1. A brief discussion on the legal due diligence process
What are we buying?
A brief discussion on the legal due diligence process
Paul W. Griepentrog 1

2. Goals of legal due diligence
Confirm assumptions underlying the proposed purchase price
Identify potential risks and hurdles to closing
Integration planning
Verify disclosure schedule information

3. Assemble a team Identify key players
Understand costs – internal time and external fees
Schedule weekly update meetings

4. Build a process Non-disclosure agreements Due diligence request list
Data room
Stage the review process
Specialist reviews
Handling sensitive information
Schedule onsite visits
Customer calls and employee visits

5. Report the findings Written summaries of information review
Identification and proposed resolution of issues
Specific indemnification
Post-closing issue resolution checklist

6. Other concerns
Anti-Trust
Anti-Bribery

7. STRUCTURE OF TRANSACTIONS
Richard A. Latta

8. Structure of transactions – common types
Asset purchase
Stock purchase
Other types
Tax-Free mergers
Section 363 Sales in bankruptcy
Chapter 128 Sales
UCC Article 9 Sales

9. Why choose one over the other?
Asset Purchase – Advantages
No unwanted assets
No unwanted liabilities
Full tax basis
Asset Purchase – Disadvantages
Depreciation Recapture
Possible two levels of tax for C Corps
Possible multiple levels of tax for pass-throughs

10. Stock purchase – advantages
One level tax to seller
No depreciation recapture to seller
Transfers of otherwise non-transferable assets
Stock purchase – disadvantages
Buyer receives all assets and liabilities
Buyer may inherit unknown liabilities
Buyer obtains seller’s (typically low) basis in assets

11. Comparison of tax outcome of asset v. stock purchase
After-tax cash to shareholder (per $1.00 of sales price) subject to numerous exceptions, phase- outs, Section 1(h) gain, AMT, the Net Investment Income Tax, etc.)
 Type of Entity
If Long-Term Capital Gain to Seller
Basis to Buyer
Asset Sale
C Corp
$0.49
$40m
S Corp
$0.70
Stock Sale
$0.77
$4m
$0.78

12. Estate planning as part of purchase process
Buyer as public corporation
Buyer as private company
Seller-side considerations
Gifts to other generations/estate planning

13. Regulated entities and interaction with regulators
Unique issues created by minority shareholders

14. BENEFIT ISSUES IN ACQUISITIONS
Todd M. Cleary

15. Benefits transition approaches
Stock acquisition
Leave target’s plans in place indefinitely
Leave target’s plans in place for period after closing, then terminate and move to buyer’s plans
Require target to terminate its plans prior to closing and bring employees into buyer’s plans

16. Benefits transition approaches
Stock acquisition
If target is participating in plans of another member of selling group, leave employees on those plans until new plans can be established or buyer’s plan can accept them
Consider potential “multiple employer” plan issues
Seller may need to obtain insurance company approval

17. Benefits transition approaches
Asset acquisition
Assume seller’s plans
Bring into buyer’s plans immediately at closing
Pay for COBRA coverage under seller’s plan until new plans can be established
plan likely needs to be held by a member of selling group after closing
not effective for retirement plans or non-medical plans that aren’t subject to COBRA
not effective even for medical plans as to new hires

18. Other transition issues
Nondiscrimination testing for retirement and medical plans
Transition period for retirement plans
Consider whether to require pre-closing termination of target’s 401(k) plan in stock acquisition
401(k) plan loans may become due
Flexible spending accounts may need to be transitions
COBRA responsibility could flow to buyer

19. Benefits liability concerns
Multiemployer withdrawal liability
Pension plan underfunding
Legal noncompliance of target
Affordable Care Act penalties
Disqualified retirement plans
COBRA and/or HIPAA penalties

20. Representation and Warranty Insurance
Current trends in M&A
Representation and Warranty Insurance
(“R&W Insurance”)
Danielle M. Machata 20

21. R&W Insurance Basics What does it cover?
Breaches of representations and warranties in a purchase agreement.
How long is the typical coverage period?
For fundamental and tax representations, the coverage period is typically 6 years.
For other representations, the coverage period will equal the contractual survival period for those representations in the purchase agreement, subject to a right to extend the coverage period for up to 6 additional years beyond the contractual survival period.

22. Benefits to Buyers
In the case of no-indemnity transactions, can avoid extensive negotiation of seller indemnity provisions;
In a competitive auction process, allows a buyer to enhance its bid relative to its competitors;
In rollover situations, prevents a buyer from having to sue their management team;
Avoids indemnity collection issues in the case of multiple sellers or sellers that may be credit risks;
Can provide a longer survival period for representations and warranties, even if the purchase agreement is limited to a shorter period of time; and
May allow a buyer to price a deal more aggressively knowing that it will be able to take less post-closing risk.

23. Cost of Coverage
One time premium cost of between 2% and 4% of the amount of coverage purchased.
Policies include a “retention” amount of between 1% and 3% of the transaction value.

24. Typical Exclusions Known issues; Breaches of covenants;
Purchase price adjustments;
Certain environmental matters such as asbestos, PCBs and recognized environmental conditions identified in environmental reports;
Fines and penalties;
Product liability claims;
Wage and hour claims;
Specific indemnities set forth in the purchase agreement outside of the representations and warranties; and
Deal specific issues that the carrier may not be comfortable insuring.

25. Impact of the Exclusion of Known Issues
A typical response of a seller that is being asked to make broad representations and warranties in a purchase agreement is to prepare a set of disclosure schedules that is equally broad (likely overbroad) and comprehensive.
However, any items set forth in the disclosure schedules will not be covered by the insurance policy. Therefore, the buyer will take one of two strategies:
Refuse to allow certain matters to be set forth on the schedules in fear that they will lead to unanticipated high liability and no coverage; or
Attempt to revise the representations and warranties so that certain information is no longer required to be provided in the disclosure schedule.

26. Impact of the Exclusion of Known Issues
In pushing the removal of items from the schedules that are known exceptions to the warranties, the buyer effectively is telling the seller to give up some of its basket/retention so that the buyer can have access to the policy, which can be very controversial.
If the representations and warranties are revised so that items can be removed from the disclosure schedules, the representations and warranties could become more limited and less useful in shifting the risk to the insurer.
Furthermore, these strategies do not solve the problem that a buyer will be required to deliver a “declaration” to the insurer that states that no member of the buyer’s “deal team” has knowledge of a breach of any of the representations and warranties or that any document or information delivered to the insurer is materially false, incomplete, inaccurate or misleading.

27. Ways to Address Issues Relating to Exclusions
Assess whether a traditional indemnification provision would be better for the transaction at hand.
Try to have the seller agree in the letter of intent that the seller will bear traditional indemnification risk (which would be substantially more than the retention) for all items excluded from the policy.
Before proceeding with extensive due diligence to identify and understand certain risks for which coverage would not otherwise exist, assess whether such additional due diligence will make the buyer more or less protected.

28. Ways to Address Coverage Gaps
Request specific indemnification from the seller, which would provide protection outside of the representations and warranties.
Limit the definition of knowledge in the policy to “actual” knowledge.
Make sure the “deal team” whose knowledge counts is as limited as possible.

29. Definition of Losses
Categories of damages sellers push to exclude from the definition of losses: incidental, consequential, lost profits or revenues, diminution in value, exemplary and punitive damages. 
2013 ABA Deal Points Study - Private Target Mergers and Acquisitions:
The losses that are covered did not specifically mention diminution in value in 69% of all purchase agreements, expressly included diminution in value in 14%, and expressly excluded diminution in value in 17%;
The losses that are covered did not specifically mention incidental damages in 67% of all purchase agreements, expressly included incidental damages in 16% and expressly excluded incidental damages in 17%; and
The losses that are covered did not specifically mention consequential damages in 44% of all purchase agreements, expressly included consequential damages in 2% and expressly excluded consequential damages in 54%.

30. Definition of Losses
The express exclusion of these types of damages in the purchase agreement may prevent the buyer from recovering its actual damages for many of the “worst case scenario” problems intended to be protected under the insurance policy. For example:
Suppose a seller represents to a buyer that the seller’s top customer has agreed in a contract to purchase a certain number of products from the seller over the next 3 years. If that contract is not binding or does not exist, and buyer has excluded lost profits as a measure of damages from the purchase agreement, the buyer would not be able to recover its actual damages for that breach of representation. 
Similarly, if the seller’s audited financials drastically overstated earnings, and buyer paid a multiple of earnings for the seller, buyer may have paid a purchase price that was 50% more than the seller’s value but not be able to recover any of these losses under the insurance policy.

31. Takeaways
Typical seller behavior can create problems with your R&W Insurance policy.
R&W Insurance policies contain exclusions from coverage, so a buyer may not be getting all of the protection it thinks it is getting; and
As a result of the exclusions, a buyer may want (or need to) seek specific indemnities from a seller in order to address coverage gaps, leading to disappointed sellers.