Despite a retracement in reported UK M&A value and deal flow in 2022 following record 2021 levels, US based corporates, investors and financial institutions remain a major source of UK inward-investment. This is a product of not only the unrivalled access to the innovative, unique businesses within the UK ecosystem and the wealth of resource and expertise afforded by the US, but also the cultural alignment between the two nations.
However, transatlantic differences in approach to M&A transactions can, if the transacting parties are unaware of or fail to adequately address them in a transaction's infancy, protract negotiations, increase cost and ultimately hinder efficient completion.
Below we compare some of the principal differences between UK and US M&A custom and practice to highlight potential pitfalls for sellers of UK private companies being acquired by US counterparties.
Warranties vs. representations
Typically, a seller should seek to avoid giving warranties as 'representations'. Whilst warranties and representations are fundamentally similar (each being statements of fact), classifying warranties as representations or omitting carefully tailored exclusions could afford the buyer additional, non-contractual (tortious), claims for 'misrepresentation'. This could entitle a buyer reliant on that misrepresentation to damages on a more advantageous basis than conventional contract law and, in some circumstances, to rescind the sale agreement.
In contrast, US sale agreements typically do not distinguish between representations and warranties, the terms being synonymous from a US legal perspective. They are therefore often used interchangeably, and breach of either will provide commensurate remedies – typically an indemnity claim (as understood under US law) absent an ability to rescind the sale contract. As such, UK sellers should avoid (and carefully review the acquisition documentation for) reference to non-contractual or misrepresentation claims.
UK and US approaches to the disclosure process are substantially similar, typically resulting in a disclosure letter containing both general and specific disclosures, referencing documents in a mutually agreed data room. Market sentiment in recent years has seen UK acquirers increasingly accept general disclosure of data rooms, typically meaning that all matters reasonably apparent on the face of the data room documents are deemed disclosed to the acquirer. The notion of general disclosure is typically resisted by US acquirers, though this will hinge on the nature of the deal and the breadth of the data room. Party alignment as to general or non-general disclosure of the data room should therefore be sought at an early stage to avoid inadvertent transaction delay.
The two most prevalent price adjustment mechanisms are the completion accounts and locked box adjustment mechanisms. The type of adjustment mechanism itself can typically be agreed absent lengthy negotiations, however the operation of such mechanisms can give rise to unforeseen issues.
For example, UK completion accounting mechanisms can feature a 'cash free, debt free' adjustment in which a value of the target company is agreed, with that value set to exclude the target's cash and debt. From the UK viewpoint, post-completion, the completion accounts would then indicate the target's actual level of cash and debt, with excess cash being added to the purchase price and debt being deducted. It is not uncommon however, for example, for a US buyer to assume that 'cash free' denotes a nil level of cash in the business. As such, US buyers on occasion request sellers to remove excess business capital pre-completion, typically by way of dividend, a notoriously tax-inefficient method of returning value to shareholders.
Consequently, whilst it may appear that the parties are aligned on the adjustment mechanism to be deployed, care should be taken to ensure that such alignment flows through the entirety of the adjustment.
A related issue can arise in relation to 'pro-sandbagging' clauses. These clauses, occasionally contained in US sale agreements, permit acquirers to claim for breach of warranty despite the acquirer having knowledge of the matters resulting in the breach. In the UK, the Court of Appeal has questioned the enforceability of the pro-sandbagging clause, suggesting that whilst damages may be payable if an acquirer is aware of a breach pre-completion and subsequently claims, the damages are likely to be nominal. Therefore, US acquirers will typically seek consideration reductions or indemnity cover in relation to such issues, something that UK sellers should consider with their legal counsel.
Acquisition documents often, irrespective of the locale of the parties or the target, feature restrictive covenants, which preclude sellers from engaging in certain activities for prescribed periods post-completion. Restrictive covenants may, for example, prohibit sellers from poaching customers or employees of, using the name of, or competing with, the target.
The US approach typically sees acquirers pushing for stringent covenants, both in terms of geographic scope and timeframe. English case law has contrastingly established that any restraint contained in a corporate or commercial contract must not exceed that which is necessary to protect the legitimate interests of the benefitting party. These principles exist to avoid the unnecessary restraint of UK trade. UK-style restrictive covenants are therefore typically less onerous on sellers, who are likely to be released from them at an earlier date post-completion.
Parties should aim to agree restrictive covenants early, preferably at term sheet stage, to eliminate potential negotiation points in the latter stages of the transaction.
Passing of risk and material adverse change
A sale under English law featuring a split exchange and completion will typically see the business risk of the target pass to the buyer at exchange. However, in a US-governed agreement, this risk typically does not pass until completion. 'Split sign and close' US governed transactions therefore tend to feature higher degrees of conditionality. For example, that the target must not suffer any 'material adverse change' during the interim period.
Material adverse change clauses allow a buyer to refuse to finalise a transaction if the financial prospects of the target both materially and adversely diminish before completion. These clauses are more common in US agreements, given the English law approach to the passing of business risk. This is despite various US courts having construed them narrowly and, in some instances, even precluding buyers from relying on them.
It should therefore be a priority, if material adverse change provisions are a pre-requisite for the acquirer, to negotiate their scope, which a prudent seller will look to limit as far as is practical.
The Mishcon de Reya Corporate department frequently act on multi-jurisdictional M&A transactions, including the sale of UK businesses to US acquirers.