
items have been delegated among team members, and the seller and its
counsel have had the chance to collect and review all of the items
requested, the seller’s counsel typically prepares a formal written response
to the due diligence request list.

In an ideal world, the seller would be able to produce all of the items
requested at once. In practice, however, and in order to keep the due
diligence process moving forward, the seller will usually be unable to
assemble all of the requested information and materials at once. In these
situations, the parties will usually deliver a partial response and will follow
up with additional information as it is assembled. All materials delivered by
the seller should be accompanied by a written response and should be
organized to correspond with the due diligence request list (e.g., a response
that addresses each requested document item-by-item). This will allow the
buyer and seller to more efficiently and effectively locate and review the
desired information and will make subsequent supplements or updates
easier.

Typically, commencement of the due diligence process will require that
a large amount of information be located, reviewed, and produced in a
relatively short period of time. In most cases, the buyer will require that the
seller, and the seller will wish to, keep the potential transaction confidential
and not disclose its existence to the employee base. This reduces the
number of people on the seller’s side available to help in the due diligence
process. As a result, most of the information gathering is done by a handful
of the seller’s personnel, who are oftentimes the high-level executives of the
seller, or the seller’s legal counsel. Some of the information may need to be
collected by or from employees who have yet to be informed of a potential
transaction, and accordingly, production of such items may need to wait
until the likelihood of consummating the transaction is higher.

It is important that no due diligence material is produced to the other
side until counsel to the disclosing party has had the opportunity to screen,
if not complete its review of, and organize, such material. A provider of
information should always memorialize what they send to the other side.
Often, particularly in time-intensive situations, the provider responds to the
due diligence request with an “information dump”, where armfuls of doc-
uments are grabbed from drawers and file cabinets, boxed up, and sent
without first being inventoried.
27


Practical Tip: Information Dumps May Have Bad Results

Among the unfortunate results of the “information dump”
approach are

• potential disputes down the road over what was and was not
provided;

• potential inadvertent waivers of the attorney/client
privilege; and

• potential disclosure of sensitive documents.

To minimize the risks of inadvertent disclosure, it is essential to estab-
lish a control mechanism with respect to the review, organization, and
delivery of the documents by the provider and its evaluation by the recipient,
and the creation of an accurate record of the documents so provided. The
most common approach is to designate a single person or a very small
group of people to act as a gatekeeper through which all documents must
flow. In certain situations, this approach may produce internal resistance
because of concerns that such coordination will slow down the review
process.

The due diligence process can be very disruptive to the operations of a
seller. Because the buyer is trying to review a large portion of the seller’s
books and records (and the information may not be readily organized and
available), collection and review can be time-consuming and in turn divert
the attention of company personnel to matters other than the seller’s core
business objectives and operations.

Practical Tip: Source Code Protection and other
Proprietary Information

For protection of source code or other highly confidential propri-
etary information the seller may insist that the parties engage a third-
party/independent organization tasked with evaluating the source
code base or other highly confidential proprietary information rather
than delivering it directly to the buyer.
28


Scope and Process of Review
Once documents have been delivered, the reviewing party may wish to
consider imposing some sort of control on the reviewing team as to the
allocation and distribution of the documents. As discussed above, a full-
scale due diligence review — particularly when the provider is a large
company — will involve experts in many disciplines (for example, tax,
accounting, intellectual property, employee benefits, environmental, and
regulatory areas). Within each discipline, more than one reviewer will
probably be necessary. For instance, different people may be needed to
review federal and state tax issues, or patents and copyrights. In order to
control this process and track the documents that are being reviewed by
various team members (in case the documents must be returned or
destroyed), a single individual responsible for each category of requested
information should be established. This procedure helps ensure that there
is a “closed loop” of identified individuals who know about the transaction
and receive the documents for review.
Once an NDA has been signed, the due diligence request has been
submitted, coordination procedures have been put in place on both sides,
and the information has begun to flow, the real due diligence work can
begin: evaluating the information and its relevance to the potential trans-
action. In this part of the process, the due diligence team will begin to review
all the documents and materials provided to date, paying particular atten-
tion to those issues that may impact the proposed terms in the definitive
transaction documents or the likelihood of consummation of the deal.
Much of the diligence review during this process is often performed by
relatively junior team members. As such, it is important for junior team
members to raise potential problems to the more senior members of the
team as quickly as possible. Experience is the key to effectively analyzing
and evaluating the results of a due diligence review. For example, an issue
that may be deemed to be “interesting, but immaterial” to a junior member of
the due diligence team may be extremely material to a more senior person
who has firsthand knowledge of the problems associated with these situ-
ations. In fact, such information may ultimately be linked to another issue
that, together, may be one of the most important issues to the buyer. Thus,
coordination among reviewing team members is critical to success.
An equally important mechanism in the due diligence process is the
exchange of information orally through site visits, interviews with management,
formal presentations, and informal discussions. This part of the due diligence
review is often performed by the acquisition team and other principal employ-
ees or consultants of the reviewing party. Generally, attorneys are not
29


significantly involved in this process. In this step, members of management of
the disclosing party may prepare and deliver detailed presentations that give
an overview of the operations, prospects, and finances of the subject company.
The acquisition team will then have the opportunity to talk to these individuals
to “drill down” on the assumptions and statements made in the presentations.
An important fact to remember in these situations is that presentation mate-
rials, statements made in these meetings, handouts, and other materials will
directly affect the scope and substance of the representations and warranties
and the extent of indemnification obligations (if any) in the definitive acquisition
agreement. The buyer’s team will note any inconsistencies and inaccuracies in
these statements and use these facts to shift any risks relating to the state-
ments to the seller and its stockholders under the representations, warranties,
and covenants contained in the definitive agreement.

Results of Review
The results of the due diligence review will ripple through all aspects of
a proposed M&A transaction. A detailed summary of the due diligence
review, often called a due diligence memo, is usually prepared by counsel
as a way to organize, track, and manage which documents have been
reviewed, who reviewed them, and what issues or action items were
identified. The due diligence memo may also become an important tool
for both the business and legal aspects of negotiating the final deal terms.
Once the parties have digested the results of their respective due
diligence investigations, the last step in the due diligence process is making
certain determinations:
• Can or should we do the deal?
• Do we still want to do the deal?
• Is the seller worth the valuation as originally proposed or should there
be a reduction in the purchase price?
• Should an alternative form of consideration or payment be consid-
ered, such as an earn-out?
• To what extent should the scope of the representations and warran-
ties be expanded?
• Is an adjustment to the indemnification and escrow term or amount
necessary?
• Should additional covenants or conditions to closing be added (e.g.,
third-party consents, employee retention targets, required termina-
tions (of contracts, customers, or personnel)?
30


Practical Tip: Hot Issues in Due Diligence

Following is a list of “hot” issues that may arise during the course
of the diligence investigation, and which may impact the definitive
transaction documents:
• capitalization issues
• nonassignability clauses
• termination/default provisions
• change of control provisions
• employment/severance agreements
• discovery of “hidden” liabilities (i.e., litigation, environmental)
• discovery of provisions that conflict with the transaction or
require consent/waiver
• non-competition or non-solicitation restrictions on the seller
• open source software
• privacy issues
• export control violations
• source code escrow arrangements
• acceleration of stock options
• 280G parachute payments or 409A issues

Assuming the parties wish to move forward with the deal, the due
diligence memo and related documents are invaluable to the buyer in
confirming the contents of the disclosure schedules to the definitive agree-
ment. Moreover, by maintaining an accurate record of all documents dis-
closed pursuant to a due diligence request list, the seller may use this list in
the preparation of the disclosure schedules.
As mentioned above, the due diligence process continues until the
transaction is closed. The parties will continue to request, deliver, and
review information throughout this period. As such, the parties should
recognize that due diligence is an evolving process that will require a
significant time commitment on each of their parts.
31


32

Chapter 5
Deal Structures
Principal Deal Structures
A business acquisition can take many forms. The optimal structure in
any particular transaction will depend on a number of factors, such as the
nature of the business, assets and liabilities being acquired, the economics
of the business deal, tax considerations, required third-party consents,
securities laws considerations, and similar issues. Determining the optimal
structure for the acquisition is a critical step in every deal and must be
addressed early on in the transaction process, ideally at the term sheet
stage.
The structure may affect the buyer and the seller very differently from
an economic perspective and is therefore often an important part of early
business negotiations. For example, a structure that is tax optimal to the
seller may be less so for the buyer, and vice versa. The structure will also
affect the scope of the due diligence and disclosure process. For example,
structure may impact the scope and nature of the liabilities the buyer will
assume, or the consents required for contract assignment. Setting structure
will be a prerequisite to determining appropriate documentation for the
transaction. Finally, the structure chosen will have a significant impact on
the overall deal process.
The three principal categories of negotiated acquisition structures are
stock purchases, asset acquisitions, and mergers.

Stock Purchase
In a stock purchase, the buyer negotiates directly with the target and its
stockholders to acquire the target’s outstanding shares of capital stock
directly from each of the target’s stockholders. As consideration for the
acquisition of the stockholders’ shares, the buyer may pay cash, its own
capital stock, debt, or other property. As with all acquisition structures,
sometimes a combination of cash, stock, and/or other property may be
used as consideration.

33


The following illustrates a typical stock purchase structure:

STOCK PURCHASE

Cash,Stock or
Before:
Other
Consideration
Stockholders
B of
S
Stock of S

S

After:

(if stock consideration)
Former
B Stockholders
of S

Assuming B purchases 100%
of S's stock

S

After the stock purchase has closed, the buyer will own whatever
percentage of the target’s stock is represented by the shares the buyer
acquired. Importantly, the buyer may not acquire 100% ownership if some
stockholders do not sell their shares. After the closing, the target will
continue as it existed prior to the acquisition with respect to the ownership
of its assets and liabilities, its employees and the conduct of its business.

Asset Acquisition
In an asset acquisition, the buyer acquires certain enumerated assets
and liabilities of the seller in exchange for the buyer’s cash, stock, or other
property. The buyer only acquires those assets that are specifically listed in
the asset acquisition agreement and also only acquires those liabilities that
are explicitly assumed. As a result, this structure can provide greater
flexibility for the buyer if it seeks to limit its exposure to undesired or
unknown liabilities or to acquire only those assets that are meaningful to it.
34

Chapter 5 - Principal Deal Structures

For example, a buyer that is not interested in the seller’s entire busi-
ness can limit the purchase to a discrete set of assets, such as a single
business line or division, or an intellectual property portfolio. Similarly, a
buyer could negotiate to leave behind a lawsuit or other class of liabilities,
although the seller might only be willing to keep such liabilities if the seller is
retaining other assets or has a plan for handling such liabilities. When a
buyer acquires all or substantially all of a seller’s assets, the seller will
typically distribute the consideration that the buyer paid for those assets to
its stockholders in advance of the seller’s liquidation.
The following illustrates a typical asset acquisition structure:

ASSET ACQUISITION

B

Cash,Stock or
Other
Consideration Assets

Stockholders
S of
Distribution of Cash,
S
Stock or other
Consideration as part
of or after asset sale

After the asset acquisition transaction has closed, the buyer will own
only those assets of the seller, and be responsible for only those liabilities of
the seller specifically enumerated under the asset acquisition agreement.
Importantly, the seller will continue in place as it existed prior to the
transaction — absent the business assets and liabilities sold to the buyer.

Mergers
A business acquisition may also be structured as a direct or indirect
merger, which is a creature of state statute and based on detailed statutory
requirements that vary from state to state. As with stock purchases, merg-
ers result in the buyer’s acquisition of the seller’s equity from the seller’s
stockholders, and depending on the type of merger will often result in the
continued existence of the seller as a separate legal entity. Unlike a typical
stock purchase, however, a merger does not require approval by each of the
seller’s stockholders in order for the buyer to acquire 100% of the seller’s
equity interests. Once the requisite vote of the seller has been obtained —
35


e.g., a majority of the issued and outstanding shares of capital stock — a
merger can be effected and the buyer will acquire 100% of the seller’s
outstanding equity pursuant to the operation of the state’s merger statute.

Practical Tip: Appraisal Rights

Most states’ laws provide appraisal rights to stockholders who do
not vote to approve a merger and who decline the merger consider-
ation. These rights typically enable the non-consenting stockholders
to petition the court to cause the buyer to pay them a higher value for
their shares than that offered in the merger.

Direct Merger
A direct merger occurs when the seller merges with and into the buyer,
with the buyer continuing as the surviving entity. As demonstrated in the
diagram below, the seller’s stockholders receive the merger consideration
upon the consummation of the merger, which may be cash, stock, or other
property. A direct merger will generally require the approval of both the
seller’s and the buyer’s stockholders under state law, which is one of the
reasons it is a less-favored structure. The seller does not survive after the
closing as a separate entity, but is incorporated into the buyer.

36


The following illustrates a typical direct merger structure:

DIRECT MERGER
Before:
Cash, Stock or
StockholdersS Other StockholdersB
Consideration

S Stock B Stock

S B
Merger

After:

StockholdersS StockholdersB

B Stock B Stock

B

Surviving Corp = Buyer

Indirect Merger
In an indirect, or “triangular” merger, the buyer establishes a merger
subsidiary to effect the acquisition.
In a forward triangular merger, the seller merges with and into the
buyer’s merger subsidiary, with the merger subsidiary surviving the merger.
The buyer pays the seller’s stockholders consideration in exchange for the
cancellation of the shares of the seller’s stock. After giving effect to the
merger, the merger subsidiary survives as the wholly-owned subsidiary of
the buyer. All of the seller’s assets and liabilities are deemed to have been
transferred from the seller to the merger subsidiary, which represents the
continuing business post-merger.

37


The following illustrates a typical forward triangular merger structure:

FORWARD TRIANGULAR MERGER
Before:
Cash, Stock or
Other
Consideration
Stockholders B

S MS
Merger
Buyer forms
merger subsidiary
After:

B Stock Former S
B Stockholders

MS Surviving Corp = MS
(combined with S)

In a reverse triangular merger, the buyer’s merger subsidiary merges
with and into the seller, with the seller surviving the merger as a wholly-
owned subsidiary of the buyer. The buyer receives all of the seller’s out-
standing stock in exchange for the merger consideration it pays the seller’s
stockholders. This is often the favored acquisition structure for several
reasons, including the fact that the seller continues to exist after the closing,
minimizing the need for contract assignments and other special efforts to
continue the business.

38


The following illustrates a typical reverse triangular merger structure:

REVERSE TRIANGULAR MERGER
Before:

Cash, Stock or
Other
Consideration
StockholdersS B

S MS
Merger
Buyer forms
After: merger subsidiary

B B Stock Former S
Stockholders
(If Stock Deal)

S
(combined with
MS)
Surviving Corp = Seller

Considerations in Choosing a Structure
A number of considerations are involved in choosing a deal structure
for a typical M&A transaction. Although these considerations vary greatly
depending on context, they generally fall into five principal categories:
• Business and economic considerations
• Corporate and securities laws and mechanics
• Allocation of liabilities
• The need for third-party consents or approvals
• Tax considerations
It is important to recognize that the considerations driving a particular
structure are dynamic and often overlapping, and in any given case the
ultimate choice may depend on an analysis of a number of competing
39


factors. Moreover, as is discussed in more detail below, the buyer and the
seller often have opposing interests in the choice of the structure, which can
contribute to significant complexity in the negotiations.
In addition, the structures are not rigid, and may be combined in a
creative fashion to achieve a particular result. For example, a stock pur-
chase in which the buyer acquires less than 100% of the seller’s outstand-
ing stock may in some cases be followed by a “back-end” merger in order to
“squeeze-out” minority stockholders who have not consented to sell their
shares. If the buyer acquires a certain percentage of outstanding shares
(typically 90%) in the stock purchase step of the transaction, stockholder
approval may not be required to effect the back-end merger, which may
allow the buyer to use a stock purchase to acquire a company even when it
is not able to directly acquire every last share. Similarly, combinations of
structures may be used in order to gain favorable tax treatment in a
particular transaction, such as a “multi-step” merger implemented in an
attempt to obtain favorable tax treatment while reducing some of the
limitations inherent in a typical merger.

Business and Economic Considerations
The nature of the seller’s business and the economic reasons for the
acquisition typically influence the choice of structure. The most obvious
example is where the buyer is looking to acquire a line of business from the
seller rather than the entire company. In this case, an asset acquisition is an
obvious choice, because the buyer can enumerate which assets it is
interested in acquiring and leave behind those it does not want. In contrast,
a buyer with a number of independent business lines may be interested in
acquiring the seller’s entire business, but intends to run the business
separately as one of several standalone subsidiaries. In that case, a stock
purchase or subsidiary merger are good choices.
The type of consideration the parties would like to use is another
important factor that drives deal structure. While some sellers prefer the
immediacy, certainty, and liquidity of cash, others prefer taking an invest-
ment in buyer’s stock if they believe the upside potential of the stock is
significant. On the buy-side of a transaction, a buyer may not have sufficient
cash to use as consideration for the acquisition and may be unable to incur
additional debt due to financial covenants and existing debt loads. In that
case, using its stock will be the obvious alternative from the buyer’s per-
spective. As is described in more detail below, the type of consideration the
parties choose will in turn influence the type of structure that can be used in
a particular deal due to both legal and practical constraints, such as the
40


limitations inherent in using cash in the context of a tax-free merger, as well
as securities law considerations.

Corporate and Securities Laws and Mechanics

• Corporate approvals

Different deal structures may require different types of board and
stockholder approvals for both the buyer and the seller, and the practical-
ities of obtaining such approvals in certain cases may dictate a specific
structure. In the case of board approvals, while a merger or substantial
asset acquisition typically requires approval by the seller’s board of direc-
tors as a matter of statute and corporate practice, and will require the
approval of the buyer’s board if the transaction is material to the buyer, a
stock purchase often does not require approval of the seller’s board
because the shares are acquired directly from the stockholders them-
selves. If the buyer negotiates a contract with the seller in a stock purchase
transaction, however, the seller’s board will need to approve the agreement.

The need for target board approval is thus relatively universal, but
stockholder approval is not always required. In the merger context, approval
by the seller’s stockholders is required to consummate the deal, but the
buyer will be able to acquire 100% ownership of the seller without first
obtaining every stockholder’s consent. Because a merger is a creature of
state statute, each state’s merger laws will dictate the baseline level of
stockholder approval required in a merger in order for the buyer to con-
summate the transaction, and typically the affirmative vote of a majority of
the outstanding shares is required for such approval. In the stock purchase
transaction, in contrast, each stockholder must approve the sale of its stock
in order for the buyer to obtain 100% control over the equity. For this reason,
buyers typically only use a stock purchase structure with a purchase of a
division or the acquisition of sellers with few stockholders, so that the buyer
can be sure to acquire the desired control over the seller with minimal
holdouts and cost.

Approval by the seller’s stockholders may not be necessary for some
asset acquisitions depending on the scope of the transaction. Typically, if
the acquisition involves all or substantially all of the seller’s assets, stock-
holder approval is required. State law requirements vary as to what con-
stitutes “substantially all of the assets” and the approval required, and these
requirements should be reviewed carefully.
41


On the buyer side, subject to the requirements of public stock
exchanges and national markets with respect to publicly-traded buyers
(e.g., the requirement that buyer’s stockholders approve any issuance of
shares in excess of a certain percentage of the buyer’s outstanding shares),
the buyer’s stockholders would typically not need to approve an acquisition
effected as a stock purchase, asset purchase, or indirect subsidiary merger.
However, they would likely need to approve an acquisition effected by the
direct merger of the seller into the buyer.

Practical Tip: Contract and Charter Approval Require-
ments May Be More Stringent than the Statute

Attention must be paid to any applicable contracts or charter
requirements that might require more stringent approvals than those
dictated by statute.
For example, investors’ rights agreements in the private company
context often require approval of a discrete class or series of stock-
holders that would not otherwise be required by state law — such as
approval rights on behalf of a series of preferred stock owned by a
venture capital investor.

• Appraisal rights
Appraisal rights are another element of statutory corporate law that
varies based on the nature of the transaction structure. For example,
Delaware law provides that stockholders of unlisted companies who do
not approve of a merger may exercise appraisal rights if they are dissatisfied
with the consideration the stockholders are to receive in the merger. On the
other hand, appraisal rights are not present in a stock purchase transaction
because stockholders are required to agree to the sale of their shares in
order for such a sale to take place. Some jurisdictions provide for appraisal
rights in connection with certain asset sales as well, although state law
varies.
• Deal process and mechanics
The process and mechanics of effecting the transaction vary depend-
ing on the deal structure, with mergers typically requiring more state
mechanics because mergers are creatures of state law. The merger pro-
visions of the various state corporation laws typically require the prepara-
tion and filing of detailed documentation (such as articles of merger) with
42


the Secretary of State or comparable state official in order to close the
transaction. These procedures can become more complicated when mul-
tiple jurisdictions and state merger statutes are involved due to the location
of the buyer and the seller. In contrast, parties to asset acquisitions need to
clarify any required mechanics with respect to transferring title to the assets
being sold, which can lead to some complexity depending on the assets and
the laws of the states involved. Because a stock purchase is effected for
equity at the stockholder level, the corporate law mechanics involved are
typically the least onerous of the deal structures, at least where the target is
a private company.

• Securities laws and mechanics

As discussed in Chapter 9, securities law considerations may impact
the choice of acquisition structure significantly. For instance, if a seller’s
stockholders are not all “accredited investors,” the buyer may not be able to
take advantage of an appropriate exemption from the registration require-
ments under the Securities Act of 1933, as amended, in order to issue the
seller’s stockholders shares of the buyer’s stock as consideration for
acquiring their shares. In that case, the buyer may choose to pay cash
at least to the non-accredited stockholders rather than go through the time-
consuming and expensive process of registering the buyer’s stock. Secu-
rities law requirements and mechanics could also make a cash deal faster
to close than a deal involving the buyer’s stock. There are additional
considerations if either the buyer or the seller are publicly traded.

Allocation and Assumption of Liabilities

By structuring a deal as an asset acquisition, a buyer can specifically
identify which of the seller’s liabilities it wishes to assume and which
liabilities it wishes to leave behind. This determination is very important
to both sides and therefore will likely have a very significant impact on the
negotiation and valuation of the transaction. For example, a seller may be
reluctant to retain a contingent liability once the business associated with
the liability is sold.

In contrast, a transaction structured as a stock purchase or merger, will
result in the buyer acquiring the seller’s equity ownership, and thus the
buyer will also assume responsibility for any and all liabilities inherent in the
seller’s business.
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Practical Tip: Liability Protection

The buyer may look to certain mechanisms within the specific
terms of the agreement to protect itself from the seller’s liabilities, even
where the buyer is acquiring all the seller’s stock, and thus acquiring
all the seller’s liabilities.
For example, the buyer may seek indemnification from the seller
and/or its stockholders, and it may insist on a holdback and escrow
with respect to the deal consideration to ensure that funds are avail-
able should liabilities arise after closing. See Chapter 7 for more
information on these techniques

A distinction also exists with respect to the type of stock acquisition. In
a stock purchase or indirect subsidiary merger, the seller continues after the
closing as a subsidiary of the buyer. In contrast, in a direct merger, the seller
and the buyer will become one entity, with their assets and liabilities pooled
together in one enterprise. To the extent the buyer is concerned about
liabilities from the seller’s business impacting its existing business and
assets, it will likely prefer having the liabilities contained within a separate
corporate subsidiary rather than merged with its own business.
The buyer should not rely too heavily on the notion that it can simply
walk away from the seller’s liabilities by structuring a deal as an asset
acquisition in which it picks and chooses the liabilities it wishes to assume.
In some jurisdictions, courts have applied the “de facto merger” doctrine to
treat a deal the parties had originally structured as an acquisition as a
merger instead. As a result, the buyer was required to assume all of the
seller’s liabilities.
Although uncommon, the risk that an asset acquisition will be rechar-
acterized as a merger highlights the importance from the buyer’s perspec-
tive — even in the context of an asset acquisition — that the buyer conduct
thorough due diligence and obtain appropriate representations and war-
ranties and indemnification from the seller. There is also case law relating to
liabilities associated with the business such as taxes, product liabilities and
environmental claims that cannot be left behind in an asset acquisition

Need for Third Party Consents
In structuring transactions, parties seek to minimize the number of third
party approvals required to consummate the deal. Having to obtain third
party consents can delay and even prevent an acquisition from getting
44


done, so it is important that the parties address assignment issues early in
the process.
An asset acquisition by definition involves the assignment of assets
between the seller and the buyer. Thus, parties to an asset acquisition must
carefully review important commercial agreements the buyer is expecting to
assume (such as license agreements, real estate leases, professional
services agreements and the like) in order to confirm whether such agree-
ments require the other party to consent to the assignment.
Because the forward triangular merger structure results in the seller
merging out of existence into the buyer’s acquisition subsidiary, such
transactions also require special attention with respect to the need for
third-party consents.
In contrast, a reverse triangular merger and stock purchase are not
likely to trigger anti-assignment provisions in third-party contracts because
the seller continues in existence as the surviving entity after the transaction
has closed and only the ownership of the seller changes hands. However,
diligence must be conducted to determine if consents are required under
specific agreements due to “change of ownership” or “change of control”
contractual provisions.

Practical Tip: Contract Assignment Provisions

In the absence of a specific provision in the contract explicitly
defining a stock purchase or merger as an assignment for purposes of
the contract, state law generally provides that an assignment of the
agreement has not taken place.

Tax Considerations
Tax considerations may in some cases be the most significant factor in
determining deal structure, and can also affect the overall economics of the
deal. The interests of the buyer and the seller may not be aligned in terms of
the optimal tax approach, which can lead to significant negotiations around
this issue.
The seller’s preferred result from a tax perspective is often to eliminate
the payment of tax upon closing the transaction — preferably at both the
entity and stockholder levels. Whether or not this is possible in a given
transaction will generally be determined by the structure of the transaction,
45


the nature and amount of the consideration the seller will receive in the
transaction, and the nature of the seller’s entity (e.g., whether the entity is a
C corporation or S corporation for tax purposes). Different rules apply
where sellers are LLCs or partnerships.
The buyer, on the other hand, often seeks to obtain a “step-up” in the
tax basis of the seller’s assets in order to claim larger tax deductions for
depreciation later on. Generally, an asset basis step-up is only possible if
the transaction is structured in such a way as to result in tax to both the
target corporation itself and its stockholders. Chapter 12 contains a more
in-depth discussion of some of the tax considerations inherent in an M&A
transaction.
While the buyer and seller’s preferences as to the best structure will
often conflict at any given price, it is sometimes possible to choose a
structure which, together with a price adjustment, results in everybody
coming out ahead.

46

Chapter 6
Definitive Acquisition Agreement
Business acquisitions are typically documented by a comprehensive,
definitive acquisition agreement, as well as a variety of ancillary agree-
ments that cover a number of substantive areas and address different
aspects of the deal. This chapter focuses on the key terms and provisions of
the definitive acquisition agreement, particularly as they impact the nego-
tiation and consummation of the transaction.

The title, scope and overall substance of the definitive acquisition
agreement will depend largely on the transaction structure. For instance,
an M&A deal effected as a stock purchase will be governed by a “Stock
Purchase Agreement,” whereas a deal effected as a merger will be gov-
erned by an agreement such as a “Merger Agreement” or “Reorganization
Agreement”. Most of the principal substantive differences among the var-
ious types of definitive acquisition agreements relate to differences in the
underlying transactions, such as the need in a Merger Agreement to have
provisions that deal with the statutory merger requirements arising from
applicable state law. Moreover, even within each type of transaction struc-
ture and agreement, there will always be substantive differences from
agreement to agreement that reflect the particular terms and idiosyncrasies
of the particular deal. Oftentimes these distinctions derive from differences
in the basic facts of the deal, such as the nature of the consideration being
paid (e.g., cash vs. stock) and the nature of the business agreement being
struck (e.g., whether or not there will be an escrow). Moreover, even where
the underlying substance of two agreements is generally comparable, there
may be considerable variation in the order of presentation of the various
provisions and the specific language relied upon to memorialize the busi-
ness arrangement.

Nonetheless, despite the many differences that exist among definitive
acquisition agreements from one M&A deal to another, virtually all agree-
ments in the negotiated acquisition context include the following basic
components:

• Definitions

• Economic and structural terms (i.e., form of transaction, purchase
and sale, pricing and related matters)

• Representations and warranties

• Covenants

• Deal protection devices
47


• Closing conditions and termination rights

• Remedies and indemnification

• Miscellaneous provisions

Definitions
Given the complexity of M&A transactions and the resulting complexity
of the definitive acquisition agreements themselves, most agreements
contain a separate section setting forth the principal defined terms in the
agreement. This is often useful from an organizational and structural
standpoint with respect to readability of the document. It is worth noting
that some of the defined terms that are used throughout the agreement are
very much substantive in nature and can have a real impact on the
underlying business deal. For instance, the definitions of “knowledge”
and “material adverse change” can be critical to the parties’ basic risk
allocation under the representations and warranties and indemnification
sections. For this reason, the negotiation of key definitions like these can be
critical to the ultimate resolution of the transaction.

Economic and Structural Provisions
The first few sections of the definitive acquisition agreement generally
cover the following key issues:

Purchase price amount and form

This section addresses the crucial issues of how much will be paid for
the business and what form the consideration will take. The nature of the
consideration to be paid will drive additional information and disclosure that
will flow throughout the rest of the agreement. For instance, if the consid-
eration includes buyer’s securities, the parties must address securities law
ramifications — i.e., a seller receiving unregistered shares of buyer’s stock
will likely demand registration rights, which will be reflected within the
definitive acquisition agreement and in a separate registration rights agree-
ment. Alternatively, if the issuance of the buyer’s stock to seller is being
registered, the definitive acquisition agreement will include provisions dic-
tating the timing and other details of necessary securities filings, including a
Form S-4 registration statement.
48

Chapter 6 - Definitive Acquisition Agreement

Closing and payment mechanics
This section details such mechanics as how the payments will be
made — e.g., wire transfer — as well as when and where the closing will
take place. This section will also include descriptions of statutorily-driven
requirements such as filing of articles of merger.

Identification of assets and liabilities
In the case of an asset acquisition, this section of the definitive asset
purchase agreement will contain a precise description of the assets to be
acquired and the liabilities to be assumed, which is of critical importance to
the underlying substance of the deal.

Timing of payments and earn-outs
The parties may agree to pay consideration in installments, in which
case the definitive acquisition agreement will detail the timing of ongoing
payments. In many cases, installment payments will be tied to future
performance. These so called “earn-out” provisions detail the negotiated
performance goals the successor company must achieve after the closing
to trigger additional payment obligations from buyer to seller. A seller might
rely on an earn-out to maximize consideration where it believes the future
performance of the business will be substantially better than its historical
performance. The buyer may be able to lower its initial cash outlay, avoid
overpaying for future revenues, and use earn-outs as an incentive to retain
and motivate key personnel of the seller after the closing. Properly drafted,
earn-outs may provide incentives to continuing management and maximize
value for both parties.
However, earn-outs are difficult to negotiate because of competing
concerns of the seller and buyer. The seller will be concerned about its
ability to track the financial performance of the business post-closing in a
way that accurately reflects the seller’s contribution to the performance,
whereas the buyer, particularly a strategic buyer, will seek the greatest
flexibility in operating and integrating the acquired business. The parties
should carefully consider how much time they will need to assess the
seller’s performance while ensuring that they don’t motivate the seller’s
management to maximize short term revenue at the expense of growth and
sound long-term business planning. Earn-out provisions should include
carefully drafted statements about who controls the successor entity, the
method of operating the business after the closing and methods of account-
ing for revenues, profits, losses and/or expenses, or other milestone
49


determinants. Although earnouts represent a possible way to bridge the
gap between an optimistic seller and a conservative buyer, these provisions
often lead to disputes post-closing.

Purchase price adjustments
Many definitive acquisition agreements contain provisions to adjust the
purchase price upon review of final financial information about the perfor-
mance of the business prior to closing, which is typically not available until
after completion of the transaction. For example, parties may include
purchase price adjustments to reflect changes in the seller’s working capital
or stockholders’ equity in the period prior to closing that could not be verified
in time to be reflected in the closing purchase price. This helps ensure that
the actual performance of the seller through closing was appropriately
captured in the purchase price. When purchase price adjustments are
included, the definitive acquisition agreement will typically contain mechan-
ics of delivery and review of financial statements covering the metrics
relating to the purchase price adjustment, dispute resolution, time limits
for bringing claims, payment of auditing fees, etc. The definitions of the key
terms and applicable accounting methods for determining the purchase
price adjustment are critically important.

Holdbacks and escrows
The parties may agree to hold-back and/or escrow a portion of the
transaction consideration to cover the seller’s indemnification obligations,
reductions in purchase price due to post-closing adjustments, or other
liabilities. In certain circumstances, the buyer may agree to escrow a portion
of the consideration payable upon achievement of earn-out targets. If the
parties agree to an escrow arrangement, the definitive acquisition agree-
ment will contain some basic details concerning the escrow arrangement
and the parties often also will enter into a separate escrow agreement with a
third party that will govern the management and release of escrowed funds.
In some cases a well-financed seller, whose business will continue after the
transaction, will not enter into an escrow arrangement and will have the
direct obligation to make any payments.

Exchange ratios caps and collars
If the consideration being paid by the buyer is shares of its public stock,
the parties will sometimes include provisions to adjust the number of shares
being issued at closing based on fluctuations in the buyer’s stock price
between signing and closing in order to ensure some limits on changes to
50


the underlying deal value. Negotiations over such adjustments can be key
to reaching agreement on the economics of the deal. The exchange ratio
can be “fixed,” that is, a set number of shares will be delivered at closing
based on a set ratio of shares of buyer stock to seller stock. This will
produce deal consideration that fluctuates on the value of buyer stock.
Alternatively the exchange ratio could be floating if the transaction is a
certain fixed dollar value of buyer stock, with the number of shares based on
the current market price typically measured over 5, 10 or 20 trading days
prior to closing of the buyer’s stock. This could result in a larger number of
shares being issued if the buyer’s stock price dips, resulting in potentially
unattractive dilution to the buyer.
The risks related to the two types of exchange ratios can be mitigated
by a collar or cap, pursuant to which the transaction will either result in (i) a
floating ratio becoming fixed or a number of shares becoming set at some
agreed upon point, or (ii) providing walk away rights for the parties at such
agreed upon value. The buyer and seller will need to negotiate these
provisions carefully, often requiring consultation with each party’s financial
advisors.

Purchase price allocation
The purchase and sale provisions in a definitive asset acquisition
agreement may allocate the purchase price between the business acquired
and the value of an agreement by the principals of the seller not to compete
with the business. In some cases, courts are more likely to enforce a non-
competition agreement if the party seeking enforcement can demonstrate
that sufficient consideration was delivered. Parties may also specify how
much of the purchase price should be allocated to goodwill. This allocation
is economically important and often the parties have opposite tax results
from any particular allocation, making this a critical negotiation.

Treatment of options and restricted stock
Merger agreements will typically contain a provision detailing the
treatment of the seller’s outstanding options to purchase seller’s stock in
the transaction, as well as unvested restricted stock, if any. For instance, in
many cases the buyer will assume the seller’s employee stock option plans
such that any unexercised options after the closing will become exercisable
for shares of the buyer’s common stock (after being adjusted for the
applicable exchange ratio in the merger). In other cases, such as where
the seller’s outstanding options permit the seller to cancel any unexercised
51


options in advance of a merger, the buyer and seller may agree to terminate
any options that have not been exercised as of the closing.

Appraisal rights
Where applicable, a merger agreement will contain a provision detail-
ing stockholders’ rights to seek appraisal remedies under applicable state
law. The buyer will often insist that its obligation to close the transaction be
conditioned on there not being more than a de-minimus percentage of
stockholders who pursue such appraisal remedies.

Representations and Warranties
The principal purpose of the seller’s representations and warranties is to
set forth, as of a certain point in time, key facts about the seller and its business
that the buyer considers to be material to the value of the business and its
decision to go forward with the transaction. For instance, the seller will be
required to represent to the buyer that it has obtained all requisite corporate,
contractual, and governmental consents necessary for the seller to sell its
business to the buyer. Other representations will focus on the seller’s business,
such as a representation stating that the seller has prepared its financial
statements in accordance with generally accepted accounting principles, or a
representation that the seller has paid all of its taxes on time.
The drafting and negotiation of the representations and warranties
must be considered in close conjunction with the seller’s preparation and
delivery of schedules to the representations and warranties — known as
“disclosure schedules” — that disclose any known exceptions to the state-
ments being made by the seller in the representation and warranties. For
example, if one of the representations requested by the buyer in the
agreement is that the seller is not in breach of any material agreements
involving the license of software, but the seller knows that in fact it is in
breach under such an agreement, the seller would need to include in the
disclosure schedules a description of the nature and scope of the breach.
By doing so, the buyer is put on notice that there is a potential liability and
the seller is complying with its obligation to disclose to the buyer all of the
material facts about the seller and its business.
Although the buyer will obtain much of the information it requires to
determine whether to proceed with the transaction and on what terms
through its due diligence review of the seller, the seller’s written represen-
tations serve as a critical backstop for the buyer’s diligence by confirming, in
a formal and legally binding manner, the information provided to the buyer.
52


Together with the disclosure schedules, the representations and warranties
also serve as a critical mechanism for allocating risk between the parties
and they can be a significant source of liability for the seller should any of the
representations and warranties prove to be untrue after the deal has closed.
In addition to (and sometimes in lieu of) a standard breach of contract
action, the seller may be required to indemnify the buyer for breaches of the
representations and warranties, which can be an especially powerful
weapon for the buyer where there is an escrow in place to support the
seller’s indemnification obligations. The representations and warranties
may also impact the buyer’s obligation to close the transaction. The poten-
tial impact on the closing of the transaction and on the seller’s future liability
to the buyer provides an important additional incentive to the seller in the
diligence process, helping to ensure that the seller is motivated to disclose
all material information to the buyer.

Typical Seller representations and warranties
Although the actual representations and warranties in the definitive
acquisition agreement will vary from agreement to agreement, some of the
more typical seller representations cover the following topics:
Consummation of the deal, e.g.:
• legal authority to complete the transaction, the nature of required
consents and approvals and legal and contractual non-contravention
• whether the seller owes any brokers’ or finders’ fees in connection
with the transaction
Legal matters, e.g.:
• due organization, qualification
• outstanding capitalization, rights to acquire securities and related
matters
• subsidiaries
• litigation
• intellectual property ownership and infringement issues, including
with respect to patents, trademarks, material licenses, etc.
• compliance with environmental laws and regulations
• compliance with laws
53


Financial matters, e.g.:

• preparation of financial statements

• undisclosed material liabilities

• preparation and filing of tax returns, payment of taxes

• accounts receivable/payable

• inventory

Composition and conduct of the seller’s business, e.g.:

• title to and condition of assets

• conduct of business and absence of material adverse change since
last balance sheet date

• material contracts and leases and absence of default relating to
same

• customers and suppliers

• provisions relating to any government contracts

• employee matters, including with respect to compensation, labor
disputes, employee benefits, etc.

• title to and condition of real property

• real property leases

• transactions with affiliates

• insurance

• permits

• a “catch-all” 10b-5 representation certifying as to the completeness
of the seller’s disclosure to the buyer

If unregistered securities of the buyer constitute part of the consider-
ation in a stock purchase or merger, the seller’s stockholders should also be
required to make comprehensive investment representations that are
drafted to ensure that the transaction will qualify for an exemption from
registration.
54


Key issues involved in negotiating the seller’s representations and
warranties
• Who is required to make the representations on behalf of the seller?
The selling entity will almost always make representations and war-
ranties to the buyer in the definitive acquisition agreement. In addition, the
buyer may ask any significant stockholders of the seller to make compre-
hensive representations and warranties as well, particularly if they have a
significant operating role with the seller. At a minimum, if the seller’s
stockholders are parties to the definitive acquisition agreement, such as
in the context of a direct stock purchase, they will be required to make
representations relating to their ownership of their shares and their ability to
enter into and perform the agreement.
The issue of who is making the representations and warranties on the
seller’s side is related to the question of purchase price adjustments,
holdbacks, escrows and other terms impacting risk allocation. The buyer
may be more comfortable proceeding without stockholder representations
if a sufficient portion of the purchase price has been held back to satisfy any
indemnification claims.
• As of what date(s) are the representations and warranties made?
The representations and warranties are typically made as of signing of
the definitive acquisition agreement. Moreover, in a typical transaction in
which the closing takes place some period of time after signing of the
agreement, the representations and warranties will also be “brought down”
to the closing. In most cases, the mechanism for ensuring that the repre-
sentations are valid as of closing is the inclusion of a closing condition that
the representations and warranties that were originally made at signing
must also be true and correct as of the closing. In some cases, this “bring-
down” may be qualified based on materiality, but that must be considered in
the context of the specific materiality qualifiers that exist within the repre-
sentations themselves (i.e., the buyer will want to ensure that the seller’s
representations are not subject to a “double-materiality” standard, that is, a
representation already qualified as to materiality should not typically be
further qualified to be “deemed to be true in all material respects” or except
where breach is not a “material adverse effect,” but instead is required to be
true without further qualification).
Additionally, a senior officer of the seller will be required to provide a
closing certificate certifying, on behalf of the seller, that the representations
and warranties are true and correct as of the closing. The seller may seek
55


the right to qualify a representation or amend a corresponding schedule
based on changes between signing and closing to account for intervening
events or new information. If the buyer accepts the seller’s right to update
the schedules, thus cutting off any indemnity claim for such updated
schedules, the buyer may be given the right to terminate the deal due to
such changes.
• Materiality and knowledge qualifiers
Much of the negotiation throughout the representations and warranties
will focus on the extent to which the representations will be qualified by
materiality considerations or considerations as to the seller’s knowledge.
For example, most practitioners would agree that the seller should be
entitled to rely upon a knowledge qualifier with respect to the typical
representation as to “threatened” litigation — i.e., the seller will not be
liable for failing to disclose any threatened litigation to the extent the seller
did not know that litigation was in fact threatened against it. In a similar vein,
most sellers would insist that they should not be liable to the buyer for failing
to disclose liabilities that would not have a material impact on the seller’s
business, such as a risk that the seller may lose its contract with the
company that provides it with water coolers for its employee lounge.
Negotiating the representations and warranties is in many ways an
exercise in risk allocation, and the buyer will typically resist many of the
seller’s requested qualifiers and insist on the seller bearing as much of the
risk as possible. For example, while the seller would in all cases prefer to
limit a representation it makes regarding its compliance with its contractual
obligations so that it only makes representations as to “material breaches”
of “material agreements,” the buyer has every incentive to want the seller to
make a “flat” representation in which the seller represents that it is not in
breach of any agreement to which it is a party. That is, the buyer wants the
seller to assume the full risk of any violations instead of forcing the buyer to
prove materiality.
In addition to the broader issue of risk allocation that is reflected in the
tension over the negotiation of materiality and knowledge qualifiers, sig-
nificant negotiation can take place at the more granular level of what forms
of knowledge and materiality qualifiers to use with respect to discrete
representations. For instance, the parties may negotiate whether to use
the phrase “to the knowledge of seller,” as compared with “to the best
knowledge of seller,” or even “to seller’s best knowledge after due inquiry.” A
related question is whose knowledge counts — while some agreements are
silent on how to determine whether the seller should be deemed to have
56


had knowledge of something, others specify that the actual knowledge of
enumerated senior officers or employees of the seller must be used to
determine whether the seller is deemed to have had knowledge in a given
case or provide that knowledge of any employee is sufficient.
Similarly, the definition of materiality is often sharply negotiated in
various contexts throughout the agreement. Definitions of “material con-
tracts” are often based upon a minimum dollar value. Another example is
the definition of “material adverse change,” which is often critical to deter-
mining the import of various representations and warranties, including the
standard representation that there has not occurred a material adverse
change since the balance sheet date. A typical negotiation point in this
definition is whether a material adverse change will be deemed to have
occurred if the material change relates to the seller’s prospects, as opposed
to its existing business. Forward-looking language like “prospects” injects
an element of subjectivity into the test for harm from a breach of a repre-
sentation. Sellers might also seek to negotiate a set of events that are not
deemed material adverse effects, such as changes in the conditions in the
economy or the industry or failures to meet internal projections. In each of
these cases, the precise word or combination of words used may impact the
eventual liability of the parties.
• Relationship of representations and warranties to indemnification
In most acquisition agreements, the representations and warranties
are closely connected to the indemnification provisions, and the two sec-
tions must be negotiated in careful conjunction with one another. For
instance, the indemnification provisions may apply differently to different
representations. Different treatment may include different survival periods
and different caps on liability. A brief overview of indemnification follows in
this chapter, while a more in-depth discussion of this topic is set out in
Chapter 7.
• Double materiality
The buyer should be wary of the effect of “materiality” qualifiers
throughout the definitive acquisition agreement, which may create a “dou-
ble materiality” standard. For example, if one of the conditions to the buyer’s
obligation to close provides that the seller’s representations and warranties
must be true and correct “in all material respects” as of the closing, the test
with respect to any representations that are qualified by materiality within
the body of the representation itself, such as a representation that there are
no material liens on any of the buyer’s assets, would have to breach two
materiality thresholds for the condition to fail. To avoid this issue, which
57


creates an ambiguity, the definitive acquisition agreement is often drafted to
make clear that the materiality qualifier on the closing condition does not
apply to any representation that as written is already so qualified. Similar
double-materiality issues can arise in connection with the indemnification
provisions to the extent the Seller seeks to limit certain of its indemnification
obligations to material breaches.

• Public company sellers

In the public company context, the seller’s representations may be
more limited and will likely incorporate its filings with the Securities and
Exchange Commission.

Typical Buyer Representations

The definitive acquisition agreement will also contain the buyer’s rep-
resentations to the seller, however, except for deals involving a “merger-of-
equals,” the buyer’s representations and warranties will typically be less
detailed than those given by the seller. If the buyer is issuing stock as
consideration in the acquisition, the buyer’s representations will be more
complete regarding its business than if cash is the consideration.

Practical Tip: Effect of Mergers of Equals and Stock
Transactions on Diligence and Representations

In a true merger-of-equals, the distinctions between buyer and
seller are less relevant — e.g., in a merger-of-equals, each entity
would likely be conducting the same basic level of diligence and be
equally concerned about receiving comprehensive representations
and warranties from the other party. In a stock transaction, the seller
will also typically do some diligence on the buyer, with the level of
diligence and scope of representations from the buyer growing as the
percentage of the combined company represented by the transaction
grows in significance.

Typically, these representations will be limited to the basics, such as
those ensuring that the buyer has all necessary corporate and legal
approvals necessary to consummate the transaction, can do so without
breaching its existing agreements, is not a party to litigation that would
impact the transaction, and has not hired a broker in connection with the
transaction.
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Depending upon the deal and the nature of the consideration being
paid, the buyer also may be asked to make representations regarding its
financial ability to complete the deal. If the buyer is issuing stock as part of
the consideration, the definitive acquisition agreement should contain addi-
tional representations regarding the due authorization and issuance of the
securities. In some stock transactions, the seller also may ask the buyer to
make additional representations relating to its business, based on the
notion that the acquisition will in effect constitute an ongoing investment
by the seller’s stockholders in the buyer. The scope of the representations
depends on the percentage of the combined company represented by the
stock issued in the transaction.

Interim and Post-Closing Covenants
In contrast to representations and warranties that essentially serve as
a “snap-shot” of the seller and its business at a particular moment in time,
covenants govern the relationship of the buyer and seller over a certain
period of time both before and after the closing of the transaction. The
majority of the key covenants cover the period between signing and closing,
but some covenants continue in effect post-closing. Depending on the
nature of the transaction, some covenants will be made by the buyer, some
by the seller, and some by both parties. They take the form of agreements
by a party either to do something or to refrain from doing something.
Depending upon the nature of the covenant, the parties may spend time
negotiating the extent of their obligation to perform certain undertakings —
for example, the distinction between a party using its “best efforts” vs. its
“reasonable commercial efforts” as compared to a flat obligation to do
something.

Interim covenants
Interim — or pre-closing — covenants are undertakings by the buyer
or seller to take or not take certain specified actions between the signing of
the definitive acquisition agreement and the closing. Their principal function
is to preserve the status quo such that the parties can be assured that the
business the buyer is acquiring at closing will be substantially the same as
the business the buyer agreed to acquire upon signing the definitive
acquisition agreement. For instance, the seller will typically covenant not
to sell a material amount of its assets. Another important purpose of interim
covenants is to ensure that the parties will take the necessary steps to
cause the transaction to be consummated, such as using their best efforts
to obtain all required regulatory consents necessary to close. Of course,
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interim covenants are only necessary to the extent there is a delay between
signing and closing, which is the case in most significant M&A transactions.
The reasons for a delayed closing are discussed further below in the
discussion of conditions.
Although they will vary from deal to deal, typical interim covenants
relate to the following types of issues:
• Agreement by the seller to conduct business in the ordinary course,
e.g., no capital expenditures in excess of a specified amount, no
material pay increases or bonuses, no dividends, no new hires, no
charter amendments or other transactions that would fundamentally
alter the nature of the business to be purchased, no sale of a material
amount of assets, etc.
• Seller providing the buyer with ongoing access to the seller’s records,
facilities and employees and the buyer’s ability to conduct due
diligence
• Agreement by parties to seek all necessary third party consents
• Confidentiality obligations of the parties, as well as agreements
relating to public announcements of the deal
• Agreement by both parties to make Hart-Scott-Rodino anti-trust
filings (to the extent applicable)
• Agreement of the seller to deliver interim financial statements or
copies of regulatory filings
• Agreement of the seller to notify the buyer of certain events, such as
the seller becoming involved in new litigation
• Agreement of the seller to a no-shop or non-solicitation provision that
prohibits the seller from shopping the deal once it has been
announced

Post-closing Covenants
Whereas pre-closing covenants relate solely to the period between
signing and closing, post-closing covenants are undertakings by a party
that are to be performed after the closing has occurred. For example:
• Agreement of the seller (and/or its former executives) not to compete
with the acquired business
• Allocation of deal expenses
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• Tax treatment and reporting
• Licenses and related provisions concerning technology and corpo-
rate names
• Continuing access to information and preservation of books and
records
• Registration rights where consideration includes unregistered secu-
rities (such provisions may also be contained in an ancillary
agreement)
• Continuing or transition support services, particularly in the context
of an asset sale or the sale of a division or subsidiary
• Covenant of the buyer to provide indemnification and/or directors
and officers insurance to outgoing directors and officers

Employee Matters
Most definitive acquisition agreements contain provisions that address
the treatment of employees in connection with the transaction, including
with respect to employee benefits issues. For instance, in a reverse trian-
gular merger in which the seller will remain in existence as the surviving
corporation after the merger, the agreement may require the buyer to
continue the employee benefit plans in place prior to closing at the same
levels for some period of time post-closing. In asset acquisitions where the
buyer acquires all or substantially all of the assets of the seller, the
employee-related provisions are often especially important given that the
employees’ employment with the seller will terminate as of the closing and
the parties may need to account for the hiring of the employees by the
buyer. The seller may want assurances that the buyer will extend offers of
employment to certain employees on certain terms and conditions, and the
buyer may want assurances that the seller will assist the buyer in hiring
employees that the buyer considers necessary to the ongoing business.
Regardless of the form of transaction, either or both parties will often
make the execution by the buyer of employment or consulting agreements
with key members of the seller’s management team a condition to the
parties’ respective obligations to close the transaction. The negotiation of
these arrangements can be difficult and time-consuming, particularly
around the issues of equity, change of control provisions, severance terms,
and the like. In addition, the specifics of noncompete provisions requested
by the buyer can be a sticking point in negotiations.
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Deal Protection Devices
A critical aspect of many M&A transactions, particularly deals involving
public company sellers, are the so-called “deal protection ” devices. Deal
protection devices are essentially anti-takeover provisions imposed by the
buyer to reduce the odds that a third party can come in and outbid the buyer
after the deal has been announced but before the stockholders of the seller
have approved the transaction and the deal has closed.
There are many types of deal protection devices, including the follow-
ing typical approaches:
• No-shop/no-talk clauses seek to limit the ability of the seller to solicit,
negotiate with, and in some cases provide information to, competing
bidders once the definitive acquisition agreement has been
executed.
• Termination — or “break-up” — fees can be used to compensate the
buyer with cash in the event the definitive agreement is terminated
prior to closing for reasons such as the failure of the seller’s stock-
holders to approve the deal because the seller’s board receives and
recommends a superior bid.
• Voting Agreements obligate certain stockholders of the seller to vote
their shares in favor of the consummation of the deal with the buyer,
making it more likely that stockholder approval for the buyer’s deal
will be obtained.
• Commitment to call a stockholder meeting requires the seller’s board
to submit the buyer’s deal to the seller’s stockholders, even if the
seller’s board withdraws its recommendation to vote in favor of the
deal.
• Stock options give the buyer the right to acquire a large percentage of
the seller’s stock — typically no more than 19.9% — under certain
circumstances related to the emergence of a competitive bidder for
the seller.
A key element of the no-shop/no-talk provision mentioned above is the
“fiduciary-out” provision, which serves to mitigate the impact of the no shop
covenant by giving the seller’s board some flexibility in responding to and
pursuing competing proposals, if it concludes that its fiduciary obligations
require it to do so. There are many variants of fiduciary-out clauses pro-
viding for more or less discretion and flexibility for the seller’s board
depending on their formulation: The fiduciary out might permit a seller’s
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board to break a “no-talk” restriction by providing information in response to
unsolicited proposals. Another provision will typically allow the board to
withdraw its recommendation to its stockholders under some conditions,
including the determination that fiduciary duties are at issue. In some cases,
a fiduciary-out termination right is drafted to permit the seller’s board to
terminate the definitive agreement and walk away from the deal entirely.

Even if the target board has a fiduciary-out clause, however, deal
protection devices can form a substantial impediment to the efforts of a third
party bidder to acquire the seller after it has announced a deal with the
buyer. For this reason, courts have limited the ability of intended buyers and
sellers to use these devices — i.e., they may not be “preclusive. It is
important to note, that the appropriateness of protection devices in any
given case must be considered based on the totality of the terms and the
circumstances surrounding the transaction; there are many variables that
can affect how a court in retrospect may view a given transaction, and many
of them depend on the specific facts underlying the deal.

Due to both the importance of deal protection devices to a given
transaction and the complexity of the applicable law, both the buyer and
the seller should very carefully consider their alternatives before agreeing to
any package of deal-protection devices. Chapter 8 looks at deal-protection
devices in more detail.

Conditions to Closing
A closing condition is a condition that must be satisfied in order for one
or both parties to be obligated to close the deal. The condition might take
the form of either an affirmative action by either party to the agreement or by
a third party, or the absence of an action or event. Failure or inability to
satisfy a condition to a party’s obligation to close will give that party the right
to terminate the transaction without any further obligation or liability.

Most agreements contain separate conditions to each party’s obliga-
tion to close, as well as common conditions to both parties’ obligations. For
instance, under almost all circumstances, the buyer will have as a condition
to its obligation to close some variant of the conditions that the seller’s
representations and warranties must be true and correct at closing. Alter-
natively, conditions to both parties’ obligation to close will likely include the
requirement that there not be any court order enjoining the parties’ con-
summation of the deal.
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Of course, closing conditions are only necessary to the extent there is a
gap in time between signing the definitive agreement and closing the deal.
There are numerous reasons why transactions are effected through
delayed closings, but they principally fall into three broad categories: the
need for regulatory approvals, the need for stockholder approvals, and
pragmatic deal considerations.
• Regulatory: There are many possible regulatory causes for delayed
closings. For example:
• Depending upon the size of the transaction and the size of the
parties involved, the parties may need to make antitrust notice
filings under the Hart-Scott-Rodino Act, which typically requires a
minimum 30-day waiting period before the transaction can be
consummated (assuming no early termination). In some cases,
the notice filing might trigger a more involved antitrust review,
which could further delay the transaction.
• In a stock-for-stock transaction that involves the issuance of reg-
istered shares by the buyer, the buyer will be required to file a
registration statement with the SEC and will need to obtain SEC
approval before the shares can be issued.
• Stockholder approval: Where stockholder consent is required, one
or both parties may need to convene a meeting of stockholders in
order to approve the transaction. This is most typical where there are
numerous stockholders and obtaining a written consent is not prac-
tical — or is not permitted by the applicable charter documents or
state law. Where a meeting of stockholders is required, it cannot take
place until sometime after the definitive agreement has been signed.
• Deal considerations: Often business and legal issues related to the
deal are the principal reasons behind a delayed closing. For example:
• Buyer must complete aspects of its diligence investigation of the
seller that it was not able to complete before the parties signed up
the definitive agreement (but note that in most cases the buyer and
seller are both well-advised not to enter into the definitive agree-
ment until buyer has substantially completed its diligence review);
• Parties must obtain certain contractual consents, such as a con-
sent of the seller’s primary bank, landlord, principal customer,
etc.; or
• Buyer must obtain financing to fund the deal consideration.
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In transactions where a delayed closing is necessary, both parties must
ensure first and foremost that the conditions that created the need for the
delayed closing are satisfied before the closing can take place — for
instance, if a Hart-Scott-Rodino notice filing is required, as further dis-
cussed in Chapter 11, the deal cannot close until the notice period has
expired or been terminated, or Hart-Scott-Rodino approval has otherwise
been obtained. Once a delayed closing is mandated, however, the parties
also must ensure that the passage of time does not alter the deal that they
agreed to when they signed the agreement. This latter necessity is of
primary importance to the buyer, which will want to know that the seller’s
business is substantially the same when they close the transaction as it was
when they signed up the deal sometime earlier.
As with most M&A deal terms, the nature of the closing conditions in a
particular deal will by necessity depend upon both the structure of the
transaction and the specific facts underlying that deal. For instance, con-
tractual consents are less likely to be necessary in deals structured as
reverse triangular mergers, so it is in turn less likely that obtaining con-
tractual consents will be a material closing condition of either party in a
reverse triangular merger. Similarly, issues unearthed in the due diligence
process will often impact the drafting of the closing conditions in a particular
deal. With that said, the following are typical conditions that appear reg-
ularly in a variety of different transactions:
• performance or satisfaction of pre-closing covenants reflected in the
definitive agreement;
• continued truthfulness of representations and warranties;
• satisfaction of regulatory requirements, such as HSR clearance;
• there having been no law, regulation or court order seeking to enjoin
the transaction;
• obtaining governmental and third party contractual consents;
• obtaining stockholder approval(s);
• no material adverse change with respect to the seller or its business;
• entering into any required ancillary agreements (e.g., escrow agree-
ment, registration rights agreement, voting agreement, employment
agreements and noncompetes, etc.);
• delivery of requisite legal opinions;
• delivery of other closing documents and certificates.
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It is also important to recognize the relationship between the closing
conditions and the interim covenants discussed above. Whereas covenants
of the seller contractually prohibit it from taking certain actions prior to
closing — or require it to take certain actions — in order to protect the
buyer’s interest in the transaction between the signing and closing, a closing
condition with respect to the seller’s compliance with such covenants will
enable the buyer to walk away from the deal if in fact the seller breaches a
covenant. For instance, if the seller were to breach a covenant prohibiting it
from selling a material portion of its assets before closing by selling an
important product line that the buyer expected to acquire in the transaction,
the buyer not only would have a possible claim against the seller for breach
of contract (and likely indemnification as well), but also would have the right
to terminate the agreement and walk away from the deal because it was no
longer getting what it had bargained for. In some deals, the buyer might also
be entitled to a break-up fee due to such breach and termination.
Two types of conditions are worth some further discussion: the con-
ditions that representations and warranties be true and correct; and the
material adverse change condition. Each typically engender negotiation.
The condition that the seller’s or buyer’s representations and warran-
ties be true and correct is subject to negotiation over two significant issues:
how significant a breach might result in failure of the condition, and when is
the truth of representations measured? Representations must generally be
true subject to some materiality standard. Thus representations must be
true “in all material respects” or “except where inaccuracies in the aggre-
gate do not result in a material adverse effect”. The difference between
these standards can be significant. In addition, often the representations
must be true both at signing and closing; while in some transactions the
representations must simply be true at closing, or less frequently at signing
(a so called “hell or high water” deal). These terms may affect the parties’
obligations to close the deal after a business setback has occurred. The
seller’s representations can be considered many separate conditions for
the buyer, all of which must typically be true or not materially false in any
way that harms the seller’s business in order for buyer to be obligated to
close.
The “no material adverse change” condition is another condition on
which buyer might argue no obligation to close on the occurrence of a
negative event in seller’s business subsequent to the signing of the agree-
ment. In some agreements buyers negotiate for a condition that there be no
material adverse effect on seller’s prospects, a forward-looking condition
that is difficult to measure. Sellers often negotiate carve outs to the
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definition of what is a material adverse effect, like effects arising from
economic or industry conditions, effects arising from the agreement, such
as loss of employees, customers or suppliers, or failures to meet projections
or “street” estimates. In each case the buyer will seek to limit such carve
outs, if accepted at all, by requiring that the effects not disproportionately
affect the seller, that the effects be directly related to the agreement or that
the underlying causes of a failure to meet a projection not be carved out of
the definition.
The importance of these two types of conditions, the truth of repre-
sentations and the material adverse change condition, is that changes in
the seller’s business between signing and closing will often trigger these
conditions. Accordingly, these are the conditions most likely to be asserted
if a buyer chooses to walk away from a transaction. The facts and circum-
stances surrounding the transaction and the parties’ intent may become
material to the resolution of any dispute.

Indemnification
Indemnification provides a post-closing remedy for losses sustained by
a party after the closing of the transaction as a result of breaches of the
parties’ representations, warranties and covenants. The indemnification
provisions are crucial to understanding the real risk allocation between the
buyer and seller under the agreement. We discuss indemnification at length
in Chapter 7.

Termination
In transactions with a delayed closing, the definitive agreement will
contain termination provisions that set forth the terms by which either or
both of the parties can terminate the agreement and walk away from the
deal before closing. The termination section is closely related to both the
covenants and the closing conditions and must be considered together with
those provisions. For instance, a breach by a party of a covenant will
typically allow the non-breaching party to terminate the agreement and walk
away from the deal. An example of this would be when the buyer terminates
the agreement because the seller failed to satisfy its covenant to obtain an
important customer consent, the receipt of which was a condition to the
buyer’s obligation to close. Note that, from the buyer’s perspective, a well-
drafted agreement would also give the buyer the right to waive the breach
and go through with the closing, while still preserving its right to recover
from the seller for the breach.
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Although they differ from transaction to transaction based on the
nature of the covenants, conditions, and other relevant deal points, the
following are examples of occurrences that will typically give rise to the right
of one or both parties to terminate the agreement:
• if both parties agree to terminate;
• if the transaction has not closed by a certain date (a “drop dead”
date)(provided that a party that was responsible for the transaction
not closing in time due to willful failure to perform a required covenant
should not be entitled to terminate under such provision);
• in the event of the inaccuracy of representations and warranties or a
breach of covenants in a manner resulting in a failure of the condition,
typically after some cure period;
• if required stockholder approval has not been obtained;
• if closing the transaction would violate any nonappealable final order,
decree or judgment, or any law; or
• by the buyer, if the seller has experienced a material adverse change
in its business.
As is the case with the relationship between the closing conditions and
the representations and warranties, the parties must be careful to consider
the possible impact of materiality qualifiers throughout the representations
and warranties and covenants on the parties’ potential termination rights.
For example, the buyer will likely resist a formulation that results in the seller
having the benefit of a double-materiality standard, such as when a rep-
resentation that is by its terms qualified by a materiality standard must also
be materially breached in order for the buyer’s termination right to apply.

Miscellaneous Provisions
As with the vast majority of corporate transactional documents, the
definitive acquisition agreement will include a number of provisions under
the heading of a “miscellaneous” section, such as provisions related to
governing law, notices, methods of dispute resolution, successors and
assigns, severability, payment of expenses, amendment and the like.
Although many of the so-called miscellaneous provisions approach “legal
boilerplate” and are not of real interest to the parties, some — such as
provisions addressing governing law, dispute resolution, and expenses —
can become of critical importance in the event the transaction does not
close or otherwise results in a dispute between the parties.
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Chapter 7
Indemnification & Contribution
Chapter 6 discussed how the definitive acquisition agreement will
include representations, warranties and covenants of the parties that serve
as conditions to the parties’ respective obligations to close the transactions
contemplated in the agreement and as risk allocation devices between the
buyer and the seller. Generally, the indemnification obligations of the parties
in the definitive agreement provide the mechanism through which the
parties can recover damages in the event of a breach of a representation,
warranty or covenant.

Why Indemnification?

If a post-closing event occurs or a pre-closing fact or circumstance is
discovered that causes damage to the seller, its business or the buyer (by
virtue of its post-closing ownership of the seller or its business), the buyer
will bear the risk of loss associated with this event, fact or circumstance
unless it has a contractual right of indemnification or some other cause of
action. To understand the need for indemnification rights it is helpful to know
the alternative avenues of recovery.

Breach of contract claims may be available to the buyer where the
seller fails to comply with its obligations under the definitive agreement. One
major drawback to breach of contract claims is the fact that parties to
litigation generally bear their own legal fees and expenses. Thus, even if the
buyer is successful on the merits of a breach of contract claim, it generally
will not be “made whole” in light of the legal fees and expenses incurred to
recover damages from the seller.

Tort claims such as fraud may also be available to the buyer in certain
circumstances. Major drawbacks to tort claims include the fact that proving the
elements of a tort claim is often difficult and that the time involved in success-
fully concluding tort litigation is often considerable. Further, as with breach of
contract claims, a buyer who brings a tort action generally will not be able to
recover its legal fees and expenses incurred with respect to the litigation.

To avoid the drawbacks associated with breach of contract and tort
claims, the buyer generally relies on rights of indemnification in the definitive
acquisition agreement. In most acquisition transactions other than acquisi-
tions of public companies, the seller and/or its stockholders will provide at
least some level of post-closing indemnification protection to the buyer.
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What Is Indemnification?
A typical indemnification provision will require one party to “defend,
indemnify and hold harmless” the other party from all “damages” that result
from a breach of the agreement or some other event or circumstance. In
other words, the indemnifying party will pay or reimburse the indemnified
party for any damages that its suffers with respect to matters included within
the scope of the indemnification provision. The definition of “damages” will
generally include legal fees and expenses associated with pursuing the
indemnification claim or defending the indemnified party against a third-
party lawsuit. This is done to make the indemnified party whole from the
losses it suffers.

The indemnification obligations in the definitive agreement are con-
tractual rights. As such they are defined and limited by the provisions of the
definitive agreement. Indemnification rights are typically subject to numer-
ous qualifications and limitations which are discussed below. Bear in mind
that a culpable act of a party may not be a prerequisite for recovery under an
indemnification provision. The parties to a definitive acquisition agreement
are free to agree to indemnification for any event or circumstance, regard-
less of whether it is the subject of a representation, warranty or covenant.
Thus indemnification is a highly effective means to allocate risk between the
buyer and seller, without regard to the malfeasance of a party.

Acquisitions of Publicly-Traded Targets
When the buyer acquires a publicly-traded target, it will rarely be able to
negotiate for post-closing indemnification from the selling stockholders.
The market’s resistance to post-closing indemnification rights in the public
context and the difficulties involved with seeking damages from a large and
disparate group of stockholders generally preclude the buyer from raising
the issue with the seller. Nevertheless it may be possible for the buyer to
negotiate for post-closing indemnification rights under certain
circumstances.

For instance, in a “going private” transaction where the seller’s stock is
not widely held and a small group of controlling stockholders hold a sig-
nificant majority of the outstanding shares, the buyer may be able to
successfully negotiate indemnification rights. The logistics of dealing with
contribution rights from selling stockholders may be manageable in this
context. The question will ultimately be decided by the negotiating leverage
of the buyer and the seller.
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Chapter 7 - Indemnification & Contribution

Types of Indemnified Matters
There are several types of matters for which indemnification rights are
typically provided in a definitive agreement. Often the limitations and
qualifications on the indemnification rights will vary depending on the type
of matter in question.

Representations and Warranties
The representations and warranties in the definitive agreement serve
both as conditions to the parties’ obligations and as a method for allocating
risk among the parties. As discussed earlier, in addition to the parties’ other
due diligence efforts, they will look to each other to reaffirm their under-
standings regarding the buyer, the seller and its business by making
representations and warranties in the definitive agreement. If it turns out
that any of the representations and warranties are not true as of the signing
of the definitive agreement and/or as of the closing, the parties will generally
have a right to walk away from the transaction.
However, most agreements provide that immaterial breaches do not
give rise to a walk away right, but do allow the aggrieved party to make an
indemnification claim after the closing to the extent damages are suffered. If
the parties close the acquisition and thereafter it is discovered that a
representation or warranty was breached, and as a result of that breach
the other party suffered damages, then the aggrieved party will generally be
able to bring an indemnification claim.
A typical definitive acquisition agreement will require the seller to make
many representations and warranties regarding itself, its business and its
legal ability to consummate the contemplated transaction. Particular atten-
tion may be paid to specialty areas such as tax, real property, environ-
mental, intellectual property, employee benefits and labor matters. One
area of negotiation is the time period after closing for which indemnification
is available, or the “survival period.” Standard representations might survive
for a period such as six months to three years, depending on the industry
and specifics facts of the parties. Specialty representations such as tax,
environmental, benefits, etc. might survive for longer periods, such as two
to six years, or for the period of the statute of limitations for the particular
type of claim.
The buyer’s representations and warranties in the definitive agreement
will generally be more limited. The seller will want to know the buyer has the
legal and financial ability to close the contemplated transaction. As
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discussed, much of the legal negotiation with respect to the definitive agree-
ment will center around the scope of the seller’s representations and
warranties.

Covenants and Agreements
Besides the principal obligation of the parties to consummate the
transactions contemplated by the definitive agreement, there will be several
other covenants (or undertakings) among the parties in the definitive
agreement. These agreements will generally be organized into pre-closing
covenants and post-closing covenants. Pre-closing covenants will focus on
the actions necessary to close the transaction, such as cooperation with the
buyer’s due diligence efforts, coordination with respect to required third
party consents, and perhaps deal protections for the buyer such as “no
shops” and “break-up fees” for the period between signing and closing.
Post-closing covenants will generally include agreements between the
parties regarding information rights and the transition of benefit plans
and employees to the buyer. The buyer will frequently obtain restrictive
covenants as well such as non-competition, non-solicitation and non-dis-
closure provisions.

Pre-Closing/Post-Closing Actions
The buyer will often try to obtain indemnification for any action that was
taken by or with respect to the seller and its business prior to the closing.
This request is usually resisted by the seller as it in effect expands the scope
of liability that was negotiated in the representations and warranties. If the
seller is unsuccessful in resisting this demand, it will sometimes argue for a
reciprocal right, i.e., indemnification for all actions taken by or with respect
to the seller and its business after the closing. The buyer will generally resist
this request as well as it can be used by a seller to circumvent the negotiated
risk allocations in the representations and warranties.

Specific Areas of Concern
In addition to indemnification for representations, warranties and cov-
enants, the buyer will generally require separate indemnification rights for
certain areas of concern, regardless of whether a representation or war-
ranty was breached. For instance, the buyer will almost always have
indemnification rights with respect to the disclosed tax liabilities of the
seller prior to the closing. The buyer also frequently obtains separate
indemnification rights with respect to disclosed environmental and
employee benefit plan liabilities of the seller prior to the closing. If during
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due diligence the buyer identifies any specific areas of concern, such as a
threatened or existing litigation matter, the buyer will usually negotiate for a
separate indemnification for such item as well. The buyer will also often
seek indemnification for transaction expenses and dissenters’ rights claims.
The buyer will frequently require that any negotiated limitations on indem-
nification, discussed below, will not apply to these special areas of concern.

Definitional Limitations on Indemnification
The buyer and the seller generally negotiate several limitations and
qualifications regarding their respective indemnification obligations. These
limitations and qualifications are usually discussed with respect to the
seller’s indemnification obligations, since the majority of the representa-
tions, warranties and post-closing covenants are obligations of the seller.

Scope of the Indemnified Parties and Indemnifying Parties
Perhaps the first limitation to negotiate is who will give indemnification
rights under the definitive agreement. Usually all of the parties to the
definitive agreement grant indemnification rights with respect to their
respective representations, warranties and covenants. But if one party is
uncomfortable with the credit risk associated with another party, it may
negotiate for an indemnification right from a more credit worthy affiliate,
such as the parent of the party to the agreement. Sometimes a minority
stockholder may be able to negotiate for limited or no indemnification
obligations if the buyer is satisfied with the credit risk of the majority,
controlling stockholder.
Another threshold limitation to negotiate is who will be a beneficiary of
the indemnification rights under the definitive agreement. Usually all of the
parties to the definitive agreement will be beneficiaries of the indemnifica-
tion obligations of the other parties. But it is not uncommon for other, related
parties to also be entitled to indemnification. The parents, subsidiaries,
officers, directors and employees of the parties to the definitive agreement
are frequently included within the scope of the indemnified parties. Some-
times the lawyers, accountants and lenders of the parties are also included.
Some provisions provide that any affiliate of a party is included within the
scope of the indemnified parties.

Scope of the Indemnified Breaches
Post-closing breaches of representations, warranties and covenants
will be included within the scope of indemnified matters in most definitive
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agreements other than an acquisition of a publicly-traded entity. The treat-
ment of pre-closing breaches is less uniform. The seller frequently is able to
exclude breaches which are disclosed prior to signing and sometimes will
be able to exclude breaches which occur after signing but before closing, so
long as the breach does not rise to the level where a closing condition is
unfulfilled. This type of arrangement sometimes calls for a hard decision by
the buyer: either close the transaction and waive its ability to seek damages
for the disclosed breach or walk away from the transaction. See the
discussion below regarding prior knowledge or “anti-sandbagging.”

Scope of Damages
The scope of the damages recoverable for indemnified matters is a
critical provision to negotiate. The seller will seek to put limitations on the
types of damages available, and will frequently seek to negotiate a limitation
that prohibits recovery of any type of damages other than actual damages
suffered. The buyer, on the other hand, typically counters that if it is able to
demonstrate to a judge that it is entitled to other types of damages, such as
consequential, lost profits and punitive damages, it should be able to
recover these damages as well. Many buyers will negotiate hard for con-
sequential damages (such as lost profits) that are reasonably foreseeable,
as these are frequently the only damages suffered due to breaches of
representations and warranties related to the seller’s customers and mate-
rial contracts. The parties will also negotiate the definition of damages and
may exclude damages based on diminution in value, damages calculated
as a multiple of earnings and punitive damages from the definitive
agreement.

Monetary Limitations on Indemnification
It is common for the seller to seek to impose monetary thresholds and
limitations on its indemnification liabilities. Sometimes the buyer will also
obtain the benefit of the negotiated limitations.

Baskets, Deductibles and Mini-Baskets
Baskets and deductibles are minimum thresholds that must be
exceeded by the aggregate amount of all losses claimed by an indemnified
party before it is entitled to indemnification. If the provision is expressed as a
basket, then once the threshold has been met, the party entitled to indem-
nification will be able to recover all of its losses related to the indemnified
matters, including the losses below the threshold. If the provision is
74


expressed as a deductible, then the indemnified party will only be able to
recover its losses in excess of the threshold. Baskets and deductibles have
the effect of shifting some initial portion of the risk of loss from the indem-
nifying party to the indemnified party.
A related concept is the mini-basket. With mini-baskets, if the damages
claimed by an indemnified party do not exceed the negotiated threshold,
then the indemnifying party does not have to indemnify for the loss, and the
amount of the loss is disregarded for subsequent determinations of whether
the basket or deductible has been reached. The theory behind mini-baskets
is that there is some threshold level of losses that is de mininis, and that an
indemnifying party should not be forced to investigate such claims because
the time and costs greatly outweigh such “nuisance” claims. Most buyers
resist mini-baskets and argue that their purpose is already served by the
materiality thresholds negotiated in the representations and warranties.

Caps
Caps are maximum limitations on the obligations of an indemnifying
party. If an indemnified party’s losses exceed the negotiated cap, then the
indemnified party will only be able to recover its losses up to the cap (and
subject to any baskets or deductibles).

Carve-Outs
It is common for buyers to negotiate to “carve-out” from the baskets,
caps and other limitations certain types of indemnification obligations.
However, indemnified parties generally do not want to create a situation
where an indemnifying party has an economic incentive to breach a pro-
vision of the definitive agreement because its indemnification exposure is
less than its anticipated economic gain by breaching the agreement. This is
particularly important in the context of obligations like non-competition
covenants. Where the parties end up is almost always impacted by the
individual facts of the transaction, as well as the parties’ relative negotiating
power.

Materiality Qualifiers
As noted, certain representations and warranties will have materiality
and knowledge limitations within their text. These limitations may also affect
whether a representation or warranty has been breached for purposes of
indemnification obligations. The buyer may argue, however, that materiality
and knowledge limitations should be disregarded for purposes of
75


determining whether a breach giving rise to indemnification has occurred
on the theory that the presence of a basket coupled with these limitations
creates a “double materiality” limitation and is “unfair” to the indemnified
party. If these limitations apply to the determination of the indemnification
right, they nevertheless typically do not act as a limitation on damages once
the breach has been established.

Other Limitations on Indemnification
In addition to definitional and monetary thresholds and limitations,
many definitive agreements contain one or more of the following limitations.

Prior Knowledge (Anti-Sandbag)

Anti-sandbag provisions provide that an indemnified party is not enti-
tled to indemnification for any matters that it knew about prior to closing.
The seller frequently negotiates for these provisions arguing that the con-
tract should provide an incentive for the buyer to raise any such matters
prior to closing so that the parties can negotiate a resolution of the issue
before the deal is closed. Buyers object to these provisions as unnecessary
to compel the buyer to discuss a problem with the seller — which naturally
happens during the due diligence process — and because the real purpose
of the provision seems to be to create a procedural hurdle for making
indemnification claims. The buyer argues that the seller will always claim
the buyer had prior knowledge of the matter if an indemnification claim is
made, and that the buyer will be forced to spend time and money refuting
this argument and will be forced to prove a negative (i.e., lack of
knowledge).

Prior Resolution (Purchase Price Adjustment)

Purchase price adjustment provisions are intended to ensure that an
indemnified party does not recover twice for the same indemnified matter.
The problem arises where the matter in question is the subject of a balance
sheet reserve and/or purchase price adjustment and an indemnification
covenant. For instance, if there is a $100,000 reserve for doubtful accounts
on the closing balance sheet which reduces the purchase price and a
representation in the definitive agreement that the accounts receivable will
be collected, and if it turns out that $100,000 of receivables are not col-
lectible, the buyer arguably should not be entitled to any indemnification for
losses because the purchase price delivered at the closing already
76


compensated the buyer for this loss via the reserve. To allow the claim
would effectively be a “double dip” in the seller’s eyes.

Insurance Proceeds

Another common provision that is requested by the seller and resisted
by the buyer is the concept that the losses recoverable by an indemnified
party should be reduced by the amount of any insurance proceeds actually
received with respect to the indemnified matter. As with the purchase price
adjustment, the indemnifying party’s concern is that the buyer should not
recover more than the losses suffered on account of an indemnified matter.
The buyer will typically agree to such provisions provided that they take into
account any increases in the cost of insurance caused by the matter, such
as premium increases or drop of coverage.

Tax Benefits

The seller may negotiate for a provision that provides that the losses
recoverable by an indemnified party should be reduced by the amount of
any tax benefits actually received or recognized with respect to the indem-
nified matter. As with the purchase price adjustment and the insurance
proceeds provisions, the indemnifying party’s concern is that the buyer
should not recover more than the losses suffered on account of an indem-
nified matter. However, measuring the tax benefits actually received on
account of an indemnified matter can be quite difficult, at best.

Sole and Exclusive Remedy
Many definitive acquisition agreements provide that indemnification
under the escrow is the sole and exclusive remedy of a party with respect to
an indemnified matter unless there is fraud, in which case the limitations are
generally not applicable under the terms of the agreement.

Indemnification Procedures; Dispute Resolution
In addition to defining the types of matters for which indemnification is
available and the limitations on the damages recoverable through indem-
nification, definitive acquisition agreements typically provide the procedural
mechanics for bringing and resolving an indemnification claim.
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Disputes Between the Parties
Many definitive acquisition agreements distinguish between third-party
claims and disputes between the parties to a contract when negotiating the
indemnification procedures. If the dispute does not involve a third-party
claim, then the ground rules established at the time of the signing of the
definitive agreement regarding how the parties will resolve their disputes
can be used to speed the negotiation and dispute resolution procedures in
the agreement. Required periods of negotiation, mediation, arbitration and
traditional litigation are all tools that are available to the parties to the
agreement.

Third Party Disputes
Resolving indemnification claims regarding third party disputes are
more problematic. Each of the parties will want to control the dispute
resolution process with the third-party and use its own lawyers and other
professionals. Each of the parties will want to have a say in the resolution of
the dispute, particularly if any fault is admitted or if any precedent is
established. The indemnifying party will many times negotiate to control
the dispute and its resolution, subject to the indemnified party’s ability to
participate at its own expense and to veto any settlement requiring it to
admit fault or pay damages.

Special Matters
Certain substantive areas such as tax and compliance with environ-
mental laws will frequently have additional procedures that govern indem-
nification claims. These tend to be fairly technical and are usually
negotiated directly by the relevant experts.

Hold-Backs of the Purchase Price
To secure the indemnification obligations of the seller and/or its stock-
holders under a definitive agreement, buyers frequently require a hold-back
from the purchase price. The form of the hold-back may be an escrow of a
portion of the purchase price, a contractual deferral of the obligation to pay a
portion of the purchase price until some date in the future, a promissory
note for a portion of the purchase price, or some combination of the
forgoing. In order to secure the seller’s performance of its indemnification
obligations, the hold-back usually will be coupled with a right of set-off that
will allow the buyer to forgo payment of the deferred portion of the purchase
price in the amount of the damages suffered. Sellers often resist the buyer’s
78


efforts to obtain the right of set off, although hold backs are quite common.
Another key question is whether the escrow is the exclusive remedy for
indemnification. Sellers will often negotiate for the escrow to be the sole and
exclusive remedy, while buyers will resist such term, which is effectively a
cap.

Contribution Agreements
Contribution agreements are entered into by parties who share joint
and several liability for an obligation. When there are two or more sellers in a
transaction, they will frequently enter into a contribution agreement to clarify
how they will allocate responsibility for indemnification claims among the
sellers for any liabilities that arise post-closing under the definitive agree-
ment. Usually sellers will bear responsibility pro rata based upon their
respective ownership interests with respect to representations, warranties
and covenants that are made on a joint and several basis, while imposing all
of the liability on the applicable seller with respect to representations,
warranties and covenants that are made on an individual basis.
The contribution rights of the sellers allow them to go against the
assets of the other sellers to the extent that they are forced to pay the buyer
for an amount under the definitive acquisition agreement in excess of their
allocated responsibility under the contribution agreement. In order to
secure the contribution obligations of the sellers, contribution agreements
frequently require a portion of the deal proceeds be set aside in an escrow.
Limitations on the parties’ indemnification rights and obligations on
both the upside and the downside are typically one of the most heavily
negotiated aspects of the indemnification section of the definitive acquisi-
tion agreement, with the parties often constructing complex and elaborate
provisions in order to establish an overall risk allocation scheme that is
satisfactory to them.

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80

Chapter 8
Fiduciary Duties of Board of Directors
A board of directors considering whether to commit the corporation to
an M&A transaction owes fiduciary duties, including duties of care and
loyalty, to the corporation and its stockholders. It is essential, therefore, that
directors considering M&A transactions understand and engage in strong
corporate governance practices and ground their decision-making in a
good-faith, disinterested, well-informed and well-documented process.
In M&A transactions involving “interested” directors, directors must
engage in a process to assure that the duty of loyalty is satisfied. In the
event of the sale of control of a corporation or transactions with
deal-protection devices, directors may have heightened fiduciary duties.

Overview of Fiduciary Duties
The Business Judgment Rule
The common law “business judgment rule” reflects the recognition by
the courts that businessmen, not judges or stockholders, run corporations.
The rule provides an important defense to sustain well reasoned, informed
and good faith business decisions by the board. The Delaware Supreme
Court has summarized the rule as follows:
“The business judgment rule ‘is a presumption that in making a busi-
ness decision, the directors of a corporation acted on an informed
basis, in good faith and in the honest belief that the action taken was in
the best interests of the company.’ ...A hallmark of the business judg-
ment rule is that a court will not substitute its judgment for that of the
board if the latter’s decision can be ‘attributed to any rational business
purpose’...” Unocal Corp. v. Mesa Petroleum Co., (Del. 1985).
To have the benefit of the business judgment rule, directors must
demonstrate that they have met the duty of care, the duty of loyalty and the
duty to act in good faith.

Duty of Care
Generally, directors have a duty to act in good faith and with reasonable
care. Directors must exercise the degree of care that a reasonable person in
a like position would exercise under “similar circumstances.”
The Delaware Supreme Court explained this duty in the context of
mergers as the duty “to act in an informed and deliberate manner in
determining whether to approve an agreement of merger before submitting
the proposal to the stockholders.” Smith v. Van Gorkom (Del.
81


1985)(emphasis added). In determining whether a board has met its duty of
care, the legal test is whether a board availed itself of all reasonably
available material information about the subject of the decision.
The extent and nature of a board’s review and ultimate determination
concerning a proposed M&A transaction may vary depending on, among
other things, the nature of the deal, its importance to the corporation, the
size of the corporation and certain timing considerations. The duty of care
requires directors to observe a process to make an informed decision.
Thus, a court’s review does not turn on whether a proposed transaction
ultimately turns out to have been unwise, a mistake of judgment or detri-
mental to the corporation, but rather on whether the directors’ actions in
reaching a decision on the proposed transaction evidence an appropriate
degree of rationality, diligence, consideration and deliberation.
Van Gorkom, however, has made it clear that the business judgment
rule’s protection in the context of M&A transactions requires directors to
prove that there was a decision making process that was designed to allow
the directors to be informed and consider all reasonable alternatives. In that
case, the court determined that a corporation’s directors were liable for
breaches of their duty of care for making an uninformed decision even
though there was no evidence of interested directors, personal gain, bad
faith or fraud.
The facts of Van Gorkom are illustrative:
Jerome Van Gorkom, the Chairman of the Board of Trans Union
Corporation, commenced discussions with a potential acquirer of Trans
Union without consulting with his board. Only after reaching terms for the
sale of Trans Union did Mr. Van Gorkom call a special board meeting to
consider the transaction. The directors were not provided notice regarding
the purpose of the meeting and were not provided materials, such as term
sheets, proposed valuation reports or transaction documents to review in
advance of the meeting.
Since Mr. Van Gorkom had also negotiated the terms of the proposed
transaction with only limited involvement from senior management, most
senior management members first found out about the proposed sale
during a meeting for senior management called an hour before the board
meeting was to be held.
During the meeting with management, the senior management team,
with the exception of the two executives who had assisted Mr. Van Gorkom
with negotiating the terms of the deal, expressed a strong negative reaction
82

Chapter 8 - Fiduciary Duties of Board of Directors

to the proposed transaction. Nonetheless, the board meeting went ahead
as scheduled.

During the board meeting Mr. Van Gorkom provided the board an
overview of the transaction — which ran approximately twenty minutes.
Trans Union’s Chief Financial Officer, who opposed the transaction at the
management meeting, stated that he could not indicate if the price was fair
but that the price per share offered was “at the beginning of the range” of a
fair price (it was noteworthy that Mr. Van Gorkom had actually suggested
the sale price to the potential buyer but did not disclose this fact to the
board).

After just two hours of meeting time, the board approved the transac-
tion without ever reviewing the definitive acquisition agreement. Mr. Van
Gorkom signed the definitive acquisition agreement later that evening. In
total, the board

• received little advance warning of the meeting,

• held only brief deliberations and discussions of the proposed
transaction,

• did not consult with or consider the advice of experts,

• did not review material transaction agreements, and

• disregarded the obvious hesitancy of members of senior manage-
ment regarding the proposed transaction.

With these facts in hand, the court concluded that Trans Union’s directors
had breached their fiduciary duty of care.

Directors considering proposed M&A transactions must not presume
that the business judgment rule will offer an absolute shield of protection.
Rather, they should take reasonable efforts to ensure a process that
demonstrates that they have reached a conclusion in a good-faith, well-
informed and well-documented manner.

Practical Guidelines for Considering the Duty of Care

While the determination as to whether a board has met its fiduciary
duties in the context of an M&A transaction will always be made by a court
vested with the benefit of 20/20 hindsight, practical guidelines on how a
83


board may satisfy its duty of care can be distilled from case law and
corporate statutes, and include the following:

• Know Your Business — Directors should have a working knowledge
of the business of the corporation as well as its products, plans and
potential problems.

• Haste Makes Waste — The board should avoid not only haste, but
the appearance of haste, in approving an M&A transaction.

• Decisions regarding M&A transactions should be made only after
directors have had a full opportunity to digest all available material
information.

• Directors should receive information in sufficient time to review it
adequately.

• Important and complex transactions, such as a sale of the corpo-
ration, generally will require more than one board meeting.

• No Substitute for Diligence — Directors should review and consider
carefully all available material information, and the board should
carefully review all relevant documents, including the definitive acqui-
sition agreement, prior to authorizing their execution.

• Obtain Expert Advice — Directors should consider the advice of
advisors or experts, including outside legal counsel and/or the
corporation’s investment banker, chosen with reasonable care (note
that the board may not entirely delegate its responsibilities or the
decision-making process to third parties). A board should consider
whether persons providing information regarding a proposed acqui-
sition are potentially biased due to severance arrangements, fee
arrangements or otherwise. Directors should also be convinced that
the advisors to the board are competent, were chosen with reason-
able care and are providing sound advice.

• Look Beyond the CEO — Directors should consider the advice of the
corporation’s other officers and employees who would be expected
to have relevant information on the subject.

• Ask Questions — Directors should ask questions and actively probe
and test all information presented to them, judging its reliability and
accuracy and understanding it fully, and review all issues important to
the directors’ conclusion.
84


• Be Cognizant of Conflicts — The board should ensure that “inter-
ested” directors recuse themselves from the discussion and the
decision.
• Leave a Thoughtful Record — The record of the board’s delibera-
tions should be documented carefully and completely.
Neither the presence nor absence of any one of these factors is likely to
be dispositive of a director’s compliance or breach of his or her duty of care.
Instead, courts will consider whether a director has given thoughtful con-
sideration to the issues, and will review methods of inquiry and sources of
information available to and employed by the director. Courts have, how-
ever, been more likely to conclude that directors have failed to meet their
duty of care when they have acted hastily or as passive participants without
carefully examining information provided by management and experts.

Duty of Loyalty
In addition to the duty of care, directors have a fiduciary duty to make
decisions based on the “best interests” of the corporation and its stock-
holders and not their own personal interests. This duty of loyalty is intended
to prohibit “self-dealing” by directors and generally requires that directors
have an absence of personal financial interest in the matters they approve.
Directors are not viewed as “interested” simply because they may
become directors of the combined entity, or because they are stockholders
or option holders. In contrast, a director who also serves as an officer or
employee of the corporation, or who is a member of a firm receiving
substantial revenue from the corporation, whether or not in the particular
transaction, may be viewed as having a self-interest not shared equally by
all stockholders. There may be employment agreements with management
directors which should be considered in determining if self-dealing trans-
actions exist.
A person who is a director of both the target corporation and a pro-
spective buyer has a conflict of interest, as the director owes a duty of loyalty
to each corporation. This director is required to keep information of each
corporation confidential, but is also obligated to provide material informa-
tion in his possession to each board on topics he knows are being con-
sidered. A director in this circumstance must recuse himself from any
discussion about a potential transaction for either company, and cannot
serve as an agent of either company without breaching his duty to one or
the other corporation.
85


All possible transactions or relationships that might influence a direc-
tor’s decisions concerning an acquisition, including relationships with other
prospective acquirers, should be fully disclosed to the board as a whole.
Courts have found that a board has met the requirement of independence
where a majority of the board consists of independent outside directors.

Practical Tip: Conflicts of Interest are Not Inherently
Improper But Require Good Process

Today, transactions that present conflicts of interest involving a
director are not viewed as inherently improper. Courts will instead
inquire as to the manner in which the board addressed the conflict of
interest to determine if the board’s decision was improperly influenced
by the interests of any interested directors or other corporate parties.

When an interested director transaction has not been approved by a
majority of informed and disinterested directors, courts may disregard the
business judgment rule and instead apply the “entire fairness analysis” —
which shifts the burden to the parties who entered into the transaction to
prove that the transaction was fair to stockholders. As such, the entire
fairness analysis is based not on whether directors acted in bad faith but
whether, in the absence of arms-length negotiation and bargaining, the
transaction, viewed objectively, is in fact fair and reasonable.
In the M&A context, the parties to the transaction will be required to
show that the transaction was the product of both fair dealing and fair price.

Practical Guidelines for Considering the Duty of Loyalty
The involvement of disinterested, independent directors in approving
an M&A transaction can increase the likelihood that a board’s decision will
receive deference under the business judgment rule or will survive the
heightened scrutiny attendant in cases involving sale of control
transactions.
For boards comprised of a majority of disinterested, independent
directors this protection can be found by having the interested minority
abstain from approving or negotiating the deal. Care must be taken to
ensure the special interest is fully disclosed to the board by the interested
director(s). When a majority of the board is interested and/or not indepen-
dent, or in cases where management is actively working with the buyer,
86


however, the board may wish to form a special committee comprised of
uninterested and independent directors and delegate to the committee the
authority to review and negotiate the terms of the proposed transaction.

Use of Special Committees
An effective special committee must:
• consist of members who are truly independent from the matters
under consideration,
• have the power to act independently,
• have access to all relevant material information, and
• engage in arms-length negotiation of the transaction terms.
When a board creates a special committee it is important that the
committee both be involved in the transaction and have the authority and
power to negotiate and ultimately disapprove the transaction. The com-
mittee, moreover, should be involved throughout the entire process of the
proposed transaction and not just at the initial or term sheet level or in the
initial efforts to choose one suitor from a field. Critically, a special committee
must also have a clear conception of its role in the deal negotiation and
approval process and must be aware that its members have the authority to
ultimately disapprove the deal. A special committee is not effective if it is
used only as a “rubber stamp” for a transaction negotiated by the man-
agement or interested directors.
To ensure that the committee members are fully informed regarding the
transaction, and have independent advice on strategy and tactics for
negotiations, the courts have held that special committees require their
own set of financial and legal advisors separate from those advising the
board. The special committee should have the power to select these
advisors and the advisors should report directly to the committee.

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Practical Tip: An Effective Special Committee Takes
Planning

The use of a special committee may be an invaluable tool to
address duty of loyalty concerns but requires advance planning,
additional time to accommodate the special committee’s separate
deliberations and the costs associated with retaining separate advi-
sors for the committee.

Alternatives to Special Committees
When a board is comprised of a majority of disinterested directors, it
may seek to address the potential influence of interested directors through
the following means:
• Approval by Disinterested Directors — When a director faces a
possible conflict of interest, such director should:
• submit such action or decision for approval by the disinterested
members of the board, and
• provide such disinterested directors or committee with full disclo-
sure as to the nature of the conflict of interest.
• Recusal from Board Discussions — Where a conflict of interest is
inherent, the most prudent course of action for an interested director
may be to withdraw from participation in both the voting upon the
issue (in order to achieve disinterested board member approval) as
well as the board’s discussion of the matter.
• Stockholder Approval — The board may choose to:
• submit the action or decision for approval by the stockholders of
the corporation (excluding any shares that might be held by the
interested director or affiliate), and
• provide the stockholders with full disclosure as to the nature of the
conflict of interest and the terms of the transaction in question.
Such stockholder approval (with full disclosure) may also bring an
interested director transaction within the scope of applicable statutory
safe harbors for interested party transactions.
In all cases, during the board meeting at which the potentially “inter-
ested” transaction is presented for approval, directors should thoroughly
88


review and discuss the proposed transaction, analyze and question the
internal and outside reports prepared in connection with the board review,
ensure that open issue items are addressed, and reflect in the minutes the
diligent deliberations in which the board members had been engaged.

Heightened Fiduciary Duties
Directors have heightened duties and a restricted range of action in
M&A transactions in two situations — those that will result in a sale of
control of the corporation or in transactions involving deal-protection
devices. In such instances, the conduct of the board with respect to a
proposed transaction is judged under an “enhanced scrutiny” standard.
Where the directors have determined that a sale of “control” or break
up of the company is “inevitable,” their duty is “the maximization of the
company’s value at a sale for the stockholders’ benefit.” Revlon, Inc. v.
MacAndrews & Forbes Holdings, Inc., (Del. 1986) “In the sale of control
context, the directors must focus on one primary objective — to secure the
transaction offering the best value reasonably available for the stockhold-
ers.” Paramount Communications v. QVC Network, Inc., (Del. 1994). A cash
merger or other business combination in which stockholders are cashed
out, or in which a stockholder or affiliated group of stockholders of the buyer
controls the continuing entity, is generally viewed as a “sale of control.” This
is because such a transaction represents the stockholders’ only opportunity
to receive a control premium. Thus, an acquisition transaction that is
primarily a cash transaction is judged under the Revlon standard, and if
the directors decide to pursue a sale of the company for cash the board’s
obligation is to obtain the best available terms for the stockholders.
Not every merger is a “sale of control.” Delaware courts have held that a
“stock-for-stock” merger, where a majority of the shares in the combined
entity will continue to be held after the merger by a “fluid aggregation of
unaffiliated shareholders representing a voting majority,” is not a sale of
control. Of course, even in a stock-for-stock merger, a board must continue
to exercise due care, reviewing all reasonably available information con-
cerning the transaction and other alternatives.
Even when a board is subject to Revlon duties, no one method of
obtaining the best value is required, and the board has reasonable latitude
in determining the method of sale most likely to produce the highest value
for all the stockholders. The clearest method to assure that the directors
have obtained the “best” available price is to conduct a public auction of the
company. Nevertheless, the courts have recognized that such an auction
89


damages the company, perhaps irretrievably, in the event a deal cannot be
made with potential buyers, and adversely affects the company’s ongoing
operations during the auction process. Perhaps as important, the courts
recognize that most bidders are unwilling to expend the time and effort on a
possible acquisition merely to serve as a “stalking horse” for another bidder.
Accordingly, Delaware courts have sometimes accepted as reason-
able directors’ reliance on a “market check” in which private inquiries to the
most likely bidders have been made, or where the transaction has been
publicly announced far enough in advance so that competing bidders may
have a reasonable opportunity to express interest. Moreover, Delaware
courts have held that in determining the adequacy of the offer in a sale of
control, directors may approve a transaction without employing an auction
or a market check, so long as they are able to demonstrate that they
possessed a “body of reliable evidence” on which to base their decision.
QVC Network, Inc. v. Paramount Communications, Inc., (Del. Ch. 1993),
citing Barkan v. Amsted Industries, (Del. 1989), affirmed (Del.1994). In
Barkan, the court noted there is “no single blueprint” for obtaining the
necessary evidence to satisfy Revlon duties. However, Delaware law is still
developing as to what constitutes sufficient “reliable evidence” on compar-
ative value.
In one Chancery Court case, the judge explained that although a target
“negotiated with a single bidder, it bargained hard and made sure the
transaction was subject to a post-agreement market check...” In re
Pennaco, Inc. Shareholders Litigation, (Del. Ch. 2001). In a recent case,
however, the Chancery Court noted that “[a]lthough the directors have a
choice of means they do not comply with their Revlon duties unless they
undertake reasonable steps to get the best deal.” In re Netsmart Technol-
ogies, Inc. Shareholders Litigation, (Del. Ch. 2007).
In the Netsmart case, the Chancery Court noted the obligation of the
board or committee to control every aspect of the process, including the
diligence process, to maximize value, and also criticized the special com-
mittee in that case for failing to consider seriously possible strategic buyers.
The target company board developed a process with their banker seeking
only private equity buyers, and relying on a post-signing market check as
the means to determine if other interest, including interest from strategic
buyers, existed. The Netsmart case signals the Delaware courts’ view that if
a board decides to pursue a cash sale of the company, the directors are
obligated to take “reasonable efforts to maximize the return to ... investors.”
This recent case confirms earlier cases permitting the board to use a
“market check” of likely buyers rather than a full-blown auction, but requires
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the board to use its business judgment to develop a process that will enable
a market check for logical buyers, and notes that reliance on a post-signing
market check is not per se reasonable. The Chancery Court noted the
“potential utility of a sophisticated and targeted sales effort,” tailored to “a
few logical buyers” and the use of a banker with industry connections to
market the company. The Court further elaborated that a board can legit-
imately consider the risks to the company from going to a broad group of
potential buyers, but that the risk must be real and weighed against the
board’s duty to obtain the best available price and terms. The board must
make a “genuine and reasonably-informed evaluation of whether a targeted
search might bear fruit.”

Exclusivity Agreement
A prospective buyer will sometimes propose an exclusivity agreement
to a target, arguing that the buyer does not want to be a stalking horse and is
unwilling to undertake significant expense in diligence efforts and negoti-
ation of an acquisition agreement without such an exclusivity agreement.
These types of arrangements are subject to significant scrutiny by the
courts, particularly in a cash transaction, given the board’s duty to maximize
stockholder value, and should be evaluated with caution. These arrange-
ments should not be entered into without board approval and only after
considering all the factors relevant to the arrangement, including the like-
lihood of other bidders, the duration and extent of any market check
undertaken, the amount of time requested for exclusivity, the status of
negotiations relating to price and terms and the relative attractiveness of the
offer compared to other alternatives reasonably available to the company,
the risk of losing the transaction at hand in the event exclusivity is not
granted and any other relevant factors.

Fiduciary Duty Implications of Certain of M&A Transaction
Terms
The board’s approval of certain transaction terms, no matter how well
discussed or considered, may itself constitute a breach of the directors’
fiduciary duties. In particular, the board’s approval of certain types of no-
shops, termination fees, breakup fees and voting agreements, and other
such deal-protection devices have been subject to scrutiny by courts. In a
transaction involving these “deal protection” devices, the courts have
applied a two prong test for determining whether a board has breached
its fiduciary duty. The first prong of the test is that the directors must have
had a reasonable belief that the takeover bid posed a danger to the
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corporation. The second prong of the test is that there must have been a
reasonable relationship between the threat of takeover and the actual
defensive tactics adopted by the board.

No-Shop Provisions
No-shop provisions are protective mechanisms used in M&A transac-
tions that seek to reassure a prospective buyer that the seller will not accept
a competing offer, by prohibiting the seller from soliciting other bids or
negotiating with other potential buyers. No-shop provisions reduce the risk
to the potential buyer that a proposed transaction in which it has invested
substantial time, energy and costs will be used as a stalking horse. No-shop
provisions may also benefit the prospective seller by inducing the prospec-
tive buyer to enter agreements for M&A transactions despite the risks that
the deal may not get done.
Directors have a fiduciary duty to carefully review and consider no-
shop provisions because the provisions may have the effect of precluding
competing bids that might offer greater value to the stockholders. In sale of
control transactions, no-shops provisions will generally only pass muster if
they are:
• found to be reasonably necessary to induce an offer that the board
reasonably believes is the best available bid, and
• drafted so as to contain a “fiduciary out” clause.
Fiduciary out clauses permit boards to consider unsolicited offers,
provide other unsolicited suitors with information, accept competing offers
and withdraw recommendations to the stockholders if the failure to do so
would result in a breach of the directors’ fiduciary duties.
The buyer can seek to limit fiduciary outs in a number of ways. The
most common way is to require that the seller’s board first conclude that the
alternative transaction on which the board seeks to exercise its fiduciary out
is a “superior proposal”. The seller can negotiate the definition of “superior
proposal” so that it is only triggered by a bid that is financially or strategically
better then the buyer’s offer or more likely to actually be consummated
based upon on a good faith determination of the board and/or supported by
the advice of a nationally recognized financial advisor that such offer is
indeed a “superior proposal” as well as advice of legal counsel that failure to
accept the new offer would result in a breach of the directors’ fiduciary
duties. A prospective buyer can also negotiate the fiduciary out to include a
provision that requires the seller to provide the buyer with advance notice of
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the competing offer and granting the original prospective buyer the right to
match the new offer.

Termination and Breakup Fees
Termination and breakup fees are financial penalties that must be paid
by one party to another party to a proposed M&A transaction upon the
occurrence of certain events that result in the transaction failing to close.
Such fees usually are triggered by:
• the seller’s decision to exercise its fiduciary out under a no-shop
clause and pursue a superior proposal; or
• the seller’s board’s withdrawal of its recommendation or failure to
reaffirm such recommendation upon the announcement of another
acquisition proposal; or
• an alternative transaction is announced and subsequently the target
stockholders do not approve the transaction and within some period
such as 6-18 months after termination of the merger agreement the
target enters into a definitive agreement for an acquisition proposal
or is acquired; or
• breach of the no shop.
Termination and breakup fees are generally permissible if required by
the target to induce the buyer to enter into the agreement. A board’s
decision to approve termination and breakup fees, however, is subject to
heightened scrutiny and may lose the protection of the business judgment
rule when the size of such fees becomes so large as to preclude bids which
might offer substantially greater value to the stockholders.
Directors determining whether to approve termination and breakup
fees in an M&A transaction thus must carefully consider both the size of the
fee and the events triggering its payment. There is no clear guideline as to
how large is too large, but court approved fees have generally ranged
between 1.0% to 4.5% of transaction value. Courts have said that there is
no “one size fits all” percentage but the terms must be considered in the
particular fact pattern to determine if the fees are preclusive to an alter-
native bidder.
The timing and triggering events for termination and breakup fees also
merit careful attention by directors. If a fee is triggered by a seller’s mere
provision of information to a potential suitor who makes an acquisition
proposal deemed by the target board to be reasonably likely to lead to a
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superior proposal, this would be of particular concern. The board should be
able to discuss with a prospective buyer in that case whether the offer is in
fact superior. The board generally should not fear losing the deal in hand
and having to pay a termination fee in connection with exploratory discus-
sions with a suitor who may offer greater value to the stockholders, so long
as the offer is unsolicited. In a recent Chancery Court decision, the Vice
Chancellor favorably commented on a termination fee structured to ensure
that stockholders “would not cast their vote in fear that a “no” vote alone
would trigger the fee; the fee would be payable only if the stockholders were
to get a better deal.”

Voting Agreements
A prospective buyer will often try to “lock-up” an M&A transaction by
obtaining a commitment from the stockholders, typically holders of 5% or
more of the voting stock and management stockholders, that the stock-
holders will

• vote in favor of the proposed transaction,

• vote against any proposal adverse to the buyer’s, and

• agree to certain restrictions on transfers of their shares until the
transaction is approved and consummated.

The lockup typically takes the form of a voting agreement between the
buyer and the seller’s stockholders and grants an irrevocable proxy. Voting
agreements containing lockup provisions warrant particular scrutiny
because they commit stockholders to vote in favor of a transaction even
though a more favorable offer may arise and without regard to the fact that
the board may have chosen to exercise a fiduciary out.

Voting agreements may implicate directors’ fiduciary duties because
directors are required to approve the agreements in certain instances. For
example, the applicable corporate statute may require corporations and
thus their boards to approve any lockup agreement in an M&A transaction to
which the voting securities of the corporation are subject.

Whether a voting agreement contains an unreasonable lockup, the
approval of which by a director constitutes a breach of fiduciary duty, can
hinge on the degree of the lockup and its preclusive effect on other offers. If
the voting agreement locks up too many of the seller’s stockholders such
that it creates a preclusive block on any other transaction, courts have held
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that the board’s approval of such a voting agreement will constitute a breach
of fiduciary duties.
Under Delaware law, if a merger agreement contains a “force the vote”
provision (under which the seller’s directors are required to submit a pro-
posed transaction to a stockholder vote even if the board subsequently
changes its recommendation), then it is illegal under Delaware law to also
have a voting agreement with a majority of the corporation’s stockholders to
vote in favor of the transaction. Delaware courts have held that the coupling
of a “force the vote” requirement and voting agreement that locks up a
majority of the voting shares effectively precludes any competing bids for
the seller and that by permitting the corporation to be subject to such
provisions, the seller’s directors may be in breach of their fiduciary duties by
not negotiating a fiduciary termination right.
Directors must ensure that any board approved voting agreement
containing a “force the vote” provision also provides for a fiduciary termi-
nation right or not govern so many shares as to preclude any other trans-
actions. Exactly where this preclusive threshold lies is unclear (courts have
found 33.5% of the outstanding voting stock to be sufficiently preclusive in
certain circumstances while finding that a 40% lockup was not truly locked
up).
In summary, arrangements such as “no shop” clauses, “break up” fees,
stockholder voting agreements, and “force the vote” provisions may be
justified under Delaware law if the board determines that the defensive
provision is necessary to obtain a favorable merger proposal, but only if the
provisions, taken as a whole, do not preclude the board’s consideration of a
more favorable transaction for the stockholders. Recent Delaware cases
make it clear that these types of “lockup” provisions are not to be entered
into without significant board scrutiny and a determination that the provi-
sions are reasonably tailored and actively negotiated to protect the
enhanced value inherent in the transaction and not to preclude all com-
peting deals.

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96

Chapter 9
Stockholder Approvals and Securities Law
Compliance
The parties to an M&A transaction will have to determine whether
either party will need to obtain stockholder approval for the completion of
the transaction. This is most often an issue for the seller in the transaction,
but depending on the deal structure and consideration to be paid in the
transaction, the buyer may also need to seek stockholder approval.
Stockholder consent requirements are usually driven by the laws of the
state of incorporation of the subject corporation or its charter documents
(i.e., certificate/articles of incorporation and/or bylaws). For example,
Section 251 of the General Corporation Law of Delaware requires that a
merger agreement between domestic stock corporations be submitted to
the stockholders of the constituent corporations for approval at an annual or
special meeting for such purpose. Note that in Delaware, if a buyer uses a
subsidiary corporation to make the acquisition, the parent corporation is not
a “constituent” corporation. In addition, the charter documents of the seller
may require additional consents from a separate class or series of shares,
e.g., from holders of a majority of the outstanding preferred stock (this type
of requirement is most often found in the charter documents of privately
held companies).
Another source of a requirement for stockholder approval may be the
listing agreement or governance requirements of a stock market or
exchange such as the New York Stock Exchange (NYSE), American Stock
Exchange (AMEX) or the Nasdaq Global Market (Nasdaq). Even in an
acquisition of a private company there might be a requirement on the buyer
side in connection with the issuance of the buyer’s stock as consideration
for the acquisition.
The requirements under stock exchange rules for stockholder approval
vary, but generally approval is necessary for transactions in which the buyer
will issue, or has the potential to issue, 20% or more of its outstanding
common stock, or if the issuance will for some other reason impact the
control of the buyer. The NYSE, AMEX and Nasdaq each have specific
rules in effect in this regard, and the rules need to be carefully reviewed to
determine application to the particular transaction. The impact of these
requirements and the determination of whether they are applicable to a deal
can be especially tricky in a transaction where the acquisition consideration
is based on a fluctuating per share price, or if the number of shares can
increase as the function of an earn-out provision. The buyer may include a
cap on the number of shares that may be issued in the transaction to
eliminate a need for buyer stockholder approval. Even in a situation where
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the buyer first raises money in a financing transaction (in which the 20%
limitation does not apply) in order to make a subsequent cash acquisition, if
the number of shares sold in the financing transaction constitutes 20% or
more of the outstanding common stock, Nasdaq generally takes the posi-
tion that such transaction would require stockholder consent.

Obtaining Stockholder Approvals
Timing
Obtaining stockholder approval usually takes place after the parties
sign the definitive acquisition agreement and should be a condition to the
closing of the proposed transaction. The buyer and seller will want to be
sure that they have a fully negotiated transaction before going to stock-
holders for consent. This is especially the case where the seller is a public
company and the consent solicitation material, or proxy statement, is
publicly filed with the SEC, as discussed below.
The period of time required for the stockholder consent process can
also vary greatly in length depending on whether the buyer and seller both
need stockholder consent and whether the seller is a public or private
company.

Practical Tip: Stockholder Approval Covenants

The parties typically include covenants within the definitive acqui-
sition agreement concerning the use of “commercially reasonable” or
“best” efforts to obtain requisite stockholder consents and to prepare
and file with the SEC any related materials as soon as practicable
after the signing of the agreement.

Voting Agreements
To mitigate the risks of the parties not being able to deliver required
stockholder consents, and therefore not being able to close the deal, the
parties may use voting agreements. Voting agreements, if used, are typ-
ically required of the seller, but when both parties are required to obtain
stockholder consents, they may be reciprocal. As discussed in Chapter 8, a
voting agreement is used to contractually bind a stockholder to vote in favor
of the proposed transaction and to vote against any alternative transaction.
The stockholders asked to sign voting agreements are typically limited to
those with a significant amount of stock.
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Chapter 9 - Stockholder Approvals and Securities Law Compliance

As noted in Chapter 8, the use of voting agreements is subject to
judicial scrutiny because of the restrictions that voting agreements may
impose on the ability of the board to fulfill its fiduciary duty to maximize value
to stockholders. In a private company acquisition, buyers often avoid this
issue by requiring the target to deliver consents of stockholders to approve
the transaction at the signing of the definitive agreement, or require stock-
holder approval to be obtained prior to the buyer entering into the acqui-
sition agreement. Note also that entry into voting agreements may also
require the buyer and/or subject stockholder to file with the SEC a Form 13D
with respect to changes in beneficial ownership of the seller’s stock.

The Process
The process by which the parties to an M&A transaction obtain
required stockholder consents will depend in large part on their status as
either a privately held or a publicly traded corporation and the nature of the
consideration being paid in the transaction. In any case, the parties will want
to be sure to provide to their stockholders information sufficient to make an
informed decision as to whether to consent to the transaction.
If the party seeking stockholder consent is a publicly traded corpora-
tion, it will include this information in a proxy statement that is filed with the
SEC. If the party seeking consent is a privately held corporation, it may
prepare an information statement that is not filed with the SEC, but which
includes most, if not all, of the information that would be contained in a proxy
statement filed with the SEC. If the buyer is issuing stock in the transaction,
and is not registering the stock with the SEC under Form S-4, the buyer will
need to find another exemption from registration, such as Regulation D or
Rule 3(a)(10) and in these cases the buyer will need to comply with the
information requirements of either Regulation D or of the state securities
laws governing the fairness hearing under Rule 3(a)(10).

The Proxy Statement
Once the definitive acquisition agreement is signed by the parties, the
preparation of the proxy statement begins in earnest. It is important to note
that the securities laws define the term “solicitation” broadly, which creates
problems for the constituent corporations trying to communicate about the
proposed transaction after announcement of the transaction and prior to
the filing of the proxy statement. Under Regulation MA, the SEC has
permitted companies to speak about the transaction prior to the filing of
the proxy statement, but the trade-off is that the corporation must file all
“solicitation” materials with the SEC on the date of first use with a legend
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indicating that they are additional soliciting materials. The judgment call as
to whether press releases, investor presentations or employee presenta-
tions are additional material required to be filed requires careful analysis
and should be considered with the assistance of legal counsel.
Schedule 14A under the Securities Exchange Act of 1934 outlines the
information to be disclosed in a proxy statement concerning a transaction
being submitted for stockholder consent. This information may include:
• Description of the Transaction — A description of the basic mechan-
ics and effects on the constituent corporations of the merger
transaction
• Background of the Transaction — A chronological description of the
facts and circumstances behind the proposed transaction and how
the parties came to sign the definitive agreement
• Reasons for the Transaction — A description of reasons that the
board deems the proposed transaction to be in the best interests of
the corporation and its stockholders
• Recommendation of the Board of Directors — A statement as to the
board’s recommendation whether or not to approve the transaction
• Fairness Opinion — A description and background behind any fair-
ness opinion rendered by financial advisors as to the fairness of the
proposed transaction to the stockholders from a financial point of
view
• Interests of Officers and Directors in the Transaction — Disclosure
regarding the interests of the officers and directors of the corporation
in the transaction, including deal consideration, change of control
payments, severance, employment arrangements, etc.
• Appraisal or Dissenters Rights — A description of any appraisal or
dissenters rights available to stockholders that do not vote in favor of
the transaction
• Material Tax Consequences — A discussion of the tax impact of the
transaction on the stockholders of the subject corporation
• The Definitive Acquisition Agreement — A description of the material
terms of the definitive acquisition agreement, including mechanics
and effects, consideration, representations and warranties, cove-
nants, conditions to closing and termination rights and effect of
termination
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The corporation seeking stockholder consent will need to file the proxy
statement with the SEC in preliminary form at least ten days prior to
distributing the materials to the stockholders. These preliminary proxy
materials are subject to review and comment by the SEC. The SEC will
promptly advise the corporation if it intends to review the preliminary proxy
materials. If the SEC advises that it will not review the materials, the
corporation is free to distribute the definitive proxy materials to its stock-
holders and concurrently file them with the SEC. If the SEC comments on
the preliminary proxy materials, the corporation may be required to file
amended proxy materials or may be able to make requested changes in its
definitive proxy statement. In the event the SEC elects to review the
preliminary proxy materials, it may take thirty days to receive comments
and forty-five to sixty days to complete the review and comment process,
sometimes longer. Accordingly, it is prudent to file the preliminary proxy
materials well in advance of the anticipated mailing date of the definitive
proxy materials to stockholders. A filing fee is required with the filing of a
proxy statement and is generally equal to one 50th of one percent of the
aggregate value of the transaction.
If instead the transaction is being accomplished without a filing with the
SEC, the target company will have to determine the material information
required to disclose the transaction; it is advisable to consider the types of
information deemed material by the SEC in making this determination. If the
buyer is issuing stock, the buyer will also need to determine that all material
information is provided to the target stockholders for their determination as
to whether to approve the transaction. Regulation D sets forth information
requirements for the sale of securities, and state securities laws may
provide information requirements, particularly if the buyer is relying on
an exemption from registration under Section 3(a)(10). State case law may
also provide further rules on information to be provided to stockholders.
Once the definitive proxy statement has been completed, it will be
mailed to the stockholders. State corporate law and the corporation’s
charter documents will establish the time frames for delivery of notice of
the stockholder’s meeting concerning the transaction. The notice period is
generally no less than twenty days and no more than sixty days prior to the
stockholders’ meeting. The notice is usually included as part of the proxy
statement. In order to ensure that stockholders have sufficient time to
receive and act upon the proxy materials, the corporation will want to
distribute the materials as far in advance of the meeting date as permitted.
Recently, electronic distribution (via Internet and e-mail) of proxy
materials has become available and is encouraged by the SEC, subject
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to certain requirements and constraints. These methods help increase the
efficiency and decrease the costs of the proxy solicitation process. How-
ever, care should be taken to comply with both federal securities laws, with
respect to disclosure and delivery, and state laws, with respect to voting
procedures.

Proxy Solicitors
To help ensure that the required stockholder consent to the transaction
is obtained, the publicly traded corporation seeking consent will often
employ a proxy solicitor. Proxy solicitors can be particularly helpful dealing
with brokerage houses that hold large numbers of shares in “street name”.
The role of the proxy solicitor becomes more important in a transaction that
is contentious or not universally viewed as a positive event for the
corporation.

The Stockholders’ Meeting
The time and location of the stockholders’ meeting will have been
included in the notice of meeting and proxy statement and may be held at
the offices of the corporation or at any other facility that is adequate to
accommodate the stockholders. Oftentimes, a corporation will choose to
hold the stockholders’ meeting at an off-site location to minimize disruptions
among employees. However, if the proposed transaction is generally
viewed as a positive event, the corporation may want to encourage
employee attendance and participation. Given that many stockholders will
simply complete and return their proxy card, rather than appear at the
meeting to vote in person, frequently only stockholders that live in the
vicinity of the meeting will attend. Attendance can be expected to increase
in a contentious transaction.
In addition to the stockholders, senior management and some or all of
the members of the board of directors will attend the stockholders’ meeting.
This gives the stockholders the opportunity to ask questions and obtain
feedback from management and the directors concerning the issues raised
by the proposed transaction.
The corporation will also appoint an inspector of elections to tabulate
the votes cast at the meeting in person and by proxy and to certify the
results of the vote. The inspector of elections is usually a representative of
the corporation’s transfer agent, but may be another independent third
party. In most cases, the corporation will also have its legal counsel attend
the special meeting to address any voting or procedural issues. Presence of
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legal counsel may be particularly important in the context of an unpopular or
contested transaction.

Once it has been determined that a quorum is present at the meeting
either in person or by proxy, the vote will proceed. Thereafter, the inspector
of elections will tabulate the votes to determine if the requisite stockholder
consent was obtained. Oftentimes, corporations will include as a proposal
in the proxy statement the adjournment of the meeting if deemed necessary
to facilitate the approval of the proposed transaction, including to permit the
solicitation of additional proxies if there are not sufficient votes at the time of
the meeting to approve the transaction.

Information Statements and Written Consents

As noted above, if the corporation seeking stockholder consent to a
proposed transaction is a privately held corporation, the process will likely
be simpler and faster than a public corporation. Depending on the circum-
stances of the transaction, the information requirements for the stockholder
solicitation may be substantially the same as those for a proxy statement or
somewhat less. Either way, the corporation should strive to provide as much
information as practicable on which the stockholders can base their deci-
sion whether or not to consent to the deal. The simple fact that the
corporation will not be required to file the information statement with the
SEC and potentially deal with a review and comment period will greatly
streamline the process.

The other factor that will simplify the stockholder consent process by a
privately held corporation is that the stockholders of many privately held
corporations are permitted by the charter documents of the corporation or
applicable state corporate law to act by written consent in lieu of a meeting.
In this circumstance, the corporation can save the expense and time of a
stockholders meeting and circulate a written consent with the information
statement. As noted above, a buyer may insist that a private seller provide
consents sufficient to approve the transaction at the time of signing of a
definitive agreement. This will be possible if the affiliates of directors and
officers knowledgeable about the transaction hold sufficient shares to
approve the transaction. In most states, if approval by written consent is
obtained by less than unanimous vote, the other stockholders must be
notified “promptly” of the stockholder approval. Alternatively, a target might
mail an information statement to all stockholders on the date of signing of
the definitive agreement and accept consents from those stockholders who
have sufficient knowledge of the transaction at the date of signing.
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Registration Statements for Buyer’s Securities
As noted above, if the buyer proposes to use its own securities as the
consideration for the transaction, it must either register those securities with
the SEC or have an available exemption from registration in order to
distribute the securities to the seller’s former stockholders at the closing
of the transaction. The buyer’s securities will normally be registered on
Form S-4, if no exemption from registration is available. The prospectus
contained as part of the registration statement becomes a proxy statement
for the seller’s stockholders meeting and is usually referred to as a proxy
statement/prospectus. In the event the consent of the buyer’s stockholders
is also required (e.g., due to stock listing requirements), the same docu-
ment may be used as a proxy statement for the buyer’s stockholder’s
meeting.
The information requirements of Form S-4 are voluminous and require,
in addition to all of the information contained in a proxy statement, detailed
information regarding the businesses of the corporations, financial infor-
mation, stock ownership information and much more. Incorporation by
reference to SEC filings is permitted subject to various requirements,
and legal counsel should be consulted about the preparation of the proxy
statements/prospectus.
Alternatively, buyers may rely on Regulation D or Rule 3(a)(10) for an
exemption from registration; as noted above, each of these exemptions has
requirements as to information and procedures for seeking stockholder
approval.
Given the timing considerations and overall importance to the parties’
ability to close the deal, an early assessment of the stockholder approval
and securities registration requirements for a proposed transaction is key.

104

Chapter 10
The Role of Investment Bankers in M&A
Transactions
Up to this point, we have assumed that the prospective buyer and seller
unilaterally found each other and commenced acquisition discussions.
While a prospective seller may have a sense of who in its market is a
potential buyer and vice versa, even the most sophisticated company is
unlikely to fully grasp the universe of prospects, valuation issues, market
deal terms and the like. That’s where outside advisors such as lawyers,
accountants and, in particular, investment bankers add value to a trans-
action. Accordingly, this chapter focuses on considerations in engaging an
investment banker in an M&A transaction, as well as what to consider when
engaging a banker.
• Bankers come in all shapes and sizes.
Investment bankers and deal brokers can help a prospective seller
identify and attract prospective buyers and vice versa. Oftentimes, a bank-
ing firm will, on its own volition, identify potentially synergistic transactions
and present such potential deals to either the potential buyer or seller in the
hopes of being engaged by one party. Because they are immersed in the
world of M&A transactions, investment bankers typically have a deep
industry knowledge that even seasoned managers can benefit from. There-
fore, beyond the introductory step of identifying a willing buyer and a willing
seller, bankers have other key roles to play as well. For example, a banker
can:
• develop the sales process for a target company or the acquisition
process for a serial buyer;
• provide advice not only on deal terms but also deal psychology;
• help a buyer or seller determine how to bridge a valuation gap, or
identify solutions to issues arising in due diligence;
• assist a seller who is concerned about a deal term by thinking of
alternatives that may address the issue;
• identify terms that might be traded to achieve the parties’ goals in
order to get a deal done; and
• advise a buyer or seller when a deal is simply too difficult to close the
gap between the parties.
Despite considerable consolidation, by some estimates, there are
more than 2,000 companies in the U.S. offering investment banking ser-
vices. Larger banks, particularly those at the upper end of the market
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referred to as in the ‘bulge bracket’, tend to have expertise in a broader array
of industries and may also be able to assist with buyer financing and
international transactions. Smaller regional banks may focus on specific
industries within their particular region; while boutique investment banks
often maintain a national and even international focus in a particular
industry. Some firms structure and find deals for clients but do not advise
on the transaction itself. These so-called “deal brokers” can also be helpful
particularly for smaller transactions that may not be of interest to larger
banks.

The reputation of an investment bank with a prominent name can bring
credibility to a proposed transaction. Note that the company’s management
will be working with a particular lead banker and his or her team. Therefore,
it is important to know which bankers management will be working with and
find those individuals who have the expertise and approach the company is
seeking. If the company is hiring a banker for an M&A transaction, it will
want to consider the firm’s credentials and experience in mergers and
acquisitions rather than just its general experience.

• Fees

Fees vary among investment banks and deal brokers. Smaller
banks, regional and boutique banks and brokers typically offer lower fees,
and larger banks may have minimum fees. Therefore, consider the level of
outside advice and fees that are appropriate for the deal. A company
completing a series of small “roll-up” transactions may prefer to allow its
own managers to identify, structure and negotiate the deals, and only turn to
an outside expert for advice on a merger of equals or other significant
transaction.

Who Should Choose?
In most instances the managers of the company interview and hire or
suggest to the board that the company hire a particular investment bank.
However, the board should consider retaining this decision or delegating the
decision to a special committee when the transaction brings significant
financial gain to management, controlling stockholders or inside directors.
Removing these interested individuals from the engagement process will
enhance the actual and perceived independence of the investment banker
and its advice.
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Chapter 10 - The Role of Investment Bankers in M&A Transactions

Directors who rely on the advice of outside advisors with links to
interested parties leave themselves open to arguments that they did not
properly inform themselves about the proposed transaction.

A company can benefit from talking to investment bankers early in the
transaction process, even in an interview setting, but should balance the
benefit of early advice against any need it may have to maintain confiden-
tiality prior to engagement of the banker.

The Engagement Letter
After a company selects an investment banker to assist in an M&A
transaction, the banker will deliver the bank’s standard form of engagement
letter tailored to the particular engagement and setting forth the financial
terms. Engagement letters are negotiated, and a company should involve
counsel familiar with these types of arrangements. Because the investment
banker will be a key member of the transaction team and will be working
with management and outside legal counsel for several months, negotiating
the engagement letter can be a delicate process. The negotiators should
modify the letter where appropriate to reflect the interests of the company
and eliminate overreaching in the bank’s form but also demonstrate an
understanding of and sensitivity to the banker’s legitimate concerns. The
goal is an engagement letter that aligns the interests of the company and
the investment bank.

Covered Transactions

The first section of the engagement letter will describe the “transac-
tions” for which the investment banker will be paid a fee. The initial draft of
the letter will likely contain broad language defining the included “transac-
tions” as any sale of stock or assets. The scope of this language would
include a transaction for even one share of stock or a single piece of
inventory. Thus, while the investment banker has a legitimate interest in
securing its right to receive its fee, it is important that the letter accurately
reflect the economic realities of what the company is intending to accom-
plish in the deal — e.g., an M&A transaction involving all or a material
portion of a company’s stock or assets. Because there is often a minimum
fee payable upon a qualifying transaction, the sale of a percentage of the
company’s stock or assets triggering a fee should be evaluated in light of the
minimum fee’s relationship to the expected fee for a complete transaction.
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The company should also exclude routine business transactions that
might meet the technical definition of a qualifying transaction such as:

• licensing its intellectual property in the ordinary course of business;

• borrowing money or issuing equity to lenders or stockholders outside
the transaction; or

• other transactions unique to the company.

The company should review the company’s charter, securities and any
stockholders agreement to determine whether there are any transactions
that should be excluded.

Investment bankers do not like to share the risk that a deal will fall apart
after a term sheet is signed, however, they generally accept that they should
receive the success fee only if the deal is actually consummated. Conse-
quently, the appropriateness of any language providing for a success fee
upon the signing of a term sheet or letter of intent should be thoughtfully
considered.

If the company was investigating or shopping the transaction before
hiring the investment banker, it must decide whether the potential buyers or
targets it previously identified will trigger a payment to the investment
banker. If the negotiations are advanced, the company may wish to exclude
these parties from an included transaction. The tension in this situation is
the banker’s concerns that it will lose its success fee because of the
exclusions. The company may also consider allowing a banker to earn a
fee for these buyers or sellers as well, particularly when a significant
amount of work remains to be done. One compromise approach is to
provide for a discounted fee if the identified buyer or target becomes the
ultimate counterparty to the deal.

Scope of Services

The services the investment banker will provide should be spelled out
in sufficient detail to insure both that the company knows how much support
it can expect from the banker and to limit those services to the specific
transaction. Engagement letters often specify that the banker is the “exclu-
sive” banker for the transaction, which is acceptable so long as that
exclusivity does not carry over into other assignments. Bankers often
request that that they be retained for follow-up transactions and financing
or to complete a partial transaction.
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Fees
The fee section will attract considerable attention from both the com-
pany and investment banker and presents a key opportunity to align the
interests of the company and banker. The most common fee arrangement is
a success fee formulated as a percentage of the total transaction value.
When a banker represents the seller, the percentage typically increases as
the sale price exceeds the expected price. Thus the banker has an incentive
to seek the highest sale price for the seller and will be less tempted to
promote a low bid.
This practice reverses a long-standing approach, in which the per-
centage of the transaction value paid as a fee decreased as the size of the
transaction increased. Minimum fees and fees paid even if a transaction
does not close are appropriate when the banker will do a significant amount
of work and a transaction is not seen as likely to occur. Bankers often
request these fees to protect themselves against risks in completing a deal
identified by the banker that is unraveled by something outside the banker’s
control. To avoid disputes at the end of the transaction, the engagement
letter should specify that any deposit made by the company is credited
toward the final success fee.
Investment bankers prefer to be paid their entire expected fee in one
lump sum at closing, but the sale consideration is often paid over time and
may be contingent on meeting certain “earn-out” targets such as annual
EBITDA or revenue targets. If a portion of the purchase price is subject to an
earn-out, the fee should typically be paid and the base calculated when the
consideration is finally determined and actually received by the company.
Fees on sale consideration held by an escrow agent should also typically be
paid when the money is released from escrow.

How Fees Are Measured
An investment banker’s success fee will typically be measured as a
percentage of the aggregate consideration in the transaction. Aggregate
consideration is often defined very broadly to include not only obvious
consideration such as cash or stock but other arrangements including
payments for services, rent, separate real estate transactions and contin-
gent payments.
This broad definition evolved to protect the investment bankers from
attempts by companies to exclude consideration from the fee base by
recasting it as a side payment or part of a separate transaction. Tradition-
ally, assumed debt is also included in the aggregate basis in asset sales,
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and that trend has expanded to include the target’s debt in a stock trans-
action. Whether bonuses and payments to managers should be included in
the base depends on whether they are intended to be part of the sale price
but merely structured as a payment to managers. This situation is most
likely to occur when the stockholders are also the managers of a company.

Expenses
The company will typically agree to the investment bank’s request for
reimbursement of “reasonable” expenses but may establish a cap beyond
which the banker must request permission to incur any additional
expenses.

Conflicts and Confidentiality
Investment banks often work for more than one company in an indus-
try. Further, a bank and its affiliates may hold the stock of the company or a
proposed buyer in the accounts of its customers or trade in the stock of the
company. While these arrangements are often permitted, in some indus-
tries, companies are more sensitive to banks representing their competitors
or dealing in their stock, and each company must negotiate these items with
its banker.
Banks may wish to represent more than one bidder for a company in a
formal auction, and companies typically prohibit multiple representations
unless there is an irreplaceable advantage for using that particular bank.
Some investment banks will also seek permission to take the some-
what less controversial step of representing the seller and providing financ-
ing to the buyer in an M&A transaction. This can occur as “stapled financing”
in which the seller’s investment banker offers the same financing to every
potential buyer or on an ad hoc basis.
While the banker’s initial draft of the engagement letter will likely
explain the banker’s procedure for protecting and not sharing information
with its affiliates and third parties, these internal provisions do not protect
the company if information is accidentally or intentionally released. There-
fore, the company should add a duty on the part of the banker to maintain
the confidentiality of the company’s information.

Duration of Engagement and Tail Periods
The investment banker is likely to request that the company use its
services for as long a term as possible. However, given that most M&A
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transactions can be accomplished within six months, and a deal may be
perceived as “stale” if shopped for a longer period of time — a flexible
month to month or a fixed term of six to twelve months is an appropriate
arrangement for most engagements. A company will not want to be obli-
gated to continue working with an investment banker if the transaction is not
progressing and the company does not wish to continue the relationship.
The company will want an express right to terminate the banker’s
engagement after the initial period has expired. However, following termi-
nation, the engagement letter will likely provide for a “tail period” of some
duration (a negotiated point) in which the banker will still earn its fee if the
transaction that it was hired to negotiate occurs. This arrangement is
ostensibly to protect the good work of the banker when a transaction is
slow to materialize or delayed. This approach, however, will often prevent
the company from pursuing similar transactions on its own or hiring different
investment bankers. Therefore, a better approach is to negotiate a shorter
tail period and limit the qualified transactions to ones solicited by the banker.
This standard can be tightened to include only those counterparties that
were:
• contacted by the banker;
• expressed an interest in the transaction; and
• executed the confidentiality agreement.
Intermediate positions agreeable to both parties can also be negotiated.

Indemnification
Companies generally agree to indemnify the investment bank against
losses arising from the bank’s representation of the company. The compa-
ny’s obligation to indemnify will exclude losses caused by the bank’s willful
misconduct, gross negligence or bad faith. Often companies will also
attempt to exclude indemnification for losses resulting from the bank’s
ordinary negligence, but this term is accepted by banks only in rare
circumstances. In any event, the company will want the ability to control
the defense of any indemnifiable litigation and restrict the bank from settling
without consent of the company.
What happens in the situation in which the company and investment
bank are both involved in litigation but no liability is ultimately found? Who
pays for the bank’s litigation costs? Generally the company is required to
pay for litigation costs unless the investment bank is found to be the cause
of the liability through its willful misconduct, gross negligence or bad faith.
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Finally, the company will also be asked to waive any claims arising from
the bank’s representation except, again, those resulting from the bank’s
willful misconduct, gross negligence or bad faith.

Fairness Opinions
A fairness opinion is a letter from an outside investment banker to a
company’s board of directors stating that the consideration the company or
its stockholders is receiving or paying in a transaction is “fair from a financial
point of view.” Fairness opinions may also address other aspects of the
transaction — e.g., the board may seek outside confirmation that an
unusual or complicated structure is financially fair.

The primary function of a fairness opinion is to help directors demon-
strate that they have met their fiduciary obligation to act in the best interest
of stockholders. Courts have created the “business judgment rule,” which is
also codified in some statutes, to grant directors protection from liability
while managing a company. The rule is a presumption that in making a
business decision, the directors of a corporation acted on an informed
basis, in good faith and in the honest belief that the action taken was in the
best interest of the company and its stockholders. A fairness opinion can
help demonstrate that the directors were informed and acting in good faith
when approving an M&A transaction and refute a claim that the directors
should be liable for alleged losses resulting from the transaction.

After having fallen out of favor over a period of years, in 1985, in
response to a decision from the Delaware Supreme Court, companies,
public companies in particular, rekindled their affinity for fairness opinions.
That case was the Van Gorkom decision, which is discussed at some length
in Chapter 8.

In Van Gorkom, the court determined that the directors of a target
company failed to meet their fiduciary obligation to the stockholders
because they had not informed themselves of the relevant facts by use
of information reasonably available to them. The court elaborated that the
board’s consideration of a fairness opinion would have supported an
argument that they were informed. Thus despite the court’s further clari-
fication that a fairness opinion from an independent banker is not a legal
requirement, directors often request opinions to demonstrate that they were
informed and to place themselves squarely within the protections of the
business judgment rule. The letters serve a second purpose of educating
shareholders voting to approve a proposed merger, and as described later,
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are often summarized or included in proxy materials delivered to
stockholders.

Advance and Retreat
After the Van Gorkom decision, fairness opinions were viewed by many
as a requirement for target boards, and their popularity may have undermined
their integrity. Recently, fairness opinions have run into criticism causing
companies and investment banks to reevaluate their opinion practices. Most
of these criticisms stem from the relationship between investment banks and
their clients. In an acquisition, investment banks will often provide more than
one type of service to a company. The bank may be hired to find a suitable
target or buyer, underwrite the financing of the transaction or give other
strategic advice. An investment bank earns up to ten times more fees for
these services than for preparing a fairness opinion, and these larger fees are
often contingent on a successful conclusion of the transaction. If the same
investment bank is asked to prepare the fairness opinion for the transaction, it
has an incentive to produce a favorable opinion regardless of the underlying
evidence or risk losing substantial success fees for its acquisition work. In other
cases, banks may advise more than one party in a transaction, which creates
an incentive to justify the transaction to all parties since it has already deemed
it advisable.
Fairness opinions have also been criticized for the variety of valuation
methods and assumptions used. In the most favorable light, the array of
valuation methods: discounted cash flow, value of the company’s assets if
sold separately, multiples of revenue or EBITDA, comparable transactions,
and other methods, is necessary to give bankers latitude to use the most
appropriate valuation methodology for the transaction and industry. It is
worth noting, however, that even when a fairly objective valuation method,
such as discounted cash flow, is employed it can produce different results
based on the assumptions that are used in the formula.

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Make the Fairness Opinion Count

Practical Tip: Effective Fairness Opinions

If the directors desire the benefit of a fairness opinion, they should
be sensitive to the inherent shortcomings of such opinions and create
a process that will render an opinion on which they can justifiably rely.

The board should be sensitive to:

• the general reputation of the investment bank;

• the experience and training of the opinion team;

• whether the valuation methodology is appropriate and if the selection
of that methodology is adequately explained;

• whether the assumptions in the valuation are appropriate;

• who hired the investment banker — to avoid pro-management bias,
the board should consider hiring and supervising the banker directly;

• to whom does the banker report — is a special disinterested com-
mittee of the board necessary to avoid the influence of interested
directors; and

• whether the fee is sufficient to compensate the banker for a thorough
opinion.

Ultimately, in deciding whether to request a fairness opinion, who will
deliver it and what methodologies will be used, the board must balance its
need for reliance on the opinion against the cost of the opinion. A public
company has the option of including a fairness opinion in any proxy mate-
rials submitted to shareholders in connection with a transaction and in a
registration statement for shares to be issued as consideration in the
merger, and the SEC’s rules require a public company to describe any
fairness opinion it receives. Thus, when a challenge to the transaction is
expected, it is not only important that the fairness opinion be the profes-
sional work of an independent investment banker, it must be perceived as
such by the courts and those who will criticize the transaction.
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Chapter 11
Hart-Scott-Rodino and Related Regulatory
Matters
The Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the “HSR
Act” or the “Act”) was enacted to enable the federal antitrust enforcement
agencies to detect and deter potentially anticompetitive M&A transactions
before they occur. While the purpose of the Act is fairly straightforward, the
statutory scheme is a maze of technical tests and “triggers” that typically
require specialized expertise for accurate interpretation. This chapter offers
a high-level roadmap through the HSR Act and related regulatory require-
ments, but should not be considered an all-inclusive guide to the Act.
Obtaining the advice of specialized counsel to address the HSR Act
implications of specific M&A transactions is recommended.

Brief History and Purpose of the Act
In 1914, Congress passed the Clayton Act to prohibit, among other
things, mergers and acquisitions that may “substantially lessen competi-
tion” or “tend to create a monopoly.” The Clayton Act created a specific legal
basis to challenge potentially anticompetitive business combinations in
court, but did not provide federal enforcement agencies with a mechanism
to detect such combinations before they occurred. This left the agencies
facing substantial practical difficulties in seeking to undo mergers and
acquisitions long after consummation, giving rise to market inefficiencies
that often were seen to outweigh the potential competitive benefits of
enforcement.
The HSR Act was enacted in 1976 to address that problem by requiring
parties to transactions meeting certain thresholds to notify the federal
agencies in advance, and to await the expiration of a statutory waiting
period before consummating the transaction. Thus, the HSR Act gave the
Federal Trade Commission (“FTC”) and the Antitrust Division of the United
States Department of Justice (“DOJ”) a window of opportunity to review
certain potentially anticompetitive M&A transactions and, when appropri-
ate, file a lawsuit to prevent consummation of those that may substantially
reduce competition or tend to create a monopoly.

HSR Notification Requirements
Reportable Transactions
The HSR Act generally applies to acquisitions of voting securities,
assets, or non-corporate interests that satisfy the so-called “Size-of-Trans-
action” test and, if applicable, the so-called “Size-of-Persons” test. In an
115


effort to keep pace with changes in the gross national product, the Federal
Trade Commission revises the thresholds to be applied under these tests
annually (effective at the end of February). This chapter uses the thresholds
effective as of February 21, 2007.

Size-of-Transaction Test
Under the Size-of-Transaction test, no transaction is reportable unless,
as a result of it, the acquiring person will hold assets, voting securities, or
non-corporate interests of the acquired person valued at more than
$59.8 million. When, as a result of the transaction, the acquiring person
will hold voting securities, assets, or non-corporate interests of the acquired
person valued above $59.8 million but not above $239.2 million, then the
transaction is reportable only if the Size-of-Persons test is also satisfied.

Size-of-Persons Test
As noted above, the Size-of-Persons test only comes into play if the
transaction is valued above $59.8 million and not in excess of $239.2 million.
When it applies, the Size-of-Persons test is generally satisfied if either the
acquiring person or the acquired person has annual net sales or total assets
equal to or greater than $119.6 million and the other person has annual net
sales or total assets equal to or greater than $12 million. When the acquired
person is not engaged in manufacturing and the acquiring person has
annual net sales or total assets equal to or exceeding $119.6 million, then
the annual net sales of the acquired person are irrelevant and the Size-of-
Persons test is satisfied only if the acquired person has total assets equal to
or exceeding $12 million.

Joint Ventures
The formation of a joint venture or other corporation may be subject to
the Act. In such a formation, the entity to be formed is treated as an acquired
person and the entities or natural persons contributing to the formation are
deemed acquiring persons. Only these acquiring persons, and not the
entity to be formed, may be subject to a filing requirement, and the waiting
period will begin to run only when all contributors that are required to file do
so. The reportability of each contributor’s “acquisition” of the voting secu-
rities, assets, or non-corporate interests of the entity to be formed must be
analyzed separately under the Size-of-Transaction and Size-of-Persons
tests summarized above. Generally, the size of the acquired person con-
sists of all assets being contributed to the venture.
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Chapter 11 - Hart-Scott-Rodino and Related Regulatory Matters

When the joint venture to be formed is an unincorporated entity, the
transaction is reportable only if, as a result of it, at least one person will
control the new entity.

Multiple Reportable Transactions
Certain transactions give rise to more than one reportable acquisition,
each requiring separate reporting and the payment of a separate filing fee.
Two examples of transactions giving rise to multiple filings include acqui-
sitions in which the consideration consists, at least in part, of the stock of the
buyer, giving rise to a potentially reportable acquisition of the buyer’s stock
by one or more sellers; and so-called “secondary” acquisitions, in which the
acquiring person buys a target that in turn holds a reportable amount of
voting securities in a company outside the target’s person, thereby causing
the acquiring person to make a reportable acquisition of that outside
company’s stock.

Exempt Transactions
The HSR Act contains a number of specific exemptions and confers
upon the FTC the power to create additional ones by regulation. As a result,
there is a wide variety of exemptions that may apply to a particular trans-
action. Some of the most frequently used exemptions are summarized in
Annex 11.

Reporting an M&A Transaction
Notification and Report
The HSR Act generally requires the “ultimate parent entity” of each
acquiring and acquired person in a reportable transaction to file a Notifi-
cation and Report Form with the FTC and the DOJ, and to certify the
person’s present intention to carry out the subject transaction. Subject to
certain exceptions, in order to make such a filing the parties must have
entered into a written agreement, at least in principle, to proceed with a
particular transaction. Generally, a letter of intent to proceed towards a
specific transaction is sufficient to support an HSR filing, but the execution
of such a letter does not mandate that a filing be made at that stage. In fact,
there is no deadline for filing under the HSR Act — if a transaction is
reportable, however, the HSR Act prohibits consummation until the nec-
essary filings have been made and the applicable waiting period (discussed
below) has been observed.
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The Notification and Report Form requires the submission of both
documents and information. Notably, in addition to basic information about
the transaction and the parties, the form requires each person to submit:
• information about revenues derived in a “base” year (currently
2002) and in the most recent year (these must be categorized by
NAICS code at varying levels of detail);
• information regarding the parties’ corporate structure and securities
holdings;
• information concerning the acquiring person’s acquisitions in the
previous five years in the same industries in which the target is
active; and
• certain SEC filings, annual reports, and recently prepared balance
sheets.
In addition, the parties must submit certain documents, known as “4(c)”
documents after the relevant item on the form, containing information
relevant to the competitive analysis of the transaction. Item 4(c) seeks
“all studies, surveys, analyses and reports which were prepared
by or for any officer(s) or director(s)...for the purpose of evaluating
or analyzing the acquisition with respect to market shares, com-
petition, competitors, markets, potential for sales growth or expan-
sion into product or geographic markets...”
The definition covers any type of “document,” ranging from an informal
e-mail or hand-written note to a lengthy and carefully prepared report. It is
limited, however, to documents that relate to the specific transaction under
scrutiny. The agencies are particularly attentive to Item 4(c) and the con-
sequences of noncompliance can be severe, including significant monetary
penalties and injunctive relief against the transaction. It is therefore imper-
ative for filing persons both to conduct a thorough search for 4(c) docu-
ments and to create a reliable paper trail of having done so.
The item 4(c) requirement also raises issues with respect to document
creation, because the agencies often rely on 4(c) documents to form their
initial impression of the competitive effects of a transaction. For this reason,
it is essential to use great care in preparing analyses (or even descriptions)
of the proposed transaction. Parties to transactions that may raise sub-
stantial competitive issues are well-advised to engage antitrust counsel in
the early stages of deal negotiation, in order to develop a successful
regulatory strategy and review all documents relating to the acquisition,
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such as board materials, press releases, public announcements and inter-
nal assessments.

Confidentiality
All submissions made by acquiring and acquired persons to the anti-
trust agencies under the HSR Act are confidential (even with respect to
other filers in the same transaction) and not subject to the Freedom of
Information Act (“FOIA”). An exception to this general rule occurs when the
parties request early termination of the waiting period (as discussed below)
and that request is granted. In such cases, the fact that early termination
was granted to a transaction between an identified acquiring person and an
identified acquired person is published in the Federal Register and on the
FTC’s Website. By contrast, no public announcement is associated with the
expiration (as opposed to the early termination) of the waiting period.
Because only the grant of early termination of the waiting period is disclosed
to the public, in some cases parties may prefer not to request early
termination in order to avoid the risk of premature disclosure.
Although HSR Act submissions are not subject to FOIA, in cases
raising substantial competition issues certain documents and information
submitted under the Act eventually may enter the public domain as a result
of becoming part of the record in a court action brought by the agencies to
enjoin the transaction. The Act’s confidentiality provisions also do not
prevent access to the information by Congress.
Transactions that raise competitive concerns also present unique
challenges from the standpoint of confidentiality because the agencies will
contact third parties — such as customers or competitors — in the context
of investigating such transactions. While the agencies are not permitted to
reveal that an HSR filing has been made, the nature of their inquiries may
very likely tip off third parties that a particular transaction is about to occur.
For this reason, parties to transactions that may raise competitive issues
often choose to initiate the HSR process only after entering into a definitive
agreement.
Confidentiality concerns can also arise vis-à-vis other filers in the same
transaction. Preparing an HSR filing often requires counsel for the various
parties to consult with each other with respect to limited aspects of the Form
and documents to be produced. Similarly, counsel to parties in a transaction
that is likely to raise competitive issues will need to communicate with each
other, and possibly with each other’s clients and expert economic consult-
ants, in advance of the filing in order to prepare and implement a defense
119


strategy. Because HSR filings are made in anticipation of the possibility that
the government may sue to enjoin the transaction, the joint defense priv-
ilege typically attaches to all such communications regardless of whether a
specific written agreement is executed to that effect. Nevertheless, parties
to transactions that are likely to raise competitive issues are well-advised to
formalize a joint defense agreement in written form during the early stages
of preparing their respective HSR filings.

Filing Fees

The acquiring person in a reportable transaction is responsible for
paying the applicable filing fee. Although the rules permit filers to split the
fee, the common practice is for one party, typically the acquiring person, to
pay the entire applicable fee and seek separate reimbursement from the
other party(ies). This minimizes confusion and ensures that the appropriate
fee is linked to the corresponding transaction.

The amount of the filing fee depends upon the size of the transaction,
and the relevant thresholds are also subject to annual adjustment by the
FTCO. The following table shows current transaction value thresholds and
the corresponding filing fees:
TRANSACTION VALUE FILING FEE
Greater than $59.8 million, but less than
$119.6 million $ 45,000
$119.6 million or more, but less than
$597.9 million $125,000
$597.9 million or more $280,000

Waiting Period

The Act prescribes a waiting period (typically 30 days) during which the
parties may not consummate the acquisition. The waiting period is intended
to maintain the competitive status quo while the agencies analyze whether
the proposed transaction may substantially lessen competition in any
relevant market. The start of the waiting period is usually triggered by
the agencies’ receipt of complete filings from each person that is required to
make one for the transaction in question. If a transaction raises no com-
petitive issues, the agencies may simply let the waiting period expire without
further action. Upon expiration of the waiting period, the parties may close
the transaction without any form of official “clearance” by the agencies.
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The parties also may request early termination of the waiting period by
checking the appropriate box on the Notification and Report Form. A single
filing person’s request for early termination is sufficient to trigger the
agencies’ review and possible grant of the request and, as discussed
above, the grant of early termination is published in the Federal Register
and on the FTC’s Website. Therefore, parties wishing to maintain the
confidentiality of the transaction must ensure that no person making a
filing in connection with the transaction requests early termination. If early
termination is requested and granted, the grant typically comes two to three
weeks after all filings required for the particular transactions are received by
the agencies.

Don’t Jump the Gun
While the HSR Act proscribes formal consummation of a reportable
transaction prior to the expiration, or early termination, of the waiting period,
certain conduct by the parties short of actual consummation can also be
deemed to transfer “beneficial ownership” of the voting securities, assets, or
non-corporate interests of the acquired person to the acquiring person, and
thereby to violate the Act’s waiting period provisions. This type of conduct is
known as “jumping the gun” and can lead to severe consequences, includ-
ing substantial monetary penalties and injunctive relief against the parties
and the transaction.
In addition to the HSR Act, the parties’ conduct prior to closing must
also comply with the substantive provisions of the Sherman Act, which
prohibits collusion among competitors. Indeed, the Sherman Act requires
the parties prior to closing to consider one another as separate, indepen-
dent entities (and competitors, if appropriate), and to continue to deal with
each other accordingly. For example, the Sherman Act requires parties
prior to closing not to share with each other certain information (such as
detailed, competitively sensitive information about customers, prospective
strategic plans or current and future pricing) that would put the owner of that
information at a competitive disadvantage vis-à-vis the other party(ies) in
the event that the deal falls through.
The antitrust agencies also understand, of course, that the success of
most mergers and acquisitions depends on meticulous due diligence and
the ability to plan in advance for a smooth transition post-closing. The
agencies recognize, therefore, that a flexible, fact-specific approach is
required in the application of the rules that govern the parties’ conduct
during the HSR waiting period and, more generally, during the period
between the signing of the deal documents and closing. It is also broadly
121


understood that the range of permissible conduct in this context increases
as the closing draws nearer and conditions precedent to closing are sat-
isfied, making consummation increasingly likely. Because the permissibility
of particular conduct depends heavily on the specific circumstances of each
case, reliance on the advice of specialized counsel in this context is
particularly advisable.
Certain clear “DOs” and “DON’Ts” nevertheless emerge against this
background. The following is a list of the major ones, but it is not intended,
and should not be taken, as a substitute for the advice of counsel under
specific circumstances:
• DON’T:
• Transfer beneficial ownership of assets from one party to the other;
• Commingle the business or assets of the two parties;
• Take part in the business decisions of the other party;
• Allocate customers;
• Jointly negotiate with or sign agreements with customers;
• Jointly market specific products to customers;
• Coordinate pricing;
• Agree to terminate any product lines or implement other output
restrictions;
• Begin joint product development;
• Agree to eliminate a marketing or promotional program;
• Share current and/or future pricing information and/or strategies;
• Share internal planning documents; and
• Share competitively sensitive cost information.
• DO:
• Plan for a successful transition without actually implementing it
until after closing;
• Create specialized teams — possibly consisting, if practicable, of
third party consultants — to handle particular transition planning
or due diligence tasks, and create firewalls to protect competitively
sensitive information;
122


• Jointly inform customers about the impending transaction, without,
however, jointly marketing specific products to customers or
reaching joint agreements with customers; and
• To the extent necessary, exchange aggregate — not specific —
customer or product information.

Practical Tip: Diligence and Transition Planning

One way to ensure thorough due diligence and a successful
transition without running afoul of the antitrust laws is to make sure
that due diligence and transition personnel for each company are
different from the personnel involved in daily business operations.

What are the consequences of non-compliance?
In a word: severe.
Failure to report an otherwise reportable transaction, gun-jumping,
failure to produce all 4(c) documents, and other HSR Act violations can
carry stiff penalties. The antitrust agencies can seek fines of up to $11,000
per day of non-compliance and drastic injunctive relief, including retroactive
relief like the undoing of the transaction and “disgorgement” of unlawful
monopoly gains.
The HSR Act and rules also punish efforts to structure or analyze
transactions in particular ways solely for the purpose of avoiding an HSR
filing. The agencies condemn such “creative” practices as “devices for
avoidance” and will disregard them, deeming the parties to the transaction
to be in violation of the Act unless and until compliance is achieved. Heavy
fines can also be imposed for engaging in such practices.
For example:
• To settle gun-jumping allegations by the Department of Justice,
Gemstar-TV Guide agreed to pay a fine of $5,676,000. See United
States v. Gemstar-TV Guide International Inc., 2003 WL 21799949
(D.D.C July 11, 2003).
• The Hearst Trust agreed to pay a $4 million fine for failure to disclose
certain 4(c) documents in connection with its acquisition of Medi-
span. United States v. The Hearst Trust and The Hearst Corp., Civ.
No. 01-2119 (D.D.C. Oct. 10, 2001).
123


• Smithfield Foods, Inc. was fined $2 million for failing to report its
acquisition of voting securities of IBP, Inc. (total exposure was almost
$5.5 million). United States v. Smithfield Foods, Inc. Civ. No. 04-526
(D.D.C. Nov. 12, 2004).

Beyond Notification
What Does the Government Do with the Information Provided?
During the statutory waiting period, one of the agencies (either the FTC
or the DOJ) takes the lead in analyzing the transaction to determine
whether it may substantially lessen competition or tend to create a monop-
oly. In the vast majority of cases, the agency will determine that the
transaction does not raise competitive concerns. In these cases, the
agencies will either let the waiting period expire or, if requested by the
parties and appropriate, will grant early termination of the waiting period.
Upon expiration or early termination of the waiting period, the parties are
free to proceed to closing as far as the HSR Act is concerned.

Additional Requests for Information and “Second Requests”
In some (relatively few) cases, an agency will identify one or more
aspects of the transaction that, in the agency’s view, may harm competition
and warrant further investigation. In these cases, as a first step the agen-
cies typically request some additional information from the parties on a
voluntary basis during the pendency of the waiting period. These requests
for voluntary production of information are designed to address specific
concerns identified by the agencies and may include, among other things,
requests for more detailed product or service information, capacity and
location of facilities, sales information, top customers, suppliers, and com-
petitors, industry or market analyses, and strategic business plans. The
agencies very likely will contact customers to elicit their views about the
state of competition in relevant markets. The agencies may also request to
speak with one or more company representatives on an informal basis
about specific issues.
Generally, it is in the parties’ best interest to respond promptly and
effectively to these informal requests for voluntary production in order to
address the agencies’ concerns before the end of the initial waiting period.
Indeed, parties to transactions that may raise serious competitive issues
are well-advised, with counsel’s assistance, to identify in advance the likely
areas of agency concern, to prepare documents and presentation materials
to address those concerns, and to anticipate the agencies’ likely requests
124


for voluntary production of information in order to respond as promptly as
possible. The reason for this is that, if the agencies’ concerns are not put to
rest within the initial waiting period, the agencies will pursue the investi-
gation by issuing a formal Request for Additional Information or Documen-
tary Material, otherwise known as a “Second Request.”
A Second Request is an extensive and considerably burdensome
request for documents and narrative responses that, among other things,
extends the waiting period for most types of transactions until 30 days after
all parties have “substantially complied” with its demands. This usually
translates into at least a several-month delay in the HSR review process
and indicates the agencies’ belief that the transaction may have serious
detrimental effects on competition. While the parties can, and usually do,
negotiate the scope and timing of a Second Request, the burden of com-
pliance remains a heavy one. It is not unusual for a submission in response
to a Second Request to include tens or even hundreds of thousands of
pages of documents and extensive and detailed narrative responses, and to
impose considerable costs on the parties in the way of diverted resources
and very substantial professional fees for attorneys and expert economic
consultants. The investigation that accompanies a Second Request is also
likely to require a company to produce one or more employees to discuss
relevant issues in person with government lawyers.

What if the transaction may “substantially lessen competition?”
At any time during the HSR review period, the antitrust agencies can
challenge the legality of the transaction in court by filing a complaint alleging
that consummation likely would lessen competition substantially or tend to
create a monopoly. The agencies likely also would request, and very likely
obtain, a preliminary injunction preventing the transaction from closing until
the legal process had run its course.
By way of relief, the agency most likely would seek either to block the
transaction altogether or to dilute its perceived anticompetitive effects by
compelling the parties to divest (or, in appropriate cases, license) certain
assets to a third part or parties. In the absence of a compromise or
settlement, the parties and the government would proceed to litigate the
antitrust claims, which are widely recognized as being among the most
expensive and time-consuming varieties of litigation.
Most frequently, however, the impending threat of litigation against the
government leads the merging parties either to abandon the transaction
altogether or to seek a compromise before a lawsuit is filed. The nature of
125


such a compromise is obviously closely tied to the specific facts of the
industry and transaction in question, but often involves some form of
divestiture to a third party.
There is also the possibility, of course, that either before, during, or as a
result of issuing a Second Request, the investigating agency will conclude
that the transaction does not raise substantial antitrust concerns and will
notify the parties of its present intention not to take further action.

Beyond the HSR Act
“Government Challenges Outside the Statutory Context”
While the HSR Act provides the federal antitrust agencies with a
framework to review certain transactions and the opportunity to raise a
timely challenge in court, the Act does not limit the agencies’ ability to
challenge any transaction in any way. In other words, the federal agen-
cies — and the offices of the state attorneys general — are generally free to
file a lawsuit against both a transaction that was not reportable under the
HSR Act and against a transaction that was reported and went through the
HSR process without challenge. The only limitations on these types of
challenges are of a practical nature. Absent the HSR statutory scheme,
governmental agencies may find it inefficient or impractical to challenge
transactions after consummation or to learn about unreportable transac-
tions in time to act effectively.

“International Pre-Merger Notification Requirements”
Today, approximately 68 national and regional jurisdictions around the
world have some form of merger notification law, most of which include
compulsory filing and waiting period provisions similar to the HSR Act and
may carry penalties for noncompliance.
Parties to transactions involving non-U.S. assets or companies are
well-advised to seek the advice of specialized counsel to determine in
advance whether the transaction in question may be subject to one or more
non-U.S. merger notification regimes.

126

Chapter 12
Tax Considerations
Taxable Transactions
The following are the basic rules that apply to the taxation of business
acquisitions in the absence of a valid tax-free structure. Generally speaking,
a taxable transaction from the seller’s standpoint can have very beneficial
results for the buyer.

Taxable Asset Sale
• The seller recognizes gain on the sale of its assets and its stock-
holders will recognize gain on the distribution of any proceeds from
the sale. Thus, an asset sale results in two levels of tax on the seller
side if proceeds are distributed, an unfavorable result for the seller
and its stockholders if significant appreciation exists.
If the seller in an asset acquisition is an S-corporation, any income or
gain realized on the sale will be passed through to the S corporation’s
stockholders and taxed directly to the stockholders, avoiding the
corporate-level tax. Generally, only one level of tax is paid where
assets of an 80%-owned subsidiary are acquired.
The result may not trouble the seller if it has substantial net operating
losses (NOLs).
• The buyer will receive a step-up in basis of the assets it acquired from
the seller, enabling the buyer to take greater depreciation on the
assets acquired. This can be a significant benefit for the buyer on a
going-forward basis.
• A taxable forward direct merger transaction or forward-triangular
merger is treated for tax purposes as an asset sale.

Taxable Stock Purchase Transaction
• In a taxable stock purchase transaction, the individual stockholders
who sell their shares to the buyer will be taxed on any gain they
realize on the sale of their shares. The seller will not realize any tax
unless a 338(h)(10) election is made, which causes the transaction
to be treated as if it were an asset sale. This election is only allowable
if the seller is an S corporation (i.e., flow-through treatment is avail-
able) or is an 80%-owned subsidiary.
The buyer will not get a step-up in basis of the seller’s assets unless
a 338(h)(10) election is made.
127


• A taxable reverse-triangular merger is treated for tax purposes as a
stock purchase.

Tax-Free Reorganizations
To qualify as a tax-free reorganization under the Internal Revenue
Code and related IRS rules and regulations, several requirements must be
satisfied. Two of the most important requirements are, broadly speaking,
that the buyer must continue the seller’s business in some form and that the
seller’s stockholders must continue to hold on to the shares of buyer stock
they received in the transaction (the so-called “continuity of interest” test).
In practice, a critical factor in whether the deal will receive tax-free
treatment is the nature of the consideration the seller and its stockholders
received. Under some tax-free reorganization structures, only stock may be
paid, whereas in others some non-stock consideration (also known as
“boot”) may be permissible. In other words, the type of tax-free reorgani-
zation the transaction is structured as will dictate the amount of cash that
can be paid in the deal. Under no circumstances, however, will tax-free
treatment be available if more than 60% of the total value of the deal is in
cash or property other than buyer stock.
In a valid tax-free reorganization, the seller’s stockholders will not
recognize any gain on the sale of stock and the seller will not recognize
gain with respect to its assets, except that tax must be paid by the stock-
holders on the value of any non-stock consideration paid. Thus, a “tax-free”
deal will in reality often result in some tax to the selling stockholders to the
extent cash is involved. With respect to the portion of their stock for which
the stockholders received tax-free treatment, they will “carry over” their
basis in that old stock to the new buyer stock they obtain in the transaction
and will subsequently realize taxable income or loss only on a taxable
disposition of those shares. A buyer will not be able to obtain a step-up in the
basis of the seller’s assets in the event of a valid tax-free reorganization.
The following transactions may be treated as “tax free”
reorganizations:
• Type A — Two-party direct statutory merger where at least 40% of
the consideration is buyer stock. If structured properly, this transac-
tion will be tax-free to the seller’s stockholders and the seller, except
to the extent of any non-stock consideration.
• Type B — A stock purchase where the entire consideration is voting
stock of the buyer. No consideration other than voting stock is
128

Chapter 12 - Tax Considerations

permitted in a Type B reorganization, although cash received in lieu
of fractional shares will not be considered boot. If structured properly,
this transaction will be tax-free to the seller and its stockholders.
• Type C — buyer issues voting stock in exchange for substantially all
of the seller’s assets. If the buyer issues non-stock consideration, the
sum of the consideration other than voting stock and liabilities
assumed cannot exceed 20% of the total consideration. Per IRS
guidelines, the buyer should obtain assets representing at least 90%
of the fair market value of the seller’s net assets and at least 70% of
the gross assets the seller holds immediately prior to the transaction.
This transaction will be tax-free to the seller and its stockholders,
except to the extent of any non-stock consideration.
• Forward Triangular Merger — Consideration in a forward triangular
merger generally includes up to 60% non-stock consideration. The
newly formed subsidiary must acquire substantially all of the seller’s
assets under the same 70-90 test as for a Type C reorganization.
This transaction will be tax-free to the seller’s stockholders, except to
the extent of any non-stock consideration.
• Reverse Triangular Merger — Permissible consideration is deter-
mined under a complex rule requiring that “control” of the target
must be acquired in exchange for voting stock of buyer. In practice, if
(1) the buyer doesn’t already own any target stock, (2) the target has
only one class of stock, and (3) all stockholders receive the same mix
of consideration per share, this translates into a requirement that
80% of the total consideration be in the form of voting stock. The
seller must have substantially all assets after the transaction under
the same test as for a Type C reorganization. This transaction will be
tax-free to the seller’s stockholders, except to the extent of any non-
stock consideration.
A few additional points worth noting:
• So-called “multi-step” tax free reorganizations can under some cir-
cumstances enable the parties to effect a reverse-triangular mer-
ger — and thereby take advantage of some of the key benefits
inherent in that structure, such as the continuity of existence of
the seller that reduces the need for third-party consents — while
including up to 60% boot in the deal rather than the usual 20% limit.
One example of a multi-step reorganization involves a standard
reverse-triangular merger, followed by an upstream merger of seller
into buyer.
129


• Other provisions in the tax code permit tax free transactions that are
less relevant in the business sale context, such as spin-offs or split
ups, recapitalizations and re-incorporations achieved through down-
stream mergers.
• Parties seeking to structure a transaction as a Type B or C reorga-
nization or a reverse triangular merger must in some cases take
great care to ensure that any stock consideration delivered will
qualify as voting stock.
• The Internal Revenue Service rules and regulations relating to tax-
ation of business combinations are extremely complex and evolving,
and are dependent on the specific facts and circumstances of each
particular case. Participants to M&A transactions must consult their
tax advisors.

130

Annex 3-A
Mutual Nondisclosure Agreement
This Mutual Nondisclosure Agreement (this “Agreement”) by and between
,a corporation, and ,a corporation (each
a “Party” and collectively, the “Parties”), is dated as of the latest date set forth on
the signature page hereto.

1. General. In connection with the consideration of a possible nego-
tiated transaction (a “Possible Transaction”) between the Parties and/or
their respective subsidiaries (each such Party being hereinafter referred to,
collectively with its subsidiaries, as a “Company”), each Company (in its
capacity as a provider of information hereunder, a “Provider”) is prepared
to make available to the other Company (in its capacity as a recipient of
information hereunder, a “Recipient”) certain “Evaluation Material” (as
defined in Section 2 below) in accordance with the provisions of this
Agreement, and to take or abstain from taking certain other actions as
hereinafter set forth.

2. Definitions.

(a) The term “Evaluation Material” means information concerning the
Provider which has been or is furnished to the Recipient or its
Representatives in connection with the Recipient’s evaluation of a
Possible Transaction, including its business, financial condition,
technology, operations, assets and liabilities, and includes all
notes, analyses, compilations, studies, interpretations or other
documents prepared by the Recipient or its Representatives which
contain or are based upon, in whole or in part, the information
furnished by the Provider hereunder. The term Evaluation Material
does not include information which (i) is or becomes generally
available to the public other than as a result of a disclosure by the
Recipient or its Representatives in breach of this Agreement,
(ii) was within the Recipient’s possession prior to its being fur-
nished to the Recipient by or on behalf of the Provider, provided
that the source of such information was not bound by a confiden-
tiality agreement with, or other contractual, legal or fiduciary obli-
gation of confidentiality to, the Provider with respect to such
information, or (iii) is or becomes available to the Recipient on a
non-confidential basis from a source other than the Provider or its
Representatives, provided that such source is not bound by a
confidentiality agreement with, or other contractual, legal or fidu-
ciary obligation of confidentiality to, the Provider with respect to
such information.
A-1


(b) The term “Representatives” shall include the directors, officers,
employees, agents, partners or advisors (including, without limi-
tation, attorneys, accountants, consultants, bankers and financial
advisors) of the Recipient or Provider, as applicable.
(c) The term “Person” includes the media and any corporation, part-
nership, group, individual or other entity.
3. Use of Evaluation Material. Each Recipient shall, and it shall cause
its Representatives to, use the Evaluation Material solely for the purpose of
evaluating a Possible Transaction, keep the Evaluation Material confiden-
tial, and, subject to Section 5, will not, and will cause its Representatives not
to, disclose any of the Evaluation Material in any manner whatsoever;
provided, however, that any of such information may be disclosed to the
Recipient’s Representatives who need to know such information for the sole
purpose of helping the Recipient evaluate a Possible Transaction. Each
Recipient agrees to be responsible for any breach of this Agreement by any
of such Recipient’s Representatives. This Agreement does not grant a
Recipient or any of its Representatives any license to use the Provider’s
Evaluation Material except as provided herein.
4. Non-Disclosure of Discussions. Subject to Section 5, each Com-
pany agrees that, without the prior written consent of the other Company,
such Company will not, and it will cause its Representatives not to, disclose
to any other Person (i) that Evaluation Material has been exchanged
between the Companies, (ii) that discussions or negotiations are taking
place between the Companies concerning a Possible Transaction or (iii) any
of the terms, conditions or other facts with respect thereto (including the
status thereof).
5. Legally Required Disclosure. If a Recipient or its Representatives
are requested or required (by oral questions, interrogatories, other requests
for information or documents in legal proceedings, subpoena, civil inves-
tigative demand or other similar process) to disclose any of the Evaluation
Material or any of the facts disclosure of which is prohibited under Section 4
above, such Recipient shall provide the Provider with prompt written notice
of any such request or requirement together with copies of the material
proposed to be disclosed so that the Provider may seek a protective order
or other appropriate remedy and/or waive compliance with the provisions of
this Agreement. If, in the absence of a protective order or other remedy or
the receipt of a waiver by the Provider, a Recipient or its Representatives
are nonetheless legally compelled to disclose Evaluation Material or any of
the facts disclosure of which is prohibited under Section 4 or otherwise be
A-2

Annex 3-A - Mutual Nondisclosure Agreement

liable for contempt or suffer other censure or penalty, such Recipient or its
Representatives may, without liability hereunder, disclose to such requiring
Person only that portion of such Evaluation Material or any such facts which
the Recipient or its Representatives is legally required to disclose, provided
that the Recipient and/or its Representatives cooperate with the Provider to
obtain an appropriate protective order or other reliable assurance that
confidential treatment will be accorded such Evaluation Material or such
facts by the Person receiving the material.

6. Return or Destruction of Evaluation Material. If either Company
decides that it does not wish to proceed with a Possible Transaction, it will
promptly inform the other Company of that decision. In that case, or at any
time upon the request of a Provider for any reason, a Recipient will, and will
cause its Representatives to, within five business days of receipt of such
notice, destroy or return all Evaluation Material in any way relating to the
Provider or its products, services, employees or other assets or liabilities,
and no copy or extract thereof (including electronic copies) shall be
retained, except that Recipient’s outside counsel may retain one copy to
be kept confidential and used solely for archival purposes. The Recipient
shall provide to the Provider a certificate of compliance with the previous
sentence signed by an executive officer of the Recipient. Notwithstanding
the return or destruction of the Evaluation Material, the Recipient and its
Representatives will continue to be bound by such Recipient’s obligations
hereunder with respect to such Evaluation Material.

7. No Solicitation/Employment. Neither Recipient will, within one year
from the date of this Agreement, directly or indirectly solicit the employment
or consulting services of or employ or engage as a consultant any of the
officers or employees of the Provider, so long as they are employed by the
Provider and for three months after they cease to be employed by Provider.
A Recipient is not prohibited from soliciting by means of a general adver-
tisement not directed at (i) any particular individual or (ii) the employees of
the Provider generally.

8. Standstill. [Note: Delete this section if target Company is not
publicly-held or likely to be publicly-held in the near future] Each
Company agrees that, for a period of one year after the date of this
Agreement, unless specifically invited in writing by the other Company,
neither it nor any of its affiliates (as such term is defined under the Secu-
rities Exchange Act of 1934, as amended (the “1934 Act”)) or
A-3


Representatives of such Company (acting in any capacity other than as an
advisor in any of the following cases) will in any manner, directly or
indirectly:
(a) effect, seek, offer or propose (whether publicly or otherwise) to
effect, or cause or participate in, or in any way assist any other
Person to effect, seek, offer or propose (whether publicly or oth-
erwise) to effect or participate in:
(i) any acquisition of any securities (or beneficial ownership
thereof) or assets of the other Company or any of its
subsidiaries,
(ii) any tender or exchange offer, merger or other business com-
bination involving the other Company or any of its subsidiaries,
(iii) any recapitalization, restructuring, liquidation, dissolution or
other extraordinary transaction with respect to the other Com-
pany or any of its subsidiaries, or
(iv) any “solicitation” of “proxies” (as such terms are used in the
proxy rules of the Securities and Exchange Commission) or
consents to vote any voting securities of the other Company;
(b) form, join or in any way participate in a “group” (as defined under
the 1934 Act) with respect to the securities of the other Company;
(c) make any public announcement with respect to, or submit an
unsolicited proposal for or offer of (with or without condition),
any extraordinary transaction involving the other Company or its
securities or assets;
(d) otherwise act, alone or in concert with others, to seek to control or
influence the management, Board of Directors or policies of the
other Company;
(e) take any action which might force the other Company to make a
public announcement regarding any of the types of matters set
forth in (a) above; or
(f) enter into any discussions or arrangements with any third party with
respect to any of the foregoing.
Each Company also agrees during such period not to request the other
Company (or its directors, officers, employees or agents), directly or indi-
rectly, to amend or waive any provision of this Section 8 (including this
sentence).
A-4


9. Maintaining Privilege. If any Evaluation Material includes materials
or information subject to the attorney-client privilege, work product doctrine
or any other applicable privilege concerning pending or threatened legal
proceedings or governmental investigations, each Company understands
and agrees that the Companies have a commonality of interest with respect
to such matters and it is the desire, intention and mutual understanding of
the Companies that the sharing of such material is not intended to, and shall
not, waive or diminish in any way the confidentiality of such material or its
continued protection under the attorney-client privilege, work product doc-
trine or other applicable privilege. All Evaluation Material provided by a
Company that is entitled to protection under the attorney-client privilege,
work product doctrine or other applicable privilege shall remain entitled to
such protection under these privileges, this Agreement, and under the joint
defense doctrine.
10. Compliance with Securities Laws. Each Recipient agrees not to
use any Evaluation Material of the Provider in violation of applicable
securities laws. [Note: Delete this section if Provider is not publicly-
held or likely to be publicly-held in the near future]
11. Not a Transaction Agreement. Each Company understands and
agrees that no contract or agreement providing for a Possible Transaction
exists between the Companies unless and until a final definitive agreement
for a Possible Transaction has been executed and delivered, and each
Company hereby waives, in advance, any claims (including, without limi-
tation, breach of contract) relating to the existence of a Possible Transaction
unless and until both Companies shall have entered into a final definitive
agreement for a Possible Transaction. Each Company also agrees that,
unless and until a final definitive agreement regarding a Possible Trans-
action has been executed and delivered, neither Company will be under any
legal obligation of any kind whatsoever with respect to such Possible
Transaction by virtue of this Agreement except for the matters specifically
agreed to herein. Neither Company is under any obligation to accept any
proposal regarding a Possible Transaction and either Company may ter-
minate discussions and negotiations with the other Company at any time.
12. No Representations or Warranties; No Obligation to Disclose. Each
Recipient understands and acknowledges that neither the Provider nor its
Representatives makes any representation or warranty, express or implied,
as to the accuracy or completeness of the Evaluation Material furnished by
or on behalf of such Provider and shall have no liability to the Recipient, its
Representatives or any other Person relating to or resulting from the use of
the Evaluation Material furnished to such Recipient or its Representatives
A-5


or any errors therein or omissions therefrom. As to the information delivered
to the Recipient, each Provider will only be liable for those representations
or warranties which are made in a final definitive agreement regarding a
Possible Transaction, when, as and if executed, and subject to such lim-
itations and restrictions as may be specified therein. Nothing in this Agree-
ment shall be construed as obligating a Company to provide, or to continue
to provide, any information to any Person.
13. Modifications and Waiver. No provision of this Agreement can be
waived or amended in favor of either Party except by written consent of the
other Party, which consent shall specifically refer to such provision and
explicitly make such waiver or amendment. No failure or delay by either
Party in exercising any right, power or privilege hereunder shall operate as a
waiver thereof, nor shall any single or partial exercise thereof preclude any
other or future exercise thereof or the exercise of any other right, power or
privilege hereunder.
14. Remedies. Each Company understands and agrees that money
damages would not be a sufficient remedy for any breach of this Agreement
by either Company or any of its Representatives and that the Company
against which such breach is committed shall be entitled to equitable relief,
including injunction and specific performance, as a remedy for any such
breach or threat thereof. Such remedies shall not be deemed to be the
exclusive remedies for a breach by either Company of this Agreement, but
shall be in addition to all other remedies available at law or equity to the
Company against which such breach is committed.
15. Legal Fees. In the event of litigation relating to this Agreement, if a
court of competent jurisdiction determines that either Company or its
Representatives has breached this Agreement, then the Company which
is, or the Company whose Representatives are, determined to have so
breached shall be liable and pay to the other Company the reasonable legal
fees and costs incurred by the other Company in connection with such
litigation, including any appeal there from.
16. Governing Law. This Agreement is for the benefit of each Com-
pany and shall be governed by and construed in accordance with the laws of
the State of applicable to agreements made and to be performed
entirely within such State.
17. Severability. If any term, provision, covenant or restriction con-
tained in this Agreement is held by any court of competent jurisdiction to be
invalid, void or unenforceable, the remainder of the terms, provisions,
covenants or restrictions contained in this Agreement shall remain in full
A-6


force and effect and shall in no way be affected, impaired or invalidated, and
if a covenant or provision is determined to be unenforceable by reason of its
extent, duration, scope or otherwise, then the Companies intend and
hereby request that the court or other authority making that determination
shall only modify such extent, duration, scope or other provision to the
extent necessary to make it enforceable and enforce them in their modified
form for all purposes of this Agreement.
18. Construction. The Companies have participated jointly in the
negotiation and drafting of this Agreement. If an ambiguity or question of
intent or interpretation arises, this Agreement shall be construed as if
drafted jointly by the Companies and no presumption or burden of proof
shall arise favoring or disfavoring either Company by virtue of the author-
ship at any of the provisions of this Agreement.
19. Term. This Agreement shall terminate three years after the date of
this Agreement.
20. Entire Agreement. This Agreement contains the entire agreement
between the Companies regarding the subject matter hereof and super-
sedes all prior agreements, understandings, arrangements and discus-
sions between the Companies regarding such subject matter.
21. Counterparts. This Agreement may be signed in counterparts,
each of which shall be deemed an original but all of which shall be deemed
to constitute a single instrument.
IN WITNESS WHEREOF, each of the undersigned entities has caused
this Agreement to be signed by its duly authorized representatives as of the
date written below.

Date:

[COMPANY NAME] [COMPANY NAME]
ADDRESS FOR NOTICE: ADDRESS FOR NOTICE:
By: By:
Name: Name:
Title: Title:

A-7


A-8

Annex 3-B

Summary Checklist

Definition of Confidential Information
Providers should

n Confirm that the definition of “confidential information” sufficiently
covers the information and materials to be provided (and, to the
extent applicable, confidential information that may have been
previously provided).

n Consider removing legending requirements (that any written mate-
rials be marked “confidential” or that oral statements be reduced to
writing and so marked to be considered confidential) to avoid acci-
dental failures to legend leading to unprotected confidential
information.

n Consider having any subset of extremely confidential information
being supplied (such as pricing information, patent information, or
source code) carved out and addressed separately under a special
NDA implementing careful controls and procedures to limit the
distribution and access of the information to those advisors or
agreed upon personnel of the recipient whom the provider believes
cannot exploit the information commercially, especially where the
recipient is a close competitor.

n Remove any “residual” clause that allows the recipient to use, in
future products or services, any information retained in the memory
of the recipient’s employees that was obtained by reviewing the
confidential information.

Recipients should

n Confirm that the exclusions from what is considered confidential
information properly reflect the principle that information should not
be protected if it was created or discovered by the recipient prior to,
or independent of, any involvement with the disclosing party.

n Consider removing legending requirements to avoid overly burden-
ing the due diligence process.
A-9


Use of Confidential Information
Providers should
n Confirm that there exists language limiting the use of the confiden-
tial information to the contemplated purpose (evaluation of the
specific transaction) and not for any other purpose.
n Confirm that there exists language clarifying that no license is being
granted to the recipient or its representatives to use the confidential
information except for the specific purpose of evaluating the trans-
action, and that no license is being granted to any of the provider’s
intellectual property.
n Confirm that the recipient is responsible/liable for its representatives’
proper use of the confidential information to the extent that the provider
does not request such representatives to be parties to the NDA.
n If the provider is a publicly traded company, confirm that the recip-
ient will not use confidential information in violation of applicable
securities laws.
n Consider implementing controls and procedures to limit the distribu-
tion and access of the information if there is extremely confidential
information being supplied or if the recipient is a close competitor, but
where these factors do not rise to the level of affording treatment of
the more sensitive portion under a special NDA.
n Confirm that there exists language clarifying that information pro-
vided does not constitute any representation or warranty of the
provider but that such representations and warranties are limited to
what is provided for in the definitive agreement.

Non-Disclosure of Discussions
Providers should
n Confirm that the NDA contains language clarifying that the fact that
discussions are taking place between the parties regarding the
transaction is confidential, especially if the provider is a publicly
traded company.
n If the provider is the selling company in an auction context, attempt
to retain some limited ability to disclose the fact that the recipient is
bidding or, to the extent possible, to disclose the terms of any bid
made by recipient.
A-10

Annex 3 -B - Summary Checklist

Recipients should

n Confirm that the NDA contains language clarifying that the discus-
sions between the parties regarding the transaction are confidential,
including the identity of the parties and the terms of any bid if the
recipient is the acquiring company.

n If the recipient is the acquiring company and needs financing for the
transaction, obtain a carve-out allowing information to be disclosed
to financiers.

Legally Required Disclosures
Providers should

n Consider requiring the recipient to fully cooperate with the provider
in obtaining any applicable protective orders if requested.

Recipients should

n Confirm that there exists an exception to the NDA allowing the
recipient to disclose information that is legally required to be
disclosed.

Return or Destruction of Materials
Providers should

n Confirm that there exists language providing for the return or
destruction of any written confidential information provided.

n If a copy is to be retained for archival/evidentiary purposes, confirm
that it will be kept by outside counsel.

Recipients should

n Consider ensuring outside counsel the right to retain one copy for
archival/evidentiary purposes.

n Confirm that the recipient is permitted to destroy or certify destruc-
tion of information to satisfy its obligations.
A-11


Non-Solicitation/Employment
Providers should

n Confirm that the NDA contains language providing for protection
against the recipient’s soliciting of the provider’s employees for
some amount of time (typically 6 months to 2 years, with one year
being fairly common) as well as against soliciting former employees
who recently departed (typically three to six months is common).

n The recipient may argue strongly against this because it is a large
entity that will have difficulty keeping track of solicitation and hiring
activities. If this occurs, consider this alternative: limiting interaction
between both parties’ employees by restricting which provider
employees the recipient will be allowed to contact.

Recipients should

n Consider a limiting provision that would apply only to “key” employ-
ees or employees of the provider who were identified to the recipient
during the diligence process.

n Confirm that there exists a carve-out for general solicitation not
directed at provider employees.

n Consider removing this provision altogether if it concerns a large
entity that would have difficulty keeping track of solicitation and
hiring activities.

Term
Providers should

n Consider language providing that the NDA does not expire, as what
is confidential now may need to remain just as confidential years
from now.

n Consider setting an unlimited term for trade secrets recipients.

n Consider limiting the NDA to a specific time period (typically 1 to
5 years).
A-12

Annex 3 -B - Summary Checklist

Remedies
Providers should
n Confirm that there exists language having the recipient acknowl-
edge and agree that monetary damages are insufficient to remedy
breach of the NDA, and that the provider is entitled to equitable relief
in addition to any other remedies.

Miscellaneous Provisions Applicable to Providers and
Recipients
Privileged Information. Consider language stating that disclosure is
not deemed to have waived or diminished attorney-client privilege, attorney
work-product protection, or any other privilege or protection applicable to
the confidential information that relies upon a form of the joint defense
doctrine. Note that the effectiveness of this provision is not certain
that.
Binding Agreement. Confirm that language exists clarifying that the
NDA does not constitute an agreement to enter into or even negotiate a
transaction, as sometimes courts have found an agreement to negotiate
absent such language.
Standstill Provisions. These provisions are only applicable where the
target company is publicly traded or likely to be public soon, and, due to their
complexity, should be carefully reviewed by sophisticated M&A counsel.
No Shop. The seller should delete provisions restricting it from shop-
ping as these are not typically agreed to until at least a term sheet or basic
transaction terms are agreed upon.
Export. If the providers have a particular concern about providing
technical information to non-U.S. persons, they should consider adding a
provision ensuring that a recipient complies with applicable export laws.

A-13


A-14

Annex 4
Sample Due Diligence Checklist
MEMORANDUM
TO: *
FROM:
DATE:
RE: Due Diligence Request List
In connection with the proposed acquisition of seller (the “Company”),
[ ], as legal counsel to the buyer, will need to review the documents
described on the attached list. References in the list to the “Company”
should be deemed to include the Company, its subsidiaries and their
respective predecessors. When you provide requested documents or infor-
mation to us, please indicate in the spaces provided whether the document
or other requested information has been previously provided, is currently
being provided, is available for review at [your offices or the Company’s
local office].
Please note that additional documents may be requested during the
course of our review of the Company. If compiling any of the requested
items would be impracticable or unduly burdensome, please let us know
and we would be happy to discuss the items with you.
In the event of any questions or comments, please do not hesitate to
contact at .
[BUYER CODE NAME]’S PRELIMINARY REQUEST FOR DUE
DILIGENCE MATERIAL FROM [SELLER CODE NAME]
“A” = Access to materials provided
“P” = Copy Previously provided
“H” = Copy provided Herewith
“N” = Not applicable
“E” = Available through EDGAR (Identify by filing type, approx. date of
filing, exhibit no.) [NOTE: Delete if Seller is private; also delete Sec-
tions 19 through 21 below]

1. BASIC CORPORATE DOCUMENTS
[ ] (a) Legal entity structure, including name, physical location and
function of all divisions, subsidiaries or affiliated entities.
[ ] (b) Certificate or Articles of Incorporation and Bylaws, including
all amendments.
A-15


[ ] (c) Minutes of all meetings and written consents of board of
directors, Board committees and other committees and stock-
holders, including copies of notices of all such meetings where
written notices were given and all written waivers of required
notices.

[ ] (d) List of all states and foreign countries where property is owned
or leased or where employees are located, indicating in which
jurisdictions the Company is qualified to do business and
indicating principal business activity at each location.

[ ] (e) List of states and foreign countries in which the Company
contemplates undertaking business operations, either directly
or through other parties.

2. STOCKHOLDER INFORMATION

[ ] (a) Samples of common and preferred stock certificates, deben-
tures and any other outstanding debt or equity securities.

[ ] (b) The Company’s stock books.

[ ] (c) Lists of all current owners of shares, including address, num-
ber of shares owned, dates of issuance and full payment, the
consideration received by the Company and applicable stop
transfer orders or restrictive legends.

[ ] (d) List of all options, warrants and other rights to acquire equity
securities, including date of grant or issuance, exercise or
conversion price, number of shares, vesting schedule and
names and addresses of holders.

3. AGREEMENTS REGARDING SECURITIES

[ ] (a) Stock option plans and forms of option agreements which
have been used.

[ ] (b) Copies of all warrants, including all amendments.

[ ] (c) Stock purchase agreements and any related documents.

[ ] (d) Any other documents relating to sales of securities by the
Company, including any private placement memoranda or
other offering circulars.
A-16

Annex 4 - Sample Due Diligence Checklist

[ ] (e) Any agreements and other documentation relating to repur-
chases, redemptions, exchanges, conversions or similar
transactions involving the Company’s securities.
[ ] (f) Permits, notices of exemption and consents for issuance or
transfer of the Company’s securities and other evidence of
qualification or exemption under applicable state blue sky
laws.
[ ] (g) Forms D or any other evidence of qualification or exemption
under the Securities Act of 1933, as amended.
[ ] (h) Employee stock ownership plans, stock purchase plans or
similar plans and forms of agreements which have been used.
[ ] (i) Copies of any voting trust, buy-sell or other similar agreement
covering any of the Company’s securities.
[ ] (j) All agreements containing registration rights or assigning such
rights or any other rights (including preemptive rights, rights of
first refusal, etc.) granted with respect to the capital stock of the
Company.

4. OTHER MATERIAL CONTRACTS
[ ] (a) Convertible, senior or other debt financings, if any.
[ ] (b) Bank line of credit or loan agreements and guarantees, includ-
ing any amendments, renewal letters, notices, etc.
[ ] (c) Description of any default by any party under any contract or
commitment affecting the Company or its property, or any
circumstance which might reasonably be expected in the
future to give rise to such default.
[ ] (d) All outstanding leases of real and personal property, including
equipment leases.
[ ] (e) All agreements entered into by the Company or any of its
subsidiaries relating to a material acquisition or disposition of
assets or stock and schedules of exceptions thereto.
[ ] (f) Material contracts (over $ ) with suppliers, contract manu-
facturers or customers, including OEM and similar agreements.
[ ] (g) List of major suppliers, indicating total and type of purchases
from each supplier during the last two fiscal years and the
A-17


current fiscal year, any key suppliers not subject to supply
agreements, sole source suppliers and any subcontracted
work.
[ ] (h) Model or standard sales or license agreements, if used by the
Company.
[ ] (i) Agreements for loans to key employees, and any other agree-
ments with officers, directors, employees and consultants,
whether or not now outstanding.
[ ] (j) Schedule of insurance policies in force covering property of the
Company and any other insurance policies in force (such as
“key man” policies).
[ ] (k) Partnership, product development and joint venture agree-
ments, if any.
[ ] (l) All security agreements covering the Company’s assets.
[ ] (m) All agreements or proposed agreements with distributors,
dealers and sales representatives.
[ ] (n) Indemnification agreements.
[ ] (o) Research and development agreements.
[ ] (p) All agreements, or proposed agreements pursuant to which
the Company licenses any of its proprietary rights or is
licensed by any third party to any proprietary rights.
[ ] (q) All agreements concerning the sharing of R&D facilities or
similar agreements.
[ ] (r) List and copies of any intercompany agreements with affiliated
entities relevant to the development, use or commercialization
of the Company’s technology (as defined below).
[ ] (s) Copies of standard forms of purchase orders, quotations and
order acknowledgments relevant to the Company’s technology.
[ ] (t) Description of any provisions that purport to restrict the Com-
pany’s ability to compete with respect to the Company’s tech-
nology, whether by agreement, court order, or otherwise.
[ ] (u) List and copies of all source code, manufacturing, develop-
ment or other form of escrow agreements, whether internal or
A-18


third party escrow accounts, which relate to the Company’s
technology and to which Company is a party.
[ ] (v) Other material contracts.

5. PRODUCTS, MANUFACTURING AND COMPETITION
[ ] (a) List of principal products and, for each product, (i) short
description of the product, (ii) principal competitive prod-
ucts, (iii) principal customers and (iv) sites where
manufactured.
[ ] (b) List of third party developers showing total and type of project
for each developer.
[ ] (c) List of third party software duplicators and manual publishers,
if any.
[ ] (d) Copies of any non-competition agreements of the Company
or employees.
[ ] (e) List of the top 20 customers of the Company, indicating the
types of products and the amounts of each purchased.
[ ] (f) List of service and support contracts.
[ ] (g) Company-financed customer purchase agreements.
[ ] (h) Price lists, catalogues and brochures for the Company’s
products.
[ ] (i) Forms of warranties and guarantees provided to customers.
[ ] (j) List of major risks, in rough priority, of technical problems or
limitations which current and planned product lines may
encounter.
[ ] (k) Description of any significant customer relationship termi-
nated or suspended within the last three years.

6. GOVERNMENTAL REGULATIONS
[ ] (a) Permits for conduct of business, including licenses, franchises
and concessions, if any.
[ ] (b) All certificates, permits, etc., evidencing compliance with spe-
cific regulations, including environmental and workers health
and safety regulations.
A-19


[ ] (c) List and description of any government regulations (federal,
state, local or foreign) of whatever kind (safety, labor, envi-
ronmental, etc.) which have special application to the Com-
pany’s business.
[ ] (d) Copies of all material filings, applications and correspondence
with, all documents relating to investigations or reviews con-
ducted by, and all demands, notices, requests for information,
approvals, authorizations, determinations, rulings or orders
received from, any federal, state, local or foreign governmen-
tal agencies.
[ ] (e) Description and status statement of all pending or threatened
regulatory, judicial or administrative actions relating to regu-
latory matters.
[ ] (f) Any material agreements, correspondence, undertakings, or
understandings between the Company and any regulatory
body.
[ ] (g) Access to the Company’s files relating to regulatory matters;
copies of reports of any inspections, surveys or audits,
whether generated internally or by regulatory authorities or
other third parties.

7. TAXATION
[ ] (a) Provide all federal, state, local and foreign income and fran-
chise tax returns of Company filed for the last three fiscal
years and all such returns for any prior year that is still subject
to audit or adjustment.
[ ] (b) Identify all jurisdictions in which sales and use tax returns are
filed by Company including a summary by jurisdiction of total
sales and use taxes paid during the last three fiscal years.
Please provide details with respect to any significant changes
to this list of filing jurisdictions since incorporation.
[ ] (c) Provide a schedule by jurisdiction of all property taxes paid
during the last three fiscal years.
[ ] (d) Identify any excise tax returns filed by the Company for the
production, sale and distribution of product; identify all juris-
dictions where the Company is subject to VAT or a similar tax.
A-20


[ ] (e) Provide any private letter ruling or other letter ruling obtained
from the IRS or any state, and each application for any ruling
(including any pending ruling) pertaining to Company.

[ ] (f) Provide summary results of all tax examinations and audits
(federal, state and foreign) pertaining to Company (including
income, sales and use, employment, and property tax) com-
pleted within the last five years (or still outstanding) including
copies of all revenue agent reports, closing agreements, or
other correspondence from or to any taxing authority address-
ing issues raised in the examination.

[ ] (g) Identify all material intercompany transactions within the last
three fiscal years, including transactions between U.S. and
foreign affiliates of the Company, as well as transactions
between the Company and its stockholders, if not provided
elsewhere.

[ ] (h) Provide all tax sharing agreements, tax indemnity agree-
ments, and transfer pricing agreements pertaining to the
Company.

[ ] (i) Provide a list of states in which more than [$100,000] products
or services were sold within each of the last three fiscal years.

[ ] (j) Provide a list of all states in which independent contractors
perform any sales, marketing or product support activities
(including installation, repair or warranty service) on behalf
of the Company.

[ ] (k) Provide a schedule of federal and state net operating loss
carryforwards and tax credit carryforwards, including years of
expiration.

[ ] (l) Provide a description of any tax contingency reserves on the
Company’s balance sheet and any work papers explaining
such tax reserves.

[ ] (m) Identify any pending claims for refund of any tax, fee or similar
item.

[ ] (n) Describe any material tax planning strategy or tax shelter
transaction implemented within the last 5 years and provide
any related correspondence.
A-21


8. LITIGATION AND AUDITS
[ ] (a) All management letters or special reports from the auditor and
responses thereto concerning internal accounting controls in
connection with any current audit and the audits for the last
three fiscal years.
[ ] (b) Settlement documents, if any.
[ ] (c) Decrees, order and judgments of courts or governmental
agencies with respect to the Company.
[ ] (d) Description of any warranty claims which have been made
against the Company or any related partnership or joint ven-
ture and the resolutions of such claims.
[ ] (e) List of pending, asserted or threatened lawsuits or other
claims or investigations, together with short summary of the
claims and related facts.

9. EMPLOYEES AND MANAGEMENT
[ ] (a) Description of any significant labor problems the Company
has experienced.
[ ] (b) Management and Organization chart.
[ ] (c) Description of any material transactions since inception with
any “insider” (i.e., any officer, director, or owner of a substan-
tial amount of the Company’s securities) or any associate of
an “insider.”
[ ] (d) Copy of form of any invention and confidentiality agreement to
protect trade secrets and list of any officers, directors, employ-
ees or consultants who have not signed such agreements.
[ ] (e) Summary of standard employee benefits (vacation, sick
leave, sabbatical, medical insurance, life and disability insur-
ance, etc.)
[ ] (f) A list of the amount of cash compensation (including as sep-
arate items the amount of salary, bonus, commission and
deferred salary pursuant to any plans) and other forms of
compensation (such as car allowances, forgiveness of loans
and other perquisites) paid to each of the Company’s officers
and directors for services rendered in the last full fiscal year
and to be paid in the current fiscal year.
A-22


[ ] (g) Description of commissions paid to managers, agents, or
other employees for the last fiscal year and to be paid in
the current fiscal year.
[ ] (h) Founders agreements, “golden parachute” and other change
of control or severance agreements, if any.
[ ] (i) Summary of worker’s compensation claims made.
[ ] (j) Personnel policies, manuals and handbooks.
[ ] (k) Number of employees by department.

10. EMPLOYEE BENEFITS
[ ] (a) Copies of all 401(k) and other qualified pension and profit
sharing plan documents, all amendments, summary plan
descriptions, adoption agreements, trust agreements, admin-
istrative services agreements, group annuity contracts, res-
olutions, IRS opinion/determination letter, last three years
nondiscrimination and compliance testing and last five years
Form 5500.
[ ] (b) Copy of group health plan document and Summary Plan
Description (SPD), last three years Form 5500.
[ ] (c) Copy of Section 125 Plan document, SPD (include dependent
care plans, health flexible spending accounts, etc.) and last
three years Form 5500.

11. FINANCIAL INFORMATION
[ ] (a) Financial, operating or business plans and projections, includ-
ing underlying assumptions.
[ ] (b) Backup data for revenue forecasts by product and/or market
segments and estimates of the Company’s market share in
each.
[ ] (c) Balance sheet account reconciliations and specific supporting
detail: cash, receivables and unbilled receivables, sales-type
leases, inventory, prepaids, fixed assets, reserves and accru-
als, sales tax, deferred income, debt, stock reconciliations.
[ ] (d) Financial statements for past [three] fiscal years, and interim
financial statements covering each completed quarter of cur-
rent fiscal year.
A-23


[ ] (e) Most current balance sheet and income statement.
[ ] (f) Quarterly projected financial statements for the next three
fiscal years.
[ ] (g) Quarterly analyses of sales and cost by major market seg-
ments/product lines for the current year to date and the next
three fiscal years.
[ ] (h) Reserves analyses as of the end of the last fiscal year and last
fiscal quarter.
[ ] (i) Comparison of budget to actual (summary and detail) for last
fiscal year and current fiscal year to date.
[ ] (j) List of all recorded or unrecorded contingent liabilities as of the
end of the last year and at the latest available date.
[ ] (k) Capital budget.
[ ] (l) Cash report and cash flow projections.
[ ] (m) Brief description of cash investment practices and policies
and status of current cash balance investments.
[ ] (n) Brief description of any foreign currency transactions, practice
and policies.

12. MARKETING INFORMATION
[ ] (a) Internal market size and growth projections (by units and
dollars) for each market segment.
[ ] (b) Market share data (by units and dollars) for the Company and
any competitors, both current and historical.
[ ] (c) Any external/independent analysis of market size, growth and
share data.
[ ] (d) List of principal competitors by market segment.
[ ] (e) Any recent analysis of competitors.
[ ] (f) Any customer survey data which has recently been collected.
[ ] (g) All current product and marketing literature.
[ ] (h) Any noncompetition agreements or other agreements restrict-
ing the Company’s business activities.
A-24


[ ] (i) Market research, marketing studies, long- and short-term stra-
tegic plans and valuation analyses prepared by the Company
or third parties for the Company.

13. GOVERNMENT CONTRACTS
[ ] (a) All Government Contracts, including all modifications and
attachments, and any Cooperative Agreements under any
Government technology transfer program, e.g. CRADAS,
which has not been “closed-out” by the Government, including
any contracts which have been fully performed but for which
the Company has not received final indirect cost rates (the
“Government Contracts”).
[ ] (b) All representations and certifications signed for each Govern-
ment Contract, including any “secondary” certifications under
the Procurement Integrity Act executed by personnel “sub-
stantially involved in the procurement.”
[ ] (c) Any and all Small Business Subcontracting Plans drafted
and/or approved for each Government Contract.
[ ] (d) Any Cost Accounting Standards Disclosure Forms submitted
with or applicable to a Government Contract.
[ ] (e) Any “Advance Agreements” pertaining to a Government Con-
tract regarding the allowability or allocability of contract costs.
[ ] (f) All Cost or Pricing Data submissions for each Government
Contract (SF 1411 and accompanying materials).
[ ] (g) Descriptions of the Company’s internal system and practices
used for gathering cost or pricing data, including practices
with regard to conducting “final sweeps” and establishing “cut-
off-dates” for submission.
[ ] (h) List and briefly describe any audit conducted and audit find-
ings for each Government Contract, including pre-award and
post-award audits, and provide any DCAA or other audit
reports in the Company’s possession relating to the Govern-
ment Contracts.
[ ] (i) List technical data provided under the Government Contracts
with:
(1) Unlimited Rights;
A-25


(2) Government Purpose (License) Rights
(3) Limited Rights
[ ] (j) List computer software provided under the Government Con-
tracts with:
(1) Unlimited Rights
(2) Government Purpose (License) Rights
(3) Limited Rights
[ ] (k) List of any restricted rights computer software incorporated
into non-commercial Government products.
[ ] (l) Any Requests for Equitable Adjustment (REA’s) or claims
submitted under any Government Contract, including all
backup material provided by the Company to the Government,
and any Government responses to such REA’s or claims.
[ ] (m) List of Firm Fixed Price or Other Fixed Price Government
Contracts currently in a cost-overrun position, and a brief
description of the magnitude and cause of such cost overrun.
[ ] (n) List and brief description of any Government claims of any sort
asserted against the Company, e.g., defective cost or pricing
data, deductive changes, false certifications, etc.
[ ] (o) Any terminations for convenience settlement proposals/
claims submitted under any Government Contract, and a brief
description of the status of any such proposal/claim.
[ ] (p) List of any Government Contracts terminated for Default and
any accompanying claims by the Government for excess
reprocurement costs.

A-26


14. EMPLOYEE BENEFIT MATTERS
[ ] (a) List of any employee benefit plans sponsored or maintained
by or for the Company, including pension, profit sharing, stock
bonus, incentive stock option, nonqualified stock option, stock
purchase, restricted stock, stock appreciation rights, savings,
401(k), nonqualified deferred compensation plans and all
welfare benefit plans.
[ ] (b) With respect to each qualified profit sharing, 401(k), money
purchase pension, stock bonus, employee stock ownership,
defined benefit pension and/or multiemployer pension plan
sponsored or maintained by or for the Company:
[ ] (1) Copies of all plan documents, trust agreements, plan
amendments and/or adoption agreements;
[ ] (2) Certified resolutions of the Board of Directors adopt-
ing the Plan, adopting Plan amendments and/or
delegating fiduciary responsibility to any person(s)
or entities;
[ ] (3) Copies of the last three years nondiscrimination and
compliance tests (e.g., ADP/ACP, 415, 410(b),
402(g)).
[ ] (4) Copies of the five most recent Forms 5500, including
all schedules, attachments and audit reports, if any;
[ ] (5) Copies of any third party funding contracts, including
group annuity contracts, insurance contracts, invest-
ment fund contracts, investment management
agreements;
[ ] (6) Copies of the most recent summary of plan accounts
prepared by the plan recordkeeper, or, if a defined
benefit plan, the most recent plan benefit
summaries;
[ ] (7) Copy of the most recent summary plan description
and any summary of material modifications distrib-
uted to plan participants;
[ ] (8) Copy of the most favorable determination letter or
opinion from the Internal Revenue Service;
A-27


[ ] (9) Copy of the two most recent Summary Annual
Reports and information as to dates of distribution;
[ ] (10) Copy of beneficiary designation form;
[ ] (11) Copies of written notice of tax consequences (Sec-
tion 402(f) notice) provided to participants, distri-
bution request forms, election and waiver forms
with respect to qualified joint and survivor annuities
and qualified preretirement survivor annuities, if
applicable;
[ ] (12) Copies of employee stock ownership plan loan
documents, including promissory notes, pledge
agreements, escrow agreements, and any other
document or agreement prepared in connection
with an exempt ESOP loan or transaction under
Treasury Regs. § 54.4975-7 or § 54.4975-11;
[ ] (13) Copies of the two most recent actuarial reports, if
applicable;
[ ] (14) Copies of PBGC-1 and Schedule A for part two
years;
[ ] (15) Copy of fiduciary bond;
[ ] (16) Information regarding any defined benefit plan
funding deficiency or multiemployer plan with-
drawal liability assessment, including information
as to the amount of the funding deficiency or with-
drawal liability, the original due date, the date the
deficiency or withdrawal liability was satisfied, cop-
ies of Form 5330 and proof of payment (canceled
check) and copy of notice distributed to employees
disclosing a funding deficiency; and
[ ] (17) Copies of any pending or previous IRS or DOL audit
inquiries/examinations or related correspondence.
[ ] (c) With respect to each welfare benefit plan sponsored or main-
tained by the Company (including all health, medical, dental,
life insurance, dependent care reimbursement, pretax pre-
mium, health care reimbursement, section 125 flexible ben-
efit, disability, accidental death and dismemberment
insurance, severance, vacation, retiree health and group legal
A-28


plans and any plan that otherwise satisfies the definition of a
welfare benefit plan under the Employee Retirement Income
Security Act):
[ ] (1) Copy of the plan document or contract under which
benefits are provided;
[ ] (2) Copy of the summary plan description and any sum-
mary of material modifications distributed to
employees;
[ ] (3) Copies of the Form 5500s, including all attachments
and schedules, for the past three years;
[ ] (4) Copy of COBRA notice (both initial and qualifying
event) and written procedures;
[ ] (5) Copy of or information concerning any promise to
extend benefits under the plan to retirees;
[ ] (6) Copies of all written communications to participants
within the past two years concerning the plan;
[ ] (7) Copies of HIPAA notices and certificates; and
[ ] (8) Copies of Cancer Rights Act notices.

15. PROPERTY, FACILITIES, PERMITS AND ENVIRONMENTAL
MATTERS
[ ] (a) List and description of all real property owned or leased by the
Company; location, character and general nature of opera-
tions conducted at each location; nature of the title held, and
any mortgages, liens or encumbrances on the property; title
documents confirming ownership; report by public notary (in
civil law countries) or other person authorized to conduct title
searches.
[ ] (b) List, with brief description, of all material personal property
owned, leased or otherwise used by the Company.
[ ] (c) List of all facilities currently owned, leased or otherwise used
by the Company, including location, square footage, space
available for expansions, presence of any known above-
ground or underground chemical or fuel storage tanks or
sumps, and brief description of lease/use terms (if applicable)
A-29


and current and prior usage (including use by other owners
and tenants, if known).
[ ] (d) Schedule of property, plant and equipment by category includ-
ing gross asset value, accumulated depreciation, range of
depreciable lives, depreciation methods and market value/
replacement cost estimates (if available).
[ ] (e) Summary of all outstanding capital purchase commitments.
[ ] (f) For material properties and facilities: deeds, mortgages,
deeds of trust, title insurance policies, title reports, surveys,
certificates of occupancy and appraisals and valuations; UCC
searches in relevant states; judgment searches in relevant
states; description of other liens, encumbrances and zoning
restrictions.
[ ] (g) List of all facilities formerly owned, leased or otherwise used
by the Company, including location, square footage, presence
of any known aboveground or underground chemical or fuel
storage tanks or sumps, dates of ownership/lease/use, and
brief description of usage (including use by other owners and
tenants, if known).
[ ] (h) List, including maximum quantity onsite at any one time and
brief description of usage, of all hazardous materials/wastes
currently or previously (if known) stored, used, transported,
generated, manufactured, treated, discharged, or disposed in
connection with the Company’s business. Provide MSDS
forms for listed items, if available.
[ ] (i) List, and brief description of status, of all permits, licenses,
certificates, and other governmental approvals (collectively,
“Permits”) held or needed by the Company in connection with
its business or properties owned, leased or otherwise used by
the Company, including Permits relating to environmental,
hazardous materials/wastes, and worker health and safety
matters.
[ ] (j) All claims, demands, notices or requests for information, and
responses thereto (collectively, “Notices”), given to or received
from any agency or other person regarding any matters con-
cerning the environment, hazardous materials/wastes, or
worker health and safety, including any Notices of potential
responsibility for environmental contamination.
A-30


[ ] (k) List, and brief description of status, of environmental, hazard-
ous materials/wastes, or worker health and safety problems,
injuries, conditions or issues known to the Company concern-
ing the Company’s business or any facility or property owned,
leased or otherwise used by the Company, and including any
environmental contamination conditions and any known or
potential violations or non-compliance with applicable laws,
rules, regulations or Permits.

[ ] (l) List, and brief description of status, of spills, leaks, or other
unauthorized discharges of hazardous materials/wastes
occurring in connection with the Company’s business or at
any property or facility when owned, leased or otherwise used
by the Company.

[ ] (m) List, and brief description of status, of all pending or threat-
ened criminal, civil, regulatory, judicial or administrative
actions or proceedings relating to the environment, hazard-
ous materials/wastes, or worker health and safety matters.

[ ] (n) Any reports, summaries or evaluations regarding matters
related to worker health and safety, the environment or haz-
ardous materials/wastes, including assessments or audits,
whether internal or external, and any sampling results from
any hazardous materials/wastes, soil, air or water related to
the Company’s business or any facilities or property owned,
leased or otherwise used by the Company

[ ] (o) List, with brief description of status, any environmental inves-
tigation or remediation which the Company or another party is
conducting, has completed, or which may be required (if
known) in connection with the Company’s business, or any
facility or property owned, leased or otherwise used by the
Company.

[ ] (p) List, with brief description of status, any modification, removal,
repair, closure or installation of equipment or improvements,
including equipment or improvements related to hazardous
materials/wastes, which the Company or another party is
conducting or which may be required (if known) in connection
with the Company’s business, or any facility or property
owned, leased or otherwise used by the Company.
A-31


16. TECHNOLOGY AND PROPRIETARY RIGHTS
[ ] (a) List and copies of all patents and applications pending, held or
being prosecuted by the Company in the United States or
elsewhere, with descriptive titles, numbers, jurisdiction, and
copies of all correspondence to or from examining authorities
or other parties regarding such patents and patent
applications.
[ ] (b) List of all copyright registrations and applications related to all
intellectual property and intellectual property rights used in
connection with the Company’s business or necessary for its
business as presently conducted and as currently proposed to
be conducted (collectively, “Technology”) pending, held or
being registered by the Company in the United States or
elsewhere, with descriptive titles, numbers, and jurisdiction.
[ ] (c) List of all trademarks, registered or unregistered, used in
connection with the Technology, whether or not owned by
or licensed to the Company, with a description of products or
services associated therewith, and numbers, jurisdiction, sta-
tus of any registration applications pending, if any.
[ ] (d) List of all categories of Technology (whether or not patented or
patentable), together with a brief description of how each such
Technology was developed or acquired.
[ ] (e) List and copies of all license agreements and sublicense
agreements related to the Technology pursuant to which
the Company licenses any technology or intellectual property
rights to or from third parties, including model or standard
sales or license agreements (including shrink-wrap or click-
wrap licenses).
[ ] (f) List and copies of all agreements related to the Technology
pursuant to which the Company has assigned any technology
or intellectual property rights to, or obtained any technology or
intellectual property rights from, third parties, including without
limitation intellectual property assets transferred into the Com-
pany at or in connection with its formation or spinoff. Also
include a description of all interests, whether direct or indirect,
whether through ownership or otherwise, of any founder, offi-
cer, director, former officer or former director in the technology
and/or intellectual property relevant to the Company, and
A-32


copies of Company’s standard form of agreements with
founders, directors, officers and advisory board members,
if applicable.
[ ] (g) List and copies of all agreements pursuant to which the
Technology are distributed or marketed by third parties,
including without limitation all sales representative, referral,
reseller, value-added reseller, original equipment manufac-
turer and all other distribution agreements.
[ ] (h) List and copies of all joint ownership, research and develop-
ment agreements which relate to the Technology and to
which the Company is a party, including for each such rela-
tionship a description of the ownership and rights to any
developed technology, and any payment or financial obliga-
tion with respect to such developed technology.
[ ] (i) List and copies of all agreements pursuant to which products
or components related to the Technology are manufactured
or assembled by, or pursuant to which the Company acquires
products or components for products from, third parties.
[ ] (j) List of engineers and other employees who have participated
in or contributed to the development of the Technology, a brief
description of their roles, and copies of their resumes or other
evidence of previous job history.
[ ] (k) List of all non-employees (individuals and entities) who par-
ticipated in any Technology development for the Company,
including information concerning each project, the amount
and type of services performed and whether each such
person has executed an assignment of rights in intellectual
property to the Company.
[ ] (l) Copies of the Company’s standard form of agreements with
employees and independent contractors regarding inven-
tions, and a list of all employees and all independent con-
tractors who have executed the agreements, and a list of all
employees and all independent contractors who have not
executed the agreements.
[ ] (m) Copies of confidentiality, non disclosure, and assignment of
invention agreements, between the Company and employ-
ees, and between the Company and independent contrac-
tors, the contents of which differ from those set forth in the
A-33


standard form, including a description of any work or inven-
tions excluded from such agreements.
[ ] (n) Copies of the Company’s standard form of confidentiality and
non disclosure agreements, between the Company and per-
sons or organizations other than employees and independent
contractors, and a list of persons or organizations who have
executed the agreements.
[ ] (o) Copies of confidentiality and non disclosure agreements,
between the Company and persons or organizations other
than employees and independent contractors, the contents of
which differ from those set forth in the standard form.
[ ] (p) All documents, correspondence, memos, and other papers
relating to the Company’s written policies on intellectual prop-
erty, including trade secrets and proprietary information.
[ ] (q) Copies of all security agreements pursuant to which a lender
or creditor has taken a security interest in specific intellectual
property assets or “general intangibles” which relate to the
Technology.
[ ] (r) Uniform commercial code filings, or other state and federal
filings, that relate in any way to the Technology.
[ ] (s) Law firm(s) handling patent, trademark, copyright and other
intellectual property matters for the Company, and any sub-
sidiary, and contact person name, address and phone
number.
[ ] (t) All documents, correspondence, memos, notes, and other
papers relating to any Technology development by the Com-
pany that involves the derivation or use of specifications or
technical information derived from the products of third parties.
[ ] (u) Listing of all open source software applications, programs,
packages, or libraries that have been used by Company to
develop any of the Technology, or that have been incorpo-
rated into the Technology, along with a copy of the accom-
panying license for such open source applications.
[ ] (v) All documents, correspondence, memos, notes, and other
papers analyzing or assessing the validity or scope of any of
the Company’s copyrights, patents, or trademarks which
relate to the Technology.
A-34


[ ] (w) Description of any development projects relevant to the Tech-
nology currently underway, including scope, personnel
involved in the development and status.
[ ] (x) Description of all Company trade secrets and related know-
how necessary or useful to conduct the business of the
Company and/or to utilize the Technology.
[ ] (y) List and copies of all other information, documents and agree-
ments relating to the Technology not covered by this list but
which would, in the Company’s judgment, be material to
evaluation of the Technology by prospective buyers thereof.
PLEASE NOTE: If the Company uses a standard format for any of these
types of agreements, please provide only a single copy of that format
and any negotiated versions with material deviations from that format.

17. DEFENSE AND PROSECUTION OF INTELLECTUAL PROP-
ERTY CLAIMS
[ ] (a) All documents, correspondence, pleadings, memos, notes,
and other papers relating to any pending or threatened intel-
lectual property litigation or claim against the Company con-
cerning the Technology, or any other assertion, suggestion, or
inquiry by a third party that the Company and/or the Tech-
nology is infringing its intellectual property rights.
[ ] (b) All documents, correspondence, pleadings, memos, notes,
and other papers applicable to any dispute or litigation with
any third party (including without limitation customers,
employees, suppliers and competitors) relating to ownership,
use or commercialization of the Technology.
[ ] (c) Materials referred to during the process of developing any
Technology that is the subject of any pending or threatened
litigation, claim, assertion, suggestion, or inquiry.

18. EXPORT MATTERS
[ ] (a) Copies of correspondence with, submissions to, or docu-
ments received from the Bureau of Industry and Security
(formerly Bureau of Export Administration), Office of Defense
Trade Controls, or Office of Foreign Assets Control, including
but not limited to any requests for advisory opinions, com-
modity jurisdiction requests, commodity classification
A-35


requests, applications for export licenses and responses
thereto (including notices of intent to deny, return without
action notices, and denials), export licenses, “is informed”
letters, reports filed pursuant to the Export Administration
Regulations or an export license, requests for documents
or other information, voluntary disclosures, pre-charging let-
ters, charging letters, warning letters, and documents reflect-
ing settlement of alleged export control violations.

[ ] (b) Copies of correspondence with or submissions to the Depart-
ment of Justice, Federal Bureau of Investigation, or any other
government agency related to any export or domestic release
of any technology or software.

[ ] (c) List or product matrix identifying the Export Commodity Clas-
sification Number (ECCN) or U.S. Munitions List classification
that applies to each of the items produced or sold by the
Company internationally. Separately identify any items that
contain or utilize cryptographic functionality (encryption).

[ ] (d) List of the license authority used to export each item exported
by the Company, with copies of any required supporting
documentation (e.g., letters of assurance to support use of
License Exception TSR).

[ ] (e) List of the countries to which Company exports or has
exported any items.

[ ] (f) List identifying Company products, technology, or services
that are: (i) on the United States Munitions List; (ii) have
substantial military applicability; or, (iii) are specially designed
or modified for military purposes, regardless of whether such
items are exported. Please indicate whether the Company
has registered with the Office of Defense Trade Controls.

[ ] (g) List of foreign national employees (and their countries of
nationality) whose job responsibilities include or require
access to technical information or software related to the
design, development or production or use of the Company’s
products. For the purposes of this request, a foreign national
employee is any employee who is not a U.S. citizen, a lawful
permanent resident alien, an asylee or a refugee.
A-36


19. SEC AND NASDAQ [NYSE] FILINGS AND RELATED MATERIALS
[ ] (a) All reports and other documents filed with the SEC (e.g., 10
Ks, 10 Qs, proxy statements, registration statements, pro-
spectuses, etc.) within the last [three] fiscal years and any
interim period, all exhibits and schedules filed therewith or
incorporated therein, other than documents that are available
via EDGAR.
[ ] (b) Comment letters or other correspondence from the SEC, if
any, and responses thereto.
[ ] (c) Any other filings or submissions made by the Company with
the SEC within the last [three] years.
[ ] (d) Filings and submissions made with The NASDAQ Stock Mar-
ket [the New York Stock Exchange] and any correspondence
with The NASDAQ Stock Market [the New York Stock
Exchange] within the last [three] years.

20. PUBLIC FINANCIAL REPORTING
[ ] (a) Reports or “management letters” received by the Company
from independent accountants or consultants during the past
five years relating to accounting or tax policies or financial
control procedures of the Company and any management
responses thereto.
[ ] (b) Any written documentation of internal control over financial
reporting and disclosure controls and procedures, as such
terms are defined in the rules of the SEC.
[ ] (c) Any written documentation of management’s assessment of
the effectiveness of the Company’s internal control over finan-
cial reporting; a description of any material changes that have
occurred since the end of the last period covered in the
Company’s periodic reports filed with the SEC or are expected
to occur in the future.
[ ] (d) Any written correspondence between the Company’s audit
committee and its management, auditors, outside counsel or
disclosure committee during the past three fiscal years and
any subsequent period; any disclosures to audit committee
since that date of (a) significant deficiencies or material weak-
nesses in internal control over financial reporting and (b) fraud
A-37


involving management or other employees with significant
role in internal control over financial reporting.
[ ] (e) Any minutes or similar documentation of the activities of the
Company’s disclosure committee, if any, during the past three
fiscal years and any subsequent period.
[ ] (f) Any report prepared by independent auditors pursuant to
Section 204 of the Sarbanes-Oxley Act.
[ ] (g) A description of any reports made pursuant to Section 307 of
the Sarbanes-Oxley Act or the Company’s whistleblowing
policy, and the Company’s response to such reports.
[ ] (h) If the Company restated its financial statements in the last five
fiscal years or in any subsequent period, furnish a description
of the relevant facts pertaining thereto.

21. SEC FILINGS
[ ] (a) All reports and other documents filed with the Securities and
Exchange Commission (e.g., 10-K’s, 10-Q’s, proxy state-
ments, registration statements, prospectuses, etc.) within
the last two years, all exhibits and schedules filed therewith
or incorporated therein and all correspondence from the SEC
with respect thereto, to the extent not available in complete
form through EDGAR.
[ ] (b) Copies of all reports or communications to security holders
during the last two years.

22. GENERAL
[ ] (a) List and description of all actual or potential conflicts of inter-
ests that the Company’s directors, officers or employees have
or may have due to their relationship with any competitor of
the Company, any supplier of goods or services to the Com-
pany, any distributor of the Company, any customer of the
Company or any other person or entity which has any interest,
financial or otherwise, in the Company.
[ ] (b) List and description of all transactions between the Company
and any stockholder, director, officer, employee or affiliate of
the Company (or any entity or person formerly having the
A-38


status thereof, including amounts and names of parties
involved) during the past three years.
[ ] (c) Description of all current or proposed loans to officers or
directors or other arrangements covered by Section 402 of
the Sarbanes-Oxley Act (including those that to which an
exemption may apply).
[ ] (d) Any director and officer questionnaires submitted within the
past five fiscal years.
[ ] (e) Copies of all director and officer liability insurance policies.
[ ] (f) List and description of all material insurance claims submitted
by the Company in the past two years.
[ ] (g) All press releases issued during the last 12 months with
respect to the Company or its business (if not available on
the Company’s website).
[ ] (h) Copies of the Company’s principal business plans for the last
three years.
[ ] (i) All legal opinions received by the Company during the last two
years.
[ ] (j) List of parties, if any, whose consent to this transaction will be
required and copies of relevant documents.
[ ] (k) All documents and information not covered by other items on
this list disclosing material information concerning the
Company.

A-39


A-40

Annex 11
Certain HSR Exempt Transactions
Following is a discussion of certain types of transactions that are
generally exempt from the HSR filing requirements. Antitrust Counsel
should be consulted when determining whether a particular exemption
may be applicable.

• Acquisitions of Goods and Realty in the Ordinary Course of
Business

Acquisitions of goods and realty in the ordinary course of business are
generally exempt from the HSR Act. Sales of new goods are generally
considered to be “in the ordinary course of business,” as are sales of certain
current supplies and certain used durable goods.

• Acquisitions Solely for the Purpose of Investment

The HSR Act and rules exempt certain acquisitions made by the
acquiring person “solely for the purpose of investment.” The existence of
the requisite intent under this exemption is a fact-intensive inquiry based
upon the circumstances of each case.

• Acquisitions of Certain Real Property Assets

The HSR rules generally exempt acquisitions of “new facilities,” used
facilities acquired by lessees from lessors under certain conditions, “unpro-
ductive” real property, office and residential property, hotels and motels
(except ski facilities), certain “recreational land,” certain “agricultural prop-
erty,” and retail rental space and warehouses (except in connection with the
acquisition of a business to be conducted on the property).

• Acquisitions of Foreign Assets or of Voting Securities of a
Foreign Issuer

An acquisition by a U.S. person of assets located outside of the United
States is exempt from the HSR Act unless the assets generated sales “in or
into the United States” in excess of $56.7 million (as adjusted) in the most
recent year.

Similarly, an acquisition by a U.S. person of the voting securities of a
foreign issuer is exempt from the HSR Act unless the foreign issuer had
sales in or into the United States in excess of $56.7 million (as adjusted) in
the most recent year. Whether sales in a particular case should be deemed
“in or into the United States” depends upon the particular circumstances of
that case.
A-41


• Acquisitions of Voting Securities of, or Non-corporate Interests
in, Entities Holding Assets the Acquisition of which Is Exempt
The HSR rules generally exempt an acquisition of voting securities of
an issuer, or an acquisition of non-corporate interests in an entity, when that
issuer or entity, together with all entities that it controls, holds assets the
acquisition of which is exempt.

A-42

DLA PIPER
DLA Piper is a global legal services organization, the members of
which are separate and distinct legal entities, with offices across Europe,
Asia, the Middle East and United States. Over 3,400 lawyers across
64 offices and 25 countries provide a broad range of legal services through
the firm’s global practice groups. The firm is relationship driven and built to
meet the ongoing legal needs of its clients, wherever they choose to do
business.

www.dlapiper.com

Adelaide, Australia Beijing, China
T: +61 8 8124 1811 T: +86 10 6561 1788
F: +61 8 8231 0014 F: +86 10 6561 5158
Brisbane, Australia Shanghai, China
T: +61 7 3246 4000 T: +86 21 50372726
F: +61 7 3229 4077 F: +86 21 50372268
Canberra, Australia Zagreb, Croatia
T: +61 2 6201 8787 T: +385 1 61 99 930
F: +61 2 6230 7848 F: +385 1 61 99 977
Melbourne, Australia Prague, Czech Republic
T: +61 3 9274 5000 T: +420 2 2423 4413
F: +61 3 9274 5111 F: +420 2 2224 6065
Perth, Australia Copenhagen, Denmark
T: +61 8 6467 6000 T: +45 7730 4050
F: +61 8 6467 6001 F: +45 7730 4077
Sydney, Australia Cairo, Egypt
T: +61 2 9286 8000 T: +202 2 795 4228/8179
F: +61 2 9283 4144 F: +202 2 795 4221
Salzburg, Austria Paris, France
T: +43 (0) 662 84 32 88 T: +33 1 40 15 24 00
F: +43 (0) 662 84 32 88 5020 F: +33 1 40 15 24 03
Vienna, Austria Tbilisi, Georgia
T: +43 1 531 78 0 T: +995 (32) 92 1464
F: +43 1 533 52 52 F: +995 (32) 93 2752
Antwerp, Belgium Cologne, Germany
T: +32 (0) 3 287 2828 T: +49 (0) 221 277 277 0
F: +32 (0) 3 230 4221 F: +49 (0) 221 277 277 10
Brussels, Belgium Frankfurt, Germany
T: + 32 (0) 2 500 1500 T: +49 (0) 69 27133 0
F: + 32 (0) 2 500 1600 F: +49 (0) 69 27133 100
Sarajevo, Bosnia-Herzegovina Hamburg, Germany
T: +387 33 295 236 T: +49 (0) 40 1 88 88 0
F: +387 33 295 242 F: +49 (0) 40 1 88 88 111
Sofia, Bulgaria Munich, Germany
T: +359 2 935 5610 T: +49 (0) 89 5908 2318
F: +359 2 935 5616 F: +49 (0) 89 5908 1332

Accra, Ghana Cape Town, South Africa
T: +233 21 249564/225674 T: +27 (0) 21 481-6300
F: +233 21 220218 F: +27 (0) 21 481-6388
Hong Kong, Hong Kong Johannesburg (Sandton), South Africa
T: +852 2103 0808 T: +27 (0)11 290-7000
F: +852 2810 1345 F: +27 (0)11 290-7300
Budapest, Hungary Madrid, Spain
T: +36 1 325 30 20 T: +34 91 319 12 12
F: +36 1 325 30 21 F: +34 91 319 19 40
Milan, Italy Stockholm, Sweden
T: +39 02 80 61 81 T: +46 8 701 78 00
F: +39 02 80 61 82 01 F: +46 8 701 78 99
Rome, Italy Bangkok, Thailand
T: +39 06 68 88 01 T: +66 2 686 8500
F: +39 06 68 88 02 01 F: +66 2 670 0131
Tokyo, Japan Dubai, UAE
T: +81 (0) 3-4550-2800 T: +971 4 363 6900
F: +81 (0) 3-4550-2801 F: +971 4 363 6901
Amsterdam, Netherlands Kyiv, Ukraine
T: +31 (0) 20 541 98 88 T: +380 (44) 490 95 75
F: +31 (0) 20 541 99 99 F: +380 (44) 490 95 77
Auckland, New Zealand Birmingham, United Kingdom
T: +64 9 303 2019 T: +44 (0) 8700 111 111
F: +64 9 303 2311 F: +44 (0) 121 262 5794
Wellington, New Zealand Edinburgh, United Kingdom
T: +64 4 472 6289 T: +44 (0) 8700 111 111
F: +64 4 472 7429 F: +44 (0) 131 242 5555
Bergen, Norway Glasgow, United Kingdom
T: +47 55 30 10 00 T: +44 (0) 8700 111 111
F: +47 55 30 10 01 F: +44 (0) 141 204 1902
Oslo, Norway Leeds, United Kingdom
T: +47 24 13 15 00 T: +44 (0) 8700 111 111
F: +47 24 13 15 01 F: +44 (0) 113 369 2949
Warsaw, Poland Liverpool, United Kingdom
T: +48 22 540 74 00 T: +44 (0) 8700 111 111
F: +48 22 540 74 74 F: +44 (0) 151 236 9208
Moscow, Russia London, United Kingdom
T: +7 (495) 221 4400 T: +44 (0) 8700 111 111
F: +7 (495) 221 4401 F: +44 (0) 20 7796 6666
St. Petersburg, Russia Manchester, United Kingdom
T: +7 (812) 448 7200 T: +44 (0) 8700 111 111
F: +7 (812) 448 7201 F: +44 (0) 161 235 4111
Singapore, Singapore Sheffield, United Kingdom
T: +65 6512 9595 T: +44 (0) 8700 111 111
F: +65 6512 9500 F: +44 (0) 114 270 0568
Bratislava, Slovak Republic Atlanta, United States
T: +421 2 5920 2123 T: (404) 736-7800
F: +421 2 5443 4585 F: (404) 682-7800

Austin, United States New York, United States
T: (512) 457-7000 T: (212) 335-4500
F: (512) 457-7001 F: (212) 335-4501
Baltimore (Downtown), United States Northern Virginia, United States
T: (410) 580-3000 T: (703) 773-4000
F: (410) 580-3665 F: (703) 773-5000
Baltimore (Mount Washington), Philadelphia, United States
United States T: (215) 656-3300
T: (410) 580-3000 F: (215) 656-3301
F: (410) 580-3001
Phoenix, United States
Boston, United States T: (480) 606-5100
T: (617) 406-6000 F: (480) 606-5101
F: (617) 406-6100
Raleigh, United States
Chicago, United States T: (919) 786-2000
T: (312) 368-4000 F: (919) 786-2200
F: (312) 236-7516
Sacramento, United States
Dallas, United States T: (916) 930-3200
T: (214) 743-4500 F: (916) 930-3201
F: (214) 743-4545
San Diego (Downtown), United States
East Brunswick, United States T: (619) 699-2700
T: (732) 590-1850 F: (619) 699-2701
F: (732) 590-1860
San Diego (Golden Triangle), United States
Easton, United States T: (858) 677-1400
T: (410) 820-4460 F: (858) 677-1401
F: (410) 820-4463
San Francisco, United States
La Jolla, United States T: (415) 836-2500
T: (858) 638-6806 F: (415) 836-2501
F: (858) 456-3075
Seattle, United States
Las Vegas, United States T: (206) 839-4800
T: (702) 737-3433 F: (206) 839-4801
F: (702) 737-1612
Silicon Valley, United States
Los Angeles (Century City), United States T: (650) 833-2000
T: (310) 595-3000 F: (650) 833-2001
F: (310) 595-3300
Tampa, United States
Los Angeles (Downtown), United States T: (813) 229-2111
T: (213) 330-7700 F: (813) 229-1447
F: (213) 330-7701
Washington, D.C., United States
Minneapolis, United States T: (202) 861-3900
T: (612) 524-3000 F: (202) 223-2085
F: (612) 524-3001
Lusaka, Zambia
T: +260 1 236319
F: +260 1 236478

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Boston London Rio de Janeiro
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Buenos Aires Los Angeles San Antonio
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Calgary Luxembourg San Diego
ph: 403-221-9400 ph: +352-47-17-55 ph: 858-623-9200

Carson Mexico City San Francisco
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