Preliminary proceedings in M&A, ordinary course and leakages

Enclosed Wheat Field with Rising Sun - Van Gogh

Para ver la versión en castellano ir a este Link.

In M&A the timing between the start of the negotiations and the conclusion of the transaction use to be very extensive, in many transactions it can elapse several months between the signing date and the closing date, this is between the agreement is reached and the transfer of the business in favor of the purchaser.

Due to the duration of this procedure, several issues need to be regulated by the parties, in order to avoid anomalies and damages from one party to the other, and in particular it is required to regulate: (i) the ordinary course of the business, and (ii) the unauthorized leakages.

These anomalies and damages can arise because the sale and purchase agreement (SPA) is static, so it needs to be referred to an specific date and figures, while the business is dynamic. This situation can be very relevant with regard to the reference date of the price, as we already seen in “Mecánica del precio en las compraventas de empresa”, where we highlighted that the price in M&A is affected by: (i) the method of valuation, (ii) the reference date, (iii) the signing date, and (iv) the closing date.

Regulation on the ordinary course and unauthorized leakages consists of including specific provisions by the seller, stating that since the reference date until the signing and the closing, the company has continued to be managed in the same way as it has been doing before such statement. These declarations also include that the company has not executed actions involving the exit of cash, rights or assets other than those corresponding to the ordinary course of the business, and under market value.

The list of unauthorized actions since the reference date can be very extensive, including regarding unauthorized leakages: distribution of dividends, share capital reductions, discounts, bonus payments to employees or executives, granting of loans or credits to related parties, waiver of rights or legal actions, etc.

On the other hand, regarding the ordinary course, it can be included actions such as: amendment of the bylaws, corporate restructuring transactions, granting of guarantees over the company’s assets and rights, initiating or terminating of business lines, amendment of contracts of certain relevance, requesting of insolvency declaration, etc.

In relation to unauthorized leakages (exits of cash), it is not enough with a simple prohibition, as the accounts can hide some exits of cash. Therefore, the figures need to be reviewed, and specific identification of the items that are considered possible exits of cash require to be defined in the SPA.

As exceptions to the ordinary course of the business, the SPA use to include some transactions necessary to clean the company from certain assets and business not related to the main activity, not interesting by the purchaser, or even referred to assets or rights referred to certain shareholders. These transactions must be identified in the SPA as permitted leakages or authorized transactions (these authorized transactions in M&A use to be called carve-outs). Among these carve-outs we can find transactions such as spin-offs secondary business lines or activities not related to the main business of the company, real estate assets, or assets that should be owned by certain shareholders than to the company.