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Company acquisition options and their legal consequences

In a previous post, we gave an overview of possible methods of acquisitions (share, asset or division purchase) and the primary business issues arising in case of each of the alternatives. Choosing from these methods, although a business decision, obviously leads to different legal consequences.

Confidentiality – an important requirement already at the phase of due diligence

As the conclusion of a final contract is typically preceded by due diligence it is important that the buyer, being a competitor present on the given market itself, is able to get a detailed understanding of the data and operational information of the target company (including, for example, the pricing method applied, the know-how and employee related data) as part of the due diligence. The buyer receives confidential information qualifying as business secrets this way knowledge of which may represent a competitive advantage if the transaction fails. 

Therefore, in order to protect the market and legal interests of the seller, a confidentiality agreement should be concluded before the due diligence exercise to restrict the use of the data received and to provide security for the seller for the case of failure of the transaction. During the transfer of information, the parties must also assess whether there are any owners potentially not concerned by the transaction whose interests may be infringed by the supply of data. In certain cases, special provisions may be necessary in order to preclude a suspicion of an information cartel as a result of the exchange of information between the competitors. 

Letters of intent – most important acquisition requirements should already be defined at this point

In the beginning of the negotiations, buyers typically sign a letter of intent (or indicative offer) having limited legal binding force to detail their fundamental contractual intentions and in another document, the parties define the key terms of the transaction, the framework of their future agreement (by singing a non-binding term sheet, heads of terms or memorandum of understanding). In terms of their legal nature, agreements of this kind have no legally binding force (except for potential confidentiality provisions and the period of exclusivity relating to the due diligence) and neither of the parties is in the position to enforce the transaction based on these documents. 

Among these preliminary agreement of terms, the parties should, by all means, define their main expectations relating to the acquisition, including, at least, the method to be applied for the calculation of the purchase price and the deadlines of each phase of the transaction process. It should also already be clarified at this point with the involvement of a legal expert whether the concentration will have to be announced to the competition authority in relation to the proposed transaction. 

Preparation of company due diligence

When planning deadlines, sellers have to take into account in the case of larger scale due diligence exercises that the gathering of data and its classification according to the buyer’s needs or perhaps its transfer to electronic form may also generate substantial work on the seller’s or target company’s side. For this reason, companies should already consider using an expert’s help or an IT system developed specifically for this purpose at the time of preparing the data room as the use of resources necessary for the operation of the target company for the preparation of the due diligence can be reduced this way. 

Sellers should also separately present sensitive matters at the beginning of the due diligence as unless the parties agree otherwise, the rules relating to defective performance shall not apply in respect of the circumstances revealed to the buyer during the due diligence. 

Risks and the information typically assessed during their identification (due diligence)

A sufficiently thorough financial, accounting, tax and legal due diligence, the identification of the risks relating to the target company’s history and past operation is especially important in the case of a share purchase as in these cases the buyer not only buys assets but the company as a whole with its past. The matters to be assessed as part of this process may differ substantially depending on the target company. 

A problem could be posed, for example, by the consequences deriving from the contracts in place with business partners of the target company due diligence of which by a legal expert is recommended by all means. Certain contracts may include so-called “change of control” clauses according to which approval of the contracting partner may be necessary to make sure that the contract in question remains in force and is not terminatable after the transfer of the shares of the target company. Circumstances carrying a risk to future operation may often also arise in relation to employees. Parties should also consider the consequences of authority procedures in progress in the case of activities requiring a license and the expiry of licenses. For the proper pricing of the transaction, the due diligence must also identify potential liabilities of the target company towards credit institutions financing it as well as obligations to be maintained in relation to tender funds. On the buyer’s side, risks deriving from a potential change of the regulatory environment of the given industry and from known intentions of legislators should also be assessed. 

The experts acting on behalf of the buyer therefore assess during the due diligence in a complex manner the company law structure of the target company and the agreements concluded with the management, the contract portfolio, the compliance of employment, the legal status of the target company’s real estate and movables of substantial value and the financing agreements concluded. In addition, matters of legal dispute, authority procedures and intellectual creations require a sufficiently thorough review also. 

After the analysis by experts of the documents and information requested and provided during the due diligence, the buyer can gain assurance as to the prudent operation of the target company based on the due diligence report and is able to properly consider risks in the purchase price and demand legal guarantees for these. If major deficiencies are identified, the buyer may also withdraw its purchase intention. 

Guarantees

In the transaction, the buyer obviously expects proper guarantee that the target company it purchases is the one it gained an understanding of based on the information received. The seller, on the other hand, would like to ensure that it receives the purchase price. 

For this reason, the buyer typically expects detailed warranty and other declarations from the buyer breach of which may give ground to a subsequent reduction of the purchase price or even a withdrawal from the transaction. In order to cover for potential future purchase price decreasing factors, a certain part of the purchase price should be withheld until the target company is transferred to the buyer and the buyer is able to make sure that it in fact received all relevant information earlier and until a certain time passes without a breach of warranty. The seller obviously also assumes a risk in relation to the withheld amount, this amount is therefore typically deposited by the buyer and the parties usually agree in advance on the transactional documents required for the release of the deposit. 

There are also cases in which shares of the target company are purchased in multiple steps. In these cases, a complex legal system needs to be developed and preparation and depositing of the documents of later steps of the transaction may be necessary also. 

Legal succession relating to division transfer

In cases of asset purchase and share transfer, it is enough for the due diligence to cover the assets or structured group of resources (particularly employees) to be transferred as the history of the company previously operating these, the skeletons in the closet only affect the buyer to a limited extent. 

A division transfer, however, makes legal steps beyond the ones relating to a share transfer necessary as it comes with legal succession of existing contractual relationships unlike in the case of a share purchase where the acquired company can continue to operate with an unchanged portfolio of contracts. In the case of an independent transfer of a division, being a unit independent from an organizational perspective with all relating properties, contracts, licenses and employees, the transfer of the contracts concluded with partners to the buyer may be necessary also. Not only may this delay the transaction due to the need to obtain the consent of the partners but it also comes with the risk that partners may try to achieve more favourable terms for themselves when re-negotiating the contract. 

In addition, the licenses relating to the activities of the given transaction have to be transferred also (or new licenses have to be obtained),which requires the approval of the licensing authority the duration and costs of this procedure should therefore also be assessed in advance. 

Labour law provisions relating to division transfer

The rights and obligations deriving from existing employment relationships are transferred from the seller to the buyer as the new employer with the division transfer (creating joint and several liability, for a one-year period, in respect of the labour law claims due before the transfer). For this reason, the seller must properly inform the employees concerned before the transfer of the changes concerning them. 

We have to point out that in these cases, the transfer of the employment of employees does not depend on the decision of the parties but takes place by virtue of law. The parties therefore cannot agree not to transfer the employees of the division with the transfer! The change of the employees is only not realized in the case of an express objection of the employee to the transfer. 

The change of the employee cannot be a rightful cause to termination by the new employer. However, the employee has the right to terminate employment within 30 days naming a cause with reference to a substantial and adverse change in the working conditions relating to him or her as a result of the change of the employer. For this reason, an informal assessment should be made in advance of the impact of the proposed changes among employees. 

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