In this article, we look at 8 key considerations for parties contemplating a split between signing (also known as exchange) and completion (also known as closing).
1. Avoid the gap?
If a transaction is particularly complicated, or if the parties need extra time to transfer funds but are keen to 'lock in' a deal, a split signing and completion can sound convenient. However, splitting signing and completion adds complexity to the legal documents and process (see below), requiring additional time and cost.
For this reason signing and completion are usually only split where the parties have no other practical choice, e.g. if a regulator or private third party needs to consent in order for the transaction to proceed legally, or in the form anticipated. Typical completion conditions include clearance from competition, pensions, financial services (e.g. FCA) or other industry-specific regulatory bodies, or the approval of a private third party required under contract (e.g. change of control provision). Financing conditions – i.e. where the buyer has a period after signing to arrange funding in order to make the relevant acquisition – were seen pre-financial crisis when financing was (generally speaking) easier to come by, but the added execution risk in today's climate means that these are now rare.
It is worth remembering that – if a party does need more time, for example to obtain a contractual consent, arrange the final piece of its financing, or complete a pre-sale reorganisation – it might be simpler to have all documents signed (undated) and held by the parties' solicitors in escrow until the agreed release date, and then sign and close simultaneously.
2. Mind the MAC
Alongside a regulatory or contractual consent condition, you may see what is known as a 'MAC' condition. 'MAC' conditions, which have historically been more common in US deals but are increasingly seen in the UK and Europe, provide that completion will also be conditional on no 'material adverse change' (MAC) being suffered by the business in the gap between signing and completion.
Broadly speaking, the content of MAC conditions can be split into two categories:
- 'Micro MAC' conditions – those elements of the MAC clause that are specific to the company in question, e.g. material adverse change triggered by the loss of material contracts, causing a material adverse change in that company's financial prospects.
- 'Macro MAC' conditions – those elements that are either entirely generic, e.g. a material adverse change triggered by a general decline in economic circumstances (which a buyer would typically want to be restricted or expressly carved out), or are non-specific to the company in question, but apply to the industry or geographic location in which it operates, e.g. a material adverse change triggered by a decline in widget sales that would reasonably be expected to affect companies in the same widget industry as the company.
MAC conditions are still unpopular outside the US, not least because they can introduce an element of subjectivity (who decides what is 'materially adverse?'), and – in order to 'prove' the negative of no material adverse change having occurred – often add to the sellers' liability by requiring them to certify or warrant that no material adverse change has occurred. Differences between UK and US practice are further discussed at https://www.mjhudson.com/newsletter/on-target-oct-2017/
3. Preserving value
A buyer will want comfort that no actions are taken between signing and completion which either extract value (especially cash) from the business, or which could prejudice the financial condition or prospects of the business beyond completion. In addition to any no-leakage provisions that might apply on a locked-box deal, the parties will typically agree a suite of actions that are prohibited, or require buyer consent, during the period between signing and completion. These typically include (among other things) restrictions on share capital changes, acquisitions and disposals, charging assets of the business, terminating or amending material contractual obligations, starting or settling litigation and borrowing. The prohibitions may also be flanked by positive obligations, e.g. to conduct the business in a manner consistent with past practice. Collectively, these are known as 'gap controls'.
The parties will debate the consequences of breaching the gap controls, e.g. whether a breach (or only a material/fundamental breach) should give rise to a right to terminate or rescind the contract (which would be the buyer's preference), or (more commonly) to a right only to sue, after completion, for damages flowing from the breach.
4. Repeating / 'bringing down' warranties
Warranties are critical to any M&A transaction, covering both the fundamental (ownership of the shares being sold, capacity to transact) and key valuation assumptions (key contracts remaining in force, assets owned, no material liabilities). They are typically given at signing, but what if – before completion – the warranted circumstances change? To address this, it is typical for warranties to be deemed repeated (or, in the US, 'brought down') at completion.
All very sensible, but the repetition of warranties begs two key questions: (1) what should be the consequence of a post-signing breach, and (2) should the warrantors be able to make further disclosure against the warranties?
From a warrantor's perspective, it is natural that a repetition of warranties is accompanied by a right to update the disclosure letter. In response to that suggestion, a buyer will want a termination right if the breach appears material, which in turn erodes deal certainty for the seller(s).
There are many potential compromise positions, but a common one is to categorise the warranties, such that a breach of fundamental warranties (and potentially matters that are within the warrantor's control, e.g. no claims brought against third parties, no borrowings above a specified level, no employees paid over a certain amount) would give rise to a termination right, whereas a breach of other commercial warranties would only give rise to a damages claim, actionable after completion. Conversely, in the US it is common to include a completion condition that there has been no breach of warranties during the gap, such that the buyer has an automatic right to walk away if a breach has occurred.
5. Pricing the gap
Assuming the business being acquired is in good health, it is reasonable to expect an increase in business value between signing and completion, whereas the purchase price may be entirely, or substantially, fixed based on the company's value at signing (or, in the case of a locked box deal, earlier at the locked box date). So, except where full completion accounts are being used to adjust the purchaser price, there may be logic in the seller arguing for some increase in the purchase price based on time elapsed. The outcome will depend on the relative bargaining power of the parties, but (if successfully negotiated by the seller) any such uplift is typically expressed as a fixed daily amount, or a percentage "ticker" on the purchase price.
6. (Ful)filling the gap
The sale and purchase agreement (SPA) should state, very clearly, what evidence or circumstances constitutes satisfaction of each condition. Taking the example of competition law/anti-trust clearance, what form will the final communication from the relevant regulatory body take? Will it be a written notice? If so, will the notice confirm clearance, no objection, or simply state that the body is not referring the transaction for further scrutiny? If there is no response from the regulator within a designated response period, does that automatically constitute clearance? It is important for the SPA drafting to anticipate all these outcomes, to avoid leaving the transaction in limbo.
Equally important is the delineation of responsibility to satisfy each of the conditions. Taking the example of a regulatory condition, the parties will have to consider who has the legal obligation to make the relevant application (say, the buyer), but also who is best placed to provide the information required in order to satisfy the regulator (which may be the sellers and the target company). The sellers and target company may also want to approve the form of any applications, and be consulted on subsequent communications with the regulator.
While every transaction is entered into in the hope that all completion conditions can be satisfied, there must come a point when – if it appears that the conditions cannot/will not be satisfied within a reasonable period (and the buyer is unable / unwilling to waive them) – the parties will want to walk away from the deal.
Accordingly, parties typically agree a 'long stop date', extendable by mutual agreement, after which the SPA will lapse. Setting the long stop date will involve careful consideration and professional advice, allowing for the maximum response period of the relevant regulator, plus any time spent responding to further information requests (as regulators can typically 'stop the clock' on their response period while waiting for information requested).
8. Completion default
The list of deliverables and actions to be undertaken at completion (including the transfer of funds) is typically extensive and, even though the parties typically create a window to prepare for completion once the final condition is satisfied (often 5-10 business days), there is always a risk that a party may be unable to satisfy all its completion obligations on time. Of course the parties may always agree to delay completion, but they will also want to agree a default position in the SPA. Typically this would allow the non-defaulting party to choose between completing despite the shortcoming, postponing completion to a later date, or terminating the SPA (while preserving any rights it may have to claim for damages).