International Deal Making – Assisting Acquirers

QUESTION ONE – In your experience, what are the key considerations that international clients should have the front of mind when assessing a target company for acquisition in your jurisdiction?

An acquirer needs to know the legal and physical context of the business, not simply its current and projected economic conditions. In the US, businesses are subject to both Federal and State laws and regulations. Depending on the business, these regulations may be complex and affect the ability of the business to meet its projections. Therefore, it is important to identify early, the laws and regulations that impact the business, the company’s regulatory history, and its relationships with the regulators and competitors.

For example, if the company has a history of strong growth and good management but potential environmental or other legal or regulatory risks, it may be better to acquire the key assets of the business – not its stock – assure a complete change in equity ownership, and, in some cases, move the location of operations in order to minimise the risks posed by historic liabilities. It is important to understand that the size of those liabilities may exceed the value of the deal. For example, in a case decided last year, a company acquired property it wanted that had been contaminated but had been cleaned by the State. It got the property for what it thought was a good price. After it bought, the State sued to recover the cost of clean-up, which was far higher than the sales price. The Court ruled that the new owner was liable for ‘all’ of the costs of clean-up – no matter when they were incurred.

As to future liability risks, there may be ways of limiting investor liability by layering a limited partnership (or perhaps an LLC) on top of the company being acquired. For example, in a business having significant environmental risk, the investors could invest money in the limited partnership as limited partners and the partnership would acquire notes and warrants in the underlying company. Should the company do well, the warrants provide the upside potential, and the absence of direct stock ownership makes it hard for regulators to assert control liability. This structure may also have tax benefits since note repayments are generally deductible to the acquired corporation. Moreover, a limited partnership is transparent for tax purposes, so the note repayments should go to the limited partners without any entity tax.

QUESTION TWO – How would you, as a professional advisor, approach the due diligence process to ensure all bases are covered prior to a sale price being agreed?

There is no ‘one size fits all’ answer to this question. The biggest mistake to avoid is to put off the environmental issues until due diligence. I have seen situations where the environmental risks are discovered late in the process and, either potentially costly risks are accepted in the name of completing the deal, or the deal has to be fundamentally restructured (for example from a stock deal to an asset purchase deal). To put it another way, environmental evaluation should be viewed as similar to a tax. The risks, opportunities, and structure of both need to be evaluated upfront.

Environmental risks involve a blend of law and engineering. Therefore, in evaluating environmental risks, engineering due diligence should be managed by an experienced environmental lawyer so as (a) not to waive any legal privilege and (b) assure that not only current but future legal and business risks are evaluated.

Also, legal trends must be considered. For example, in June of 2019, the Supreme Court of the United States handed down two decisions which are likely, over time, to increase judicial scrutiny of federal agencies interpretations of their own regulations and of the laws they implement, and also potentially reopen the scope of constitutionally permissible delegation of lawmaking decisions to federal agencies. This has far-reaching implications for environmental regulation no matter which party is in power. (Those decisions will also impact other executive branch agencies such as the FDA, OSHA and the IRS.) We have published a White Paper on those decisions that are on the IR Global web site, and Norm Bernstein will be leading a roundtable discussion about them at the General Counsel conference in New York on September 2019.

QUESTION THREE – Once an acquisition is agreed, what are the key clauses or warranties and indemnities you would recommend for inclusion in the sales contract?

Once again, it depends on the business and the deal. However, ‘indemnities’, no matter how worded, are only as good as the financial strength of the Indemnitor. It is, therefore, better to minimise those risks, adjust the price and other deal terms, or both, to realistically reflect the risks, rather than relying on indemnities that may have to be enforced in costly litigation or may be cut off entirely in a bankruptcy proceeding.

A key clause should address where and how disputes are to be resolved. We had a situation some years ago where Company B agreed to the jurisdiction of a federal court in Indiana (where the property was located) for the resolution of any disputes arising out of a contract. A dispute arose. Many of Company B’s people were in Pennsylvania where the company was headquartered, and the damages to it allegedly occurred there. Notwithstanding the contract clause, Company B brought its suit in federal court in Pennsylvania. It argued that the contract did not say ‘exclusively’ in the Indiana court and that since the contract had been terminated, the consent to Indiana Court jurisdiction was void. We defeated both of those arguments, but in selecting a forum it is important to say ‘exclusively’ and important to have the choice of forum clause expressly survive the termination of the contract.

Tips for completing a successful cross-border acquisition

Environmental liability in the US for historic contamination of property is generally strict, joint and several, and not limited by the value of the deal. Penalties for environmental protection are harsh. Clean Air Act penalties, for example, are up to USD37,500 per day, per source. Enforcement is by the US Justice Department and States Attorneys General. Under many statutes, private parties, such as environmental groups and adjacent property owners, may bring ‘citizens suits.’ Therefore, evaluating environmental risk is central to the pricing and structuring of many US acquisitions.

If the ‘we do everything’ firm heading the deal claims it has an environmental department, ask its environmental lawyers. Have you successfully litigated environmental issues against the US Justice Department in federal appellate court? Are you a trustee at hazardous waste sites including at least one site on EPA’s national priority list? Have you had ‘first chair’ responsibility for structuring deals around environmental problems?

If they can’t answer ‘yes’ to all three questions, you need advice from a firm that specialises in environmental law and can answer ‘yes’ to those questions.

This excerpt was taken from the IR Global Guide: International Deal Making: Assisting Acquirers. To view the full publication, please click here.