Für im auch US-Merger & Acquisition Geschäft tätige Berater oder Unternehmen interessanter Artikel: “Observations From a Shareholder Rep.” by Paul Koenig, Shareholder Representative Services LLC, featured in American Bar Association / Mergers and Acquisitions Committee — Spring 2012 Issue of Deal Points.
Observations From a Shareholder Rep
By Paul Koenig
SRS is engaged on a high volume of M&A transactions. We tend to be brought in on deals that have long or complicated post-closing processes or when the stakes are high with earnouts or escrows. On small, simpler deals, the parties may look for a volunteer representative or a lower-cost service provider. Based on our experience, attorneys frequently want to know what we see and which issues create problems. We have, or will be, discussing many of these issues at the recent ABA M&A committee meetings at Laguna Beach and in Las Vegas, but below is a summary of some of our findings.
Sandbagging
Discussions about sandbagging tend to get a lot of airtime at legal conferences, but the reality is that in our experience, this issue hardly ever comes up in discussions regarding the resolution of indemnification claims. There are a few possible explanations for this. First, we rarely see anti-sandbagging language included in agreements, so it would be unusual that this would be a defense to a claim. Second, most disclosure schedules are pretty exhaustive, so the number of facts that would fall within the coverage of a sandbagging provision (known to the buyer but not explicitly included in the disclosure schedule) is pretty low. Third, even where the contract is silent on sandbagging, discussions regarding what the buyer knew or did not know tend not to be the most powerful arguments. Rather, the discussions typically focus on the technical analysis of what are the facts and whether a representation or warranty has been breached. This does not mean that sandbagging terms are worthless. There are certainly unusual cases in which they could be the critical determinant of outcome. Also, the sandbagging terms can help the shareholder representative to calm down an emotional shareholder who is upset by a claim because he or she feels the buyer “knew about this.” We just don’t see them as relevant very often at the settlement or pre-litigation resolution stage.
1 Paul Koenig is Managing Director at Shareholder Representative Services LLC.
Expense Funds
Most of the transactions on which we are engaged will include an expense fund. We are often asked how much we think the selling shareholders should set aside for this purpose. According to our data, the average size of an expense fund tends to be around 2 – 3% of the escrow amount. This percentage, however, will vary considerably with deal size (declining as a percentage with the increase in size of the escrow). Our general suggested guidelines are that $50,000 will only be enough to fund an initial letter and low-level negotiations from an attorney and $250,000 is generally sufficient to fund matters up to litigation, but that more will likely be required if a dispute progresses to material litigation or arbitration. On transactions with large earnouts or escrows, or on which there is known exposure to an issue, the former shareholders will sometimes set aside $1 million or more. In our experience, the risk of actual litigation remains pretty low. The majority of the claims we receive are either accepted or settled without the need for going to court. On the other hand, we do suggest that the selling shareholder may want to err on the side of caution and make sure they have plenty set aside to meet reasonably anticipated funding needs because it can be much harder to try to raise additional money from the stockholder group months or years after closing. Our general view is that they are better off having a sufficient expense fund and not needing it than needing it and not having it.
Conflict Waivers for Target’s Counsel
We see waivers from the buyer allowing the target company’s counsel to represent the selling stockholders after closing in roughly half of our transactions. If these waivers are included, we typically can and will engage that law firm when there is a post-closing claim that requires legal counsel. If a waiver is not given, our experience is that most buyers will not agree to it later, and we are usually forced to look to another law firm.
Patent Trolls
Unfortunately, we see a large volume of patent troll claims. The announcement of the M&A transaction will sometimes trigger claims of infringement that neither the buyer nor seller was aware of prior to closing. These are a significant systemic problem because neither party wants to see the escrow unnecessarily depleted, and patent matters tend to be very expensive to make go away. While the buyer and the shareholder representative usually work together against a third party on these matters, tricky issues can arise when the best resolution is for the buyer to enter into a global licensing agreement of all of the third party’s patents. When that happens, we have to try to determine how to allocate the associated cost between what needed to be paid due to the target company’s alleged infringement and what is attributable to the buyer’s ongoing business activities. Often, there is not an easy or obvious answer to that.
Financial Misstatement Calculation of Damages
We sometimes see claims in which the parties agree that there is a mistake in the financial statements that were delivered to the buyer. The disagreement may come, however, in the calculation of the resulting damages. The selling stockholders will often believe the indemnifiable amount should be the amount of the misstatement. Buyers, however, will sometimes allege that they paid a multiple of revenue or EBITDA, and the indemnifiable loss is the amount of the misstatement times that multiple. More information on this issue is included in our booklet, Tales from the M&A Trenches, but the takeaway for practitioners is that if the answer to this damages calculation question is not clear, the dispute is not likely to be resolved quickly or easily. The bid and the ask simply tend to be too far apart. We know that this is an issue the parties often choose to punt on at the drafting stage for good reason, but it can create significant problems later if this claim is made.
Taxes
Tax claims are common, but they tend to be claims based on issues other than income taxes that often get less focus or attention from the merger parties. For example, we see a significant amount of personal property tax audits or municipal tax claims. The tax issues that tend to be the most difficult, however, are sales and use tax claims. The analysis is complicated, and the number of relevant transactions can be enormous. Our suggestion is to focus closely on this issue with your client and to try to address this issue with the buyer before closing. It tends to be much easier to get consensus on the proper analysis then rather than waiting until after closing to determine that the parties have very different views on the amount of potential liability.
