Crafting Language in an Acquisition Agreement: Part One
By J. Marc Ward
What goes on when crafting an acquisition agreement to purchase a company? Or to say it differently, why do lawyers insist on one phrase or word over another? “Legalese” has its place. In this two-week series, we will take a look at a few examples of the many fine points involved in preparing an acquisition agreement.
“Knowledge is Good” so says the motto of Faber College. Of course, a lawyer’s retort is, what do you mean by “knowledge”? Representations by the seller are often qualified by the knowledge of seller. In acquisition agreements knowledge can mean different things. Sometimes it is actual knowledge:
“Knowledge or Knowledge of Seller means the actual knowledge of [name the executive officers and sometimes the directors].”
Other times it is constructive knowledge, such as this provision creating a standard of conduct to measure the seller’s knowledge:
“Knowledge or Knowledge of Seller means (i) the actual knowledge of [name the executive officers] and (ii) the knowledge that any such person referred to in (i) above, as a prudent person, would have obtained in the conduct or performance of his or her duties as an officer.”
Another constructive knowledge clause imposes a duty on the seller’s officers to take their head out of the sand:
“Knowledge means the actual knowledge of [name the executive officers] as if these officers shall have made a due and diligent inquiry of those employees and directors of the seller whom the officers should reasonably believe would have actual knowledge of the matters represented.”
Knowledge qualifiers like those above are used to qualify or limit representations that would otherwise be unqualified or unlimited. For example, the representation that “The seller’s business has been and is being conducted in compliance with all applicable laws” is rather breathtaking in its scope. What business is in compliance with every applicable law all the time?
Naturally in such cases the seller wants to qualify that representation by adding “To Seller’s knowledge” at the beginning of the sentence. And seller wants to limit the meaning of “knowledge” to actual knowledge of the president of the company. Buyer will naturally push back and want the definition not only to include what the president knows, but what he should know, and buyer might also want to broaden the list of officers and key personnel to whom the knowledge definition applies.
When knowledge is used as a qualifier, sellers are not fortunate enough to limit the definition to actual knowledge. Most of the time, it is constructive knowledge on a reasonable or due inquiry standard and less often based on the conduct or performance of duties.
No Undisclosed Liabilities
A buyer-favorable “no undisclosed liabilities” representation, for example, would say something like this:
“Target has no liabilities other than those liabilities reflected or reserved against in the balance sheet or the interim balance sheet and current liabilities incurred in the ordinary course of business.”
This is a blanket warranty that there are no liabilities other than what are reflected on the balance sheet. None. A seller would prefer a “no undisclosed liabilities” representation more along these lines:
“Target has no liability of the nature required to be disclosed in the liabilities column of a balance sheet prepared in accordance with GAAP….”
This limits seller’s commitment to what GAAP requires, eliminating the immaterial, the unforeseen and highly contingent.
Most purchase agreements contain the buyer-favored provision.