Most acquisition agreements contain an “effect of termination” provision that limits the parties liability for pre-termination breaches. However, it is also common to include carve-outs from that limitation on liability permitting each party to hold the other responsible, post-termination, for any damages associated with certain pre-termination breaches of the agreement. This Gibson Dunn memo discusses factors that should be taken into account when negotiating effect of termination provisions and the related carve-outs in an evolving M&A market. Here’s an excerpt :
The scope of the pre-termination breaches subject to the carve-out typically is, and should be, scrutinized in transactions in which there is significant risk of the deal being terminated, such as due to a failure to receive regulatory approval or a debt financing failure. For example, in transactions in which the buyer is a financial sponsor and is relying on the availability of debt financing to pay the purchase price, the seller typically wants to ensure that, if the buyer fails to close the acquisition when required by the agreement, it has the ability to (i) keep the agreement in place and seek specific performance of the agreement to force the buyer to close, which may be limited to circumstances in which the buyer’s debt financing is available (i.e., a synthetic debt financing condition), or (ii) terminate the agreement and recover damages, often in the form of a reverse termination fee, from the buyer.
The effect of termination provision should not purport to foreclose recovery of the reverse termination fee, which in some transactions serves as liquidated damages and a cap on the buyer’s liability for pre-termination breaches. In other transactions, the effect of termination provision may also permit the seller to recover damages beyond or irrespective of a reverse termination fee, frequently limited to circumstances in which there was an “intentional” or “willful” pre-termination breach by the buyer of its obligations.
The memo goes on to note that in a very competitive M&A market, buyers have become more willing to agree to bear regulatory approval risk and for private equity buyers to backstop the entire purchase price with equity in lieu of a synthetic debt financing condition or reverse termination fee. These additional commitments make it even more important to closely scrutinize effect of termination language.
When it comes to sellers, the memo points out that the scope of liability for pre-termination breaches needs to be considered in light of the availability of R&W insurance. In these situations, sellers frequently expect that they won’t face any liability for pre-termination breaches of reps & warranties aside from fraud claims.
– John Jenkins