Unless the contrary is agreed, once firms have been acquired, the new purchasers assume responsibility for any existing liabilities of the acquired company. Due diligence must thus be conducted before a sale to ensure that there are no outstanding liabilities of which a potential purchaser is unaware, as such liabilities could significantly reduce the value of the transaction. It is essential that the purchaser is made aware of such liabilities, as this may influence their decision to buy and the price they are willing to pay.
Debt:
Includes outstanding loans, unpaid overdrafts, payments owed to suppliers, distributors or customers and bonds that have been issued and have not yet matured (meaning that the company must continue to make coupon payments to bondholders). A purchaser could require a warranty that no undisclosed debt exists.
- Outstanding Litigation: if pending litigation is settled post-acquisition, the purchaser will be liable to pay any damages awarded. It is thus essential for the purchaser to secure an indemnity for the seller against any such costs that may later arise and/or an undertaking that the litigation will be settled before the acquisition is completed. This could also cover any litigation that is not pending, but arises in the future as a result of the target’s activities pre-acquisition.
Pension Scheme Liability:
Purchasers will be liable for future pension payments that a company is obligated to make, including payments that accrued as a result of work carried out pre-acquisition. Lawyers must thus check whether a target has enough capital set aside to fulfil these liabilities and could request a warranty regarding the state of a company’s pension scheme.
- Warranties: statements of existing fact in contracts. These amount to assurances or promises relating to the present condition of an object or entity, the breach of which may give rise to a legal claim for damages. For instance, a seller may provide a warranty (to a buyer) that it is not currently involved in any litigation.
- Undertakings: statements, given orally or in writing, promising to take/refrain from taking certain action in the future. The statements must be given in the course of business/legal practice by someone held out as representing the firm (i.e. including secretaries and trainees), to a party that reasonably places reliance on them. For instance, a seller may undertake (to a buyer) that it will settle any pending litigation before completion of an acquisition and to reduce the purchase price by any amount it pays out as part of that settlement agreement. It does not matter whether the undertaking explicitly includes the word ‘undertake’, although statements of intention do not constitute undertakings.
- Indemnities: promises to pay the other party pound for pound compensation if specified scenarios take place. For instance, if the target company is in the middle of a law suit at the time it is acquired, the seller can agree to reimburse the buyers in the future for any money that the target company is required to pay out in relation to the law suit once it comes under the buyer’s control. Indemnities may be subject to financial caps, i.e. limits on the amount that the seller will have to pay out if a claim relating to the circumstances covered by the indemnity is made. Indemnities may also be subject to time limitations, meaning that after a pre-agreed period of time post-acquisition, the buyer can no longer rely upon the indemnities.
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By Jake Schogger - City Career Series