The challenge of drafting purchase price adjustment clauses in merger & acquisition contracts

Autor:  Alexander W. Nürk Bestellnummer:  90011810 Preis:  48,00 EUR Hochschule:  Hochschule für Wirtschaft und Umwelt Nürtingen-Geislingen (ehemals FH Nürtingen) Deutschland Benotung:  1.3 Abgabedatum:  01.06.2008

The challenge of drafting purchase price adjustment clauses in merger & acquisition contracts

Introduction:
The topic of Mergers and Acquisitions (M&A) is currently on everyone?s lips. No day passes by without reading about a planned or realised M&A transaction in the newspapers. The last few years have been record years for the M&A business. The year 2007 could in fact top the record year of 2006. Although, the first half of 2007 was remarkably successful, the subprime crisis of the credit markets led to a slow-down in the second half. However, M&A transactions with a transaction volume of approximately $ 4.830 billion took place worldwide in 2007. The forecasts for 2008 expect a recession of the transaction volume of up to 25 % of the previous year. Mega-deals will not make the headlines as often as in 2007, because banks became more careful in granting credits for such deals due to the subprime crisis. However, M&A International INC. (MAI) expects that the subprime crises will have only little impact on small and medium-sized M&A transactions and 2008 will still be a good year for the M&A business.Various companies have also taken advantage of the weak U.S. Dollar exchange rate and plan M&A deals overseas. Since the wind has not yet been taken out of the M&A businesses sails, the challenge of performing a successful M&A transaction remains.
Like any other businesses, M&A transactions are a dynamic process which has to be accounted for. When a buyer purchases a company (target), the assets of the company cannot be held in stasis until the transaction is settled. The company is in a constant flow and its value changes constantly. This makes it hard to determine a precise purchase price that remains valid from the beginning until the end of the transaction process. Since the value of the company changes through this process, the purchase price has to be adjusted. Therefore, purchase price adjustment tools have to be part of the M&A contract to ensure so. Generally, legal counsels are assigned to draft M&A contracts for the parties. Although, an M&A team should consists not only of lawyers, but also of accountants, tax consultants and others, where every member is specialised in a certain field, the legal counsel should have a general overview, since he is the one drafting the contract. The quality of his drafting becomes apparent when disputes arise. Most lawyers have no clue about company valuation methods or the principles of orderly accounting. However, these two applications are essential when it comes to drafting purchase price adjustment clauses.
This paper addresses lawyers and everybody who is in the position of drafting M&A contracts. Since M&A contracts include various clauses, this paper covers only purchase price adjustment tools. It gives a general overview of purchase price adjustment tools, manipulation issues, purchase price calculation standards and the coordination of the clauses among each other. Various possible problems which should be factored into the drafting process will be mentioned. It is impossible to predict every potential issue that is relevant for purchase price adjustment, because every transaction is different. Therefore, this paper is rather a guideline which supports the drafter of a purchase price adjustment clause to think about the main issues that can occur and to inspire further thoughts.
In chapter 2, the basics of M&A are discussed, such as the scope of definition for M&A, and motives and phases in the M&A process. Chapter 3 provides a brief introduction into company valuation methods. This is a very important chapter for the following purchase price adjustment tools. Someone who drafts purchase price adjustment clauses has to know how the company was valued, since different valuation techniques can lead to different results, and hence to different purchase prices. The various valuation approaches can be applied to purchase price adjustment issues. Therefore, it is essential to know their components to obviate manipulation potentials. Three company valuation methods are discussed: the net asset value method, representing single-valuation-procedures, capitalised earnings value method and discounted cash-flow method, representing total-valuation-procedures. Main attention is focused on discounted cash-flow methods, since they are the ones that are mainly used, especially in international transactions.
In chapter 4, various guarantees will be highlighted where breaches can also result in purchase price adjustment. Discussion focuses especially on the guarantees under German law, which have different impacts on the magnitude. An ambiguously formulated clause can have the surprising opposite effect than desired by the parties. This leads to one of the central themes that can be found throughout the paper; unambiguous precise formulation of clauses is the basis for a successful contract drafting, resulting in a reduction of potential future disputes.
The main chapter of this paper is chapter 5 where the two tools which directly influence the purchase price will be discussed: retrospective purchase price adjustments (post-closing adjustments) and future-oriented purchase price adjustments. While post-closing adjustments only apply to the period between signing and closing date, future-oriented purchase price adjustments come into effect after the closing date. The differences, advantages and disadvantages for both parties, the appropriate metric, manipulation issues and the calculation of the purchase price adjustment will be topics covered to provide support to the drafter of relevant clauses of most problems which can occur subsequently.
Chapter 6 provides a brief introduction to dispute resolution problems, which are particularly relevant in international M&A transactions, since arbitration does not follow the same rules internationally. As other clauses in an M&A contract also have influence, mainly indirectly, on the purchase price, chapter 7 covers the matter of coordination of purchase price influencing clauses. This chapter concludes with a case, decided from an U.S. Court, where contradictory clauses in an M&A contract cost the buyer millions of U.S. Dollars of purchase price adjustment. This example shows the importance of clear formulation of the clauses so that it leaves no room for interpretation.
The paper does not deal with tax issues that affect purchase price adjustment procedures. It further does not address Generally Accepted Accounting Principles (GAAP) in detail, but rather shows some differences and issues that might occur. It is also impossible to mention every possibility for manipulation that the parties might thinks of, since every transaction is different and each industry and business branch has its own peculiarities. Overall, this paper is meant to be a guideline and does not provide an ultimate solution for purchase price adjustment.