Russian M&A

Question 1

Timeline M&A sale process for a privately-held company

Answer 1

typically take from 3 to 6 months from beginning to end, assuming no significant delays due to, for example, contractual consents, or other governmental or regulatory approvals

Question 2

Shares or Assets

Answer 2

in the Russian market most deals are share deals, meaning no cherry picking of assets and liabilities. Subject to pre-sale restructuring and hiveouts, and to negotiated buyer protections, the buyer is going to inherit all upsides and problems in the target group

Question 3

Confidentiality Agreement or NDA

Answer 3

seller will seek confidentiality and non-solicitation commitments (for itself and its group) as a precondition of disclosure

Question 4

Confidentiality Agreement or NDA - remedy for breach

Answer 4

damages requiring proof of loss. That loss, in terms of just disclosing negotiations as opposed to commercial secrets, is often hard to prove, so the value of confidentiality agreements not backed by penalties or liquidated damages is open to question.

Question 5

Confidentiality Agreement or NDA - liquidated damages

Answer 5

Liquidated damages are pre-estimated fixed damages which should not be a penalty and if a payment is structured as a payment for the right to use confidential information or solicit it is not a penalty. If acting for a buyer, you need ensure that there are exceptions to non-disclosure permitting buyer to contact financing counterparties

Question 6

Exclusivity - Buyer

Answer 6

enforceable under English law but without more engineering will only give rise to a damages with need to prove loss and causation of loss claim (essentially equal to wasted costs of investigating the asset). So a buyer will push for a “break fee” whereby if the seller sells or perhaps even talks to someone else within a fixed period the prospective buyer is entitled to a fee or, more rarely, a right of matching offer. The buyer may also want to get paid to do due diligence/expend costs, particularly in a distress situation

Question 7

Exclusivity - Seller

Answer 7

The flip slide is that a seller may want to lock a prospective buyer out of deals for rival assets for a period, secured by a break fee or liquidated damages provision and/or require the buyer to pay for exclusivity. Once there is binding exclusivity the dynamic shifts in favour of the buyer

Question 8

Term sheets - enforceability

Answer 8

mismatch between what clients think they have with a “binding term sheet” under English law, and the reality, which is an unenforceable agreement to agree (they generally have too much uncertainty to be specifically fully enforceable and contrary to myth an English law tribunal will not write a contract for you where the intention of that contract was not clear)

Question 9

Holding the pen

Answer 9

in an auction process the seller will draft the SPA. In a share sale it is typically the buyer (asset sale the seller), but not always, and the “advantage” of holding the pen is exaggerated

Question 10

Conditions precedent - mandatory, voluntary

Answer 10

they can be either mandatory (anti-trust), whereby if there is a closing without being satisfied there would either be substantive invalidity (title impairment or other consequences) or fines, or voluntary, in the sense that they are things (further due diligence, completion of a restructuring, hive out of unwanted assets, porting in of a new management team) that have been negotiated

Question 11

Conditions precedent - risk of staisfaction

Answer 11

the key in negotiating CP is to make sure that the responsibility (and cost) of satisfaction is clearly allocated to one party or another, and that the consequences of non satisfaction are clearly laid out. So for example a seller may accept that a buyer must obtain FAS or shareholder approval but if these are not forthcoming want compensation in the form of a break fee. Otherwise the prospective buyer is just being given a risk free way out of the contract

Question 12

Buyer’s motivation

Answer 12

buyer wants wide walk away rights including a 100% subjective “material adverse change clause” (“MAC”).

Question 13

MAC

Answer 13

provision that allows a buyer to decide that there has not just been a seismic global economic game changer but a material change in the target or just one subsidiary justifying a complete walkaway as opposed to proceeding to closing and seeking price protection pursuant to warranties and indemnities (and perhaps completion accounts) it has negotiated.

Question 14

Seller’s Motivation

Answer 14

the seller wants to minimise CP; and/or to negotiate a non-refundable deposit (structured as a payment not for breach but for the right to walkaway) and/or to negotiate a “pay to walk” provision; and/or to negotiate a best endeavours obligation on the buyer to satisfy or procure satisfaction of conditions precedent.

Question 15

Seller’s Motivation - CP

Answer 15

The seller also wants the ability to “decide” that any CP cannot be satisfied and just sell to a third party at a higher price without having to account to the buyer. If we are acting for the seller: we want to resist a MAC and any subjective CP or CP in the power of the buyer; we want to ensure, particularly if the economics of the deal mean that on closing the buyer gets the benefits of the period between signing and closing, that client is compensated for any walkaway by the buyer so that the buyer is paying for the option to walk

Question 16

Signing -> closing - price

Answer 16

a buyer commits to a certain price or a formula price or a price subject to adjustment on signing but will not pay that price (or not all of it) until closing. But he is on risk in that period subject to any walkaway rights he has negotiated. The seller on the other hand has no particular interest in running the business for profit or in fact doing anything beyond the minimum required to avoid the buyer exercising walkaway rights (or getting hit in any post-closing price adjustment or claim).

Question 17

Signing -> closing - dividends / interest on purchase price

Answer 17

A related issue in who is entitled to the benefit of dividends in the period between signing and closing and whether or not interest should accrue on the purchase price.

Question 18

Signing -> closing - dividends / interest on purchase price - tension

Answer 18

The seller will obviously want to keep dividends or not account for them at closing and to argue that interest should accrue because it represents the price of the pre-completion undertakings that it has committed to. The buyer will argue that the CP were just technicalities, that commercially it was on risk from signing so the effective economic value date should be signing, in which case it should get the dividends. Logically the buyer should pay interest on the purchase price

Question 19

Signing -> closing dividends / interest Seller’s Motivation

Answer 19

the seller might accept certain negative rights and vetoes (eg on dividend, big items of CAPEX and OPEX and such like) but cannot give up the keys to the kingdom, that is day to day operational control and the right, eg, to control important litigation

Question 20

Signing -> closing dividends / interest Buyer’s Motivation

Answer 20

buyer will want the seller to commit to run the target “in the ordinary course”, perhaps transfer in certain assets and/or reorganise or achieve certain milestones (including perhaps agreed or capped dividends). Perhaps with the consent or even under the control of or with the cooperation of the buyer.

Question 21

Signing -> closing - compliance

Answer 21

Compliance is likely to be a CP, though if acting for the seller we will resist this and at least make the requirement “in all material respects” or not give rise to a termination right. For the buyer it is about value leakage that is not pre-agreed (dividends, disposals etc) even if there are to be completion account adjustments, and preventing impairment (deliberate or just neglectful)

Question 22

Signing -> closing - control over biz

Answer 22

Sometimes, buyer representatives will be allowed on the board, there may be an agreed business plan, but the greater the rights the buyer has not to close the less rights it should have and our position should be that if a buyer is really on the hook to close then it should get something but if it has effectively just negotiated an option to close then it has not done enough to get anywhere near control nor involvement so should get negative rights only to stop value shifting

Question 23

Warranties - tension - buyer

Answer 23

buyer on the other hand wants to have the most extensive dataroom ever, wants the quality of disclosure to be fully warranted, and wants full disclosure with the seller strictly liable for any extent to which, as against the warranted position as qualified by disclosure, the truth is that the target group is not “pretty much ok”

Question 24

Warranties - tension - seller

Answer 24

seller would, obviously, like to disclose nothing, have no liability for the quality or absence of disclosure, sell on a SPA with some limited warranties but no ability to terminate the SPA for material breach of warranty and then take its chances on warranty claims on the basis that the buyer and/or its advisers knew or should have known about the problem and assumed the risk (so there should be no price adjustment because it was baked into the price).

Question 25

Warranties - motivation - buyer

Answer 25

(a) any material breach of warranty coming to light between signing and closing should give rise to a termination right (plus compensation) (b) any disclosure at signing should be “full, fair, detailed and exactly identify the problem” (c) no qualifications on claims otherwise than by reference to things specifically disclosed, no deemed knowledge (d) no additional disclosures between signing and completion (e) long claim period (f) low aggregate and de minimis caps and claims and limited other limitations of liability (g) damages for warranty claims on the indemnity basis, with proceedings indemnity(see next slide) (h) no conduct of claims given to seller (i) withholding of purchase price against claims or earnouts or other incentivisation mechanisms for if there are no claims (j) collateral for claims

Question 26

Warranties - motivation - seller

Answer 26

warranties are dangerous for the seller pre-closing if they entitle the buyer not to close, ie if the truth of the warranties at and following signing is a CP to closing. Seller must resist this and say that breach of warranty only gives rise to a claim in damages. Warranties are less dangerous for a seller post-closing. That is because the buyer – unless the warranties are on the indemnity basis - must prove that if it had known the warranties were not accurate it would have paid a different price. This can be difficult to prove. Plus unless the SPA provides otherwise the seller does not have a claim to the extent it knew about the problem or was disclosed information about the problem

Question 27

Warranty - indemnities

Answer 27

warranty claim is not that valuable because the buyer has to prove that he would have paid a different price. This is why buyers push for the “indemnity basis” of claim generally, because this permits “$ for $ recovery”. The difference is best illustrated in relation to the purchase of a table with only 4 chairs instead of the warranted 5. On the indemnity basis, there was a warranty for 5, there were in fact 4, so the recovery, subject to limitations in the SPA, is the cost of 1 chair (plus perhaps the recovery costs of claim if there is a proceedings indemnity). On the indemnity basis it does not matter that there was a known and disclosed risk that there might be a problem with 1 chair. An indemnity is like an insurance policy, the risk of there being a problem with 1 chair is being passed to the seller. On the normal basis of damages the buyer would have to prove that he did not actually know there was a problem (or even had a strong suspicion) and that the absence of the chair, if he had known about it, would probably have resulted in his retrading the purchase price to material degree. And it is not always or indeed often easy to convince a court or tribunal that you would have paid a different price (particularly if you are purchasing on an earnings multiple rather than net assets basis).

Question 28

Warranties - indemnity - seller strategy

Answer 28

seller will strongly resist generally the indemnity basis, and, if it gives it at all (otherwise than in relation to title), will give it only for disclosed risks and contingencies which the buyer would otherwise have priced in (but does not, instead trading current price adjustment for future price adjustment through the indemnity insurance policy). The seller will also want to apply all or most of the general limitations on liability (aggregate caps, time periods etc.) to claims on the indemnity basis

Question 29

Limitations on claims - motivation - seller

Answer 29

the seller wants to have global limitations, ie applying to both warranties and indemnities and indeed everything, amongst other things: to have an aggregate cap on liability at somewhere down towards 50% of the purchase price; a prohibition on bringing any individual claim unless it is above a certain amount; a prohibition on bringing claims unless all individual claims exceed a certain amount and then only claims above that amount may be brought. On top of these the seller will want to argue that losses were due to the actions of the buyer, or were compensated through accounting overstatements or in the completion accounts

Question 30

Limitations on claims - motivation - buyer

Answer 30

buyer will want to recover at least 100% of the purchase price, have minimal de minimis and caps and to keep the limitations very binary. The buyer will also want to draw a distinction between limitations on warranties and limitations on indemnities (on the basis that the whole point of indemnities is that they act as insurance and therefore should provide a full payout). If acting for the buyer the objective is to cross nearly all the limitations out, accept a fair materiality threshold and say: “look, we accept that if we paid 100 then until we have a claim for 10 we cannot bring a claim but after that it is open season up to the full amount of the price”. The buyer will also want to retain some money from the purchase price or put it in escrow to cover claims or perhaps structure the deal by way of an earnout so that the seller is incentivized to ensure that the warranties were true

Question 31

Limitations on claims - motivation - practice

Answer 31

overall cap on liability is between 50-100% of purchase price (with proceedings indemnity sometimes on top), though particular risks can be given bespoke treatment, the time limit on claims is somewhere between 1-3 years (people often operate by reference to completed accounting periods on the basis that audit draws out problems) though tax and environmental, due to statutory limitation periods, can be significantly longer. The most hotly contested aspects tend to be conduct of claims, materiality thresholds/caps and the time periods. If acting for a buyer there is just no way that you can accept that a seller would have any say in conduct of claims that might give rise to warranty or indemnity liability, and you typically need at least 2 if not 3 post closing accounting periods to flush out problems

Question 32

Limitations on claims - recourse

Answer 32

Deep pocket multi-asset-holding parent guarantees, escrow, earnouts, linking the deal to another deal where the seller has skin in the game are all structural solutions to this problem

Question 33

Closing - DVP delivery versus payment

Answer 33

the biggest foul up you can make acting for a buyer is to allow the cash to move before title or at least 100% of the wherewithal to move title has moved from the seller to the buyer. Obviously, the seller has the reverse concern. The practical solution is to get simultaneous DVP, or “constructive” DVP. This is often achieved by cash settlement through lawyers with money not released until title has moved but the money release order is out of the hands of the buyer itself, and in the control of its external counsel with the purchase money having moved within a bank at which both the buyer and the seller have opened settlement accounts

Question 34

Closing - committed seller assistance

Answer 34

the second biggest foul up, particularly when there has been a pre-sale restructuring and assets have been hived out, is to close on the deal without being sure that any contractual assistance that the restructured asset will need are going to be provided by the selling group or that all stakeholders in the target are on board

Question 35

Closing - Inter-Conditionality Trap

Answer 35

third biggest foul up is inter-conditionality, whereby you cannot get to closing because both buyer’s and seller’s obligations are conditional on the other, so they can never get unconditional. There needs to be a clear batting order for settlement and notification of settlement of conditions and a detailed minute by minute order for the closing meeting

Question 36

Closing - taking control

Answer 36

buyer needs to make sure that in terms of replacing BOD, appointing auditors, getting control of bank accounts, registration of title etc. it has a clear plan of action to avoid any third party or even the seller itself from interrupting the process

Question 37

Closing - failure to close

Answer 37

if there is a failure to call for closing on the fixed timetable or to satisfy closing obligations on the closing date, the non-default party will often get a “second bite”, ie the option to call for a deferred closing. Or to terminate in return for liquidated damages or a break fee. It is important not just to prepare to avoid a failure of satisfaction of CP or closing (no fault) but to prepare for deliberate default and to ensure that there is a schema in the SPA to apportion risk and liability for such failure

Question 38

Post-closing - seller - motivation

Answer 38

100% of the purchase price in cash paid to a SPV; no indemnities; no completion accounts; wide limitations on claims; no collateral contracts or obligations vis a vis the seller or target beyond vague further assurance; anti-embarassment provision (whereby if the buyer onsells within a period at a higher price the seller will get a %); conduct of claims

Question 39

Post-closing - buyer - motivation

Answer 39

part deferral or escrow of purchase price, and/or a staged acquisition with a ratcheting price on there being no problems and/or certain KPI being met, completion accounts (whereby the accounting and valuation assumptions underlying the purchase price are tested by negotiation and third party evaluation), ability to call on the seller to help with litigation post-closing, continued equity participation from the seller post-closing; non-compete; locked up key personnel

Question 40

Completion - accounts

Answer 40

In order to minimise possible disputes, the seller and buyer should set out in a schedule to the acquisition agreement the principles on which the accounts are to be drawn up and should specify who should prepare them, who should bear the cost of their preparation and how to resolve any disputes

Question 41

Closing - earn outs

Answer 41

target shareholders the right to receive additional purchase consideration if the “legacy” target business meets specified financial performance or other criteria over defined periods of time after the acquisition closes. Since the buyer will control the legacy target business after the closing, a key negotiated point for target shareholders, in addition to whether the earnout criteria are realistic, is whether the buyer is required to provide funding, personnel and/or other operational support to enable the legacy target business to achieve the earnout goals. Another negotiated point is often whether credit is given for “near misses” of earnout goals, either through “catch-up” provisions in subsequent periods or by breaking the goals into multiple segments that reward partial performance, rather than being “all or nothing” tests.