This practice note discusses a high-level overview of key distinctions of U.S. private mergers and acquisitions (M&A) legal concepts and market practice for non-U.S. companies considering an acquisition of a U.S. private company (i.e., a target company incorporated under the laws of a U.S. state). With the current regulatory and financing environment, cross-border transactions are facing a level of complexity and scrutiny that requires transacting parties to be well-prepared in advance for differences in practice and underlying principles across jurisdictions. This practice note examines assumptions surrounding U.S. private M&A market practice and distinguishes the myths and the truths that may arise in a cross-border transaction.

Where relevant, this practice note includes links to other LexisNexis resources and material on related topics. For a full listing of U.S. M&A provision-specific guidance, see M&A Provisions Resource Kit and for a full listing of U.S. regulatory guidance, see Regulatory Considerations in M&A Transactions Resource Kit.

Overview of the U.S. Legal System and Contract Law in the M&A Context

Myth - "U.S. Law" Will Govern the Purchase Agreement

As the U.S. is a federal legal system, no uniform "U.S. law" generally applies to private M&A purchase agreements and other transaction documentation. Rather than relying on conflicts of law rules, parties have the freedom to agree which U.S. state law will govern the agreement via a choice of law provision in the purchase agreement. In addition to the agreed governing law of the transaction documentation, federal and state law relating to antitrust, securities, transfer of employees, property title, and other areas may also be relevant.

In practice, many U.S. private M&A purchase agreements are governed by New York law. New York is recognized as having a sophisticated court system and substantial case law when it comes to contractual disputes. Delaware law is a popular alternative given its ubiquity as the preferred U.S. state for entity incorporation and due to the state's well-developed corporate case law. Transactions structured as mergers are carried out in accordance with the laws of the states of incorporation of the relevant parties and therefore such laws can influence the applicable governing law of the transaction documentation.

Certain differences exist between New York and Delaware law that are worth noting and that can influence which state law to use. For example:

  • The statute of limitations for contractual breach claims is longer in New York (six years compared to three years in Delaware).

  • Delaware courts have a more comprehensive interpretation of material adverse change (MAC) clauses and when a MAC is found to have occurred.

With a focus on the popular choice of either Delaware or New York governing law, both states have a literal, as opposed to a purposive, approach to contractual interpretation. The general rule of contractual interpretation in both states is that, in the absence of ambiguity on the face of the document, courts will not rewrite the language as agreed between parties. Evidence outside the four corners of the contract is generally inadmissible where a written agreement is complete, clear, and unambiguous on its face.

Delaware and New York law both also impose an implied covenant of good faith and fair dealing in every contract. The implied covenant functions as a legal mechanism for courts to interpret an ambiguous clause as it imposes an obligation of faithfulness to the parties' agreed purpose of the contract and requires consistency with the reasonable expectations of the other contractual party. Hence, if a contract is clearly drafted with certain terms, the implied covenant will be unlikely to nullify express contractual provisions.

Parties should also be mindful of the relevant choice of forum provision in the transaction documentation, including whether the governing law and jurisdiction clauses are compatible with each other and the appropriate dispute resolution procedure for the parties.

General Principles

Truth - U.S.-Style Purchase Agreements Are Longer Than Non-U.S. Style Purchase Agreements

U.S.-style purchase agreements tend to include information in the main body of the agreement that is more regularly found in schedules of non-U.S. style purchase agreements, extensive provisions to account for a multitude of hypothetical situations, and long clauses with fewer discrete subclauses. The result of this drafting style is a longer and more extensive transaction document than is typically seen in a non-U.S. context.

In the U.S., disclosure schedules tend to be used to only list exceptions to the representations and warranties and information that is too extensive to list in the main body of the agreement. Thus, limitations on liability (e.g., de minimis claims thresholds, deductibles, caps, etc.) and indemnification provisions would also be included in the main body of the agreement.

Representations and warranties also appear in the main body of the agreement. Representations and warranties can be extensive because the parties make statements of fact and assurances on a wide range of topics. In fact, the representations and warranties section of a U.S.-style purchase agreement is typically the longest section of the agreement and takes the most time to negotiate.

Truth - A U.S. Deal Is Typically More Buyer-Friendly toward Conditionality

The U.S. approach to conditionality is generally more favorable to the buyer than the seller. It is standard practice in the U.S. to include conditions precedent (CPs), such as absence of any material adverse change (a MAC CP) and the accuracy of representations and warranties at closing, which is not as commonly seen in other markets. While having additional CPs introduces a greater degree of conditionality to a transaction and, in theory, a buyer has more walk-away rights at its disposal, in practice it is rare for a transaction to fail to close on these grounds.

A MAC CP is a condition precedent to closing that a material adverse change in the target company or its business has not occurred between signing and closing or, commonly, since the company's last balance sheet date. In the U.S., it is standard practice to include a MAC CP in the purchase agreement, either as a standalone CP or as a bring down at closing of the "absence of material changes" representation and warranty.

The prevalence of MAC CPs in the U.S. market seems to be linked to the U.S. market's general acceptance of the principle that the risk of the unknown between signing and closing should be apportioned, to some degree, between the buyer and the seller, rather than falling solely on the shoulders of the buyer. This willingness by a seller to accept the apportionment of risk may also be a result of the practical difficulty for a buyer to enforce a MAC CP in the United States. In general:

  • The burden of proof falls on the buyer. The buyer must make a strong showing to invoke a MAC exception to its obligation to close.
  • To be material, an event must "substantially threaten the overall earnings potential of the target" and such event must impact the earnings of the target over a "commercially reasonable period" (years not months). See Akorn, Inc. v. Fresenius Kabi AG, No. 2018-0300-JTL, 2018 Del. Ch. LEXIS 325 (Del. Ch. Oct. 1, 2018). -and-
  • The event must materially affect the business as a whole, rather than any specific division or business line.

Only in 2018 did a Delaware court find its first occurrence of a MAC in Akorn, Inc. v. Fresenius Kabi AG, No. 2018- 0300-JTL, 2018 Del. Ch. LEXIS 325 (Del. Ch. Oct. 1, 2018), where the Delaware Chancery Court upheld the termination right of Fresenius in connection with its proposed $4.3 billion acquisition of Akorn following a significant drop in Akorn's post-signing performance coupled with a particularly egregious set of facts. The court did, however, reaffirm the heavy burden required in order to find that a MAC has occurred.

In addition to Delaware courts' apparent reluctance to enforce a MAC CP, MAC definitions customarily include an extensive list of carve-outs, which make it even more difficult for a buyer to successfully invoke a MAC exception to its obligation to close. A typical MAC carve-out exculpates a target for most nontarget specific factors, such as a general economic downturn or industry-wide regulatory changes (unless such factors disproportionately affect the target). In the post-COVID-19 era, it is increasingly common to see the effects of the pandemic (and/or governmental responses to the pandemic such as social distancing requirements, mandatory shutdowns, and other public health responses) included in the already long list of customary MAC carveouts. See Material Adverse Change Definitions.

It is standard market practice in the U.S. to include a CP as to the accuracy of the representations and warranties made as at signing and closing. The buyer has the right to terminate the transaction if such representations and warranties are not accurate. In practice, except for certain fundamental representations (typically capitalization and title representations), high materiality thresholds and MAC qualifiers commonly apply to this CP. Therefore, a transaction very rarely fails to close on these grounds.

Myth - The Disclosure Schedule Will Include by Reference All Documents Provided in the Data Room

U.S. buyers generally resist disclosure of the entire data room against the representations and warranties made in the purchase agreement. This is because the U.S. does not have a legal concept of "fair disclosure" comparable to certain other jurisdictions, which generally requires matters to be disclosed in sufficient detail to enable a reasonable buyer to understand the impact of what is disclosed. A U.S. buyer will therefore find it difficult to accept any general disclosures, including the general disclosure of the data room, which would allow for the disclosure of every piece of information in the data room for the seller's benefit. While a seller negotiating with a non-U.S. buyer may attempt to include a general disclosure of the data room by including a very explicit standard of fair disclosure, it is very uncommon in the U.S. market.

Myth - Representations and Warranties Are Only Given at Signing of the Purchase Agreement

As noted above, it is standard market practice in the U.S. to include a CP as to the accuracy of the representations and warranties as at signing and continued to closing. If that condition is not met, the buyer typically has the right to terminate and not close the transaction. Requiring the representations and warranties to be repeated at closing ensures that the buyer is protected against changes in the seller's business occurring between signing and closing. The U.S. view is that any breach of the target's representation or warranties prior to closing is the responsibility of the seller, which remains in control of the business prior to closing. Such concept goes hand in hand with the purpose of interim operating covenants, which impose on the seller the obligation to maintain the target business between signing and closing and to deliver it at closing without material impairment.

Myth - Recourse for Breach of Representations and Warranties Is Limited to Breach of Contract Claims

As mentioned, it is standard practice in the U.S. to use representation and warranties in conjunction with indemnification clauses as a tool for risk allocation. An indemnification clause is a contractual tool that allows parties to agree in advance as to who will bear the liability associated with specific risks related to the contract (e.g., breaches of representations and warranties in a purchase agreement).

A well-drafted indemnification clause allows the nonbreaching party to shift the burden of unassumed losses resulting from a breach of the breaching party's representation. To form a basis for post-closing liability, the representations, warranties, and the indemnification clause must survive the closing. However, the indemnifying party will usually seek to limit their exposure to the indemnified liabilities by insisting on a time limit in the purchase agreement for the survival of the representation, warranties, and indemnification clause post-closing. This means the indemnified party can bring a claim under the indemnification clause after the transaction has closed, as long as the survival period has not expired. The survival period for the representations and warranties could vary based on the nature of the representation or warranty, but in general U.S. survival periods typically range from 12 to 18 months after closing of the transaction for business or commercial representations and warranties. The reason frequently given for time periods in this range is that the buyer should be able to complete a full audit cycle to uncover any issues that are not readily apparent upon the closing of the acquisition.

Indemnification claims also allow the buyer to recover legal fees incurred, which otherwise are typically split between the parties in the United States. This is one of the key reasons for providing for an indemnity. It is also important to note that U.S. market practice does not differentiate between representations and warranties, and instead uses them interchangeably and always in reference to their function as a risk allocation tool.

For additional information, see Indemnification Claims in Acquisitions.

Myth - A Buyer Cannot Bring a Claim for a Breach of Representation or Warranty Where It Had Knowledge of the Breach prior to Signing or Closing

Sandbagging is a concept that is very familiar among U.S. practitioners but may be less so among lawyers in other parts of the world where such concept does not exist or is prohibited.

A "sandbagger" closes on a deal knowing there is a breach by the seller and intending to sue. Even in the U.S., the law is not settled in this area among the different states. Pro-sandbagging clauses in the purchase agreement expressly allow the buyer to bring a claim for breach of a representation and warranty where it had knowledge of the breach prior to signing or closing. Conversely, a seller may negotiate for an anti-sandbagging provision, which expressly precludes a buyer from obtaining post-closing recovery based on facts the buyer knew before the closing.

Delaware and New York are generally seen to be pro-sandbagging states by default, but the positions differ slightly when the purchase agreement is silent on this point. See Silence on Sandbagging in Private Acquisitions Chart (CA, DE, NY, TX).

Absent an express anti-sandbagging provision in an agreement, Delaware law holds sellers to the terms of their representations and warranties and buyers may prevail on a claim for breach regardless of their pre-closing knowledge of the breach.

Under New York law, an express pro-sandbagging clause can be relied upon. Where the contract is silent on the point, the position is a bit more complicated. The buyer may still be able to bring a claim where it had knowledge of the breach prior to signing or closing but only if the source of the knowledge of the breach was a third party (i.e., not the seller) or if it was common knowledge.

U.S. Antitrust and Foreign Investment Considerations

Myth - Only Statutory Timelines Should Be Factored into the Deal Timeline from a Regulatory Perspective

From a regulatory perspective, a cross-border transaction will very likely implicate U.S. federal laws regarding antitrust and national security, as summarized below.

Antitrust - The Hart-Scott-Rodino Antitrust Improvements Act

The Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (HSR Act), requires that the parties to proposed stock or asset acquisitions file premerger notification reports with the Federal Trade Commission (FTC) and the Antitrust Division of the Department of Justice (DOJ) and observe a waiting period (usually 30 calendar days) if the transaction exceeds certain thresholds. Generally, a filing will be required if the value of the transaction exceeds a certain amount as adjusted annually (the "size of transaction" test); for certain transactions, an additional "size of parties" threshold applies that requires one party to have sales or assets of a certain amount as adjusted annually and the other party to have sales or assets of a certain threshold as adjusted annually in order to trigger a filing. For current values and thresholds, see Current HSR Thresholds Chart. It should also be noted that several exemptions to the HSR reporting obligation exist which may allow parties to forgo filings for certain transactions (i.e., for foreign-to-foreign transactions or passive investments in some circumstances). The notifications require a filing fee ranging from $30,000 to $2,250,000 per transaction.

The initial HSR notification requires the filing parties to disclose information that the government uses to assess the possible competitive implications of the transaction (including various market, competition, market share, and similar analyses). Because collecting these items can be onerous, antitrust counsel will need time to review and prepare the filing. Therefore, parties should factor HSR preparation time into any deal timeline.

The initial 30-day waiting period allows federal antitrust authorities to investigate the transaction prior to closing. If the government concludes within the initial waiting period that it does not intend to take enforcement action concerning the acquisition, the waiting period will simply expire, and the parties will be free to close their transaction from a U.S. antitrust perspective within one year. Otherwise, the government may act before the initial period expires by issuing a "Second Request," although the acquirer may choose to "pull and refile" its notification, effectively granting the government an additional 30-day period to review the transaction without issuing a Second Request.

Second Requests require the parties to submit a wide range of documents and answer numerous interrogatories, typically including broad requests for competition, market, pricing, and transaction-related documents and additional information regarding the parties, their operations, and locations along with revenue breakdown by location and product line, as well as costs. After the parties have substantially complied with these requests (note there is no deadline for substantial compliance so the timing is elastic), a second 30-calendar day waiting period begins, during which the government and the parties may negotiate remedies if applicable or the parties make final presentations. If the government still has substantive concerns about the transaction at the end of this period and has not reached agreement on an appropriate remedy, it can seek to enjoin the closing of the transaction in federal district court. Otherwise, parties may close the deal. It is the usual practice of the FTC and DOJ to seek a timing agreement with the parties that obligates the parties to provide several weeks' notice of substantial compliance and closing.

For a deal with a Second Request, parties can expect to have to wait up to a year from the initial filing through the end of the Second Request waiting period, with longer timelines if the authorities challenge the proposed transaction in court.

Foreign Investment - Committee on Foreign Investment in the United States

While there are multiple foreign investment review processes in the U.S., the Committee on Foreign Investment in the United States (CFIUS) is one of the broader and more frequently considered regimes and addresses certain acquisitions of U.S. assets by non-U.S. persons.

Most filings are voluntary and based upon foreign acquisition of control over a U.S. business or certain U.S. real estate. However, filings are mandatory, even for noncontrolling investments, if the investor will acquire material governance or information access rights in a U.S. business involving critical technology, critical infrastructure, or sensitive personal data and either (1) a foreign government holds at least a 49% voting interest in the investor and the investor is acquiring at least a 25% voting interest in the U.S. business, or (2) in a business involving critical technology, an export license would be required to transfer the technology (whether actually transferred or not) to the home country of the investor or any 25% owner of the investor.

CFIUS's regulations contain a broad definition of control and many undefined terms, which complicates evaluations of CFIUS's jurisdiction and whether a filing is mandatory. Parties not subject to mandatory filings may choose not to file, but if CFIUS has jurisdiction over a transaction, CFIUS has perpetual post-closing authority to review transactions and subsequently impose mitigation conditions or require divestment.

CFIUS receives two types of filings: declarations and notices. A declaration, available for both mandatory and voluntary filings, requires less information from the parties, involves no filing fee, and gives CFIUS 30-calendar days to complete its assessment; in many cases, the entire declaration process can be completed within two months. While less onerous than a notice, declarations do not guarantee conclusive outcomes. There are two primary outcomes from filing a declaration: CFIUS can clear the transaction or it may ask the parties to file a notice. Filing a notice can add significant time and expense to the overall process, which can be frustrating because parties often choose to file a declaration with the hopes of avoiding a notice. In some cases, CFIUS may also decide not to clear the transaction but not to request a notice; this outcome is tantamount to a "no action" letter, though CFIUS reserves the right to request a notice in the future.

Parties can also file a notice directly. This will ensure a clear decision from CFIUS but requires significantly more information from both parties and a filing fee of up to $300,000. It is prudent to allow four to six months after signing to complete the notice process, including drafting and CFIUS intake (described below), a 45-calendar day "review" period, and a possible 45-calendar day "investigation" period. Occasionally, CFIUS will need more time to complete its diligence or agree on mitigation conditions both internally and with the parties; in these situations, the parties administratively "withdraw and refile" the notice rather than force CFIUS to leave the matter to the U.S. President for decision.

Preparing information for a CFIUS filing can take several weeks before a submission can be made. In the case of a notice, the investor must provide detailed personal identifier information for board members, senior officers, and 5% individual shareholders. The process of collecting this information is often time-consuming and may implicate data privacy concerns. The target will be required to provide details concerning the applicability of export controls to its products and services, something less mature companies may not have considered, as well as details of contracts directly or indirectly supporting the U.S. government. Previous CFIUS experience can shorten the data collection process for both parties.

Filing parties must consider CFIUS's intake process. Customarily, parties provide a draft notice to CFIUS before formal submission to ensure that CFIUS will accept the filing. This can potentially involve responding to a number of staff comments before the notice is accepted. Once the parties are "on the clock" they should expect to receive further questions during CFIUS's consideration of both notices and declarations.

After reviewing a notice, the CFIUS process can come to three outcomes: CFIUS can (1) clear the transaction without mitigation conditions, (2) clear the transaction with mitigation conditions, or (3) recommend that the U.S. President block the transaction or order divestment of a previously acquired investment. Mitigation conditions can either be agreed with the parties or imposed unilaterally by CFIUS. If CFIUS recommends a block or divestment, they will inform the parties of the unclassified basis of their decision in a "Ralls letter." Parties can sometimes rebut the basis for CFIUS's decision, but more typically the parties abandon the transaction to take advantage of CFIUS's confidentiality and avoid a high-profile presidential decision.

For more information and insight from Linklaters, see Navigating U.S. Foreign Investment.

Additional Key Items of Note

Purchase Price Adjustment

The overwhelming majority of purchase agreements in the U.S. use the closing accounts mechanism for purchase price adjustments. In some other jurisdictions, the opposite is true, and a majority of purchase agreements use the locked box/no adjustment mechanism.

The locked box method is a more seller-friendly construct because the purchase price is fixed and the seller has certainty over the proceeds, provided the target company does not "leak" value. When a purchase agreement uses a locked box mechanism, the purchase price is agreed by the parties based on a balance sheet prepared as of an agreed date. The buyer bears the financial risk for losses that might occur in the interim period between the locked box date and closing. Purchase agreements may include provisions to account for any "leakage," which protect the buyer from any improper extraction of value from the target company (whether by way of dividends, related-party transactions, or otherwise) before closing.

By contrast, with a closing accounts mechanism, the agreed base price at closing will be based on estimates derived from figures in the last audited accounts of the target company. Post-closing true ups or adjustments will then occur to take account of the difference between the estimates and the actual figures that are determined following closing. The closing accounts mechanism is generally viewed as more buyer-friendly because the purchase price is adjusted post-closing based on the target company's actual financial performance in the interim period between signing and closing. This aligns with parties' near-universal acceptance (and expectation) in the U.S. of a bring down of target representations and warranties at closing due to the premise that the transfer of economic risk to the buyer occurs at closing instead of, as with a locked box deal, an earlier agreed locked box date. See Purchase Price Adjustment Provisions in M&A Transaction Documents.

No Shop, No Talk Provisions

"No shop, no talk" provisions are another key provision for consid eration by non-U.S. buyers. A no shop, no talk provision expressly prohibits the seller from talking (or providing confidential information) to any other potential buyer in the interim period between signing and closing. In the U.S., the practice of including no shop, no talk provisions in purchase agreements migrated from public M&A in which the directors of a target company are generally prohibited from soliciting other buyers once the merger agreement is signed subject to certain exceptions. The no shop, no talk provision allows a buyer to exercise its rights of specific performance after signing and seek an injunction to prevent any sale of the target company that would be in breach of the terms and conditions of the purchase agreement rather than relying on a claim for damages. The provision may also be coupled with a (reverse) break fee payable to the buyer. For more detail, see Exclusivity (No-Shop) Agreements in Private M&A Deals.

Liability Caps

In the U.S., it is common practice to set an aggregate cap on liability under the purchase agreement. Liability caps in the U.S. are typically around the 10% mark (i.e., 10% of the deal value), which is a much lower percentage than some non-U.S. jurisdictions. This is one of the key exceptions to the general principle that the U.S. is a more buyer-friendly regime. While a number of the conditionality and risk allocation points are stacked in the buyer's favor in the U.S., a buyer's total available recourse may be generally lower in the United States.

Materiality Scrapes

The concept of a "materiality scrape" or "materiality read-out" is a U.S.-specific, buyer-friendly concept. An example of such a provision would be: "any breach of any representation or warranty shall be determined without regard to any materiality, MAC, or similar qualification or exception." It is a provision that effectively eliminates (or "scrapes") any materiality qualifiers in a representation/warranty or covenant in specific contexts, which include:

  1. Satisfaction of a CP
  2. Calculating the quantum of losses arising out of a breach as the quantum of the indemnification is calculated following the materiality scrape -and/or-
  3. Assessing whether a breach of representation or warranty occurred (By removing the materiality threshold in a representation or warranty, any loss will qualify as a breach, from which point an objective materiality threshold will be imposed through the de minimis and/or basket when assessing the quantum of losses.)

Where both (2) and (3) are included, this is called a "double materiality scrape." This is the most common version of the concept. It is worth noting that including the materiality qualifier in any such representation/warranty still serves a purpose in assisting with the scope of disclosure. See Materiality Scrape Clause (Indemnification).

Representations and Warranties Insurance

In the U.S., similar to global trends, buy-side representations and warranties insurance policies (RWI) have increased in popularity for private-target M&A in recent years, and the presence of RWI in a transaction can alter some of the standard market practice points described above.

In the U.S., firm exclusions to RWI coverage include known risks, disclosed facts and circumstances, intent or fraud by the insured, forward-looking statements, purchase price adjustments, and sanctions violations. U.S. carriers are typically more willing to underwrite matters such as tax, contamination, product liability, and data protection than insurance providers in other jurisdictions, subject to thorough due diligence.

Consequential Losses

It is common practice in the U.S. for a seller to attempt to limit its liability in the purchase agreement by excluding liability for consequential losses. Provisions that exclude such losses are derived from the U.S. courts' desire to prevent a party being responsible for each and every type of loss that might be incurred by a buyer and to ensure that a seller is only liable for the losses that the courts believe are fair for the seller to incur.

Nonetheless, recently in the U.S., there has been a decrease in express exclusions of consequential losses and an increase in purchase agreements being silent on the topic of consequential losses. In addition, with the increase in RWI-insured deals during the last few years, since sellers may not ultimately be on the hook for these losses, sellers have negotiated with less conviction on these exclusions as they would in an uninsured deal, which may well drive a degree of convergence on certain liability limitation provisions.

Originally published by LexisNexis Practical Guidance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.