TABLE OF CONTENTS 1.

TABLE OF CONTENTS
1.
Extract from Model Asset Purchase Agreement with commentary, Committee on
Negotiated Acquisitions, Section of Business Law, American Bar Association, 2001.
2.
Extract from Model Stock Purchase Agreement with commentary, Committee on
Negotiated Acquisitions, Section of Business Law, American Bar Association, 1995.
3.
“Purchase Price Adjustments, Earnouts and Other Purchase Price Provisions”, written by
Leigh Walton and Kevin D. Kreb, February 2005.
4.
Purchase Price Adjustments Bibliography.
5.
Sample clauses regarding purchase price adjustments.
EXTRACT FROM MODEL ASSET PURCHASE AGREEMENT
WITH COMMENTARY, COMMITTEE ON NEGOTIATED ACQUISITIONS,
SECTION OF BUSINESS LAW, AMERICAN BAR ASSOCIATION, 2001.
2.3 CONSIDERATION
The consideration for the Assets (the “Purchase Price”) will be (a) ______ dollars
($______) plus or minus the Adjustment Amount and (b) the assumption of the Assumed
Liabilities. In accordance with Section 2.7(b), at the Closing, the Purchase Price, prior to
adjustment on account of the Adjustment Amount, shall be delivered by Buyer to Seller as
follows: (a) ______ dollars ($______) by wire transfer; (b) ______ dollars ($______) payable
in the form of the Promissory Note; (c) ______ dollars ($______) paid to the escrow agent
pursuant to the Escrow Agreement; and (d) the balance of the Purchase Price by the
execution and delivery of the Assignment and Assumption Agreement. The Adjustment
Amount shall be paid in accordance with Section 2.8.
COMMENT
In Section 2.3 of the Model Agreement, the consideration to be paid by Buyer for the
assets purchased includes both a monetary component and the assumption of specific liabilities
of Seller. In addition to the consideration set forth in Section 2.3, Seller and Shareholders may
receive payments under noncompetition and employment agreements. If an earnout, consulting,
royalty or other financial arrangement is negotiated by the parties in connection with the
transaction, additional value will be paid.
The amount a buyer is willing to pay for the purchased assets depends upon several
factors, including the seller’s industry, state of development and financial condition. A buyer’s
valuation of the seller may be based upon some measure of historical or future earnings, cash
flow or book value (or some combination of revenues, earnings, cash flow and book value) as
well as the risks inherent in the seller’s business. A discussion of modern valuation theories and
techniques in acquisition transactions is found in Thompson, A Lawyer’s Guide to Modern
Valuation Techniques in Mergers and Acquisitions, 21 J. Corp. L. 457 (Spring 1996). See also
Dickie, Financial Statement Analysis and Business Valuation for the Practical Lawyer (1998).
The monetary component of the purchase price is also dependent in part upon the extent to which
liabilities are assumed by the buyer. The range of liabilities a buyer is willing to assume varies
with the particulars of each transaction and, as the Comment to Section 2.4 observes, the
assumption and retention of liabilities is often a heavily negotiated issue.
The method of payment selected by the parties depends upon a variety of factors,
including the buyer’s ability to pay, the parties’ views on the value of the assets, the parties’
tolerance for risk and the tax and accounting consequences to the parties (especially if the buyer
is a public company). See the Comment to Section 10.2 and Appendix B for a discussion of the
tax aspects of asset acquisitions and the Comment to Section 2.5 for a discussion of the
allocation of the purchase price. The method of payment may include some combination of
cash, debt and stock and may also have a contingent component based upon future performance.
For example, if a buyer does not have sufficient cash or wants to reduce its initial cash outlay, it
could require that a portion of the purchase price be paid by a note. This method of payment,
together with an escrow arrangement for indemnification claims, is reflected in Section 2.3. If
the method of payment includes a debt component, issues such as security, subordination and
post-closing covenants will have to be resolved. Similarly, if the method of payment includes a
stock component, issues such as valuation, negative covenants and registration rights must be
addressed.
If a buyer and a seller cannot agree on the value of the assets, they may make a portion of
the purchase price contingent upon the performance of the operations following the acquisition.
The contingent portion of the purchase price (often called an “earnout”) is commonly based upon
the assets’ earnings over a specified period of time following the acquisition. Although an
earnout may bridge a gap between the buyer’s and the seller’s views of the value of the assets,
constructing an earnout raises many issues, including how earnings will be determined, the
formula for calculating the payment amount and how that amount will be paid (cash or stock),
how the acquired business will be operated, who will have the authority to make major decisions
and the effect of a sale of the buyer during the earnout period. Resolving these issues may be
more difficult than agreeing on a purchase price. See the form of Earnout Agreement attached as
Ancillary Document 4.
The Model Agreement assumes that the parties have agreed on a fixed price, subject only
to an adjustment based upon the difference between Seller’s Working Capital on the date of the
Balance Sheet and the date of the Closing (see Sections 2.8 and 2.9).
2.8 ADJUSTMENT AMOUNT AND PAYMENT
The “Adjustment Amount” (which may be a positive or negative number) will be
equal to the amount determined by subtracting the Closing Working Capital from the
Initial Working Capital. If the Adjustment Amount is positive, the Adjustment Amount
shall be paid by wire transfer by Seller to an account specified by Buyer. If the Adjustment
Amount is negative, the difference between the Closing Working Capital and the Initial
Working Capital shall be paid by wire transfer by Buyer to an account specified by Seller.
All payments shall be made together with interest at the rate set forth in the Promissory
Note, which interest shall begin accruing on the Closing Date and end on the date that the
payment is made. Within three (3) business days after the calculation of the Closing
Working Capital becomes binding and conclusive on the parties pursuant to Section 2.9,
Seller or Buyer, as the case may be, shall make the wire transfer payment provided for in
this Section 2.8.
COMMENT
The Model Agreement contains a purchase-price adjustment mechanism to modify the
Purchase Price in the event of changes in the financial condition of Seller during the period
between the date of the Initial Balance Sheet and Closing. Such a mechanism permits the parties
to lessen the potentially adverse impact of a flat price based upon stale pre-closing information.
Through use of a purchase-price adjustment mechanism, the parties are able to modify the
purchase price to reflect more accurately the seller’s financial condition as of the closing date.
Not all transactions contain purchase-price adjustment mechanisms, however. Such mechanisms
are complex in nature and are frequently the subject of contentious negotiations. As a result, the
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parties rely on other mechanisms in many cases, such as resorting to claims for breach of
representations and warranties, indemnification rights and walk-away or termination provisions
to achieve their objectives.
In the absence of a purchase-price adjustment mechanism such as the one employed in
the Model Agreement, provision is frequently made for the proration of certain items (such as
rent under Leases included within the Assumed Liabilities and ad valorem taxes with respect to
the Real Property and Tangible Personal Property) to ensure that the seller is responsible for such
liabilities only to the extent they cover periods up to and including the date of closing, and the
buyer is responsible for such liabilities only to the extent that they cover periods subsequent to
the closing. A proration mechanism is rarely appropriate if the parties have agreed to a purchaseprice adjustment mechanism. The following is a sample of a proration provision:
ADJUSTMENTS TO PURCHASE PRICE
The Purchase Price shall be subject to the following credits and adjustments, which
shall be reflected in the closing statements to be executed and delivered by Buyer and Seller
as hereinabove provided:
(a)
Prorations. Any rents, prepaid items and other applicable items with respect
to the Assumed Liabilities shall be prorated as of the Closing Date. Seller shall
assign to Buyer all unused deposits with respect to the Assumed Liabilities and shall
receive a credit in the amount thereof with respect to the Purchase Price.
(b)
Ad Valorem Taxes. Ad valorem real and tangible personal property taxes
with respect to the Assets for the calendar year in which the Closing occurs shall be
prorated between Seller and Buyer as of the Closing Date on the basis of no
applicable discount. If the amount of such taxes with respect to any of the Assets for
the calendar year in which the Closing occurs has not been determined as of the
Closing Date, then the taxes with respect to such Assets for the preceding calendar
year, on the basis of no applicable discount, shall be used to calculate such
prorations, with known changes in valuation or millage applied. The prorated taxes
shall be an adjustment to the amount of cash due from Buyer at the Closing. If the
actual amount of any such taxes varies by more than
dollars ($
)
from
estimates used at the Closing to prorate such taxes, then the parties shall reprorate
such taxes within ten (10) days following request by either party based on the actual
amount of the tax bill.
The type of purchase-price adjustment mechanism selected depends upon the structure of
the transaction and the nature of the target company’s business. There are many yardsticks
available to use as the basis of a post-closing adjustment to the nominal purchase price. They can
include, among others, book value, net assets, working capital, sales, net worth or shareholders’
equity. In some cases, it will be appropriate to adjust the purchase price by employing more than
one adjustment mechanism. For example, in a retail sales business, it may be appropriate to
measure variations in both sales and inventory. Finally, the nominal purchase price may be
subject to an upward or downward adjustment or both. The purchase price also may be adjusted
dollar for dollar or by an amount equal to some multiple of changes in the yardstick amount.
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The Fact Pattern indicates that Seller is a manufacturing concern with a full range of
business activities and, for purposes of illustration, the Model Agreement provides for an
adjustment to the Purchase Price based upon changes in Seller’s Working Capital. Working
Capital of Seller is determined as of the date of the Balance Sheet and the Closing Date, and the
nominal Purchase Price is adjusted either upward or downward based upon the amount of the
increase or decrease in the level of Seller’s Working Capital. In order to lessen the opportunity
for manipulation of the Working Capital amount during the measurement period, restrictions on
Seller’s ability to manipulate its business operations and financial condition are set forth in
Seller’s pre-closing covenants contained in Article 5.
The parties may also choose to place limits on the amount of the purchase-price
adjustment. Depending upon the relative bargaining position of the parties, the acquisition
agreement may provide an upper limit (a “cap” or “ceiling”) to any adjustment amount the buyer
will be obligated to pay the seller. Alternatively, the parties may agree upon an upper limit to any
adjustment amount the seller will be obligated to pay or give back to the buyer after the closing,
the effect of which is to reduce the final purchase price paid by the buyer to a specified “floor.”
The acquisition agreement may further provide for both a cap or ceiling and a floor (when used
in such combination, a “collar”) on the adjustment amount. The purchase-price adjustment
provision can also contain a de minimis “window” (i.e., a range within which neither party pays
a purchase price adjustment amount).
2.9 ADJUSTMENT PROCEDURE
(a)
“Working Capital” as of a given date shall mean the amount calculated by
subtracting the current liabilities of Seller included in the Assumed Liabilities as of
that date from the current assets of Seller included in the Assets as of that date. The
Working Capital of Seller as of the date of the Balance Sheet (the “Initial Working
Capital”) was ______ dollars ($______).
(b)
Buyer shall prepare financial statements (“Closing Financial Statements”) of
Seller as of the Effective Time and for the period from the date of the Balance Sheet
through the Effective Time on the same basis and applying the same accounting
principles, policies and practices that were used in preparing the Balance Sheet,
including the principles, policies and practices set forth on Exhibit 2.9. Buyer shall
then determine the Working Capital as of the Effective Time minus accruals in
accordance with GAAP in respect of liabilities to be incurred by Buyer after the
Effective Time (the “Closing Working Capital”) based upon the Closing Financial
Statements and using the same methodology as was used to calculate the Initial
Working Capital. Buyer shall deliver the Closing Financial Statements and its
determination of the Closing Working Capital to Seller within sixty (60) days
following the Closing Date.
(c)
If within thirty (30) days following delivery of the Closing Financial
Statements and the Closing Working Capital calculation Seller has not given Buyer
written notice of its objection as to the Closing Working Capital calculation (which
notice shall state the basis of Seller’s objection), then the Closing Working Capital
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calculated by Buyer shall be binding and conclusive on the parties and be used in
computing the Adjustment Amount.
(d)
If Seller duly gives Buyer such notice of objection, and if Seller and Buyer
fail to resolve the issues outstanding with respect to the Closing Financial
Statements and the calculation of the Closing Working Capital within thirty (30)
days of Buyer’s receipt of Seller’s objection notice, Seller and Buyer shall submit the
issues remaining in dispute to ______, independent public accountants (the
“Independent Accountants”) for resolution applying the principles, policies and
practices referred to in Section 2.9(b). If issues are submitted to the Independent
Accountants for resolution, (i) Seller and Buyer shall furnish or cause to be
furnished to the Independent Accountants such work papers and other documents
and information relating to the disputed issues as the Independent Accountants may
request and are available to that party or its agents and shall be afforded the
opportunity to present to the Independent Accountants any material relating to the
disputed issues and to discuss the issues with the Independent Accountants; (ii) the
determination by the Independent Accountants, as set forth in a notice to be
delivered to both Seller and Buyer within sixty (60) days of the submission to the
Independent Accountants of the issues remaining in dispute, shall be final, binding
and conclusive on the parties and shall be used in the calculation of the Closing
Working Capital; and (iii) Seller and Buyer will each bear fifty percent (50%) of the
fees and costs of the Independent Accountants for such determination.
COMMENT
The specific terms of the business deal must be considered when developing a purchaseprice adjustment mechanism. For example, if the transaction contemplates an accounts
receivable repurchase obligation requiring the seller to repurchase all or a portion of its accounts
receivable uncollected prior to a certain date, the purchase-price adjustment procedure must take
such repurchases into account when determining the adjustment amount. The Model Agreement
provides that Buyer will prepare the Closing Financial Statements and calculate the Working
Capital as of the Effective Time. In order to account for the effects of the underlying transaction,
Working Capital is limited to the difference between the current liabilities of Seller included in
the Assumed Liabilities and the current assets of Seller included in the Assets.
In order to minimize the potential for disputes with respect to the determination of the
adjustment amount, the acquisition agreement specifies the manner in which the adjustment
amount is calculated and the procedures to be utilized in determining the adjustment yardstick as
of a given date. The Model Agreement addresses this objective by stating that the Closing
Financial Statements shall be prepared on the same basis and applying the same accounting
principles, policies and practices that were used in preparing the Balance Sheet, including the
principles, policies and practices listed on Exhibit 2.9. Therefore, the buyer’s due diligence
ordinarily will focus not only on the items reflected on the Balance Sheet but also on the
accounting principles, policies and practices used to produce it because it may be difficult for the
buyer to dispute these matters after closing. For cost, timing and other reasons, the parties may
elect to prepare less comprehensive financial statements for the limited purpose of determining
the adjustment amount. Determination of the adjustment amount will depend upon the type of
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financial statements that have been prepared, and special accounting procedures may need to be
employed in calculating the adjustment components. Where the parties engage the accountant to
issue a report of findings based upon the application of agreed-upon procedures to specified
elements, accounts or items of a financial statement, such agreed-upon procedures should follow
applicable statements on accounting standards and be clearly set forth in the acquisition
agreement. See Statement on Auditing Standards No. 75, “Engagements to Apply Agreed-Upon
Procedures to Specified Elements, Accounts, or Items of a Financial Statement,” and Statement
on Standards for Attestation Engagements No. 4, “Agreed-Upon Procedures Engagements.”
Unless consistent accounting principles, policies and practices are applied, the purchase-price
adjustment will not be insulated from the effects of changes in accounting principles, policies
and practices. Because purchase-price adjustment mechanisms rely heavily on the application of
accounting principles and methods to particular fact situations, the input of the parties’
accountants is important to the crafting of a mechanism that is responsive to the facts, workable
and reflects the expectations and intentions of the parties in establishing the ultimate purchase
price.
Provisions establishing dispute resolution procedures follow the provisions for the initial
determination and objection. If the parties are unable to amicably resolve any disputes with
respect to the Closing Financial Statements and the Closing Working Capital, Section 2.9(d)
provides for dispute resolution by independent accountants previously agreed to by the parties. If
the acquisition agreement does not specify who will serve as the independent accountants, the
parties should establish the procedure for selection. Even if the independent accountants are
named, it may be wise to provide replacement procedures in case a post-closing conflict arises
with respect to the selection of the independent accountants (e.g., through merger of the
independent accountants with accountants for the buyer or the seller).
The procedure to be followed and the scope of authority given for resolution of disputes
concerning the post-closing adjustments vary in acquisition agreements. Section 2.9 provides
that Buyer will determine the Closing Working Capital based upon the Closing Financial
Statements using the same methodology as was used to calculate the Initial Working Capital.
The Closing Financial Statements and Buyer’s determination of the Closing Working Capital are
then delivered to Seller, and, if Seller has not objected within the requisite time period to the
Closing Working Capital calculation (stating the basis of the objection), the calculation is
“binding and conclusive on the parties”. If Seller objects and the issues outstanding are
unresolved, the “issues remaining in dispute” are to be submitted to the accountants for
resolution “applying the principles, policies and practices referred to in Section 2.9(b).” The
determination by the accountants of the issues remaining in dispute is “final, binding and
conclusive on the parties” and is to be used in the calculation of the Closing Working Capital.
The procedure set forth in Section 2.9 does not provide for the accountants to act as
arbitrators, and there is no separate arbitration provision governing disputes under the Model
Agreement. See the Comment to Section 13.4. Section 2.9, however, provides that the
determination by the accountants is to be “final, binding and conclusive” on the parties. To what
extent will this determination be binding on the parties, arbitrable or confirmable by a court?
This is largely a question of state law, except that the Federal Arbitration Act will preempt any
state law that conflicts or stands as an obstacle to the purpose of the Act to favor arbitration. The
issue is often addressed in the context of a motion to compel arbitration by one of the parties to
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the acquisition agreement. The court in Talegen Holdings, Inc. v. Fremont General Corp., No. 98
Civ. 0366 (DC), 1998 WL 513066, *3 (S.D.N.Y. Aug. 19, 1998), dealt with such a motion as
follows:
In resolving a motion to compel arbitration under the Federal Arbitration Act ... , a court
must: (1) determine whether the parties agreed to arbitrate; (2) ascertain the scope of that
agreement to see if the claims raised in the lawsuit fall within the terms of the agreement;
(3) if federal statutory claims are asserted, decide whether Congress has deemed those
claims to be nonarbitrable; and (4) if some, but not all claims are to be arbitrated,
determine whether to stay the balance of the proceedings pending arbitration.
It then stated that “[c]ourts have consistently found that purchase price adjustment
dispute resolution provisions such as the one at issue here constitute enforceable arbitration
agreements.” Id. The clauses providing for dispute resolution mechanisms need not expressly
provide for arbitration in order for a court to determine that the parties have agreed to arbitration.
If a court determines that the parties agreed to arbitration, the extent to which arbitration
will be compelled under the Federal Arbitration Act depends upon whether the provision is
broadly or narrowly drawn. A broad clause creates a presumption of arbitrability, whereas a
narrow clause allows a court to consider “whether the claims fall reasonably within the scope of
that clause.” Id. Even with a narrow provision, “[b]ecause the [Federal Arbitration Act]
embodies Congress’s strong preference for arbitration, ‘any doubts concerning the scope of
arbitrable issues should be resolved in favor of arbitration’.” Id.; see also Wayrol PLC v.
Ameritech Corp., No. 98 Civ. 8451 (DC), 1999 WL 259512 (S.D.N.Y. April 30, 1999);
Advanstar Communications, Inc. v. Beckley-Cardy, Inc., No. 93 Civ. 4230 (KTD), 1994 WL
176981 at *3 (S.D.N.Y. May 6, 1994) (although a narrow clause must be construed in favor of
arbitration, courts may not disregard boundaries set by the agreement).
The question of what comes within the arbitrable issues is a matter of law for a court. If
the dispute arises over the accounting methods used in calculating the closing working capital or
net worth, a court might compel arbitration as to those issues. See Advanstar, 1994 WL 176981
(clauses allowing arbitration of disagreements about balance sheet calculations “include disputes
over the accounting methods used”). A court can disregard whether the claims might be
characterized in another way. See Talegen at *17. On the other hand, some courts require that the
provision include on its face the issue in dispute. In Gestetner Holdings, PLC v. Nashua Corp.,
784 F. Supp. 78 (S.D.N.Y. 1992), the court held that an objection as to the closing net book
value includes an objection to whether the closing balance sheet failed to comply with generally
accepted accounting principles; however, the court did not rule on whether the initial balance
sheet, for which the defendant argued that indemnification was the exclusive remedy, could also
be considered an arbitrable dispute. See also Gelco Corp. v. Baker Indus., Inc., 779 F.2d 26 (8th
Cir. 1985) (clause covering disputes concerning adjustments to closing financial statements did
not encompass state court claims for breach of contract); Twin City Monorail, Inc. v. Robbins &
Myers, Inc., 728 F.2d 1069 (8th Cir. 1984) (clause extended only to disputed inventory items and
not to all disputes arising out of the contract); Basix Corp. v. Cubic Corp., No. 96 Civ. 2478,
1996 WL 517667 (S.D.N.Y. Sept. 11, 1996) (clause applied only to well defined class of
disagreements over the closing balance sheet); Stena Line (U.K.) Ltd. v. Sea Containers Ltd.,
758 F. Supp. 934 (S.D.N.Y. 1991) (only limited issues concerning impact of beginning balance
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sheet on later balance sheet are arbitrable); Medcom Holding Co. v. Baxter Travenol Lab., Inc.,
689 F. Supp. 841 (N.D. III. 1988) (clause limited to accounts or items on balance sheet does not
encompass objections to valuation of property or accounting principles by which property is
valued).
The scope of the accountants’ authority in Section 2.9(d) is expressly limited to those
issues remaining in dispute and does not extend more broadly to the Closing Financial
Statements or to the calculation of the Initial Working Capital or the Closing Working Capital.
The authority cited above suggests that, if there is a dispute over whether the financial statements
from which the Initial Working Capital or the Closing Working Capital are calculated have been
prepared in accordance with generally accepted accounting principles or reflect the consistent
application of those principles, Buyer may not be able to resolve the matter under the procedure
established in Section 2.9(c) and (d). Buyer might, however, be able to make a claim for
indemnification based upon a breach of the financial statement representations and warranties in
Section 3.4. If any of the items in the financial statements from which Initial Working Capital is
computed are in error, the inaccuracy could affect the Adjustment Amount payable under Section
2.8. Again, Buyer’s recourse might be limited to a claim for indemnification. If the error is to the
disadvantage of Seller, it may not be able to restate the financial statements or cause the Initial
Working Capital to be adjusted and, therefore, would have no recourse for its own error. See
Melun Indus., Inc. v. Strange, 898 F. Supp. 995 (S. D. N.Y. 1992).
In view of this authority, the buyer may wish to weigh the advantages and disadvantages
of initially providing for a broad or narrow scope of issues to be considered by the accountants.
By narrowing the issues, it will focus the accountants on the disputed accounting items and
prevent them from opening up other matters concerning the preparation of the financial
statements from which the working capital calculation is derived. Reconsideration of some of the
broader accounting issues, however, might result in a different overall resolution for the parties.
The buyer might also consider whether to provide that the accountants are to act as arbitrators,
thereby addressing the question of arbitrability, at least as to the issues required to be submitted
to the accountants. This may, however, have procedural or other implications under the Federal
Arbitration Act or state law.
The phrase “issues remaining in dispute” in the second sentence of Section 2.9(d) limits
the inquiry of the independent accountants to the specific unresolved items. The parties might
consider parameters on the submission of issues in dispute to the independent accountants. For
example, they could agree that, if the amount in dispute is less than a specified amount, they will
split the difference and avoid the costs of the accountants’ fees and the time and effort involved
in resolving the dispute. The parties may also want to structure an arrangement for the payment
of amounts not in dispute.
Purchase-price adjustment mechanisms do not work in isolation, and the seller may want
to include in these provisions a statement to the effect that any liabilities included in the
calculation of the adjustment amount will not give the buyer any right to indemnification. The
rationale for such a clause is that the buyer is protected from damages associated with such
claims by the purchase-price adjustment.
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EXTRACT FROM MODEL STOCK PURCHASE AGREEMENT
WITH COMMENTARY, COMMITTEE ON NEGOTIATED ACQUISITIONS,
SECTION OF BUSINESS LAW, AMERICAN BAR ASSOCIATION, 1995
2.2 PURCHASE PRICE
The purchase price (the “Purchase Price”) for the Shares will be $______________
plus the Adjustment Amount.
COMMENT
The purchase price and the method of its payment can take a wide variety of forms, an indepth discussion of which is beyond the scope of this Commentary. The amount the
Buyer is willing to pay for the Company depends on several factors, including the
Company’s industry and stage of development, and can be based on some measure of
historical or future revenues, earnings, cash flow, or book value (or some combination of
revenues, earnings, cash flow, and book value), as well as the risks inherent in the
Acquired Companies’ businesses.
The method of payment also depends on a variety of factors, including the Buyer’s ability
to pay, the parties’ views on the value of the Company, the parties’ tolerance (or lack
thereof) for risk, and the tax and accounting consequences to the parties (especially if the
Buyer is a public company). The method of payment may include some combination of
cash, debt, and stock and may also have a contingent component based on future
performance. For example, if the Buyer does not have sufficient cash or wants to reduce
its initial cash outlay, the Buyer could require that a portion of the purchase price be paid
by a note. The Sellers may then seek to structure the transaction, if possible, so that it
qualifies for treatment as an instalment sale under the Internal Revenue Code, which
allows the Sellers to defer payment of their tax liability over the period during which the
instalments are paid (with in some cases the current payment of interest on the deferred
tax). If the method of payment includes a debt component, issues such as security,
subordination, and covenants will have to be resolved. Similarly, if the method of
payment includes a stock component, issues such as valuation and registration rights will
have to be resolved.
If the Buyer and the Sellers cannot agree on the value of the Company, they may make a
portion of the purchase price contingent on the performance of the Company after the
acquisition. The contingent portion of the purchase price (often called an “earnout”) is
commonly based on the Company’s earnings (or other agreed-upon criterion such as
sales) over a specified period of time after the acquisition. Although an earnout may
bridge a gap between the Buyer’s and the Sellers’ views of the value of the Company,
constructing an earnout raises many issues, including how earnings will be determined,
the formula for calculating the payment amount and how that amount will be paid (cash
or stock), how the Acquired Companies’ businesses will be operated and who will have
the authority to make major decisions, and the effect of a sale of the Buyer during the
earnout period. Resolving these issues may be more difficult than agreeing on a purchase
price.
The Model Stock Purchase Agreement assumes that the parties have agreed to a fixed
price, subject only to an adjustment based on changes in the Company’s consolidated
stockholders’ equity between the date of the balance sheet and the date of closing (see
Sections 2.5 and 2.6).
2.5 ADJUSTMENT AMOUNT
The Adjustment Amount (which may be a positive or negative number) will be
equal to (a) the consolidated stockholders’ equity of the Acquired Companies as of the
Closing Date determined in accordance with GAAP, minus (b) $______________.
COMMENT
The adjustment amount used in the Model Stock Purchase Agreement is based on the net
worth or stockholders’ equity of the Company on a consolidated basis as reflected in the
closing financial statements. Stockholders’ equity is the difference between assets and
liabilities, for this purpose as reflected on the audited balance sheet included in the
closing financial statements.
In most acquisitions, the purchase price is determined, at least in part, on the basis of the
last audited consolidated financial statements and any interim financial statements of the
Company delivered to the Buyer. The purchase price adjustment protects the Buyer
against a diminution in the value of the Company during the period between the date of
signing the acquisition agreement and the closing. If the closing financial statements
differ substantially and adversely from the last audited financial statements and interim
statements delivered to the Buyer, the Buyer should consider, as an alternative to the
purchase price adjustment, remedies available to it under the Sellers’ representations
concerning the financial statements and possibly under theories of fraud.
Purchase price adjustment provisions can include a de minimis “window” - a range of
closing date stockholders’ equity values within which neither party pays a purchase price
adjustment amount. Other alternative provisions include “caps,” “collars,” and “floors.”
A “cap” is the upper limit on the adjustment amount to be paid by the Buyer; a “floor” is
the upper limit on the adjustment amount to be refunded by the Sellers. A “collar” refers
to the use of both a “cap” and a “floor.”
Parties applying “caps,” “collars,” and “floors” to purchase price adjustment provisions
should consider the financial and contractual consequences of reaching the limits of the
“cap” or “floor.” Is the “cap” or “floor” a risk allocation feature under which one party
benefits and one party suffers with no further contractual remedies? Does the “cap” or
“floor” instead require the parties to turn to other contractual provisions such as an
“unwind” provision, a deferred payment provision, or the indemnity provisions? If the
acquisition agreement is silent on the rights, for example, of the Buyer if a “floor” is
reached, the Sellers may then take the risk that the Buyer will seek a remedy under the
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indemnity provisions for a breach of a representation such as the financial statements,
accounts receivable, or no material adverse change representation.
The parties can also place a portion of the purchase price paid, or funds in excess of the
purchase price, in escrow to facilitate payment of the adjustment amount.
The Model Stock Purchase Agreement defines the adjustment amount as “the
consolidated stockholders’ equity of the Acquired Companies as of the Closing Date
determined in accordance with GAAP” (less the portion of the purchase price paid in
cash and notes at the closing). Both the Buyer and the Sellers should be aware of the
flexibility permitted by GAAP (see the fourth paragraph of the Commentary to the
definition of GAAP in Section 1). The parties may want to negotiate, or confirm in
writing at the time the acquisition agreement is signed, the method of valuation of
significant line items on the closing financial statements. The parties should also consider
describing “past practice” in writing as a schedule to the acquisition agreement.
Accountants for both parties should be involved in these discussions. If the parties agree
on specific guidelines concerning the determination of stockholders’ equity for purposes
of the adjustment amount, the acquisition agreement should specify that, in the event of a
conflict between GAAP and the guidelines, the guidelines control.
2.6 ADJUSTMENT PROCEDURE
(a)
Sellers will prepare and will cause _____________________, the Company’s
certified public accountants, to audit consolidated financial statements (“Closing
Financial Statements”) of the Company as of the Closing Date and for the period
from the date of the Balance Sheet through the Closing Date, including a
computation of consolidated stockholders’ equity as of the Closing Date. Sellers will
deliver the Closing Financial Statements to Buyer within sixty days after the
Closing Date. If within thirty days following delivery of the Closing Financial
Statements, Buyer has not given Sellers notice of its objection to the Closing
Financial Statements (such notice must contain a statement of the basis of Buyer’s
objection), then the consolidated stockholders’ equity reflected in the Closing
Financial Statements will be used in computing the Adjustment Amount. If Buyer
gives such notice of objection, then the issues in dispute will be submitted to
________________, certified public accountants (the “Accountants”), for resolution.
If issues in dispute are submitted to the Accountants for resolution, (i) each party
will furnish to the Accountants such workpapers and other documents and
information relating to the disputed issues as the Accountants may request and are
available to that party or its Subsidiaries (or its independent public accountants),
and will be afforded the opportunity to present to the Accountants any material
relating to the determination and to discuss the determination with the
Accountants; (ii) the determination by the Accountants, as set forth in a notice
delivered to both parties by the Accountants, will be binding and conclusive on the
parties; and (iii) Buyer and Sellers will each bear 50% of the fees of the Accountants
for such determination.
-3-
(b)
On the tenth business day following the final determination of the
Adjustment Amount, if the Purchase Price is greater than the aggregate of the
payments made pursuant to Sections 2.4(b)(i) and 2.4(b)(iii) and the aggregate
principal amount of the Promissory Notes, Buyer will pay the difference to Sellers,
and if the Purchase Price is less than such aggregate amount, Sellers will pay the
difference to Buyer. All payments will be made together with interest at _____%
compounded daily beginning on the Closing Date and ending on the date of
payment. Payments must be made in immediately available funds. Payments to
Sellers must be made in the manner and will be allocated in the proportions set
forth in Section 2.4(b)(i). Payments to Buyer must be made by wire transfer to such
bank account as Buyer will specify.
COMMENT
Section 2.6 provides that the Sellers will prepare and cause the Company’s accountants to
audit the closing financial statements. If the Sellers will no longer be affiliated with the
Company (as employees, consultants, or otherwise) after the closing, the Buyer may be in
a better position to do this. Because determination of stockholders’ equity under GAAP is
not a science, parties frequently seek to have their own accountants make this
determination. The initial determination will then be subject to objection, accompanied
by an explanation of the objection, by the party not controlling the initial determination.
Provisions establishing dispute resolution procedures should follow the provision for the
initial determination and objection.
The Model Stock Purchase Agreement provides for dispute resolution by independent
accountants previously agreed to by the parties; if the acquisition agreement does not
specify who will serve as these independent accountants, it should contain provisions
establishing the procedure for their selection. Often the acquisition agreement instructs
these accountants to act as arbitrators and not as auditors. The phrase “issues in dispute”
in the third sentence of paragraph (a) limits the inquiry of the independent accountants to
the specific line items to which the objecting party has objected. The parties should
consider setting parameters on the submission of issues in dispute to the independent
accountants. For example, the parties could agree that if the amount in dispute is less than
a specified amount, they will split the difference and avoid the cost of the accountants’
fees and the time and effort involved in resolving the dispute. The parties may want to
add an exception for manifest error to the statement that the accountants’ decision will be
binding and conclusive.
Under the Model Stock Purchase Agreement, the Buyer has the right to object to the
initial determination of stockholders’ equity as of the closing date. Because the Sellers
usually have a relationship with the Company’s accountants, the Buyer should assume
that the accountants will resolve items involving the accountants’ judgment in favor of
the Sellers. The Company’s accountants may seek to continue to represent the Company,
however, and not the Sellers. Thus, the Sellers may, upon evaluating their relationship
with the Company’s accountants, seek an objection right similar to that of the Buyer.
-4-
Section 2.6(b) provides that any payments of the adjustment amount are to be made in
immediately available funds. The parties may want to provide that a portion or all of the
adjustment amount will be paid by adjusting the amount of the promissory notes. The
Buyer should negotiate for a set off right under the promissory notes if the Sellers fail to
pay the adjustment amount.
The Sellers may want to include in these provisions a statement to the effect that any
liabilities included in the calculation of the adjustment amount will not constitute a
breach of any of the Sellers’ representations in the acquisition agreement and will not
give the Buyer any right to indemnification. The rationale for such a clause is that the
Buyer is protected from damages associated with such liabilities by the purchase price
adjustment.
-5-
AMERICAN BAR ASSOCIATION
SECTION OF BUSINESS LAW
2005 SPRING MEETING
Nashville, Tennessee
PURCHASE PRICE ADJUSTMENTS, EARNOUTS
AND OTHER PURCHASE PRICE PROVISIONS
Leigh Walton
Bass, Berry & Sims PLC
Nashville, Tennessee
Kevin D. Kreb
PricewaterhouseCoopers LLP
Chicago, Illinois
February 2005
Table of Contents
I.
FORMS OF CONSIDERATION FORMS OF CONSIDERATION ...............................1
A. In General....................................................................................................................1
B. Cash Payment..............................................................................................................2
C. Payment by Stock........................................................................................................2
1. Valuation Issues ..................................................................................................2
2. Restrictions on Resale.........................................................................................4
3. Shareholder Approval .........................................................................................4
4. Tax Considerations .............................................................................................5
D. Payment by Promissory Note......................................................................................6
1. Set-Off Rights .....................................................................................................6
2. Tax Benefits ........................................................................................................6
3. Security for Payment of the Notes ......................................................................6
II.
HOLDBACKS OF PURCHASE PRICE IN ESCROW....................................................7
A. Overview.....................................................................................................................7
B. Benefits and Risks.......................................................................................................7
C. Tax Treatment .............................................................................................................7
III.
PURCHASE PRICE ADJUSTMENTS ..............................................................................8
A.
B.
C.
D.
Overview.....................................................................................................................8
Construction of the Post-Closing Adjustment.............................................................9
Typical Mechanics ....................................................................................................10
Drafting Considerations ............................................................................................11
1. Amount Paid at Closing ....................................................................................11
2. Accounting Specifications ................................................................................12
a. “Preferable” versus “Acceptable” GAAP ................................................12
b. GAAP versus Consistency.......................................................................13
c. Interim versus Year-End Reporting. ........................................................13
d. Errors or Irregularities Discovered after Closing.....................................14
e. Materiality. ...............................................................................................14
f. Changes in Accounting Policies or Practices. ..........................................15
g. Hindsight..................................................................................................16
h. Right to Offset..........................................................................................16
3. Issues of Control ...............................................................................................17
4. Caps and Floors.................................................................................................18
5. Interplay Between the Post-Closing Adjustment and Indemnification.............18
6. Dispute Resolution: Designation of Independent Accountants ........................18
7. Mechanisms to Ensure Payment of the Adjustment Amount ...........................20
i
IV.
EARNOUTS ........................................................................................................................20
A. Overview...................................................................................................................20
B. Some Risks Associated with the Use of Earnout Provisions ....................................21
C. Drafting Issues...........................................................................................................21
1. Establishing the Earnout Benchmark; Types of Possible Benchmarks ............21
a. Financial Benchmarks..............................................................................21
b. Non-Financial Benchmarks .....................................................................22
2. The Formula for Calculating the Payment Amount..........................................22
3. The Length of the Earnout Period.....................................................................23
4. Determination of Whether the Threshold Has Been Satisfied..........................23
a. Determination of the Earnout...................................................................23
b. Accounting Issues ....................................................................................24
5. Form of Payment of Earnout Obligation ..........................................................28
a. Valuation Issues .......................................................................................28
b. Securities Issues .......................................................................................28
c. Related Tax Questions .............................................................................29
6. Operation of the Acquired Business During the Earnout Period......................29
a. Operation by the Buyer Post-closing .......................................................30
b. Operation by the Seller’s Management Team Post-closing.....................30
c. Protection Placed in the Acquisition Agreement .....................................30
7. Payment of Earnouts to Public Shareholders....................................................31
8. Shareholders Designated to Act for the Seller..................................................32
9. Sale of the Target During the Earnout Period...................................................32
10. Integration of the Target into the Buyer’s Other Businesses ...........................32
11. Averaging Periods of Strong Performance With Weak Performance ..............32
12. Dispute Resolution ...........................................................................................33
13. Registration Issues for Earnout Rights.............................................................33
14. Special Industry Limitations ............................................................................34
V.
CONCLUSION ...................................................................................................................34
ii
PURCHASE PRICE ADJUSTMENTS, EARNOUTS
AND OTHER PURCHASE PRICE PROVISIONS
by
Leigh Walton
Bass, Berry & Sims PLC
Kevin D. Kreb
PriceWaterhouseCoopers LLP
February 2005
This article considers the various ways in which payment of the purchase price in an
acquisition can be structured. Variations can occur in the types of consideration payable at the
closing, and many acquisitions provide for a post-closing adjustment or true-up. Further, the
acquisition may include an earnout payable over a considerable period of time after the closing.
Each of these purchase price provisions significantly impacts the leverages of the parties, the tax
and accounting treatment of the transaction, the securities laws ramifications of the acquisition
and the relationship of the buyer and seller after the closing.
I.
FORMS OF CONSIDERATION
A.
In General
The purchase price in an acquisition is typically paid by cash, stock of the
acquiring entity, installment notes, the assumption of indebtedness or some
combination thereof. Factors that affect the way the purchase price is paid
include:
•
•
•
•
•
the buyer’s access to cash;
the seller’s desire or willingness to invest in the buyer’s business;
the seller’s desire for a tax-free transaction;
the structure of the transaction as a stock purchase, merger or asset
acquisition; and
the buyer’s desire to extend payments through notes, creating a source to
satisfy indemnification claims.
____________________
©2005 Leigh Walton and Kevin D. Kreb. The authors express their appreciation to Bryan Metcalf, Angela
Humphreys Hamilton and Steven Morris of Bass, Berry & Sims for their assistance with this article. The authors
wish to thank William B. Payne of Dorsey & Whitney LLP for his thoughtful comments on this article.
1
B.
Cash Payment
Payment by cash is appealing in its simplicity and because (absent a holdback to
secure post-closing claims) it will largely terminate the relationship between the
buyer and the seller at the closing. A cash payment, however, will result in the
seller realizing an immediate gain for tax purposes on the transaction.
The Financial Accounting Standards Board (“FASB”) issued Statements of
Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, in
2001. SFAS No. 141 eliminated the pooling of interests method of accounting for
transactions initiated after June 30, 2001. SFAS No. 141 requires all business
combinations initiated after June 30, 2001 to be accounted for using the purchase
method of accounting. See Jan R. Williams, 2004 Miller GAAP Guide, at 4.0.
With the elimination of pooling of interests, cash-based transactions have
increased, with cash being used as the sole consideration for the transaction or in
combination with stock.
Cash payment, when chosen, may be made by bank cashier’s check, certified
check or wire transfer. The seller generally will insist on same day funds through
a wire transfer.
C.
Payment by Stock
In transactions in which equity securities are used as consideration, complex
issues of valuation are presented. Further, the securities issued in the transaction
must be registered under the Securities Act of 1933, as amended (the “Securities
Act”), or an exemption from registration must be available.
1.
Valuation Issues
Once the parties agree to use stock as consideration and a purchase price
has been arrived at, the parties must value the stock to be transferred.
They may agree that the stock is to be valued at the market price as of the
moment of their agreement on the price, as of the date the acquisition
agreement is signed, as of the closing date or at or during some other time
period. If the stock is not registered under the Securities Act, or if the
transfer of the stock is otherwise restricted, the seller may demand a
discount from market price. If the buyer’s stock will be registered under
the Securities Act, the Securities and Exchange Commission (“SEC”) will
insist that the number of shares to be issued to the seller’s shareholders be
clearly indicated in the proxy statement for the meeting at which the
transaction is approved, or be ascertainable from external sources at that
time.
To avoid the obvious risk posed by using a single day’s stock price in the
valuation, the parties typically choose to use an average market price of
the buyer’s stock over some specified period of time, for example, the 10
trading days immediately preceding the third business day prior to the
2
closing. To protect against extreme fluctuations in price, the parties will
likely place an upper and lower limit – a collar – on the range within
which the stock price may vary for the purposes of valuation. The collar
may be defined by either share price or shares issuable in the transaction:
for example, no greater than 1,500,000 shares to be issued but no fewer
than 1,350,000; or a share price of no greater than $55, but no less than
$45. Although it is most common for both components of the collar to be
present in a transaction, occasionally deals are structured having only one
component, the upper limit or the lower limit, depending upon the
bargaining power and strategic positioning of the parties.
In a stock purchase price formula using both a collar and an average
closing price to value a listed security, the parties might agree to the
following provision:
“The aggregate number of shares of Buyer
Common Stock issuable to Seller shall equal that
number of whole shares of Buyer Common Stock
equal to the quotient of (a) $100,000,000, divided
by (b) the average of the closing prices of Buyer
Common Stock as reported on the New York Stock
Exchange for the 10 trading days ending on the
date that is three Business Days prior to the Closing
Date (the “Average Price”); provided, however, if
the Average Price is less than $45, the calculation
shall be made as if the Average Price were $45, and
if the Average Price is greater than $55, the
calculation shall be made as if the Average Price
were $55.”
The parties also may agree that there is a right to terminate the contract if
the price extends beyond the collar limits. For example, the definitive
agreement may provide that in the event the purchase price falls below the
lower limit, the buyer may, but is not required to, provide additional
consideration, in cash or stock, to bring the purchase price up to the lower
limit. If the buyer is unwilling to provide such additional consideration,
the seller may terminate the agreement if it is unwilling to accept the
lower purchase price. In drafting provisions of this type, it is important to
consider the notification requirements of the parties. Once it is determined
that the lower limit of the collar will not be met, must the buyer first notify
the seller whether it is willing to provide additional consideration to
increase the purchase price to the lower limit, or must the seller notify the
buyer whether it will terminate the agreement if the purchase price is not
increased to the lower limit? Such provisions should be clearly addressed
in order to avoid uncertainties and will be subject to negotiation.
3
Finally, as is discussed later in this article, many acquisition agreements
contemplate a post-closing adjustment that can result in the buyer paying
additional consideration, or the seller in effect refunding previously paid
consideration to the buyer. If a portion of the consideration involved in
the post-closing adjustment is stock, the mechanism for valuing the stock
delivered in the adjustment should be specified.
2.
Restrictions on Resale
Securities issued in an acquisition (like any other type of securities
issuance) must be registered under the Securities Act, or an exemption
from registration must be available. Typically Form S-4 is used for
registration (although the use of Form S-1, S-2 or S-3 may be mandated if
no shareholder approval is required or if a majority shareholder of the
seller has agreed to support the transaction, thus assuring shareholder
approval).
If the seller agrees to accept unregistered securities, a private placement
exemption through Section 4(2) or Regulation D under the Securities Act
is the typical route to securities laws compliance. When the seller’s
shareholders receive stock that is issued under an exemption, they must
hold the stock until it can be sold publicly under Rule 144 (typically a
minimum one year holding period), another exemption from registration is
available or the stock is registered. Even if received in a registered
transaction, securities held by affiliates of a seller prior to the acquisition
will, pursuant to Rule 145, be subject to the resale limitations of Rule 144
(other than the holding period limitations).
The seller may demand registration rights that obligate the buyer to
register the seller’s resale of the stock. This provision may be constructed
as a “demand registration right,” whereby the seller may require the buyer
to register the securities upon demand, or a “piggyback registration right,”
whereby the securities are registered as an add-on to another registration
statement being filed by the buyer. Faced with the prospective expense of
filing a registration statement for the stock, the buyer may resist such a
provision or may seek to limit it. The buyer may limit the number of
registrations that will be effected, may place time limits on the rights or
may require that a minimum number of shares from the seller’s
shareholders be available for sale. The seller may insist that no other
registration rights be granted that are on terms more favorable than those
granted to the seller’s shareholders and that the buyer pay all expenses (to
the extent allowable under NASD regulations) of the registration.
3.
Shareholder Approval
Approval of the buyer’s shareholders may be required for the issuance of
the buyer’s stock as consideration for the acquisition. Approval of the
buyer’s shareholders is necessary when the stock issued in the transaction
4
is in excess of the buyer’s authorized shares or, in some instances, when
the buyer’s shares are listed on the New York Stock Exchange (“NYSE”),
the American Stock Exchange (“AMEX”) or the Nasdaq National Market
(“Nasdaq”). The requirements for shareholder approval vary, but
generally approval is necessary for transactions in which the buyer is
issuing (or in the case of AMEX, has the potential to issue) 20% or more
of its outstanding common stock, or if the issuance will for some other
reason impact control of the buyer. The NYSE, AMEX and Nasdaq each
have specific rules in effect in this regard.
Of course, state law also may require that the buyer’s shareholders
approve the transaction. For example, under Section 6.21(f) of the Model
Business Corporation Act, action by the shareholders of the surviving
corporation in a merger is required if, among other conditions, the voting
power of shares that are issued and issuable as a result of the merger will
comprise more than 20% of the voting power of the shares of the
corporation that were outstanding immediately before the transaction.
It is important to monitor a fluctuating purchase price involving the
issuance of stock to determine if approval of the buyer’s shareholders is
required. Upon execution of a definitive agreement including a purchase
price based upon a fluctuating per share price, it may be anticipated that
the price will remain high enough that the number of shares of buyer stock
to be issued at closing will not reach the threshold requiring shareholder
approval. However, if the buyer’s stock price drops, assuming the number
of shares to be issued at closing is not first capped by the lower limit of the
collar, the number of shares of buyer stock to be issued at closing could
reach the threshold requiring shareholder approval.
If obtaining
shareholder approval is a concern, one alternative may be to pay the
balance of the purchase price in cash.
4.
Tax Considerations
In order to minimize the tax consequences of a transaction, an all stock
transaction typically is structured as a reverse triangular merger. That is,
the acquiring entity will set up a merger subsidiary that merges into the
target. If a combination of cash and stock is used, a reverse triangular
merger typically will be tax-free if the stock constitutes at least 80% of the
aggregate consideration for the transaction. Because the value of the stock
is determined on the closing date, parties intending their transactions to be
tax-free under these provisions should provide some adjustment
mechanism in the contract if market fluctuations cause the value of the
stock in the deal to dip below 80% of the aggregate consideration. If the
stock involved is less than 80% of the aggregate consideration, a forward
triangular merger often will afford partially tax-free treatment. That is, the
acquiring entity will set up a merger subsidiary and the target will merge
into the merger subsidiary. If the stock involved falls below 45% of the
5
aggregate consideration, the stock component of the transaction generally
will be taxable unless a complex structure is used. In any reorganization,
shareholders will pay tax on the lesser of their gain realized and the cash
received; thus, it may not be worthwhile to structure a tax-free transaction
with respect to the stock being issued if cash comprises a large portion of
the deal consideration.
D.
Payment by Promissory Note
Use of promissory notes as consideration can be attractive for several reasons.
The buyer may wish to pay by note if it is cash-constrained or for some other
reason wishes to lower its original cash outlay. By retaining a portion of the
purchase price, the buyer retains leverage with the seller for payment of
indemnification claims. Payment by note may also be beneficial to the seller for
tax reasons.
1.
Set-Off Rights
The buyer may desire to use non-negotiable installment notes as part of
the consideration to create a source against which indemnification claims
can be offset. Although the right of offset is automatic under most state
laws, the buyer’s counsel is well advised to clearly establish the right in
the promissory note.
2.
Tax Benefits
If payment is made by note, the seller will generally report any gain from
the sale on the installment method under §453 of the Internal Revenue
Code of 1986, as amended. Reporting on the installment method permits
the seller to defer a portion of its tax liability until it receives installment
payments on the note. The note cannot be secured by cash or certain cash
equivalents. Furthermore, the seller must make interest payments to the
government on the deferred tax liability on installment obligations
generally to the extent they exceed $5,000,000 in the year they arose.
After much debate, in 2000 Congress repealed a statute making
installment sale treatment available for accrual and cash basis taxpayers.
3.
Security for Payment of the Notes
The seller may wish to negotiate security for payment of the note accepted
in the acquisition. The seller may demand a security interest in the
buyer’s assets, a letter of credit or a guarantee by a third party. The seller
also may accept a pledge of the target’s stock acquired by buyer.
If this last technique is used, the seller should negotiate protections to
ensure that the business, if returned in the event of default, has not been
stripped of all of its value by the buyer. Provisions to protect against such
a possibility include stipulating a minimum level of working capital to be
6
maintained until the note is paid, prohibiting the buyer from engaging in
the target’s line of business except through the target, restrictions on the
sale of certain assets, restrictions on dividends from the target to the buyer
and requiring the business of the target to be maintained in a separate
entity.
II.
HOLDBACKS OF PURCHASE PRICE IN ESCROW
A.
Overview
The buyer may demand a readily accessible pool of money to cover post-closing
indemnification claims and other specified contingencies. One common way to
provide such a pool of money is an escrow arrangement providing that a part of
the purchase price be placed in escrow, usually with an independent escrow agent,
for a specified period of time after the closing. With the elimination of pooling
transactions, restrictions regarding the types of contingencies and number of
shares (previously, no more than 10%) with respect to which an escrow may be
established also will be eliminated.
B.
Benefits and Risks
The escrow fund established will provide greater ease of recovery for the buyer in
the event of indemnification claims, alleviating concerns about the seller’s
ongoing solvency and potential problems in locating the seller’s assets for
executing judgments. Buyers should be aware that the seller will likely propose
that the escrow fund be the sole remedy for the buyer’s post-closing claims.
Sellers should realize that the existence of the escrow fund significantly changes
the leverages for the post-closing resolution of disputes.
C.
Tax Treatment
Funds paid into escrow and later paid to the seller generally will be taxed under
the installment method described in I.D.2. above. In most escrow situations, the
tax on payments received from escrow will be based on the presumption that all
of the escrow amount will be paid to the Seller. Adjustments are made in the
subsequent year if the seller receives less than the full amount.
7
III.
PURCHASE PRICE ADJUSTMENTS
A.
Overview
Purchase price adjustments (as contrasted to earnouts, discussed later) are used
when there is a fundamental agreement between the parties as to the value of the
target, but when there is a period of time between the signing and closing of the
acquisition. A target’s value is usually determined on the basis of the most recent
financial information available at the time of pricing. Generally, the purpose of a
purchase price adjustment provision is to reflect changes in certain values of the
target between the signing of the acquisition agreement and the closing date. This
period can be significant for a variety of reasons, including:
•
a Hart-Scott-Rodino filing or other regulatory approvals are required;
•
third party consents must be gathered;
•
the buyer requires time to finance the transaction;
•
securities are to be registered; and
•
shareholders’ approval must be sought.
The length of the pre-closing period varies, but is often one to three months.
Even in circumstances in which none of these factors is present, there is typically
a gap in time between the latest available financial statements and the closing
date, which may cause the parties to consider a post-closing adjustment. Further,
in seasonal businesses, there are often large fluctuations in working capital
balances that lead to the use of a post-closing adjustment.
These circumstances provide the primary rationale for the use of a post-closing
adjustment, it bridges the gap between the financial condition of the seller at the
time of signing the definitive purchase agreement and its condition as of the
closing date. Thus the buyer receives the benefit of its bargain by receiving the
agreed upon balance sheet (or an adjustment in the purchase price).
An additional rationale for use of a post-closing adjustment is that it effectively
allocates the economic risks and profits of continued operations during the preclosing period (at least in transactions other than asset purchases). During the
pre-closing period, the seller typically manages the business being sold. The
post-closing adjustment usually (but not always) allocates to the seller the
economic risks and profits of continued operation of the target during this period.
If a purchase price adjustment is not used, the earnings generated by the target
between the signing and the closing would accrue to the benefit of the buyer,
since most acquisition agreements prohibit the seller from making distributions
during this period. Conversely, losses would be borne by the buyer absent a
post-closing adjustment. A post-closing adjustment may also be structured to
8
protect the buyer against potential seller abuses, such as selling inventory without
replacement, accelerating the collection of accounts receivable, stretching
payables and other manipulative practices.
A post-closing adjustment is not a substitute for a “material adverse change”
closing condition, which allows the buyer to refuse to close if the target’s
financial results have materially deteriorated. The adjustment only becomes
operative if in fact the transaction closes; it allows the parties to fine tune the
purchase price after the transaction has been consummated.
B.
Construction of the Post-Closing Adjustment
A post-closing adjustment can be constructed in a variety of ways. The structure
of the post-closing adjustment often varies depending on the theory under which
the entire transaction is valued. These theories include applying a multiple of
earnings or cash flows, measuring the fair value of assets, estimating the value
based on amounts paid in other comparable transactions and calculating a value or
adjusting the value based on information regarding potential synergies with the
buyer’s existing businesses. Regardless of the theory used, the buyer will
typically arrive at a purchase price based, in large measure, on information in the
latest available financial statements and the earnings trend reflected therein.
Thus a properly constructed post-closing adjustment assures that the business the
buyer pays for is the business it ultimately receives at the closing. And regardless
of the theory under which the business of the target is valued, cash is generally
paid for on a dollar-for-dollar basis (or excluded from the acquisition in an asset
deal and left with the seller). Thus an adjustment that takes into account the
target’s current assets and its current liabilities at closing assures that the closing
working capital is accounted for.
Common post-closing adjustments compare working capital, net asset value or net
worth variances between the most recent financial statements available at signing
and the closing date financial statements.
A recent survey of purchase price adjustments in private company acquisitions
analyzed 43 publicly filed purchase agreements entered into in 2003 and 2004
with a transaction value in excess of $50 million. P. Sinka and E. Elsea,
“Purchase Price Adjustments: A Survey,” The M&A Lawyer, Oct. 2004 (the
“Survey”). The Survey found that the most common purchase price adjustment
identified in the surveyed transactions was the net working capital adjustment,
which is intended to reflect the change in the current assets and current liabilities
from the signing date to the closing date. Working capital adjustments were used
in more than 50% of the transactions reviewed. Other than working capital, none
of the purchase price adjustment mechanisms identified in the Survey were used
in more than 10% of the surveyed transactions. These other purchase price
adjustments, however, give an indication of the wide variety of matters than can
be measured and compared, such as net book value, tax liabilities, shareholders’
9
equity, cash expenditures, net debt, net worth, capital expenditures and number of
customers.
Commonly, post-closing adjustment clauses call for a dollar-for-dollar adjustment
to reflect changes in the net working capital, net asset value or other measured
financial data point between the pre-closing balance sheet and the closing date
balance sheet.
C.
Typical Mechanics
The essential concept of most post-closing adjustments is to compare a specified
financial measure taken from the pre-execution financial statements (often
referred to as a “reference balance sheet”) of the target to the same measure in the
financial statements of the target prepared as of the closing date. The comparison
can be made between balances in the reference balance sheet and the closing date
balance sheet or the comparison can be made between a specified amount and the
closing date balance sheet amount. In a transaction with a post-closing
adjustment, the closing is often scheduled for a month-end (or, even better, a
fiscal quarter-end) to avoid difficult cut-off issues. The closing date financials are
then prepared as of this date so that the comparison to the reference balance sheet
amount can be made. If a period end closing is not feasible, special procedures
should be agreed to that deal with the cut-off issues.
A critical issue relating to the mechanics of the post-closing adjustment is the
decision as to which party is charged with the preparation of the closing date
financial statements. The buyer and its accountants often contend that they
should prepare the closing date financial statements, since the buyer has assumed
control of the business. The seller may argue that it should prepare the closing
date financial statements since consistency with the pre-closing financials is of
paramount importance. According to the Survey, in 60% of the agreements
analyzed, the buyer was assigned the task of producing the post closing
calculation. In 35% of the agreements, the seller was responsible and in 5%, the
parties relied on financials prepared by an independent accounting firm.
Within a specified time period after the closing, usually between 30 and 90 days,
the responsible party delivers the closing date financial statements (often only a
balance sheet) to the other party, along with the preparer’s initial determination of
the purchase price adjustment amount.
Most disputes arising out of acquisitions and divestitures that involve accounting
and financial reporting issues result from the buyer’s preparation or review of the
closing date balance sheet and its divergent presentation of the way the seller
accounted for (or did not account for) items in the balance sheet. The buyer has
increased opportunity after the closing to understand these issues because it now
controls and operates the company it has purchased, thus allowing it access to
information that it may not have had before closing. The buyer can examine the
financial statements in more detail and use the knowledge of company personnel
who are familiar with the company’s accounting systems, practices and
10
procedures. In the presentation of a closing date balance sheet it prepares or by
objecting to certain amounts or balances in the seller’s closing date balance sheet,
the buyer is, in effect, proposing adjustments that, if proper, would reduce the
purchase price.
Notice of Objection. Under most agreements, the party not responsible for
preparing the closing date balance sheet has a specified period – often 30 to 60
days – during which it can object to items in the closing date balance sheet and
propose an alternative purchase price adjustment. If objectionable items are
discovered, the reviewing party generally must file a notice of objection within
this time. For example, a contract may state, “the Seller may dispute any amounts
reflected on the closing date balance sheet or the net asset value reflected thereon,
provided that the Seller shall notify Buyer in writing of each disputed item, and
specify the amount thereof in dispute, within 30 days of receipt of the Buyer’s
proposed closing date balance sheet.”
Some agreements set forth the required form and scope of response and mandate
that the notice of objection be specific, whereas some contracts have more general
terms. Specific notices usually must identify and explain the item in dispute and
require the objecting party to state the individual dollar amounts of all of its
objections at that time. Some general clauses require only that the notice identify
the objection, without disclosing details until a later date.
Parties often dispute whether the objecting party can submit new items after the
initial objection and whether it can revise items included in the initial notice, and
to what extent. In situations in which the contract is ambiguous, an independent
trier of fact must decide the issue, reducing the predictability of outcome on this
issue.
Preparers of closing date balance sheets have incentives to carefully define the
parameters for the notice of objection, allow a short time period between the
presentation of the closing date balance sheet and the required objection cut-off
date, mandate complete and specific disclosure of the disputed items by the
deadline, and allow little flexibility for changing the basic theory or amount of the
buyer’s position. Parties who receive and review the closing date balance sheet
generally prefer the opposite.
D.
Drafting Considerations
1.
Amount Paid at Closing
In many transactions, the buyer pays the fixed amount of the purchase
price at closing, not reflecting any purchase price adjustment. Another
possibility is for the buyer to pay at closing the fixed amount plus or
minus an estimate of the purchase price adjustment, as determined by the
seller employing the post-closing adjustment procedure to pre-closing
financials that are more current than those available at signing. In either
case, one party will have to settle with the other when the closing date
11
financial statements are finalized and the purchase price adjustment is
calculated. As discussed below, the mechanics of the payment at closing
includes a consideration of whether a portion of the purchase price should
be paid into escrow to ensure the expedited payment of the adjustment
amount.
2.
Accounting Specifications
The parties should be wary of merely stipulating that the adjustment
amount will be determined in accordance with generally accepted
accounting principles (“GAAP”) consistently applied with past practice.
GAAP embraces a wide range of acceptable accounting practices. GAAP
is also constantly in flux, with FASB bulletins presenting new guidelines
on an ongoing basis. Described below are many of the accounting issues
that are implicated in drafting a quality post-closing adjustment.
a.
“Preferable” versus “Acceptable” GAAP
Most post-closing adjustments contain a clause requiring that the
closing date balance sheet conform to GAAP consistently applied
over a relevant period that predates the sale. As noted above,
parties involved in transactions often mistakenly believe that
GAAP clearly defines one right number, and that little or no
disagreement can arise. Arguments often ensue as to whether the
method the seller used is more appropriate than the method the
buyer prefers. Such disputes may arise in at least two situations.
First, the buyer may propose an adjustment to the closing date
balance sheet based on an accounting method different from that
applied by the seller. Second, the seller may have prepared the
financial statements used in negotiating and executing the purchase
agreement according to one accounting method and subsequently
may have switched, often subtly, to a method more favorable to the
seller before the closing. This would arguably result in a closing
date balance sheet prepared using a different accounting method
than the historical information provided to the buyer, although both
may be acceptable methods under GAAP. Obviously, these
differences have the potential to significantly affect the final
purchase price.
In these scenarios, each party may make a reasonable argument for
its case. The consistent use of an acceptable accounting method,
however, usually will prevail over a claim to change to a preferable
accounting method. If the financial statements’ preparer has
consistently applied an accounting principle that is in accordance
with GAAP, an accountant would not normally take exception.
Accountants know that GAAP provides little, if any, guidance
regarding more acceptable or preferable methods in the application
12
of GAAP. Much uncertainty can be removed by specifying which
among the various acceptable GAAP approaches is to be utilized.
b.
GAAP versus Consistency.
Another common issue involves the concepts of GAAP and
consistency. Conflicts often arise regarding whether GAAP or
consistency takes precedence in applying an accounting method to
a particular transaction or a particular account balance. When
GAAP and consistency requirements appear to conflict, experts
usually designate GAAP as the higher and controlling standard.
Though important, consistency normally is a secondary
consideration to the use of GAAP. For example, a seller may have
used consistent, non-GAAP accounting. In that case, absent other
pertinent, contractual provisions or intent of the parties,
appropriate adjustments should be made to conform the financial
statements with GAAP if GAAP is the agreed upon standard.
In some instances, an agreement may specify consistency with
respect to certain items. In such a case, consistency may prevail
over GAAP, especially if the agreement clearly specifies a nonGAAP presentation of such items.
In addition, disputes may arise over the application of the term
consistent. For example, consider the following language: the
company “consistently provides an allowance for bad debts,”
versus “provides an allowance using a consistent calculation
methodology,” versus “provides a consistent amount in the
allowance.” Careful drafting is thus required to capture the
parties’ intent.
c.
Interim versus Year-End Reporting.
The acquisition agreement may mandate consistency between the
pre-closing financial statements used in negotiations and the final
financial statements at closing. Because most companies apply
more rigorous and in-depth closing procedures at year-end,
questions may arise regarding which procedures the preparer of the
closing date balance sheet should apply. The interpretation of such
an issue may differ depending on whether the closing date balance
sheet or the financial statements used in negotiations were monthor period-end, but not regular reporting year-end. For example, if
the financial statements used in negotiations were for an interim
month-end, and the agreement calls for consistently applied
accounting principles, on what basis should the closing date
balance sheet be prepared if the closing date falls at year-end?
Conversely, if the financial statements used in negotiations were
the last year’s audited financial statements and the closing date is
13
an interim date, on what basis should the closing date balance sheet
be prepared? If these timing issues are present in the acquisition,
the drafter should specify the degree of rigor to be used in the
preparation of the financial statements forming the basis of the
post-closing adjustment.
d.
Errors or Irregularities Discovered after Closing
Sometimes disputes arise as a result of information that becomes
available after the closing date, such as the discovery of previously
unknown errors, irregularities or material departures from GAAP.
Because parties usually do not anticipate errors in the financial
statements, most agreements do not address the treatment of such
issues. The handling of this situation depends on the circumstances
of the error and its discovery. For example, if the financial
statements used in the negotiation process contained the error, but
the seller corrected it to its benefit in the closing date balance
sheet, the buyer may object by arguing that the seller should not
benefit from its own errors. If the buyer, however, detects an error
detrimental to it in the closing date balance sheet and such error
was not present in the financial statements used in the negotiations,
the buyer generally should receive a purchase price adjustment.
The circumstances surrounding the error – when it occurred, when
it became known, when the seller corrected it – will influence how
it should be treated in the purchase price adjustment.
e.
Materiality.
Interpreting and applying the accounting concept of materiality to
individual items, transactions, balance sheet or income statement
line items, or the financial statements taken as a whole can result in
dispute. In purchase price disputes, the buyer usually will claim
that all purchase price adjustments, if deemed proper, should be
awarded to it regardless of materiality, unless the contract contains
a threshold, basket or other similar clause.
Agreements occasionally contain clauses indicating that postclosing adjustments will be made only if they exceed a specified
dollar amount in the aggregate – a materiality threshold. The
contract clause may provide that once the adjustments exceed such
levels, the benefiting party receives the entire amount; or the
clause may read that such party will receive only the amount by
which the adjustments exceed the specified level (a basket or
deductible limitation). A materiality level may also be implied
through contract clauses. For instance, a contract may read that no
post-closing adjustment is necessary if the net asset value changes
less than 5% from the net asset value in the financial statements
14
used in the negotiations process. This implies that the parties
agreed upon a materiality level of 5% of the net asset value. In
many true-up formulations, however, the purchase price is adjusted
upward or downward based on the precise result of the postclosing adjustment.
Accountants have traditionally evaluated materiality with respect
to the financial statements taken as a whole. Occasionally,
however, a purchase agreement indicates that materiality applies
on a line-item basis, thereby lowering the materiality threshold.
If the agreement does not address materiality in any context, either
party may have a difficult time arguing that a materiality threshold
should apply to proposed purchase price adjustments. The seller
may argue that it represented that the financial statements would be
prepared in accordance with GAAP, which contains the concept of
materiality. Therefore, to the extent that the buyer proposes
adjustments that are immaterial, either individually or in the
aggregate, the seller may successfully argue that it did not violate
the representations made in the purchase agreement. In contrast,
the buyer will argue that material for financial statements of a
going concern business means something different from material
for balance sheets closing a purchase transaction. For the going
concern, an item can be in error, but the same error occurring year
after year will not significantly affect recurring operating income
numbers and computations made on them. For a buyer, an upward
change in purchase price of $250,000, for example, may be worth
arguing about even though the amount would not be material to the
financials as a whole. Carefully drawn purchase agreements will
address the materiality standards to be used in balance sheets
closing a purchase transaction.
f.
Changes in Accounting Policies or Practices.
Buyers often will argue that sellers have changed their accounting
policies or practices in preparing the closing financial statements,
and that this change violates representations or covenants in the
agreement. The following list includes common arguments with
respect to balance sheet allowance or valuation accounts:
•
inventory obsolescence or excess inventory;
•
doubtful accounts receivable;
•
returns and allowances; or
•
estimated liability amounts.
15
The process of deriving the balances in these accounts involve
judgments that the seller may not closely review and adjust during
interim periods. Examples of common disputes include a
downward adjustment to an accrued liability by the seller in
preparing the closing date balance sheet, or reducing a general
portion of the allowance for doubtful accounts. Again, these
disputes raise consistency issues. The seller may indicate that it
reviews such accounts only periodically and at year-end, so that
presenting a balance sheet in accordance with GAAP required the
adjustment. The buyer may contend that the seller did not
consistently apply the accounting practices because the seller did
not adjust the accruals downward when it prepared the pre-closing
financial statements used in negotiations. These issues arise so
often that parties should anticipate them in drafting contracts. The
following chart indicates the most common sources of controversy
for major balance sheet items.
BALANCE SHEET ITEMS AND ISSUES OFTEN INVOLVED IN DISPUTES
Accounts Receivable Allowances
Contingencies
•
•
•
•
•
•
Adequacy of Allowances
Consistency of Allowances (methodology
and amount)
Hindsight Issues
Inventory
•
•
•
•
Allowances for Obsolescence
Excess Inventory
Interim versus Year-End Count
Valuation Procedures
Application of Standard Costs
Revenue Recognition
•
and
•
•
Accounts Payable
•
•
•
•
Complete Recording
Cut-Off Procedures and Consistency
Materiality
•
•
Deliveries under Long-Term Production
Contracts
Recording of Revenue under Government,
Construction or Other Long-Term Contracts
Recording of Revenue and Amortization of
Cost Relating to Intangibles
Deferral and Subsequent Recognition of
Income
Capitalization Issues
•
•
Accruals
•
Management Judgment Issues
Corporate Provisions
Statement
of
Financial
Accounting
Standards No. 5 – Accounting for
Contingencies
Interim versus Year-End Recording
Procedures
Materiality, Consistency
Recognition and Treatment of Interim
“Smoothing” of Accruals for Annual
Expenditures
•
16
Capitalization of Development Costs
Deferral and Subsequent Recognition of
Income Capitalization of Tangible and
Intangible Assets: Amortization Periods
Consistency
g.
Hindsight.
Often, a buyer may contend that allowances reflected in the closing
date balance sheet (such as those for bad debts) are inadequate and
were therefore not stated in accordance with GAAP. For example, a
buyer may argue that a seller’s $100,000 bad debt allowance was
inadequate because the buyer has learned post-closing that $200,000
of accounts receivable are uncollectible. The buyer may have a valid
argument if it can prove that information justifying a $200,000
allowance was available to the seller when it prepared and finalized
the closing date balance sheet. For instance, the auditors may have
identified this exposure and recommended an allowance of $200,000.
If the buyer does not have reasonable evidentiary indications that
information or knowledge existed prior to the preparation of the
closing date balance sheet, it will likely rely on hindsight. Generally,
the buyer’s use of hindsight beyond the issuance date of the financial
statements is not persuasive, especially if the seller’s method to
calculate the amount prospectively conforms with GAAP and the
seller’s historical practices.
h.
Right to Offset.
Though not written into purchase agreements, sellers often claim a
right to offset as a defense against paying purchase price adjustments
proposed by a buyer that has objected to balances or items in a
closing date balance sheet prepared by the seller. Buyers typically
will review the closing date balance sheet and identify areas or
accounts that contain, in their view, overstated assets or understated
liabilities. Acceptance of these adjustments would result in purchase
price adjustments favorable to the buyer.
Because buyers seek to reduce the purchase price, they may identify
only those items favorable to them, even though they may be aware
of contractually required adjustments that would be unfavorable to
them. For example, in its post-closing review of a closing date
balance sheet prepared by a seller, a buyer might note that the
vacation liability is under-accrued by $300,000 and that the worker’s
compensation liability is over-accrued by $300,000. The buyer may
ignore the over-accrual and claim $300,000 in a purchase price
adjustment relating to the under-accrual associated with the vacation
liability. This may lead the seller to claim the right to offset an
under-accrual by a corresponding over-accrual. The seller may argue
that this right to offset must exist to prevent the buyer from
selectively objecting to the closing date balance sheet. In some
instances, the seller may have been aware of both the over-accrual
and under-accrual, but chose not to record the offsetting adjustment.
16
The seller, additionally, may claim that the financial statements, taken
as a whole, accord with GAAP, because the items offset each other.
Because agreements seldom provide for rights to offset, it may be
difficult for the trier of fact to ascertain the intent of the parties and
decide whether to adjust the purchase price in the event the parties do
not settle the issue. Careful drafting can reduce uncertainty with
regard to offsets.
3.
Issues of Control
Issues of control arise in situations in which the party in control of the
operations can potentially manipulate accounting and financial reporting to
its benefit through the post-closing adjustment process. For example, in a
management buyout, the buyer in effect runs the company during the period
between signing the agreement and the post-closing adjustment. This time
period presents an opportunity (whether exercised consciously or
subconsciously) for management to manipulate the accounting and financial
reporting to benefit its members through the post-closing adjustment.
Alternatively, when a seller operates the company during the stub period
between the date of signing the agreement and the closing date, it may take
advantage of its control and clean up the balance sheet to the buyer’s
detriment. Buyers recognize this potential and therefore require several
provisions in the form of representations, warranties or covenants in the
contract to prevent the sellers from doing so. Buyers are cautioned not to
place undue reliance on general covenants, such as the requirement that the
seller operate the target in the ordinary course of business between the
signing and the closing. First, this provision at best protects against
manipulation after the signing (and not before). Second, proving that a
practice does not comport with the seller’s ordinary course of business is
difficult. If a particular form of manipulation is feared, carefully crafted
restrictive covenants should be considered. Further, these carefully crafted
representations should be bolstered with a post-closing adjustment that
reflects changes occurring in the stub period, regardless whether they occur
in the ordinary course or are the result of manipulation.
Conversely, it should be noted that the post-closing adjustment is not a
substitute for thoughtful representations and warranties. If the seller
generates or preserves cash by cutting back on discretionary expenses, the
result will be an increase in cash but not necessarily an offsetting increase in
accounts payable. Thus for example, the seller might decide to cut back on
advertising expenses resulting in a short-term increase in cash but no change
in accounts payable. Under a working capital post-closing adjustment, the
purchase price will increase even though the business is arguably worse off
and in fact may suffer lower revenues in the future because of the failure to
advertise.
Thus, the manipulation is rewarded by the post-closing
17
adjustment. Only a representation can provide the buyer with a remedy in
this situation. See M. Tresnowski, “Working Capital Purchase Price
Adjustments – How to Avoid Getting Burned,” The M&A Lawyer, Oct.
2004.
Issues of control are almost inevitably present when the target is a division or
subsidiary of the seller. In this context, working capital is managed centrally
and thus not part of a “closed system.” Thus the opportunity for significant
movements in working capital is present and should be anticipated by careful
drafting. Similarly, in this situation, the buyer should guard against
disappearing intercompany assets, such as deferred tax assets.
4.
Caps and Floors
Although relatively uncommon, the purchase price adjustment provision may
contain a provision for a “cap,” which is an upper limit on the adjustment
amount that may be paid out by the buyer and a “floor” that limits the
adjustment amount that may be refunded by the seller.
Some risks are inherent in employing caps and floors. Parties should
consider whether the use of a cap or a floor will grossly disadvantage one
party if no other contractual remedies are provided. Employment of a cap or
a floor may give rise to a risk that the party thus constrained will turn instead
to contractual remedies in “unwind” provisions, deferred payment provisions
and indemnity provisions.
5.
Interplay Between the Post-Closing Adjustment and Indemnification
Carefully crafted acquisition agreements will explicitly deal with the impact
that the post-closing adjustment has on the indemnification provisions of the
agreement. Sellers should insist that buyers not be allowed to “double dip”
by a recovery first under the post-closing adjustment and then again as
indemnification. For example, if an error in the pre-closing date balance
sheet line items of inventory or accounts receivable causes a net working
capital post-closing adjustment, the seller should stipulate that this error
should not also give rise to indemnification for a breach of the representation
that these line items are stated in accordance with GAAP. The buyer should
be allowed to recover the damage only once. The buyer may respond,
however, that its loss from the inaccurate inventory or accounts receivable
line item is greater that the mere impact on the post-closing adjustment, and
insist upon collection the full loss, offset by the amount of the post-closing
adjustment.
6.
Dispute Resolution: Designation of Independent Accountants
Because it is not uncommon for disagreements to arise in the determination
of the post-closing adjustment, the parties often agree upon a dispute
resolution mechanism in the acquisition agreement rather than forcing the
18
parties to resort to litigation. A common provision for dispute resolution is to
designate a firm of independent accountants to review the closing date
financial statements. These accountants may act as auditors (who review the
financial data and provide an audit of the information) or as arbitrators (who
make a determination as to the proper resolution of the disputes that have
arisen regarding the closing date financials). If the identity of the
independent accountants is not stipulated by the parties, the parties should
specify the procedure for their selection.
The lawyers drafting the provision should state whether the independent
accountants are to examine only the disputed line items, or whether they may
review the entire closing financial statements. The Model Stock Purchase
Agreement with Commentary, published in 1995 by the Committee on
Negotiated Acquisitions, Section of Business Law of the American Bar
Association (the “Committee”), provides for submission only of the “issues
in dispute” to the independent accountants, effectively eliminating this
uncertainty. Model Stock Purchase Agreement, § 2.6(a). Likewise, the
Model Asset Purchase Agreement with Commentary, published in 2001 by
the Committee, provides only for the submission of “issues remaining in
dispute” after negotiations between the parties to the independent
accountants. Model Asset Purchase Agreement, § 2.9(d).
To avoid the cost of third-party accountants’ fees on smaller issues, the
parties may set financial limits on the issues that may be submitted to the
third-party accountants for review. They may provide that they will split the
amount in dispute or ignore those smaller issues.
Other issues to be considered in drafting the dispute resolution provision
include:
•
Should the arbitrator be required to have industry experience?
•
Will the arbitration process include discovery and written
submissions:?
•
Will the arbitration be final and binding?
•
What time frame allowing for negotiations should precede the
arbitration and how long should the arbitration process take?
•
Will interest accrue during the arbitration period?
•
What rules should apply to the arbitration process?
In any event the dispute resolution provisions should clearly designate the
party who is responsible for the payment of the expenses of the dispute
19
resolution. Typically the costs are split, or the non-prevailing party is held
responsible.
7.
Mechanisms to Ensure Payment of the Adjustment Amount
The parties may place part of the purchase price in escrow to ensure
expedited payment of an adjustment amount. If a promissory note has been
used to finance the sale, the parties may agree to increase or decrease, as
appropriate, the payments under the note to reflect the results of the purchase
price adjustment.
IV.
EARNOUTS
A.
Overview
An earnout provision makes a portion of the purchase price contingent upon the
acquired company reaching certain milestones during a specified period after the
closing. The benchmarks used are typically financial, such as net revenues, net
income, a cash flow measure or earnings per share. Non-financial benchmarks are
appropriate in some circumstances. When the benchmark being measured reaches a
negotiated threshold, an earnout payment is triggered.
Earnouts (as opposed to typical post-closing purchase price adjustments) are most
often utilized when the buyer and seller cannot agree on the value of the target.
They are particularly useful in dynamic or volatile industries, or when the buyer’s
projections for the target are fundamentally more pessimistic than those of the seller.
An earnout arrangement rewards the seller if its projections are accurate, while
protecting the buyer from overpaying if they are not. Buyers can use earnouts as a
source from which they can offset indemnification claims. An earnout also may be
attractive to a buyer desiring to bridge a financing gap.
In situations in which the seller’s management will continue to run the target after
the closing, an earnout arrangement may be used by the buyer to motivate
management with performance incentives. If the earnout is used in this context,
however, the earnout may be characterized as compensation rather than payment for
the business and, as discussed later in this article, there may be accounting
implications for the buyer.
Earnouts are used in transactions large and small, involving acquisitions of private
and, to a lesser extent, public companies. Earnout arrangements are most likely to
be used when the target is private since market valuations assist in the valuation of
the public target. If an earnout is used to compensate public company shareholders,
logistical problems will ensue unless careful planning is employed. To facilitate
payments, a paying agent should be employed to disburse payments when received
by the buyer. As discussed below under “Registration Issues for Earnout Rights”
20
and to minimize logistical issues, typically earnout rights are structured so as to be
non-transferable (except under the laws of descent and distribution).
B.
Some Risks Associated with the Use of Earnout Provisions
If inappropriately drafted, an earnout can hinder a purchaser’s efforts to reorient or
restructure the target, misappropriate future value to the wrong party or motivate the
earnout’s recipients to focus on short-term goals that will maximize the earnout.
Further, earnouts have great potential for engendering later disputes about the
contingent payment. Disputes often arise when the seller suspects that the buyer is
using different accounting techniques during the post-closing period to diminish the
payout, or is artificially depressing revenues or earnings during the earnout period.
The seller also fears that the buyer simply will not run the business successfully.
Buyers face the risk that the payout formula will overcompensate the seller in some
unforeseen way, due to other acquisitions or a change in the buyer’s post-acquisition
business plan that essentially has nothing to do with the target. These fears, many
legitimate, should cause counsel for the buyer and the seller to carefully craft the
earnout provisions. The Model Asset Purchase Agreement with Commentary
contains as an attachment a separate earnout agreement that provides drafting
guidance. Since each earnout is unique, reliance on forms must be measured.
C.
Drafting Issues
1.
Establishing the Earnout Benchmark; Types of Possible Benchmarks
Earnout benchmarks may be financial or non-financial in nature, or both. In
choosing milestones, and in drafting the acquisition agreement, the parties
should identify and deal with any post-closing contingencies that could
potentially alter the target’s ability to meet the earnout benchmarks.
a.
Financial Benchmarks
Common financial benchmarks include the target’s net revenue; net
income; cash flow; earnings before interest and taxes or “EBIT”;
earnings before interest, taxes, depreciation and amortization or
“EBITDA”; earnings per share; and net equity benchmarks.
Revenue-based benchmarks are often thought to be more attractive to
sellers, since they will not be affected by operating expenses or
acquisitions. The buyer’s post-closing accounting practices will
likely have less impact on revenue than other items. Buyers are more
likely to agree to a revenue–based benchmarks if costs of goods sold
and overhead have little variability. Generally, however, buyers
oppose revenue-based benchmarks because they provide no incentive
to the earnout recipients to control expenses, and may provide an
incentive to generate short-term sales that may prove to be
unprofitable. Buyers generally favor net income benchmarks on the
ground that they are the best indicator of the target’s success.
21
Parties often use EBIT or EBITDA measures as milestones in order to
allay sellers’ concerns about net income measures. EBIT and
EBITDA reflect the cost of goods and services, selling expenses and
general and administrative expenses, and thus are more difficult to
manipulate. They are additionally desirable because they exclude
interest, taxes, depreciation and amortization, which may vary based
on the buyer’s capital structure or the way in which the acquisition is
financed. Finally, for a transaction that is initially valued using a
multiple of post-closing cash flow, the use of EBIT or EBITDA for
the earnout is logical to determine what is in essence deferred
purchase price.
Regardless of the financial benchmark chosen, the parties should
carefully analyze the potential of the earnout to distort the incentive
for producing long-term, sustainable growth. For example, as noted
above, a revenue target may tempt the earnout recipients to book
unprofitable business. An earnout based on cash flow or income
could incentivize the earnout recipient to slash expenses (e.g.
marketing and advertising costs) to bolster short-term profitability at
the expense of long-term growth.
b.
Non-Financial Benchmarks
Non-financial benchmarks often are used in acquisitions of
development-stage companies. These companies may be difficult to
value, due in part to their high growth rates, and are particularly
suited to the use of non-financial milestones. In some industries,
non-financial milestones may be the best indicator of fair value.
Non-financial benchmarks may also serve the purpose of giving
operational focus to the target.
A non-financial benchmark could be completion by the company of a
core product or new product, inclusion of a favorable article in a
publication that meets specific criteria or the receipt of a “best
technology” or “best in show” award for the company’s technology or
product. See Spencer G. Feldman, The Use of Performance (Non
Economic) Earn-outs in Computer Company Acquisitions, INSIGHTS,
August 1996.
2.
The Formula for Calculating the Payment Amount
For financial benchmarks, the parties may stipulate the flat amount of
consideration to be paid if the threshold is met. More typically, the buyer
will pay the seller a specified percentage of the amount by which the target’s
performance surpasses the threshold. For example, the buyer may make an
annual payment to the seller equal to a percentage by which the target’s
EBITDA for the year exceeds the threshold EBITDA agreed to by the
22
parties. The payment also may be adjusted so that any shortfall in EBITDA
for a previous year will reduce the payment otherwise due for the current
year. An often difficult negotiation ensues regarding whether payments are
prorated if the threshold is only partially achieved. This negotiation is
sometimes settled by establishing a minimum hurdle before any payment will
be made and providing a sliding scale or proration after that hurdle is
achieved. For non-financial thresholds, the parties must agree upon an
amount of cash consideration or a number of shares of stock that will be
delivered for each milestone that is met. In any event, the payout is often
capped at a specified amount.
Care must be taken to specify with particularity the source of the earnout –
whether the threshold is to be applied to a product line, the entire target, the
division into which the target is absorbed or some other source.
Lenders will often consider the recipient of an earnout an equity holder and
seek to subordinate the payment to the lender's unsecured obligations,
including seeking to limit payments while the lender's debt is outstanding.
The seller will object strenuously to such a limitation, likely making its
objection known early in the negotiation. On the other end of the spectrum,
the seller may demand credit enhancement (for example a letter of credit) for
the earnout. These negotiations will turn on the leverage of the parties and
the financial position of the buyer.
3.
The Length of the Earnout Period
Most earnout periods conclude after the expiration of a specified length of
time – generally between two and five years after the closing The
appropriate length will be determined based on how long it will take to
measure the projected value of the target or the period during which the
buyer desires to incentivize the former owners. On occasion the earnout is
payable upon the occurrence of a specific event, such as the sale of the target,
a change in control of the buyer or the termination of the earnout recipient's
employment. Because earnouts may affect the flexibility of the post-closing
operation of the target, and few subsequent purchasers of a business will
accept assets burdened by an earnout, it is usually advisable to the purchaser
to have a buyout option for the earnout. Crafting the valuation of the earnout
buyout is generally difficult. Often parties rely on a multiple of historic
payments or an expert valuation of the target.
4.
Determination of Whether the Threshold Has Been Satisfied
a.
Determination of the Earnout
The seller should insist that the buyer maintain separate books and
records for the target, division or other source of the earnout
throughout the earnout period. The buyer should covenant that these
23
financial records will be made available for review upon reasonable
notice.
The buyer and its accountants typically will make the initial
determination of whether the milestones have been reached. The
seller then will review the calculations and challenge them if
necessary. In certain situations, it may be appropriate to require that
the results of the earnout period be audited.
b.
Accounting Issues
For financial milestones, the parties should stipulate with as much
detail as possible the accounting principles that will be used to
calculate whether the thresholds have been met. As noted above,
GAAP embraces a wide range of acceptable accounting practices, and
is consistently in a state of flux. The ability to manipulate the results
of an earnout through adjustment to GAAP is often legitimately of
great concern to the seller. Particular care in delineating the
calculation principles should be used if the threshold is a non-GAAP
financial measure, such as EBIT or EBITDA. The parties thus should
incorporate into the acquisition agreement a description of the
accounting principles to be employed. Listed below are specific
accounting issues that may arise:
(1)
Consistency of Practice in Post-closing Accounting
A problem may arise in the form of movement of revenue and
expenses by the party in control of the target after closing.
The lawyers drafting the earnout provision should address this
possibility and stipulate that post-closing accounting in this
regard should not vary from prior practice. Special care must
be taken, however, if the target was fundamentally different in
the hands of the seller than the way it will be treated by the
buyer (e.g., if the seller was an S corporation or compensation
expense of the target as a C corporation was artificially high).
Diligence into the pre-sale accounting policies of the seller
will clarify past practice and reveal any areas of potential
dispute. The parties should consider specifying whether
changes in GAAP promulgated by the FASB after closing will
affect the determination of the earnout.
(2)
Potential Exclusions in Calculating the Payout and Other
Possible Adjustments
•
The seller should seek to exclude all transaction,
restructuring and integration related expenses that are
24
charged against the earnings upon which the earnout is
calculated.
•
When net income is used as the performance yardstick,
parties almost always adjust for heightened depreciation
caused by a write-up in assets obtained in the acquisition.
Prior to the FASB’s adoption of SFAS No. 142, Goodwill
and Other Intangible Assets, effective June 30, 2001,
parties also almost always added back goodwill
amortization in calculating an earnout based on net
income. SFAS No. 142 eliminates the amortization of
goodwill for calendar year companies for (a) goodwill
acquired after June 30, 2001, and (b) for goodwill existing
on June 30, 2001, after December 31, 2001. Instead,
SFAS No. 142 requires an annual impairment test based
on a comparison of the fair value of each reporting unit
that houses goodwill acquired to the carrying amount of
the reporting unit’s assets, including goodwill. Parties
should consider the impact of the annual impairment tests
in determining the earnout with respect to a transaction.
•
When net income, EBIT or EBITDA are used as the
performance measures, the seller should ascertain what
administrative or general overhead expenses the buyer will
allocate to the target after closing and determine how
those expenses will impact the post-closing figures. For
example, the allocation of corporate headquarters’
expenses and services allocated among affiliates should be
carefully considered.
•
The seller will likely attempt to exclude executive
compensation expense allocated to the target.
•
The seller’s counsel also may argue that indebtedness
resulting from the acquisition allotted to the target after
closing should be excluded when calculating the earnout.
If interest is excluded, care should be taken to exclude
expenses associated with financings and prepayment
penalties. The exclusion that covers the initial acquisition
indebtedness should also cover subsequent refinancings.
•
The parties also may desire to exclude extraordinary gains
and losses.
•
Intercompany transactions between the target and the
buyer or its affiliates also require adjustment to reflect the
amounts that the target would have realized or paid if
25
dealing with an independent third party on an arm’s length
basis. If an intercompany charge from the parent (even if
characterized as a management fee) is actually a
distribution of profits, the payment should not be treated
as an expense in the calculation of the earnout.
•
(3)
While most exclusions from the earnout calculation are
demanded by the seller, the purchaser should consider
whether exclusions are appropriate. In some situations it
may be appropriate for synergies arising out of the
combination to be excluded from the earnout. Particularly
if the buyer intends to use the target as a platform for
future acquisitions, revenue, income or cash flow from
these acquisitions may need to be excluded in the earnout
calculation.
Payments Pursuant to Tax-sharing Agreements
In most situations the target, once acquired, will become a
party to a tax-sharing agreement with the buyer’s taxpayer
group, or become a part of the buyer’s consolidated tax
reporting group. The seller’s counsel should assure that
payments made by the target pursuant to the agreement or as a
member of the group do not have unanticipated effects on the
attainment of the earnout thresholds.
(4)
Accounting Treatment of the Contingent Consideration
When Linked with Future Employment
A difficult accounting issue arises in those transactions in
which contingent consideration is linked with the continued
employment of the seller’s management. In transactions in
which the contingency is based on the future earnings of the
seller and the management of the seller enters into
employment contracts with the new entity, the question arises
whether the substance of the additional payments is truly a
payment for the seller or rather a salary expense in the form of
bonuses based on production. The issue is particularly
relevant to acquisitions of small businesses.
In 1995, the FASB’s Emerging Issues Task Force reached a
consensus on this issue in EITF 95-8, Accounting for
Contingent Consideration Paid to the Shareholders of an
Acquired Enterprise in a Purchased Business Combination.
The consensus opinion notes that the following factors should
be considered when evaluating the propriety of accounting for
contingent consideration based on earnings:
26
•
•
•
•
•
•
reasons for contingent payment provisions;
the
formula
for
determining
contingent
considerations;
treatment of the contingent payment for tax
purposes;
linkage of payment of contingent consideration
with continued employment;
a composition of the shareholder group; and
other arrangements with shareholders, such as
noncompetes, consulting agreements and leases.
The determination as to whether payment of contingent
consideration represents purchase price or compensation is
based on facts and circumstances. The EITF notes that if a
contingent payment arrangement is automatically forfeited if
employment terminates, a strong indicator exists that the
arrangement is, in substance, compensation. The EITF goes
on to note, however, that the absence of linkage between
continued employment and payment of contingent
consideration does not necessarily imply that the payment of a
contingency represents purchase price. Another factor is the
proportionality of the seller’s right to receive earnout payment
compared to the seller’s ownership interest. If proportionality
exists, the earnout is more likely to be characterized as a
deferred payment. If proportionality is lacking, then the
earnout is more likely to be compensatory in nature. See
Kimberly Blanchard, The Taxman Cometh, BUSINESS LAW
TODAY, May/June 1997, at 61.
It is important to note that an earnout must be treated
consistently as to avoid re-characterization. “As a threshold
manner, an earnout should be treated as compensatory only if
the seller actually performs services for the buyer after the
sale or gives an economically meaningful covenant not to
compete.” Kimberly Blanchard, The Taxman Cometh, supra,
at 60.
The same principles that are relevant for the accounting
characterization of the earnout payment apply to the tax
treatment of the payments. Earnout payments to sellers who
participate in running the business of the target during the
earnout period may be treated, not as a capital gains, but as
ordinary income.
27
(5)
Other Issues to be Considered
Other potential areas for variation that should be addressed
include inventory valuation methods (LIFO versus FIFO, as
well as the manner of treating inventory as obsolete),
depreciation schedules, accounting for retirement and welfare
benefits and reserves for bad debts. The parties should
carefully consider whether there are matters of heightened
concern or specific to the target's industry, often mandating
that the parties specify the accounting methodology to be
used.
5.
Form of Payment of Earnout Obligation
Cash is often used as the earnout payment, but not infrequently the
contingent consideration is stock. The use of cash may be a problem when
the target is thriving and the buyer’s other businesses are performing poorly.
On the other hand, the use of stock to satisfy the earnout may dilute the
buyer’s earnings per share. Additionally, the use of stock raises various
valuation, securities and tax issues. The purchaser may be required to
specify the maximum number of shares that will be issued as part of the
earnout arrangement for securities and tax reasons that are detailed below.
a.
Valuation Issues
The parties to the acquisition agreement must determine the date as of
which the stock used in the earnout will be valued, which will likely
be at either the time of the closing or the time of issuance. If the time
of the closing is selected, the buyer likely risks an increase in the
acquisition price caused by a run-up in the stock price between
closing and the issuance.
The seller runs the risk that the buyer will issue additional common
stock during the earnout period that is priced lower than the market
price or the per share value assigned in the acquisition. Counsel for
the seller may suggest a provision designed to protect against dilution
of the shares that are earned but have not yet been distributed.
b.
Securities Issues
The stock that is issued in an earnout must, of course, be registered or
exempt from registration. Affiliates of the target who receive stock
and affiliates of the buyer must abide by the selling restrictions of
Rules 145(d) and 144, respectively, of the Securities Act.
Practitioners should examine Rule 144(d)(3)(iii), under which the
earnout stock may be deemed to have been acquired at the time of the
transaction’s closing for purposes of calculating the holding periods
28
of Rule 144 if the issuer or affiliate was then committed to issue the
securities subject only to conditions other than the payment of further
consideration for such securities. An agreement to remain employed
or not to compete entered into in connection with a transaction, or
services performed pursuant to such an agreement, are not deemed
payment of further consideration. See also Medeva PLC, 1993 SEC
No-Act LEXIS 1145 (concluding that the holding period for shares
issued as deferred consideration commenced on the date the target
shareholders elected to receive payment in shares rather than cash).
Additionally, in connection with the listing of the buyer’s stock at the
time of the acquisition, a securities exchange will likely require that
the buyer specify a limit on the number of its shares to be issued as
contingent consideration.
c.
Related Tax Questions
If the acquisition is structured as a tax-free reorganization, the use of
contingent consideration may cause difficulties for the parties. In all
types of tax-free reorganizations, there are limits on the amount of
cash or other property (other than stock) that can pass as
consideration. The permissible amounts vary by transaction form.
Care must be taken to limit cash earnout payments to that allowed
under the applicable reorganization type or to pay the earnout in
additional stock that meets the applicable requirements.
Similar to escrow payments, amounts paid to the seller in years
following the year of sale generally will be taxed on the installment
method described above. The specific treatment will depend on
whether there is a stated maximum earnout amount or simply a period
over which the earnout payments will be made.
With respect to otherwise tax-free transactions, the Original Issue
Discount Rules of Section 483 of the Internal Revenue Code require
that some portion of the deferred consideration, if made in stock,
must be allocated to interest, reportable as such by the seller and
deductible as such by the buyer. The remaining portion of the stock
is generally treated as additional tax-free consideration emanating
from the original purchase. The IRS has issued ruling guidelines
relating to the treatment of this contingent stock in Rev. Proc. 84-42,
1984-1 C.B. 52.
6.
Operation of the Acquired Business During the Earnout Period
Both the buyer and the seller may fear mismanagement during the earnout
period that could affect the payout.
29
a.
Operation by the Buyer Post-closing
The seller typically has concerns that the target will not be properly
managed after the closing
In situations in which the seller’s
management team will not be retained post-closing, the seller likely
will require that the buyer operate the target in the ordinary course of
business consistent with past practice, and will attempt to reserve,
through contractual covenants, some authority regarding major
decisions made during the earnout period. The seller will likely
demand that the target be operated as a distinct business entity or
division so that its results can be verified. The seller may require that
the buyer adequately fund the target during the earnout period so that
it will be able to capitalize on opportunities presented to it. It is not
uncommon for the seller to establish minimum absolute funding
levels. The earnout may be crafted to acknowledge the parties’
agreement or intent to exploit specified opportunities. Any limitation
of the buyer’s freedom to run the target as circumstances require
likely will be resisted.
b.
Operation by the Seller’s Management Team Post-closing
Less commonly, the seller’s management will continue to operate
the target post-closing. In this situation, the buyer’s risk is that the
seller’s management team will operate the business so as to unfairly
maximize the payout amount. Counsel for the buyer should attempt
to provide appropriate controls over the target, including a
mechanism for reviewing decisions that can affect the payout.
c.
Protection Placed in the Acquisition Agreement
The parties also may wish to include detailed post-closing operational
procedures in the acquisition agreement in order to avoid uncertainty.
For example, the buyer might covenant to operate the company
consistent with past practice subject to certain exceptions, or the
buyer might agree to restrictive covenants that prevent the target from
taking specified actions (such as making large expenditures) during
the earnout period.
In Horizon Holdings, LLC v. Genmar Holdings, Inc., 244 F. Supp. 2d
1250, 1257-58 (D. Kan. 2003), the court held that when evaluating
the principles of good faith and fair dealing, a court may imply terms
to honor the parties reasonable expectations. In Horizon, the seller
had remained on staff as president of the new entity in an attempt to
realize the $5.2 million earnout. The earnout was defined in the
agreement as part of the purchase price. The seller had been assured
that he would be given autonomy as president and that he had a
realistic opportunity to receive the earnout. However, upon acquiring
30
Horizon, the buyer interfered with business operations and prevented
the seller from meeting the earnout threshold. In sweeping language,
the court held that it could imply terms in an agreement to honor the
parties reasonable expectations when those obligations were omitted
from the text of the contract. In determining whether to imply terms
in an agreement, the court noted that the proper focus was on “what
the parties likely would have done if they had considered the issue
involved.” The court stated that the jury could have readily
concluded that the parties would have agreed, had they thought about
it, that the buyer would not be permitted to undermine the president’s
authority, to abandon the companies brand name, or to mandate
production of a rival product thereby impairing the realization of the
earnout. The jury award of $2.5 million was upheld.
A key lesson to be learned from the Horizon Holdings case is that the
parties should be explicit in crafting the expectations for the postclosing conduct of the parties to circumvent a court setting the ground
rules.
In another recent earnout case, Richmond v. Peters, et al., 155 F.3d
1215 (6th Cir. 1998), plaintiff sold his business to defendant with the
price and payments to be determined, in substantial part, by reference
to the profits of the continuing business in excess of a base-level
amount. The agreement between them provided that the business was
to be managed in accordance with “sound business practices.”
Plaintiff claimed that defendant breached their agreement and further
breached a fiduciary duty owed by defendant to the seller. On motion
for judgment as a matter of law after plaintiff presented its case, the
trial court ruled that Ohio law imposed no fiduciary duty upon
defendant and that plaintiff had presented no evidence that defendant
had breached any provision of the agreement.
The court held that the facts of the case should be reviewed with
respect to the contract claim. It is significant, however, that the trial
court found, and the appellate court agreed that, at least under Ohio
law, the earnout agreement created no implied fiduciary duty between
the parties.
7.
Payment of Earnouts to Public Shareholders
Payment of earnouts to public shareholders of a seller that does not survive
the transaction can be a logistical problem. One common solution is to
establish a paying agent to disburse earnout payments to the seller’s former
shareholders. This paying agent may handle any disputes with the buyer
during the earnout period as well.
31
8.
Shareholders Designated to Act for the Seller
In situations in which the entire seller is sold to a buyer in a transaction with
an earnout, the parties should consider establishing a committee to act on
behalf of the persons who were shareholders of the seller at the closing. The
committee would speak for the shareholders on matters relating to the
earnout and indemnification. The provisions establishing the committee
should delineate its powers and how it can act. Funds should be set aside to
cover the expenses of the committee and its counsel. Often, the acquisition
agreement simply will specify that the buyer will communicate with the
committee, or shareholders’ representative, post-closing. In such case, the
obligations of the committee to the shareholders will be addressed in a
separate shareholders’ representative agreement.
9.
Sale of the Target During the Earnout Period
The parties should determine whether the target or a portion thereof may be
sold to a third party during the earnout period, and the effect of such a sale
should it take place. A similar problem arises when a third party acquires the
buyer during the earnout period. As suggested above, the lawyers for the
seller may suggest that the third party buyer be obligated to pay off some or
all of the earnout amount at the time of the second sale.
10.
Integration of the Target into the Buyer’s Other Businesses
The parties must decide how to calculate the earnout if the target should be
merged into similar entities owned by the buyer. The difficulty of measuring
performance in this case may make buyers reluctant to fully integrate the
acquired business into the rest of the buyer’s business. A parallel difficulty
arises when the buyer acquires additional, similar businesses during the
earnout period. In these situations, the buyer and seller must work with
accountants to formulate a plan for segregating the financial statements that
form the basis of the target’s earnout thresholds. This segregation can
preclude the buyer from achieving the economies of scale and synergies it
anticipated in consummating the acquisitions. One solution is to assess the
financial performance of the whole group and, for purposes of calculating the
earnout, assign to the target its pro rata share of the overall amount.
Alternatively, some buyers pay off the sellers during the earnout period to
end the arrangement early.
11.
Averaging Periods of Strong Performance With Weak Performance
The parties must decide whether performance well above threshold levels in
one part of the earnout period may be applied to supplement a lesser
performance during another part of the earnout period.
32
12.
Dispute Resolution
Disputes regarding earnouts are commonplace, and the lawyers drafting the
earnout provision are well advised to consider the appropriate form of
dispute resolution under the circumstances. Many earnouts require binding
arbitration of disagreements that the parties cannot resolve within a brief
period of time. Arbitration is favored over litigation because the former
generally is faster, less expensive and a better forum within which to deal
with complex financial issues. However, the growing perception that
arbitrators render “split the baby” decisions that attempt to satisfy both sides
has caused some advisors to favor litigation as a more predictable source of
appropriate outcome. If litigation is favored, jurisdiction and venue should
be specified. All provisions regarding dispute resolution should be detailed
and carefully crafted anticipating all plausible scenarios.
13.
Registration Issues for Earnout Rights
Under certain circumstances earnout rights may be deemed securities under
the Securities Act. To prevent the necessity of registration, acquisition
agreements usually prohibit any transfer of the right to the earnout payment
and assert that the right is not an investment contract or other type of
security.
In a series of no-action letters, the SEC evaluated whether or not specific
earnout agreements constitute a security.1 The SEC emphasized that the facts
of any particular situation must be evaluated closely, but it concentrated on
the following factors when deciding that a particular earnout did not
constitute a security:
•
The earnout right was granted to the sellers as part of the
consideration for the sale of their business and neither the
purchasers nor the sellers viewed the right as involving an
“investment” by the sellers;
•
The earnout right did not represent an ownership interest in the
purchaser and was not evidenced by any certificates;
•
The earnout right could not be transferred except by operation of
law; and
•
The earnout right did not entitle the owner to voting or dividend
rights.
1
For further information, refer to Great Western Financial Corp., SEC No-Action Letter, No. 042583014 (April 4,
1983); Northwestern Mutual Life Insurance Co., SEC No-Action Letter, No. 030783002 (March 3, 1983); Lifemark
Corp., SEC No-Action Letter, No. 112381006 (November 17, 1981); and Kaiser Aetna, SEC No-Action Letter, No.
CCH19730730010 (July 30, 1973).
33
14.
Special Industry Limitations
Advisors to parties desiring to structure an earnout are cautioned to ascertain
the legality of the arrangement under the regulatory laws applicable to the
transaction. For example, under the federal self-referral statute (commonly
known as “Stark”) a hospital may not pay for a physician practice it acquires
in installments or through an earnout (assuming the physicians will refer to
the hospital after the transaction). The prohibition’s rationale is to eliminate
a physician’s motivation to refer to the hospital, thereby enhancing the
financial strength of the hospital so it can pay the earnout. Other
industry-specific requirements may affect the ability to structure acquisitions
with earnouts.
V.
CONCLUSION
There are many forms of consideration paid in acquisitions, all with their own advantages
and disadvantages. The most common forms of payment are cash, stocks, promissory notes,
the assumption of indebtedness or some combination thereof. The parties should pay close
attention to the accounting, tax, securities laws and practical consequences of each form of
consideration. Importantly, the chosen form of consideration may affect the leverage
between the parties after the closing.
In many transactions, some form of purchase price adjustment is appropriate. Even when
there is fundamental agreement between the parties as to the purchase price, if there is lag
time between the pricing and closing, some form of “true-up” may be appropriate.
Earnouts are usually employed when there is a disagreement as to the value of the target, but
may also be useful in other scenarios such as a performance incentive. Parties should take
great care in crafting the earnout. They should specify, in detail, the nature of the hurdle
giving rise to the earnout obligation, the accounting methods that will be used in
ascertaining whether the earnout has been achieved, the inclusions and exclusions from the
earnout calculation and who will determine whether the earnout threshold had been met. It
is essential that all possible scenarios be explored as the earnout is crafted to avoid future
conflict.
34
Purchase Price Adjustment Bibliography
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COMMENTARY, pp 58-64, AMERICAN BAR ASSOCIATION (2001)
COMMITTEE ON NEGOTIATED ACQUISITIONS, MODEL STOCK PURCHASE AGREEMENT WITH
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DILLEN, CHRISTOPHER D. AND PLETCHER, BRETT A., Ch.5. Structuring the M&A Exit
Transaction, C. Selected Additional Purchase Price Topics, 2. Purchase Price Adjustment (pp 579-5-81), THE ACQUISITION AND SALE OF THE EMERGING GROWTH COMPANY: THE M&A EXIT,
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HALLER, MARK W., KREB, KEVIN D., PERKS, BENJAMIN, W. AND RIORDAN, THOMAS K.,
Mergers, Acquisitions, and Divestitures: The Nature of Disputes and the Role of the Financial
Expert, LITIGATION SERVICES HANDBOOK-THE ROLE OF THE FINANCIAL EXPERT
HARPER, ROBERT T., Financial and Accounting Provisions in Acquisition Agreements—
Purchase Price Adjustment Mechanisms, AMERICAN BAR ASSOCIATION, SECTION OF BUSINESS
LAW, 1998 SPRING MEETING (April 1998)
ISAACS, JEFFREY S. AND WISEMAN, STEPHEN M., The Pitfalls of Purchase Price Adjustment
Provisions, ACC DOCKET (September 2004)
KLING, LOU R. AND NUGENT, EILEEN T., §17.02 Post-Closing Adjustments, NEGOTIATED
ACQUISITIONS OF COMPANIES, SUBSIDIARIES AND DIVISIONS
LIDBURY, JAMES T., Drafting Acquisition Agreements, Drafting Corporate Agreements 19981999, CORPORATE LAW AND PRACTICE COURSE HANDBOOK SERIES, PRACTISING LAW INSTITUTE
(1998)
MALT, R. BRADFORD, Corporate Mergers and Acquisitions: Discussion Outline of Purchase
Price Considerations, 20TH ANNUAL ADVANCED ALI-ABA COURSE STUDY (September 9-10,
2004)
MALT, R. BRADFORD, Selected Materials on Acquisition Basics, Part IX. Discussion Outline of
Purchase Price Considerations, C. Post-Closing Adjustments, ACQUISITIONS & DIVESTITURES,
BUSINESS LAWS, INC.
SCHECTOR, DAVID, Avoiding or Resolving Purchase Price Disputes, THE CPA JOURNAL ONLINE
(March 1993)
SINHA, PANKAJ AND ELSEA, ERIK, Purchase Price Adjustments: A Survey, THE M&A LAWYER
(October 2004)
THOYER, JUDITH R. AND KORRY, ALEXANDRA D., Drafting and Negotiation of Agreements
Relating to the Sale of a Division, Advanced Doing Deals, PRACTISING LAW INSTITUTE (June 56, 1997)
TRESNOWSKI, MARK B., Working Capital Purchase Price Adjustments—How to Avoid Getting
Burned, THE M&A LAWYER (October 2004)
WARYJAS, MARYANN A., 501 Negotiating the Acquisition Agreement—Post-Closing Purchase
Price Adjustments—and 557 Negotiating the Purchase Price—Post-Closing Purchase Price
Adjustments—Drafting Corporate Agreements 2004-2005, PLI CORPORATE LAW AND PRACTICE
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2
SAMPLE CLAUSES REGARDING ADJUSTMENTS FOR
EXPENSES AND REVENUES FROM TENANTS
PLUS WORKING CAPITAL ADJUSTMENT
Section 8.2
Adjustments.
(1)
The Purchase Price shall be adjusted in accordance with the Purchaser’s Proportionate
Interest as of the Closing Date for all items of income and expense and other items adjusted in
accordance with usual commercial practice for adjustment between a vendor and purchaser with
respect to the purchase and sale of assets comparable to the Issuer’s Assets (with the Closing
Date itself being allocated to the Purchaser). Without limiting the foregoing, the adjustments
shall include interest under the Fixed Rate Mortgages, any holdback by mortgagees under the
Fixed Rate Mortgages and mortgages pursuant to the Required Refinancing Transactions, less
the costs associated with the release of such holdbacks, to the extent the same are applicable and
appropriate, realty taxes, local improvement charges, other taxes, assessments and recoveries,
resolved Assessment Appeals, operating costs, additional rent, landlord recoveries from Tenants,
utility deposits, current rents, prepaid rents, interest accruing to Tenants, if any, on any amounts
prepaid by the Tenants under any of the Leases and landlord's contributions to promotional funds
collected from Tenants and interest thereon, if any.
(2)
Any inducement (being all tenant inducements, tenant allowances and rent free periods
and any and all costs of any lease takeover, assumption, assignment or other similar
commitments payable pursuant to any of the Leases in existence as of the date hereof with the
exception of those leases entered into in accordance with the terms of Section 5.1(c) including
commissions, fees and similar costs related thereto, and excepting any such inducements,
allowances, costs or commitments where the same arise as a result of amendments or renewals
effected pursuant to Section 5.1(b)) applicable on or following the Closing Date shall be the
responsibility of the Current Limited Partners or, if not paid by the Current Limited Partners by
Closing, the Purchaser’s Proportionate Interest thereof shall be paid to the Purchaser by way of
adjustment on the Closing Date, all without duplication.
(3)
The adjustments contemplated by Section 8.2(1) and Section 8.2(2) shall be set out in a
statement of estimated adjustments (the “Statement of Estimated Adjustments”) to be delivered
to the Purchaser in draft no later than five (5) Business Days prior to Closing. With respect to
matters which cannot be determined conclusively on or before the Closing Date, the Statement of
Estimated Adjustments shall reflect estimated adjustments arrived at by the Current Limited
Partners and the Purchaser, acting reasonably, subject to readjustment pursuant to the Statement
of Readjustments. The Statement of Estimated Adjustments shall be based upon the most
recently available management financial statement prepared by z and shall, in addition to the
matters contemplated by Section 8.2(1) and Section 8.2(2) above, set out a reasonable estimate
of Net Working Capital (excluding any items already adjusted for in the Statement of Estimated
Adjustments) as at the Closing Date (the “Estimated Net Working Capital Amount”). In the
event the Estimated Net Working Capital Amount is a negative amount (the “Estimated Net
Working Capital Deficiency”), a cash amount equal to the Estimated Net Working Capital
Deficiency will be retained by the Issuer out of its available cash or will be paid by the Current
Limited Partners to the Issuer.
(4)
All available cash of the Issuer (excluding cash in the amount, if any, of the Estimated
Net Working Capital Deficiency) shall be distributed by the Issuer to the Current Limited
Partners on Closing.
(5)
A statement of readjustments (the “Statement of Readjustments”) shall be prepared by z
and settled among the Purchaser and the Current Limited Partners, acting reasonably, and the
appropriate readjustments to the Statement of Estimated Adjustments shall be made not later
than 6 months after the Closing Date unless the parties otherwise agree. The Statement of
Readjustments shall include a statement of Net Working Capital (excluding any items already
adjusted for on the Statement of Readjustments) as of the Closing Date (the “Closing Net
Working Capital Amount”). In the event the Closing Net Working Capital Amount exceeds the
Estimated Net Working Capital Amount, the difference shall be paid by the Issuer to the Current
Limited Partners. In the event the Closing Net Working Capital Amount is less than the
Estimated Net Working Capital Amount, the difference shall be paid by the Current Limited
Partners to the Issuer.
(6)
There shall be no adjustment under this Section 8.2 for security deposits remitted by
Tenants under the Leases or other amounts of a similar nature which are neither income nor
expense to the Issuer, provided that all such amounts in respect of which there is to be no
adjustment as aforesaid shall be retained by the Issuer on Closing.
(7)
The parties hereto acknowledge and agree that the purchase price under a z Offering
Transaction shall be adjusted in a manner consistent with the adjustments contemplated by this
Section 8.2.
(8)
For clarity and for the purposes of this Section 8.2, it is agreed that the costs to be borne
by the Issuer with respect to leasing costs noted in Section 8.2(2) hereof referable, in turn, to
Section 5.1(b) and Section 5.1(c) hereof, the costs referred to in Section 6.3(e) hereof and the
costs referred to in Section 11.6(3) hereof shall be borne by the Issuer on the basis that such costs
shall be borne exclusively by z, the Accredited Investors, if applicable, and the Purchaser in
their respective proportionate shares under the Limited Partnership Agreement.
2
SAMPLE CLAUSES REGARDING WORKING CAPITAL
ADJUSTMENT PLUS EARNOUT
1.1
Subject to the provisions of Sections 1.2, 1.6, 1.7, 1.8 and 1.12 below, the purchase price
for the Purchased Shares (the “Purchase Price”) shall be ____________ dollars
($___________), which shall be paid as follows:
(a)
forthwith following the execution of this Agreement, $____________ shall be
paid by the Purchaser to the Vendors’ Solicitors to be held in trust pursuant to an
escrow agreement substantially in the form attached hereto as Schedule 1.1(a)
hereof (the “Escrow Agreement”), by certified cheque (the “Escrow Amount”),
which Escrow Amount shall be held in an interest-bearing trust account, with the
interest earned being credited in accordance with the terms and provisions of the
Escrow Agreement;
(b)
at the Time of Closing, $_________ shall be paid by delivery of a promissory
note to be executed and delivered by the Purchaser to the Vendors (the
“Promissory Note”), which Promissory Note shall provide for interest to accrue
on the principal amount outstanding thereunder from time to time at a rate of 6%
per annum, calculated and payable quarterly, in arrears, with payment of principal
on the second anniversary of the Closing Date; and
(c)
at the Time of Closing and subject to Section1.12, the Escrow Amount (including
interest earned thereon) shall be released from escrow upon and subject to the
terms and conditions of the Escrow Agreement, and paid to the Vendors.
All payments to be made to the Vendors pursuant to this Section 1.1 shall be allocated
and paid to the Vendors, or as they may direct, in accordance with the percentage
allocation set out in Schedule 1.1.
1.2
In the event the Working Capital of the Corporation (prior to commencement of the
Purchaser Restructuring Plan) is less than $___________ on the Reorganization Date, the
Purchase Price shall be decreased by the amount by which the Working Capital is less
than $___________ (the “Working Capital Shortfall”). Within thirty (30) days following
the Reorganization Date, the Vendors shall, at their sole expense, deliver to the Purchaser
a balance sheet of the Corporation as at the Reorganization Date (the “Vendor’s Balance
Sheet”), which Vendor’s Balance Sheet shall be prepared by the Vendors’ accountants in
accordance with generally accepted accounting principals applied consistently with past
practice. The Purchaser shall cause the general partner of the Successor Partnership to
provide to the Vendors access to all documents, agreements and other business records of
the Corporation in its possession as may be necessary or desirable in order that the
Vendor’s accountants may prepare the Vendor’s Balance Sheet, and shall otherwise
provide to the Vendors all such reasonable co-operation as the Vendors may require in
order to prepare the Vendor’s Balance Sheet. In the event that the Purchaser disputes the
amount of the Working Capital of the Corporation as calculated based on the Vendor’s
Balance Sheet (the “Vendor’s Working Capital Amount”), the Purchaser shall so advise
the Vendor of such dispute within ten (10) days of receiving the Vendor’s Balance Sheet
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(the “Dispute Period”). In the event that the Purchaser does not advise the Vendors that it
disputes the Vendor’s Working Capital Amount prior to the expiry of the Dispute Period,
the Vendor’s Working Capital Amount shall be deemed final and binding on the parties
for the purposes of this Agreement and any Working Capital Shortfall shall be paid by
the Vendors to the Purchaser forthwith by certified cheque. In the event that the
Purchaser delivers a Dispute Notice within the time period allowed for the same herein,
the Purchaser shall retain Deloitte & Touche to prepare an audited statement of Working
Capital of the Corporation as of the Reorganization Date (prior to commencement of the
Purchaser Restructuring Plan) (the “Working Capital Statement”). Such Working Capital
Statement shall be prepared and delivered to the Vendors and the Purchaser within ninety
(90) days following the Reorganization Date, and the cost of the preparation of such
Working Capital Statement shall be paid by the Purchaser, provided that, should the
Working Capital of the Corporation as set forth in the Working Capital Statement (as
finally determined) be less than 98% of the Vendors’ Working Capital Amount, the
Vendors shall pay the cost of the preparation of the Working Capital Statement. It is
hereby acknowledged and agreed that the Vendors shall reflect a contingent liability in
the amount of $____________ on the Vendor’s Balance Sheet, in connection with the
Actions disclosed to the Purchaser hereunder. It is further expressly acknowledged that
the Vendor’s Balance Sheet shall include, as a contingent liability, a provision for bad
debt in respect of any Accounts Receivable which the Vendors believe may be
uncollectible as at the Reorganization Date. Notwithstanding anything herein contained,
and provided that the Vendors have complied with their obligations relating to the bad
debt provision as outlined above, and further provided that the Vendors have not
breached the representations contained in Paragraph 4.14 hereof, the Vendors shall have
no liability to the Purchaser hereunder in the event that any Accounts Receivable are not
collected.
1.3
The parties shall have a period of fifteen (15) days from the date on which the Working
Capital Statement is received from Deloitte & Touche, as provided in Section 1.2, to
review the same. If no objection to the Working Capital Statement is given by one party
hereto to the others within such fifteen (15) day period, the Working Capital Statement
shall be deemed to have been approved as of the last day of such fifteen (15) day period,
and any Working Capital Shortfall shall be determined based on the Working Capital of
the Corporation, as calculated based on the Working Capital Statement. If any party
objects to the Working Capital Statement within such fifteen (15) day period by giving
notice to the other parties setting out in reasonable detail the nature of such objection, the
parties agree to attempt to resolve the matters in dispute within fifteen (15) days from the
date such notice is given.
1.4
If all matters in dispute are resolved by the parties, the Working Capital Shortfall shall be
the amount agreed upon by the parties. If the parties cannot resolve all matters in dispute
within such fifteen (15) day period, all unresolved matters shall be submitted to
arbitration for resolution in accordance with the provisions of Section ___, and the
Working Capital Shortfall, if any, shall be the amount determined by the arbitrator.
1.5
As security for payment by the Purchaser to the Vendors of the portion of the Purchase
Price referred to in Subsection 1.1(b), together with interest thereon (as evidenced by the
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Promissory Note) and any and all other obligations of the Purchaser hereunder or
otherwise relating to the transactions described herein, the Purchaser shall cause the
Successor Partnership to execute and deliver at the Time of Closing a guarantee issued by
the Successor Partnership, which guarantee shall be secured by a general security
agreement pursuant to the Personal Property Security Act (Ontario) pursuant to which
such Successor Partnership shall grant to the Vendors a security interest in the assets of
the Successor Partnership, which guarantee and security agreement shall be in a form
acceptable to the Vendors and the Purchaser, each acting reasonably. The said security
interest shall be subordinated to and rank subsequent to any and all security granted or to
be granted by the Purchaser to any Canadian Schedule A Chartered Bank (whether in
respect of financing to complete the transactions contemplated in this agreement or
financing to enable the Purchaser to continue to carry on the Business, provided that the
principal amount advanced in connection with any such financings shall not exceed an
aggregate of $_______________). The Vendors hereby covenant and agree that they
shall enter into, execute and deliver to the Purchaser and to any such lenders any intercreditor or similar agreement which may be required by any such lenders containing such
terms and provisions as are acceptable to the Vendors and such lenders, each acting
reasonably.
1.6
The Purchase Price shall be increased in the following circumstances:
(a)
the Purchase Price shall increase by an amount equal to 15% of the aggregate
Gross Sales of the Successor Partnership (before taking into account any sales
attributable to any acquisition of a business after the Closing Date) in excess of;
(i)
$___________ for the fiscal period commencing on May 1st, 2004 and
ending April 30th, 2005; and
(ii)
$___________ for the fiscal period commencing on May 1st, 2005 and
ending April 30th, 2006;
provided that the increase in the Purchase Price pursuant to this subsection 1.6(a)
shall not exceed $_________ in the aggregate; and
(b)
1.7
the Purchase Price shall be increased by an amount equal to 50% of the EBITDA
of the Successor Partnership (before taking into account the EBITDA attributable
to any acquisition of a business after the Closing Date) in excess of $_________
for each of the periods set out in 1.6(a)(i), and 1.6(a)(ii), respectively, provided
that the increase in the Purchase Price pursuant to this Section 1.6(b) shall not
exceed $__________ in the aggregate.
In the event that the EBITDA of the Successor Partnership for the period from May 1st,
2004 to April 30th, 2005, as finally determined in accordance with the provisions hereof
(the “1st Year EBITDA Amount”), is below $____________, the principal amount
payable by the Purchaser to the Vendors under the Promissory Note shall be reduced
(retroactive to May 1st, 2005) by an amount derived by applying the following formula:
($_________ – 1st Year EBITDA Amount) x 4.23,
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up to a maximum reduction of $___________. For greater certainty, no reduction of the
principal amount owing under the Promissory Note pursuant to the provisions of
Paragraph 1.7 hereof shall affect any payments due under the Promissory Note during
any period prior to the effective date of such reduction.
1.8
Notwithstanding anything herein contained, in the event that the 1st Year EBITDA
Amount is less than $__________, the amounts payable by the Purchaser pursuant to the
provisions of Paragraph 1.6 hereof, if any, shall be reduced by an amount derived by
applying the following formula:
($___________ – 1st Year EBITDA Amount) x 4.23,
up to maximum reduction of $_________.
1.9
The Vendors shall have the right, at their sole cost and expense, and within sixty (60)
days of April 30th, 2005, to cause an audit to be conducted of the EBITDA amount of the
Successor Partnership for the period from May 1st, 2004 to April 30th, 2005, which audit
shall be conducted by Deloitte & Touche, or such other firm of auditors independent of
the parties hereto as the parties hereto may mutually agree. The Purchaser shall, and
shall cause the Successor Partnership, to provide to the auditors access to all documents,
agreements and other business records of the Successor Partnership as may be necessary
or desirable in order that the auditors may conduct such audit, and shall otherwise
provide, and cause the Successor Partnership to provide all such reasonable co-operation
and assistance as the auditors may require in order to complete said audit. The said
auditor shall complete the audit and deliver an audited statement of EBITDA of the
Successor Partnership for the period from May 1st, 2004 to April 30th, 2005 (the
“EBITDA Statement”) within one hundred and twenty (120) days of April 30th, 2005.
The parties shall have a period of fifteen (15) days from the date on which the EBITDA
Statement is received from the auditor to review the same. If no objection to the
EBITDA Statement is given by a party hereto to the others within such fifteen (15) day
period, the EBITDA Statement shall be deemed to have been approved by the parties
hereto, and the EBITDA of the Successor Partnership for the period from May 1st, 2004
to April 30th, 2005 shall be the amount as shown in the EBITDA Statement. If any party
objects to the EBITDA Statement within such fifteen (15) day period by giving notice to
the other parties setting out in reasonable detail the nature of such objection, the parties
agree to attempt to resolve the matters in dispute within fifteen (15) days from the date of
such notice.
1.10
If all matters in dispute are resolved by the parties, the EBITDA of the Successor
Partnership for the period from May 1st, 2004 to April 30th, 2005 shall be the amount
agreed upon by the parties. If the parties cannot resolve all matters in dispute within such
fifteen (15) day period, all unresolved matters shall be submitted to arbitration in
accordance with the provisions of Section 13.17, and the EBITDA of the Successor
Partnership for the period from May 1st, 2004 to April 30th, 2005 shall be the amount
determined by the arbitrator.
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1.11
The Purchaser shall pay any increase in the Purchase Price pursuant to Paragraphs 1.6(a)
and 1.6(b) by certified cheque or wire transfer within 30 days of determining that an
amount is payable to the Vendors pursuant to such paragraphs. For the purposes of
Section 1.6, the Purchaser shall deliver to the Vendor internally prepared annual financial
statements of the Successor Partnership by June 30th of each fiscal period, which
financial statements shall be prepared in accordance with generally accepted accounting
principals applied consistently with past practice.
1.12
The Purchase Price for the Purchased Shares shall be decreased by the amount of Long
Term Liabilities on the Closing Date. On the Closing Date and subject to completion of
the transaction contemplated by this Agreement, the Purchaser and the Vendors shall
cause the Corporation to pay in full the Long Term Liabilities on such date by directing
the Vendor's Solicitors to use a portion of the Escrow Amount to pay the Long Term
Liabilities with the balance to be dealt with in accordance with Section 1.1
1.13
The Purchaser acknowledges that a portion of the consideration for the Purchased Shares
is to be satisfied by the contingent payments described in Paragraph 1.6 hereof.
Accordingly, the Purchaser covenants and agrees to act honestly and in good faith and to
manage the Successor Partnership from the Reorganization Date to February 28th, 2006
as a prudent owner would manage the Successor Partnership, with a view to earning
profits.
SAMPLE CLAUSES REGARDING INVENTORIES AND
TENANT RECEIPTS AND EXPENSES ADJUSTMENTS
3.1
The purchase price for the Purchased Assets (the "Purchase Price") shall be a sum equal
to the aggregate of the following amounts:
(a)
for all of the Purchased Assets other than the Inventory, the Prepaid Expenses and
Petty Cash, z Dollars ($z), payable at the Time of Closing;
(b)
for the Inventory, the value thereof as determined based on the provisions set
forth in paragraph 3.2 hereof, and payable in accordance therewith; and
(c)
for the Prepaid Expenses and Petty Cash, an amount equal to the face amount
thereof, respectively, payable at the Time of Closing,
less any downward adjustments to the Purchase Price as may be required pursuant to the
provisions hereof.
3.2
The parties shall jointly conduct a physical count of: (i) all Inventory (other than the
samples) located in the Leased Premises, (ii) all Inventory (other than the samples) located at the
Warehouse, (iii) all Ticketing Inventory and (iv) all Non-Purchased Inventory, after close of
business on the day prior to the Date of Closing. Such physical count shall be completed in
accordance with the provisions of Schedule "3.2" attached hereto, by an independent service
provider, with all costs incurred in respect thereof to be borne equally by the Vendor and
Purchaser. The Inventory so counted shall be valued at the Cost Price thereof, and the aggregate
Cost Price of the Inventory so counted (the "Inventory Purchase Price") shall be paid by the
Purchaser to the Vendor, by certified cheque, bank draft or other means of immediately available
funds as follows:
(a)
at the Closing, the Vendor shall deliver a statement to the Purchaser setting out
the Cost Price of all Inventory in respect of which the Vendor shall have paid the supplier
thereof therefor prior to the Time of Closing (the "Vendor's Inventory Statement");
(b)
on Closing, the Purchaser shall pay to the Vendor an estimated amount in respect
of the Inventory Purchase Price relating to all Inventory described in the Vendor's
Inventory Statement, equal to the Cost Price thereof, as reflected on the Vendor's
Inventory Statement (the "Estimated Purchase Price for Inventory"). For the purposes
of the calculation of the Estimated Purchase Price for Inventory, the quantity of all
Moving Inventory shall be deemed to be that reflected in the Vendor's purchase order
documentation and other relevant records relating to such Moving Inventory;
(c)
from time to time and at any time following the Time of Closing, and upon the
written request of the Purchaser, the Vendor shall deliver to the Purchaser all of the
documentation and records used by the Vendor to produce the Vendor's Inventory
Statement (including without limitation, all of the documentation and records used to
calculate the Cost Price of all Inventory described in the Vendor's Inventory Statement),
together with satisfactory evidence that the Vendor has paid and discharged in full the
Cost Price of all such Inventory described in the Vendor's Inventory Statement, and any
and all such other documents and records as the Purchaser may reasonably request in
order to verify the amount payable for all Inventory described in the Vendor's Inventory
Statement; and
(d)
in respect of any portion of the Inventory (save and except for such Inventory that
the Purchaser has agreed to pay the supplier thereof directly, in accordance with the
provisions of this Agreement) for which the Vendor has not yet paid the supplier thereof,
the Purchaser shall forthwith pay the Cost Price of such Inventory to the Vendor upon the
Vendor providing to the Purchaser satisfactory evidence: (i) that it has paid the subject
supplier for said Inventory, and (ii) as to the calculation of the Cost Price of such
Inventory.
The Vendor and the Purchaser agree that subsequent to Closing, they shall make any
adjustments between them to the amounts paid by the Purchaser to the Vendor for
Inventory as may be necessary in order to account for the following:
(a)
any Inventory for which the Purchaser paid the Vendor the Cost Price thereof, but
which the Purchaser did not receive from the Vendor or the supplier thereof on or
subsequent to the Date of Closing for any reason whatsoever, including without
limitation, due to the Vendor having sold the subject Inventory prior to the Date of
Closing;
(b)
any Inventory for which the Purchaser paid the supplier thereof directly and
which was delivered to the Vendor prior to Closing, but which the Purchaser did not
receive from the Vendor on or subsequent to the Date of Closing for any reason
whatsoever, including without limitation, due to the Vendor having sold the subject
Inventory prior to the Date of Closing; and
(c)
any Inventory for which the Vendor paid the supplier thereof, and which the
Purchaser did receive on or subsequent to the Date of Closing, but for which the Vendor
did not receive the Cost Price thereof from the Purchaser.
Such adjustments shall be paid by certified cheque, bank draft or other means of
immediately available funds.
For greater certainty, no value shall be assigned to any of the samples of merchandise on hand,
all of which samples shall form part of the Inventory.
4.6
The parties hereto expressly acknowledge their intention and agreement that all amounts
payable to or by the tenants thereof under the Leases which relate to the period prior to the Date
of Closing are for the account of the Vendor and, subject to as may be otherwise provided herein,
all amounts payable to or by the tenants thereof under the Leases which relate to the period on or
after the Date of Closing (in this paragraph the "Post-Closing Period") are for the account of the
Purchaser. As such, the parties hereto agree as follows:
(a)
in the event that, subsequent to Closing, it is determined that the tenant under a
particular Lease, prior to Closing, paid amounts to the landlord thereof or to any third
party which they may be owing, which amounts are in relation to the operation of the
2
Business during the Post-Closing Period (in this paragraph the "Post-Closing
Payments"), including without limitation, in respect of rent, percentage rent, prepaid
rent, security deposits, taxes (including contribution by tenants to property taxes)
common area maintenance charges, utility charges, business taxes, merchants' association
and advertising fees and other occupancy costs, fuel, telephone and other utility charges
and provided that such Post-Closing Payments are not included in the Prepaid Expenses
or are otherwise not the responsibility of the Vendor as provided herein, the Purchaser
shall, within ten (10) Business Days of becoming aware of the payment of said PostClosing Payments, pay to the Vendor an amount equal to the Post-Closing Payments;
(b)
in the event that, subsequent to Closing, it is determined that the tenant under a
particular Lease has not paid amounts to the landlord thereof or to a third party to which
they may be owing (other than amounts being contested in good faith by the Vendor, as
described in Schedule 6.17 hereof), which amounts are in relation to the operation of the
Business during the period prior to the Date of Closing (in this paragraph the "PreClosing Amounts"), including without limitation, in respect of rent, percentage rent,
prepaid rent, security deposits, taxes (including contribution by tenants to property taxes)
common area maintenance charges, utility charges, business taxes, merchants' association
and advertising fees and other occupancy costs, fuel, telephone and other utility charges,
the Vendor shall pay to the Purchaser, within ten (10) Business Days of receiving proof
of payment by the Purchaser of the Pre-Closing Amounts, an amount equal to the PreClosing Amounts, provided that such Pre-Closing amounts are not the responsibility of
the Purchaser hereunder;
(c)
in the event that, subsequent to the Closing, the tenant under a particular Lease
receives an amount from the landlord of said Lease or from a third party, which amount
is in respect of the operation of the Business during the Pre-Closing Period, and provided
that said amount is not included in the Prepaid Expenses, the Purchaser shall, within ten
(10) Business Days of receiving said amount, pay to the Vendor an amount equal to the
amount of said receipt;
(d)
in the event that, subsequent to the Closing, it is determined that the tenant under
a particular Lease had received, prior to Closing, an amount from landlord of said Lease,
or from a third party, which amount is in respect of the operation of the Business during
the Post-Closing Period (in this paragraph the "Pre-Closing Receipt"), the Vendor shall,
within ten (10) Business Days of being advised in of the Pre-Closing Receipt, pay to the
Purchaser an amount equal to the amount of the Pre-Closing Receipt; and
(e)
in respect of determining the obligations of the Vendor and the Purchaser under
this paragraph 4.6 as regards to matters associated with percentage rent, the percentage
rent liability relating to any particular Lease shall (save and except as may be otherwise
expressly set forth herein) be apportioned between the Vendor and the Purchaser pro-rata,
having regard to the sales achieved during the period in respect of which the subject
percentage rent relates which is prior to the Date of Closing as against the sales achieved
during the period in respect of which the subject percentage rent relates which is from
and after the Date of Closing.
3
SAMPLE CLAUSES REGARDING ACCOUNTS RECEIVABLE,
INVENTORIES, PREPAID EXPENSES AND FIXED ASSETS ADJUSTMENTS
3.4
Amount of Purchase Price
The Purchase Price payable by the Purchaser to the Vendors for the Purchased Assets
shall be equal to the aggregate of (i) the amount finally determined in accordance with Section
3.7 hereof in respect of the Accounts Receivable, (ii) the amount finally determined in
accordance with Section 3.7 hereof in respect of the Inventory, (iii) the amount finally
determined in accordance with Section 3.7 hereof in respect of the Prepaid Expenses, (iv) the
amount finally determined in accordance with Section 3.7 hereof in respect of the Fixed Assets,
(allocated in the manner set forth in Schedule “3.6”) and (v) $__________ being the agreed price
for the balance of the Purchased Assets.
3.5
Payment of Purchase Price
Subject to any adjustment contemplated herein, at the Time of Closing, the Purchase
Price shall be paid and satisfied as follows:
(a)
the Purchaser shall pay the sum of ___________ Dollars ($________) (the
“Deposit”), by cash or certified cheque, to the Escrow Agent by way of deposit upon the
execution of this Agreement by all the parties hereto, to be held by the Escrow Agent in
accordance with the terms of the escrow agreement (the “Escrow Agreement”) annexed
hereto as Schedule “3.5(a)”);
(b)
as to an amount equal thereto, by the assumption by the Purchaser at the Time of
Closing of the Assumed Indebtedness, as provided for in Section 3.10 hereof;
(c)
as to ___________ Dollars ($____________) by payment thereof to the Escrow
Agent at the Time of Closing, to be held and disbursed by the Escrow Agent in
accordance with the terms of the Escrow Agreement; and
(d)
as to the balance of the Purchase Price, such amount shall be paid by the
Purchaser to the Vendors by certified cheque or in immediately available funds at the
Time of Closing.
3.7
Valuation of Accounts Receivable, Inventory, Prepaid Expenses and Fixed Assets
(a)
For the purposes of Section 3.5 hereof, and more particularly, determining the
amount of the Purchase Price payable at the Time of Closing and the amount of the
Assumed Indebtedness, the Vendors and the Purchaser hereby acknowledge that:
(i)
the purchase price for the Accounts Receivable shall be estimated to be
$___________;
(ii)
the purchase price for the Inventory shall be estimated to be $__________;
(iii)
the purchase price for the Prepaid Expenses shall be estimated to be
$_________;
(iv)
the purchase price for the Fixed Assets shall be estimated to be
$__________;
(v)
the amount of the Assumed Indebtedness shall be estimated to be
$___________;
(the aggregate of the amounts set out in paragraphs (3.7(a)(i) – (iv), inclusive, less
the amount set out in paragraph 3.7(a)(v) is hereby referred to as the “Estimated
Value of the Accounts Receivable, Inventory, Prepaid Expenses and Fixed Assets
Net of Assumed Indebtedness”).
(b)
In order to determine the final amount to be paid by the Purchaser to the Vendor
for the Accounts Receivable, Inventory, Prepaid Expenses and Fixed Assets and the final
amount of the Assumed Indebtedness to be assumed by the Purchaser (collectively, the
“Adjusted Amounts”), the Auditors shall prepare a statement, at 12:01 a.m. on the Date
of Closing, for delivery to the Vendors and the Purchaser within 45 days following the
Date of Closing (the “Statement”) setting forth the amount of each Adjusted Amount.
For these purposes, (i) the amount of the Accounts Receivable shall be determined in
accordance with generally accepted accounting principles and consistent with past
practice but with no reserve made for uncollectible Accounts Receivable; (ii) the
Inventory shall be physically counted as of 12:01 a.m. on the Closing Date and valued in
accordance with generally accepted accounting principles and consistent with past
practice; (iii) only those Prepaid Expenses of the type and nature that have been reflected
as an asset of the Vendors on their balance sheets in accordance with generally accepted
accounting principles and consistent with past practice shall be calculated; (iv) the
amount for Fixed Assets shall be the aggregate of $__________ and the value of any
Fixed Assets purchased during the Interim Period (but excluding, at the option of the
Purchaser, those purchases during the Interim Period in breach of the covenants of the
Vendors contained herein) less the value of any Fixed Assets sold during the Interim
Period; and (v) the amount for Assumed Indebtedness shall be determined in accordance
with generally accepted accounting principles and consistent with past practice. For
these purposes, the Vendors and Purchaser covenant and agree to give the Auditors
access to all of the books and records of the Businesses as they may reasonably require
and shall instruct the Auditors to perform such tests and reviews as they deem necessary
or appropriate in order to provide an audit opinion in respect of the items set out in the
Statement. The parties hereto shall instruct the Auditors to cooperate with
representatives of the parties as the Statement is being prepared and to keep the parties
apprised as to the status of the preparation thereof. Forthwith thereafter, the Vendors and
the Purchaser shall review and, if in agreement with the matters therein contained,
approve the Statement. All costs of the Auditors associated with the preparation and
finalization of the Statement shall be borne by the Vendors. If either the Purchaser or the
Vendors shall have any objections to any part of the Statement then such party shall set
forth such objections in writing with reasonable particularity in a notice to be delivered to
the other of them within fifteen (15) Business Days following receipt of such Statement.
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If such objections cannot be resolved between the Vendors and the Purchaser within ten
(10) Business Days following receipt of such notice then either of the Vendors or the
Purchaser may request that an arbitrator (for the purposes of this Article, the “Arbitrator”)
render a decision with respect to such matters in dispute between the Vendors and the
Purchaser as are particularized in such notice and the Arbitrator shall, if necessary,
determine the amount of any Adjusted Amount in accordance with the terms hereof. The
decision of the Arbitrator shall be given to the Purchaser and the Vendors as soon as
possible and shall be conclusive and binding upon the parties hereto, save and except for
clerical errors or omissions. The Arbitrator shall be determined in accordance with
Article 15 hereof. The Arbitrator shall determine the party or parties responsible for the
fees and expenses of the Arbitrator. The amount of the Accounts Receivable, determined
as aforesaid, shall be subject to adjustment, if any, in accordance with paragraph (c)
below. The amount of the Inventory, Prepaid Expenses, Fixed Assets and Assumed
Indebtedness determined as aforesaid, shall be final and binding for the purposes hereof.
(c)
For the purposes of finally determining the amount of Accounts Receivable, if the
aggregate amount collected by the Purchaser on account of the Accounts Receivable on
or before the date which is 90 days following the Closing Date is less than the value
ascribed to such Accounts Receivable in the Statement, determined as aforesaid, the
amount payable by the Purchaser for the Accounts Receivable, in accordance with the
terms hereof shall be reduced by an amount equal to such deficiency. The Purchaser
shall use its best efforts to collect all of the Accounts Receivable in a timely fashion, in a
manner consistent with past practice, and shall provide the Vendors with a report, within
10 business days of the end of each month, detailing the outstanding Accounts
Receivable. Any payment received by the Purchaser with respect to the Accounts
Receivable which does not specify the specific invoice of the Vendors to which such
payment relates shall be applied to the oldest Accounts Receivable due from the person
making such payment. The Vendors shall have the inspection rights provided for in
Section 9.7 in order to, among other things, verify the amount of Accounts Receivable
collected for these purposes. All Accounts Receivable which are not collected on or
before the 90th day from the Date of Closing, shall be transferred and assigned by the
Purchaser, free and clear of any Encumbrance, to the Vendors as soon as practicable
following such date. The Vendors covenant and agree to inform the Purchaser of the
manner in which the Vendors intend to pursue the collection of those Accounts
Receivable assigned back to the Vendors prior to taking any such action. The parties
hereto covenant and agree to cooperate with each other in connection with the collection
of those Accounts Receivable assigned back to the Vendors.
(d)
If the aggregate amount (the “Final Amount”) of (i) the Accounts Receivable, less
any reductions pursuant to paragraph (c), as finally determined, (ii) the Inventory, as
finally determined, (iii) the Prepaid Expenses, as finally determined, and (iv) the Fixed
Assets, as finally determined, less the Assumed Indebtedness, as finally determined, is
less than the Estimated Value of the Accounts Receivable, Inventory, Prepaid Expenses
and Fixed Assets Net of Assumed Indebtedness then the Holdback Amount shall be
adjusted accordingly and paid by the Escrow Agent to the Vendors and/or the Purchaser
in accordance with the Escrow Agreement. In the event that the Estimated Value of the
Accounts Receivable, Inventory, Prepaid Expenses and Fixed Assets Net of Assumed
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Indebtedness exceeds the Final Amount by more than the Holdback Amount, then the
difference (the “Difference”) shall be forthwith paid by certified cheque or wire transfer
by the Vendors to the Purchaser. In the event that the Difference, if any, is not received
by the Purchaser within five (5) Business Days of the calculation thereof, then the
Purchaser shall be entitled, in addition to any other rights it might have, to set-off such
amount against amounts owing by the Purchaser to the Vendors pursuant to this
Agreement or any other agreement entered into pursuant to the terms of this Agreement.
In the event that the Final Amount exceeds the Estimated Value of the Accounts
Receivable, Inventory, Prepaid Expenses and Fixed Assets Net of Assumed Indebtedness,
then the difference shall be forthwith paid by certified cheque or wire transfer by the
Purchaser to the Vendors.
4
SAMPLE CLAUSES REGARDING NET BOOK VALUE, EARNINGS,
ACCOUNTS RECEIVABLE AND WORK IN PROGRESS ADJUSTMENTS
2.2
Purchase Price
The aggregate purchase price (the “Purchase Price”) payable by the Purchasers for the
Purchased Stock shall be an amount equal to the sum of the following amounts:
(a)
76.9% of the Net Book Value on the Adjustment Date (the “Purchase Price
NBV”; plus
(b)
76.9% of the amount which is equal to 117% of the EBIT of the Corporation in
respect of the 12 month period ended on the Adjustment Date (the “Purchase Price
EBIT”).
The Purchase Price shall be allocated between the Vendors in the manner set out on
Schedule 2.2, being each such Vendor’s proportionate interest in the Purchase Price.
The Purchasers shall pay to the Vendors at the Time of Closing an amount equal to
$_________ being an estimate of the Purchase Price (the “Estimated Purchase Price”), which
amount shall be paid in accordance with the provisions of Section 2.5 and shall be subject to
adjustment in accordance with the provisions of Section 2.3. The Estimated Purchase Price has
been calculated as shown in Schedule 2.2(a).
2.3
Adjustments
The amount paid on account of the Purchase Price as referenced in Section 2.2 shall be
adjusted in accordance with this Section, as follows:
(a)
Net Book Value and EBIT Adjustment
If the aggregate of the Purchase Price NBV and the Purchase Price EBIT, calculated
using the Post-Closing Statements, subject to the Unbilled WIP Adjustment, to be prepared and
delivered to the parties pursuant to Subsection 2.4(a), shall be more than $___________, the
Purchase Price shall be increased by the amount of such excess and the Purchasers shall pay to
the Vendors an amount equal to the amount of such excess in accordance with Section 2.6. If the
aggregate of the Purchase Price NBV and the Purchase Price EBIT, calculated using the said
Post-Closing Statements, subject to the Unbilled WIP Adjustment, shall be less than
$_________, the Purchase Price shall be decreased by the amount of such deficit and the
Vendors shall pay to the Purchasers an amount equal to such deficit in accordance with
Section 2.6. For greater certainty, if the aggregate of the Purchase Price NBV and the Purchase
Price EBIT, calculated using the said Post-Closing Statements, subject to the Unbilled WIP
Adjustment, shall be equal to $__________, there shall be no adjustment under this Subsection.
The adjustment (if any) pursuant to this Subsection is herein called the “Net Book Value and
EBIT Adjustment”.
(b)
A/R Adjustment
It is expressly acknowledged and agreed by the Vendors that it is the Vendors’
expectation that all accounts receivable listed on the Post-Closing A/R List (the “A/R”) shall be
collected within 180 days after the Adjustment Date (the “A/R Collection Period”). If, by the
opening of business on the 180th day after the Adjustment Date, less than 97% of the total
amount of the A/R has been collected by the Purchasers or the Corporation, then the Purchase
Price shall be decreased and reduced by the amount of the uncollected A/R. In the event of such
downward adjustment to the Purchase Price, it is expressly agreed that the Purchase Price shall
be increased by 50% of the amount of any A/R not collected prior to expiry of the A/R
Collection Period, but which is collected prior to the third anniversary date of the Date of
Closing (the “Delinquent Receivables”), which amount shall be net of any costs of collection
incurred in collecting the said accounts receivables (including the net amount of any income,
sales or similar taxes incurred or payable in connection with the Delinquent Receivables).
In addition, in the event that the Corporation collects, at any time within a period of three
years following the Adjustment Date, any accounts receivable relating to the period of operations
of the Corporation prior to the Adjustment Date, but which accounts receivable were not
included on the Post Closing A/R List (the “Collected Unlisted Receivables”), the Purchasers
shall pay to the Vendors, the amount of any such Collected Unlisted Receivables, net of any
costs of collection incurred in collecting the said Collected Unlisted Receivables, (including the
net amount of any income, sales or similar taxes incurred or payable in connection with the
Collected Unlisted Receivables) (the “Unlisted Receivables Purchase Price Increase”). In the
event that any amounts remain owing under the Promissory Note at the time that any Collected
Unlisted Receivables are collected, the Principal Vendor’s Pro Rata Share of the Unlisted
Receivables Purchase Price Increase related thereto shall be added to the last amounts payable
under the Promissory Note, and the Purchasers shall pay to each Ancillary Vendor its respective
Pro Rata Share of the Unlisted Receivables Purchase Price Increase. In the event that no amounts
remain owing under the Promissory Note at the time that any Collected Unlisted Receivables are
collected, the Purchasers shall pay to each Vendor its respective Pro Rata Share of the Unlisted
Receivables Purchase Price Increase.
All adjustments (if any) made pursuant to this Subsection 2.3(b) are herein called the
“A/R Adjustments”.
(c)
WIP Adjustment
(i)
By the opening of business on the 60th day after the Adjustment Date, all
of the Billable Value of the WIP listed in the Post-Closing WIP List shall be
invoiced and billed. The Billable Value of any WIP listed in the Post-Closing
WIP List that is not invoiced and billed by the 60th day after the Adjustment Date
shall not be included in determining the amount of WIP as at the Adjustment Date
for the purpose of any calculation or determination hereunder based on the PostClosing Statements, including the calculation of the Net Book Value and EBIT
Adjustment; and
2
(ii)
If the aggregate amount of all WIP listed in the Post-Closing WIP List and
collected by the opening of business on the 181st calendar day after the respective
actual date of billing of each WIP listed in the Post-Closing WIP List is less than
97% of the total amount of the Billable Value of the WIP listed in the PostClosing WIP List which has been invoiced and billed by the opening of business
on the 60th day after the Adjustment Date shall not have been collected in full (the
“Uncollected WIP A/R”), then the Purchase Price shall be decreased and reduced
by the uncollected amount thereof, on a dollar-for-dollar basis. In the event of
such downward adjustment to the Purchase Price, it is expressly agreed that the
Purchase Price shall be increased by 50% of the amount of any Uncollected WIP
A/R which is collected on or prior to the third anniversary of the Date of Closing,
which amount shall be net of any costs of collection incurred in collecting the said
Uncollected WIP A/R (including the net amount of any income, sales or similar
taxes incurred or payable in connection with the Uncollected WIP A/R).
All adjustments (if any) made pursuant to Subsection 2.3(c)(ii) are herein called the
“WIP Adjustments”.
For greater certainty, all adjustments provided for in this Section 2.3 are cumulative, in
that the total increase (if any) to the Purchase Price arising from the said adjustments shall be net
of the total reductions (if any) to that amount arising from such adjustments, and vice-versa.
2.4
Post-Closing Statements and Declaration relating to A/R Adjustments and WIP
Adjustments
(a)
Post-Closing Statements
As soon as practicable, and in any event, within 65 days after the Adjustment
Date, the Principal Vendor shall instruct and cause the Accountants to prepare and deliver
to the parties and to the Purchasers’ Accountants the Post-Closing Statements and
calculation of the Unbilled WIP Adjustment in accordance with the provisions hereof. If
the Purchasers have any objections to any part of the Post-Closing Statements or
calculation of the Unbilled WIP Adjustment, then the Purchasers shall set out in such
objections in writing with reasonable particularity in a notice (the “Objection Notice”) to
be delivered to the Principal Vendor within 10 Business Days of the date the PostClosing Statements and calculation of the Unbilled WIP Adjustment are delivered to the
Purchasers and the Purchasers’ Accountants. Such 10 Business Day period is referred to
herein as the “Objection Period”. If the Purchasers deliver an Objection Notice within
the Objection Period, and the matters at issue are not resolved by the Purchasers and the
Principal Vendor in writing within 10 Business Days following receipt by the Principal
Vendor of the Objection Notice, the matters in dispute shall be submitted to a Florida
office of Ernst & Young jointly designated by the Principal Vendor and Purchasers or, if
no Florida office of Ernst & Young is thus jointly designated or willing to serve, then to
another independent U.S. firm of certified public accountants that is jointly selected by
the Accountants and the Purchasers’ Accountants for resolution. The firm of certified
public accountants appointed as foresaid to determine the matters in dispute is herein
referred to as the “Expert”. The decision of the Expert shall be rendered as soon as
3
possible but in any event within 10 Business Days of its engagement and shall be
conclusive and binding upon the parties hereto, and no appeal shall lie therefrom. Any
part of the Post-Closing Statements and calculation of the Unbilled WIP Adjustment not
objected to by the Purchasers within the Objection Period, or, if objected to, resolved in
writing by the Purchasers and the Principal Vendor without the necessity of proceeding to
the Expert to resolve matters in dispute shall be conclusive and binding upon the parties
hereto, and no appeal shall lie therefrom. For the purposes of this Agreement, the PostClosing Statements and calculation of the Unbilled WIP Adjustment shall be deemed to
have become final and binding on the parties hereto, on the latest of the following dates
(the “Settlement Date”):
(i)
the first to occur of: (A) the giving of written notice by the Purchasers to
the Principal Vendor stating that the Purchasers accept the Post-Closing
Statements and calculation of the Unbilled WIP Adjustment, as delivered by the
Accountants, and (B) 11:59 o’clock p.m. (U.S. EasternTime) on the last day of the
Objection Period, if no Objection Notice is delivered to the Principal Vendor
before such time; and
(ii)
if an Objection Notice is delivered to the Principal Vendor before 11:59
o’clock p.m. (U.S. EasternTime) on the last day of the Objection Period, the first
to occur of:
(A)
the Business Day on which the last of the objections made by the
Purchasers are resolved in writing by the Purchasers and the Principal
Vendor without the necessity of proceeding to the Expert to resolve such
objections; or
(B)
the Business Day on which the Expert’s decision is delivered to the
parties.
The Accountants shall issue and deliver to the parties and the Corporation the
Post-Closing Statements as finally determined in accordance with this
Section 2.4(a), together with their audit report in respect of the Post-Closing
Statements within 10 days of the Settlement Date.
The Accountants, the Purchasers’ Accountants and the Expert, if appointed, shall
be provided with all reasonable access to the books, records and other information
relating to the Corporation and the Subsidiary as the Accountants, the Purchasers’
Accountants or Expert, as applicable, may reasonably request, from time to time,
for the purpose of reviewing all transactions and financial books, records and
accounts required in connection with their preparation of and review of the PostClosing Statements and calculation of the Unbilled WIP Adjustment.
The fees and expenses of the Accountants in connection with the preparation of
the Post-Closing Statements and calculation of the Unbilled WIP Adjustment
shall be borne by the Vendors. The fees and expenses of the Purchasers’
Accountants for reviewing and participating in the matters referred to in this
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Section 2.4(a) shall be borne by the Purchasers. The fees and expenses of the
Expert in connection with the matters referred to in this Section 2.4(a) shall be
borne 50% by the Vendors, and 50% by the Purchasers.
(b)
Calculations re: A/R Adjustments and WIP Adjustments and Assignment
(i)
On the 185th day following the Adjustment Date, the Principal Vendor
shall instruct and cause the Accountants to prepare and deliver to the parties and
to the Purchasers’ Accountants a calculation of the A/R Adjustments (if any)
required to be made pursuant to Subsection 2.3(b) relating to A/R;
(ii)
Within 5 Business Days of the collection of any Delinquent Receivables,
or as soon as reasonably practical thereafter, the Principal Vendor shall instruct
and cause the Accountants to prepare and deliver to the parties and to the
Purchasers’ Accountants a calculation setting forth that part of the A/R
Adjustments (if any) required to be made pursuant to the Subsection 2.3(b)
relating to the collected Delinquent Receivables;
(iii) On the 185th day following the Adjustment Date, the Principal Vendor
shall instruct and cause the Accountants to prepare and deliver to the parties and
to the Purchasers’ Accountants a calculation setting forth the amount of the WIP
Adjustment (if any) required to be made pursuant to Subsection 2.3(c)(ii),
provided that within 5 Business Days of the collection of any Uncollected WIP
A/R, the Principal Vendor shall instruct and cause the Accountants to prepare and
deliver to the parties and to the Purchasers’ Accountants a calculation setting forth
that part of the WIP Adjustments required to be made pursuant to the Subsection
2.3(c)(ii) relating to the collected Uncollected WIP A/R;
(iv)
Within 5 Business Days of the collection of any Collected Unlisted
Receivables, or as soon as reasonably practical thereafter, the Principal Vendor
shall instruct and cause the Accountants to prepare and deliver to the parties and
to the Purchasers’ Accountants a calculation setting forth the amount of the
Unlisted Receivables Purchase Price Increase required to be made pursuant to the
Subsection 2.3(b) relating to the Collected Unlisted Receivables;
in each case, together with reasonable particulars of how the said adjustments
were determined. The Accountants shall be entitled to reasonable access to the
books and records of the Corporation for the purpose of preparing such
calculations.
If the Purchasers have any objection to any part of any calculation of the
Accountants delivered pursuant to this Section 2.4(b), then the Purchasers shall
set out in such objections in writing with reasonably particularity in a notice (the
“Calculation Objection Note”) to be delivered to the Principal Vendor within 10
Business Days of the date such calculation is delivered to the Purchasers and the
Purchasers’ Accountants. Such 10 Business Day period is referred to herein as
the “Calculation Objection Period”. If the Purchasers deliver a Calculation
5
Objection Notice within the Calculation Objection Period, and the matters at issue
are not resolved by the Purchasers and the Principal Vendor in writing within 10
Business Days following receipt by the Principal Vendor of the Calculation
Objection Notice, the matters in dispute shall be submitted to a Florida office of
Ernst & Young jointly designated by the Principal Vendor and Purchasers or, if
no Florida office of Ernst & Young is thus jointly designated or willing to serve,
then to another independent U.S. firm of certified public accountants that is
jointly selected by the Accountants and the Purchasers’ Accountants for
resolution. The firm of certified public accountants appointed as foresaid to
determine the matters in dispute is herein referred to as the “Calculation
Expert”. The decision of the Calculation Expert shall be rendered as soon as
possible but in any event within 10 Business Days of its engagement and shall be
conclusive and binding upon the parties hereto, and no appeal shall lie therefrom.
Any part of a calculation not objected to by the Purchasers within the Calculation
Objection Period applicable to such calculation, or, if objected to, resolved by the
Purchasers and the Principal Vendor in writing without the necessity of
proceeding to the Calculation Expert to resolve matters in dispute shall be
conclusive and binding upon the parties hereto, and no appeal shall lie thereform.
For the purposes of this Agreement each calculation under this Section 2.4(b)
shall be deemed to have become final and binding on the parties hereto, on the
latest of the following dates:
(i)
the first to occur of: (A) the giving of written notice by the Purchasers to
the Principal Vendor stating that the Purchasers accept the applicable calculation,
as delivered by the Accountants, and (b) 11:59 o’clock p.m. (U.S. EasternTime)
on the last day of the Calculation Objection Period applicable to such calculation,
if no Calculation Objection Notice is delivered to the Principal Vendor before
such time; and
(ii)
if a Calculation Objection Notice is delivered to the Principal Vendor
before 11:59 o’clock p.m. (U.S. EasternTime) on the last day of the Calculation
Objection Period applicable to the calculation, the first to occur of:
(A)
the Business Day on which the last of the objections made by the
Purchasers are resolved in writing by the Purchasers and the Principal
Vendor without the necessity of proceeding to the Calculation Expert to
resolve such objections; or
(B)
the Business Day on which the Calculation Expert’s decision is
delivered to the parties.
The Accountants, the Purchasers’ Accountants and the Calculation Expert, if
appointed, shall be provided with all reasonable access to the books, records and
other information relating to the Corporation and the Subsidiary as the
Accountants, the Purchasers’ Accountants or Calculation Expert, as applicable,
may reasonably request, from time to time, for the purpose of reviewing all
transactions and financial books, records and accounts required in connection
6
with their preparation of and review of the calculations required under this
Section 2.4(b).
The fees and expenses of the Accountants in connection with the matters in this
Section 2.4(b) shall be borne by the Vendors. The fees and expenses of the
Purchasers’ Accountants for reviewing and participating in the matters referred to
in this Section 2.4(b) shall be borne by the Purchasers. The fees and expenses of
the Calculation Expert in connection with the matters referred to in this
Section 2.4(b) shall be borne 50% by the Vendors, and 50% by the Purchasers.
2.5
Payment of Purchase Price and Adjustments
Out of the Estimated Purchase Price, a total of $__________ shall be paid to the Principal
Vendor, and a total of $______________ (the “Ancillary Vendors Closing Payment”) shall be
paid to the Ancillary Vendors in the proportions indicated in Schedule 2.2(b). The Estimated
Purchase Price shall be paid and satisfied at the Time of Closing by the Purchasers to the
Vendors as follows:
(a)
an amount equal to $____________, by certified cheque, bank draft, wire transfer
or other means of immediately available funds (the “Closing Funds”), $____________
of which shall be paid to the Principal Vendor at the Time of Closing and $________ of
which shall be paid to the Ancillary Vendors and to the Escrow Agent at the Time of
Closing according to the provisions of Section 2.5(c);
(b)
an amount equal to $___________, by delivery of a promissory note made by the
Purchasers jointly and severally to and in favour of the Principal Vendor in the form of
Schedule 2.5(b) (the “Promissory Note”), which Promissory Note shall:
(i)
provide for interest to accrue on the principal amount outstanding
thereunder from time to time at a rate equal to the Prime Rate, calculated and
payable annually, in arrears,
(ii)
contain adjustment provisions as set forth in Section 2.6,
(iii)
provide for principal and accrued interest to be repaid in the following
instalments:
(A)
$________, plus accrued interest on such amount, to be due one
year from the Closing Date;
(B)
$________, plus accrued interest on such amount, to be due two
years from the Closing Date; and
(C)
$_________, plus accrued interest on such amount, to be due three
years from the Closing Date.
The Promissory Note and the Purchasers’ obligations in respect thereof shall be secured
as provided in Section 2.7 below.
7
(c)
Notwithstanding the foregoing, it is expressly agreed that the amount of the
Purchase Price which is payable to the Ancillary Vendors in the proportions set out in
Schedule 2.2(b) shall be paid as set out in the following paragraphs (i), (ii) and (iii) and in
Section 2.6:
(i)
an amount equal to fifty (50%) percent of the Ancillary Vendors Closing
Payment shall be paid at the Time of Closing, and the balance of the Ancillary
Vendors Closing Payment (the “Escrow Funds”) shall be paid to the Escrow
Agent, to be disbursed by it as set out in subparagraphs (ii) and (iii) below and in
accordance with the Escrow Agreement;
(ii)
the Escrow Agent shall pay fifty (50%) percent of the Escrow Funds paid
to it pursuant to Section 2.5(c)(i) (“Tranche 1 Funds”) to the Ancillary Vendors
at the time that the Net Book Value and EBIT Adjustment is made or upon it
being finally determined that no such adjustments are required in accordance with
this Agreement; provided that, in the event that the Net Book Value and EBIT
Adjustment result in the Ancillary Vendors having to make a payment to the
Purchasers in accordance with the provisions of Subsection 2.6(b) hereof, the
amount of such payment shall be deducted from such portion of the Ancillary
Vendors Closing Payment as is described in this Subsection 2.5(c)(ii) hereof, and
the amount so deducted shall be paid by the Escrow Agent to the Purchasers. In
the event that the amount of the payment the Ancillary Vendors are required to
make to the Purchasers is in excess of the amount described in this Subsection
2.5(c)(ii), the excess amount shall be deducted from the amount which would
otherwise be payable to the Ancillary Vendors under Subsection 2.5(c)(iii) hereof,
and the amount so deducted shall be paid by the Escrow Agent to the Purchasers.
In the event that the amount of the payment the Ancillary Vendors are required to
make to the Purchasers in accordance with the provisions of Subsection 2.6(b)
hereof is in excess of the aggregate of the amounts described in Subsections
2.5(c)(ii) and (iii) hereof, no payments shall be made by the Escrow Agent to the
Ancillary Vendors under Subsections 2.5(c)(ii) or (iii) hereof and under the
Escrow Agreement, and all amounts held by the Escrow Agent shall be paid to the
Purchasers.
(iii) the Escrow Agent shall pay the other fifty (50%) percent of the Escrow
Funds paid to it pursuant to Section 2.5(c)(i) (“Tranche 2 Funds”) to the
Ancillary Vendors at the time that the A/R Adjustments contemplated by
Subsection 2.3(b) are made or upon it being finally determined that no such
adjustments are required in accordance with this Agreement; provided that, in the
event that the said A/R Adjustments result in the Ancillary Vendors having to
make a payment to the Purchasers in accordance with the provisions of
Subsection 2.6(b) hereof, the amount of such payment shall be deducted from
such portion of the Ancillary Vendors Closing Payment as is described in this
Subsection 2.5(c)(iii) hereof, and the amount so deducted shall be paid by the
Escrow Agent to the Purchasers. In the event that the amount of the payment the
Ancillary Vendors are required to make to the Purchasers is in excess of the
aggregate amount payable under this Subsection 2.5(c)(iii) hereof, no payments
8
shall be made by the Escrow Agent to the Ancillary Vendors under Subsections
2.5(c)(iii) hereof or under the Escrow Agreement and all amounts held by the
Escrow Agent shall be paid to the Purchasers.
At the Time of Closing, the Principal Vendor, the Purchasers and the Escrow Agent shall
enter into an escrow agreement (the “Escrow Agreement”), pursuant to which the
Escrow Agent shall agree to hold the Escrow Funds on the foregoing terms.
The Escrow Agreement will authorize the Escrow Agent to pay the Tranche 1 Funds to
the Ancillary Vendors on the 10th day after the anticipated date (to be set out in the
Escrow Agreement) on which the Net Book Value and EBIT Adjustment is finally
determined (or finally determined not to be required) in accordance with this Agreement
(the “Tranche 1 Release Date”) unless: (A) such final determination with respect to the
Net Book Value and EBIT Adjustment has not been made at least 10 days prior to the
Tranche 1 Release Date, or (B) based upon such final determination, the Tranche 1 Funds
are not exclusively payable to the Ancillary Vendors, and, in the case of either (A) or (B),
the Escrow Agent receives a notice in writing to that effect from either the Principal
Vendor or the Purchasers prior to the Tranche 1 Release Date. If the Escrow Agent
receives such notice from the Principal Vendor or the Purchasers, the Escrow Agent shall
not release the Tranche 1 Funds to the Ancillary Vendors on the Tranche 1 Release Date
unless jointly directed by the Principal Vendor and the Purchasers to do so, and the
Purchasers and the Principal Vendor shall jointly direct the Escrow Agent, by no later
than the 5th day following the final determination with respect to the Net Book Value and
EBIT Adjustment, to pay the Tranche 1 Funds (and the Tranche 2 Funds, if applicable),
to the parties entitled thereto as provided in Section 2.5(c)(ii).
The Escrow Agreement will authorize the Escrow Agent to pay the Tranche 2 Funds to
the Ancillary Vendors on the 10th day after the anticipated date (to be set out in the
Escrow Agreement) on which the A/R Adjustments contemplated by Section 2.3(b) are
finally determined (or finally determined not to be required) in accordance with this
agreement (the “Tranche 2 Release Date”), unless: (A) such final determination with
respect to such A/R Adjustments has not been made at least 10 days prior to the Tranche
2 Release Date, or (B) based upon such final determination, the Tranche 2 Funds are not
exclusively payable to the Ancillary Vendors, and, in the case of either (A) or (B), the
Escrow Agent receives a notice in writing to that effect from either the Principal Vendor
or the Purchasers prior to the Tranche 2 Release Date. If the Escrow Agent receives such
notice from the Principal Vendor or the Purchasers, the Escrow Agent shall not release
the Tranche 2 Funds to the Ancillary Vendors on the Tranche 2 Release Date unless
jointly directed by the Principal Vendor and the Purchasers to do so, and the Purchasers
and the Principal Vendor shall jointly direct the Escrow Agent, by no later than the 5th
day following the final determination with respect to such A/R Adjustments, to pay the
Tranche 2 Funds to the parties entitled thereto as provided in Section 2.5(c)(iii).
2.6
Adjustments
(a)
In the event that the amount paid on account of the Purchase Price pursuant to
Section 2.5 is adjusted upward as a result of a Net Book Value and EBIT Adjustment, a
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WIP Adjustment and/or an A/R Adjustment, the amount payable under the Promissory
Note shall be increased by the amount of the Principal Vendor’s Pro Rata Share of the
Net Book Value and EBIT Adjustment, the WIP Adjustment and/or the A/R Adjustment,
as the case may be, and such increased amount shall be added to the final instalment
payable under the Promissory Note. The Ancillary Vendors’ Pro Rata Share of such
upward adjustment shall be paid by the Purchasers to the Ancillary Vendors by certified
cheque, bank draft or other means of immediately available funds within 10 days after
such determination.
(b)
In the event that the amount paid on account of the Purchase Price pursuant to
Section 2.5 is adjusted downward as a result of a Net Book Value and EBIT Adjustment,
a WIP Adjustment and/or an A/R Adjustment, the amount payable under the Promissory
Note shall be decreased by the amount of the Principal Vendor’s Pro Rata Share of the
Net Book Value and EBIT Adjustment, the WIP Adjustment and/or the A/R Adjustment,
as the case may be (the “Decreased Amount”). The Decreased Amount shall be
deducted from the next instalment payable under the Promissory Note. The Ancillary
Vendors’ Pro Rata Share of such downward adjustment shall be paid by the Ancillary
Vendors to the Purchasers in the manner provided in Section 2.5(c)(ii) and 2.5(c)(iii), to
the extent of the Escrow Funds held by the Escrow Agent.
(c)
In the event that Decreased Amount is in excess of the amounts still owing under
the Promissory Note, the Promissory Note shall be deemed satisfied in full and cancelled,
and the Principal Vendor shall forthwith pay over to the Purchasers an amount equal to
the amount of such excess, by certified cheque, bank draft or other means of immediately
available funds. In the event that the Ancillary Vendors’ Pro Rata Share of any
downward adjustment under Section 2.6(b) is in excess of the Escrow Funds held by the
Escrow Agent, each Ancillary Vendor shall forthwith pay over to the Purchasers an
amount equal to such Ancillary Vendor’s proportionate share of the excess (based on the
proportion that the amount of the Purchase Price payable to such Ancillary Vendor bears
to the aggregate Purchase Price payable to all Ancillary Vendors, as set out in
Schedule 2.2 hereof), by certified cheque, bank draft or other means of immediately
available funds.
2.7
Security for Payment of the Promissory Note
At the Time of Closing, the Purchasers shall deliver or cause to be delivered to the
Principal Vendor an irrevocable standby letter of credit issued by a Canadian chartered bank or
U.S. bank acceptable to the Principal Vendor (the "Issuing Bank"), acting reasonably, and
confirmed by a U.S. bank acceptable to the Principal Vendor (the "Confirming Bank"), acting
reasonably, in form and substance satisfactory to the Principal Vendor, acting reasonably,
securing an amount equal to the Principal Amount of the Promissory Note (as used herein, the
term "Principal Amount" shall have the meaning defined in the Promissory Note), as such
Principal Amount is adjusted in accordance with the terms of the Promissory Note and this
Agreement, that will be outstanding at the Time of Closing, and which letter of credit may be
drawn upon, to the extent of any amount due and payable under the Promissory Note that the
Purchasers have failed to pay when due (including, without limitation, amounts due by
acceleration of the Promissory Note in accordance with its terms), unilaterally by the Principal
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Vendor without any consent from or other action by or documentation from the Purchasers (a) in
the event that the Purchasers fail to pay when due any amount outstanding under the Promissory
Note or (b) immediately upon the occurrence of any Event of Default (as defined in the
Promissory Note), and which letter of credit shall remain outstanding and securing the
Promissory Note and all amounts due thereunder at all times to the full extent of the outstanding
Principal Amount as adjusted pursuant to the Promissory Note and this Agreement (the “Letter
of Credit”). It is expressly agreed by the Purchasers and the Principal Vendor that the Letter of
Credit shall include provisions specifying that: i) partial draws shall be allowed under the Letter
of Credit, and each partial draw shall have the effect of reducing the face amount of the Letter of
Credit in the amount of such partial draw (subject to upward or downward adjustments of the
Principal Amount as provided in clause ii) below); ii) the face amount of the Letter of Credit
shall be adjusted upward or downward, on a dollar for dollar basis, to the extent that the
Principal Amount owing under the Promissory Note is adjusted upward or downward in
accordance with the provisions of this Agreement and the Promissory Note, iii) the face amount
of the Letter of Credit shall be adjusted downward, on a dollar for dollar basis, to the extent that
the Principal Amount owing under the Promissory Note is paid and satisfied by the Purchasers
(subject to the adjustments of the Principal Amount and the face amount of the Letter of Credit
referenced in clause ii) above), iv) any upward or downward adjustments to the face amount of
the Letter of Credit shall be effected by the Purchasers and the Principal Vendor submitting a
joint notice in writing to the Issuing Bank and the Confirming Bank specifying the amount of
such upward or downward adjustment, or in such other manner as the Issuing Bank and the
Confirming Bank may require and which is mutually acceptable and agreed to in writing the
Purchasers and the Principal Vendor, each acting reasonably (the "Joint Notice"). Each of the
Purchasers, jointly and severally, and the Principal Vendor hereby covenant and agree to submit
a Joint Notice to the Issuing Bank and the Confirming Bank within 10 Business Days after: A) a
payment of principal being received by the Principal Vendor under the Promissory Note, and B)
an upward or downward adjustment to the principal amount owing under the Promissory Note
being mutually agreed upon by the Purchasers and the Principal Vendors or being otherwise
finally determined in accordance with the provisions of this Agreement and the Promissory Note.
Failure or refusal of either of the Purchasers timely to submit a Joint Notice to the Issuing Bank
and the Confirming Bank in accordance with the covenant contained in the preceding sentence of
this Section 2.7 shall constitute an Event of Default (as defined in the Promissory Note), with the
consequence of accelerating the Promissory Note as provided therein and entitling the Principal
Vendor immediately to draw upon the Letter of Credit in the full accelerated amount of the
Promissory Note in accordance with its terms. In addition, and without limiting the foregoing,
failure or refusal of either the Principal Vendor or the Purchasers timely to submit a Joint Notice
to the Issuing Bank and the Confirming Bank in accordance with the covenant contained in this
Section 2.7 shall entitle the non-breaching party or parties to obtain injunctive or other equitable
relief in a court of competent jurisdiction, compelling such breaching party or parties forthwith
to submit the Joint Notice in compliance with such covenant in this Section 2.7, it being
stipulated and agreed among the parties that failure or refusal by either the Principal Vendor or
the Purchasers timely to comply with such covenant to submit the Joint Notice hereunder will
constitute irreparable harm to such other party or parties. A draft Letter of Credit provided by
the Issuing Bank shall be presented by the Purchasers to the Principal Vendor for the Principal
Vendor’s review and approval (acting reasonably) by no later than 7 days prior to the Closing
Date, and the Letter of Credit shall be issued by the Issuing Bank and confirmed by the
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Confirming Bank at or prior to the Time of Closing in the form so approved by the Principal
Vendor prior to the Time of Closing.
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SAMPLE CLAUSES REGARDING EXPENSE RECOVERIES ADJUSTMENT
1.1
defined):
The following shall apply with respect to Expense Recoveries (as hereinafter
(a)
The parties acknowledge that under certain Leases certain payments, such as realty
taxes and operating costs, although paid by the landlord, are charged to the Tenants and are
collected in monthly instalments on the basis of the landlord’s estimates (such payments are
herein called “Expense Recoveries”). These estimated Expense Recoveries are subject to
adjustments with the Tenants when the total amounts of same are finally determined. It is
therefore agreed that with respect to Expense Recoveries pertaining to the Real Property in
respect of 2004, adjustments shall be made as between the Vendors and the Purchaser as follows:
(i)
on the Closing Date, the Vendors shall provide or cause to be provided to the
Purchaser a statement outlining the amounts of Expense Recoveries collected from each Tenant,
as well as the amounts expended on account of Expense Recoveries by the Partnership since the
beginning of January 1, 2004;
(ii)
if such statement indicates that the Partnership has collected more on account of
Expense Recoveries than it has expended on account of Expense Recoveries, then the amount of
such difference shall be credited to the Purchaser on closing; and
(iii)
if the Partnership has collected less from the Tenants than it has expended on
account of Expense Recoveries, then the amount of such difference shall not be credited to the
Vendors but shall be paid by the Purchaser to the Vendors if, as and when the same may be
received by the Purchaser.
(b)
The Vendors shall provide or cause to be provided to the Purchaser a reconciliation
statement for the 2004 calendar year outlining the amount of Expense Recoveries collected from
each Tenant and the amount owed by each Tenant or to each Tenant (as the case may be) on
account of Expense Recoveries for such year. The Vendors and the Purchaser shall co-operate
with each other in order to allow for such reconciliation statement to be delivered to Tenants on
or before March 31, 2004. The Purchaser agrees to use reasonable commercial efforts to cause
Tenants which must make payments to the landlord pursuant to such reconciliation statement to
make those payments to the Purchaser as soon as possible after delivery of such statement.
(c)
The Vendors shall, at no expense to the Vendors, co-operate with the Purchaser in
the Purchaser adjusting with the Tenants in respect of Expense Recoveries for the 2004 calendar
year, including, without limiting the generality of the foregoing, if a Tenant disputes any
statement or financial information provided by the Vendors.
(d)
It is agreed that adjustments with the Tenants in respect of Expense Recoveries and
any readjustments which may be required as a result thereof between the Purchaser and the
Vendors shall take place as soon as reasonably possible after all information with respect to the
Expense Recoveries for such calendar year in which the Closing Date occurs has been prepared
and delivered and, in any event, on or before September 30, 2005.
(e)
The Vendors shall be responsible to make all adjustments with the Tenants on
account of Expense Recoveries for the 2003 calendar year.
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SAMPLE CLAUSES REGARDING SIMPLE WORKING CAPITAL ADJUSTMENT
(i)
There shall be a dollar for dollar adjustment to the Purchase Price equal to the aggregate
of the total dollar value of accounts receivable, cash on hand, letters of credit lodged as security
and prepaid expenses of the partnership in respect of the Real Property as of the Closing Date,
minus the aggregate of the total dollar value of accounts payable, accrued liabilities and Taxes
payable (collectively, the “Working Capital Adjustment”), all in accordance with GAAP and
consistent with the Partnership’s past practices;
(ii)
For the purposes of determining the amounts payable by the Purchaser to the Vendors at
the Time of Closing, the parties shall calculate an estimate of the Working Capital Adjustment
(the “Estimated Working Capital Adjustment”) based on the working capital shown in an
estimated balance sheet of the Partnership to be delivered to the Purchaser five (5) days before
the Closing Date (the “Estimated Balance Sheet”);
(iii)
Within five (5) Business Days following the completion of the transactions contemplated
by the SPA, the Vendors shall deliver to the Purchaser the balance sheet of the Partnership
prepared as at the Closing Date (the “Closing Balance Sheet”), at which time Working Capital
Adjustment shall be readjusted and paid as follows:
(A)
if the Working Capital Adjustment exceeds the Estimated Working Capital
Adjustment, then the Purchaser shall pay the amount of such excess to the Vendors; and
(B)
if the Estimated Working Capital Adjustment exceeds the Working Capital
Adjustment, then the Vendors shall pay the amount of such excess to the Purchaser.
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