Closing Conditions or Why Isn't the Future What I Thought It Was, Part 1

September 19, 2012, by Robert V. Hawn

Whether an acquisition is in San Jose, Cupertino, San Francisco, or anywhere else in California or the United States, any corporate lawyer will tell you that a buyer will not close a deal unless certain conditions are satisfied. Fortunately, closing conditions contained in mergers and acquisitions documentation have become standardized. Exceptions, however, always arise based on the unique attributes of the transaction, and standard does not always mean simple.

Some merger or acquisition closing conditions are standard and rarely require negotiation. For example, one of the standard closing conditions is that there is no injunction, law, or court order that prevents the transaction from proceeding. Outside of an actual known threat to a transaction, these clauses are rarely negotiated in a private company acquisition transaction.

Another standard closing condition is that the requisite corporate approvals will be secured. Because the respective Board of Directors of the each company will have approved the acquisition agreement, this is usually a noncontroversial item.

Similarly, stockholder approval is a standard condition but it can derail a deal if the company does not approach it carefully. Stockholder approval adds an additional wrinkle: dissenters' rights. These rights allow a stockholder to receive in cash the fair market value of its stockholdings, based on the value of the selling company, absent any change in value arising as a result of the acquisition. To receive this cash payment, the stockholder must vote against the acquisition. It is not sufficient for the stockholder to simply abstain from voting. To enable the stockholder to take advantage of its dissenters' rights, the selling corporation must provide notice of the right to exercise dissenters' rights, and the notice must contain specific provisions.

Why would the corporation want to allow one of its stockholders to have this right? To protect the transaction, that's why. Any stockholder who had the right to exercise its dissenters' rights, but failed to do so, can never attack the validity of the transaction. The only exception to this is if there was a problem with stockholder approval. In essence, dissenters' rights give the stockholder the choice between selling-out or going along with the deal. From the corporation's standpoint, it can feel comfortable that a transaction will proceed since all it has to do is buy-out its disgruntled stockholders.

Or can it? The problem with dissenters is that they have to be paid. If the deal is a cash deal, then the purchase price proceeds can be used to pay off the dissenters. If, however, the acquisition is a merger, where shares are going to be exchanged, the issue is tricky. Recall my discussion some time ago about an acquirer wanting to have working capital in the purchased company so that it can conduct business after the closing. Any payment to a dissenting stockholder will reduce the amount of the seller's working capital (assuming that the buyer will not use its own working capital to pay the dissenter).

The reduction in working capital arising out of a payment to dissenters will lead to a closing condition limiting the number of stockholders which can dissent to the deal. Typically, this number is less than 5% of the stock entitled to vote. Sellers who find themselves faced with such a condition find that a stockholder or stockholders holding a relatively small number of shares have, essentially, a veto right on a transaction. For this reason, executives of selling companies need to review their stockholder lists carefully to determine if there is any likelihood that a stockholder will exercise its dissenters' rights.

In my next blog, I'll discuss some of the other conditions that might crop up in a common acquisition deal.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.