If you are considering purchasing, selling, or acquiring a business, whether it be through an asset
purchase or stock purchase, the underlying agreement, and the obligations of the seller or the buyer to close on the transaction are likely to be contingent upon certain conditions.
The timing of these contingencies to occur may be before, at, or within a certain period from the transaction’s closing date. Many transactions will have an effective date whereby the seller and purchaser execute the agreement, but the closing date may be set to occur in the future. For example, the effective date may be January 20th, with the closing set for March 15th. During this interim period, the purchaser may conduct certain due diligence items, working on the financing or loan to purchase the business or other matters. Regardless, having the proper contingencies established in the purchase agreement with the appropriate language depending upon the circumstances can be critical. Below are certain contingencies that you may find in a purchase agreement. Please remember that this article is informational and should always discuss your circumstances directly with your business attorney.
Financing or Lending
It is pervasive for a business acquisition agreement to have a contingency that the transaction’s closing is contingent upon the buyer receiving the appropriate financing. While this may seem obvious, as how would most buyers have the cash to pay the purchase price without financing or lending from a bank, this contingency allows the buyer to have an “out” and perhaps terminate the agreement if they cannot obtain funding. Well, maybe not so fast for the buyer if the seller’s counsel has properly negotiated the deal. If a buyer has a financing contingency, the seller will want to protect themselves but include language such that the buyer may need to terminate the agreement due to this contingency on or before a specific date or that the buyer must use reasonable and good faith efforts to obtain financing. Thus, the buyer may be unable to completely walk away from the transaction by turning down suitable financing offered from a bank or simply not even attempting to obtain funding if they get “cold feet” after the effective date. While the seller may not be able to legally force the buyer to close and pay over the agreed-upon purchase price, the failure to complete may allow the seller to receive deposited funds or recover damages due to a breach of contract.
Assignment of Lease or Purchase of Real Estate
Suppose the seller has been leasing the premises whereby the business has been operating. In that case, it is common for the buyer to have a closing contingency whereby the seller’s lease must be assigned to the buyer on or before closing for the transaction to complete. This contingency would protect the buyer from purchasing the business but finding themselves in a situation whereby they had no location to operate the business properly. Furthermore, the company’s site may be pertinent to the overall operations. Thus, the buyer would want to continue using the exact location via an assignment of the lease instead of finding themselves in a situation where they had to relocate the business. This same contingency may hold if the seller owns the real estate or location whereby the business is operated, and the buyer wishes to purchase the real estate in addition to the company. Under these circumstances, the closing of the business acquisition would be contingent upon the parties or their related entities entering into a contract to purchase real estate, which would generally coincide with the business purchase and closing. Finally, suppose the seller of the business did own the real estate, whereby the company operated but did not wish to sell the real estate. In that case, you may again find yourself in a situation whereby the lease of the real estate with the seller as landlord and the buyer as the tenant would be a contingency to close on the transaction. Again, as a seller, you would want language within this contingency that controlled the circumstances whereby the buyer could terminate the agreement.
General Due Diligence
Many acquisition agreements may have a general and broad due diligence contingency. This due diligence may be related to the finances of the target business and other business matters, such as business relationships with customers or vendors, the condition of the business assets, or any material business issue under inspection by the buyer. Because this contingency is generally more subjective than the others, you are more likely to see a time constraint or objection deadline for the buyer to notify the seller if the buyer wishes to terminate the agreement because of their due diligence. For example, the buyer only has 15 days from the effective date to properly complete the deal due to the due diligence.
Permits and Licenses
Depending upon the permits or licenses required to operate the applicable business, a buyer will want the closing contingent upon receiving such permits or licenses. For example, if the target business is a restaurant and bar, the buyer would like to ensure they have obtained a liquor license before closing. Again, the seller would wish to appropriate language requiring the buyer to act in good faith to acquire these licenses and permits and/or need an objection deadline before the closing date for the buyer to terminate the agreement properly.
Assignment of Contracts
The value of many businesses lies within the inherent value of the businesses’ contracts with third parties. Thus, in acquiring the contracts via an asset purchase or stepping into the shoes of the target via a stock purchase agreement, the buyer should require that the proper assignment or enforceability of the contracts (or a certain percentage) act as a contingency for the buyer to close. It is important to note that this issue considers the specific terms and conditions of the contracts the buyer hopes to acquire or become a party to, such as the assignability of the agreement or change in control provisions.
The above are just a few contingencies to consider when entering into an acquisition, but perhaps some of the more common. Therefore, it is essential to consider which contingencies apply to the facts and circumstances surrounding your transaction and the specific language within each, as well as how such contingencies factor into the remaining provisions of the purchase agreement.