It is hard to believe that private equity professionals and not just comparative law professors and lawyers are intensely focused on the differences between English law sale and purchase agreements and U.S. stock purchase agreements (both referred to in this article as a “SPA”). That attention is warranted because those differences are now becoming of increasing commercial and strategic importance in sale processes. As developing economies host more private equity transactions, U.S. private equity professionals are learning that it is increasingly common for SPAs for targets outside of the UK to be governed by UK law. This is true not only for deals where the seller is based in the UK; but also the case even where neither of the parties or the target has have no real connection with the UK. For instance, in a recent transaction, a French purchaser acquired a European group (with no business in the UK) from a U.S. seller, using a UK agreement.
The choice of law is driven by a number of factors including, familiarity and confidence with English law in international transactions, concerns over U.S. litigation and costs (where a U.S. choice of law might otherwise be logical), but, more importantly, by the perceived advantages of the UK approach for sellers. In auction processes the choice of law will usually be determined by the seller, which is preparing the draft SPA.
Private equity buyers and sellers should remember that the practice and philosophy underlying a UK agreement are different from those under a U.S. contract. Critically for sellers, a typical UK agreement assumes that, even where there is a gap between signing and closing, deal certainty is required from signing and from that point risk passes to the buyer. That, combined with the fact that post-closing redress (e.g. for breach of warranty) is less likely to be pursued and harder to achieve in the UK than in the U.S., makes preparing an SPA governed by UK law a compelling strategic choice for the seller.
While, as always, there are many exceptions to the general UK approach, it is interesting that even in a deteriorating deal market, where a shift of negotiating power from sellers to purchasers might be expected, there have not been material changes in the UK approach. Under similar circumstances in the U.S., there have also been some meaningful seller friendly market changes, particularly as to remedies for buyers breach, but the U.S. approach remains markedly less friendly for sellers.
The balance of this piece discusses a number of key differences between UK and U.S. practice in greater detail.
Conditions: Typically UK agreements contain only conditions required by law or regulation, e.g., anti-trust clearances or other regulatory approvals. These are generally specified together with detailed provisions on timings for filings and consequences based upon the response from the relevant regulatory body. In contrast, U.S. deals are somewhat more likely to have greater conditionality and certainly more likely to provide for a meaningful period of time before closing, known in the U.S. as the Marketing Period, for the buyer to have a fair shot at placing its financing.
Material Adverse Change: It is unusual for UK deals to be subject to a Material Adverse Change condition. Even if a MAC condition is included, it is likely to be relevant only if an “armageddon” event occurs which is not the result of macro-economic factors. For instance, MAC clauses often now specifically exclude any direct or indirect consequences of a breakup of the Eurozone. By contrast, MAC clauses are far more common in the U.S., although they are typically interpreted very narrowly.
Financing: UK deals are usually done on a “certain funds” basis with no financing condition or financing out. Some strategic and private equity deals in the U.S. contain financing conditions. If there is no financing condition, as is the case in virtually all large cap private equity deals, there will be a reverse termination fee which requires the buyer to pay a fixed amount if the financing is not available and the other closing conditions are met. This reverse termination fee is typically seller’s exclusive monetary remedy against the buyer.
Reverse Termination Fees: Although reverse termination fees are seen in the UK they are relatively rare, certainly by comparison with U.S. practice.
Break Up Fees: In the U.S. a bidder with a definitive agreement to acquire a public company who gets trumped by a topping bid will be entitled to a breakup fee for its role as a stalking horse. In the UK, such break up fees are expressly prohibited without the consent of the UK Takeover Panel.
It is has been common for a number of years in UK governed SPAs, particularly in auctions, for the acquisition price to be determined on a “locked box” basis. The price payable for the target company is agreed upon in advance of signing based on a balance sheet drawn up to an agreed locked box date. The purchaser then bears the risk and rewards of the target’s performance from the locked box date through signing to closing. In return, the seller undertakes that there will be no “leakage” of value from the “locked box” to the sellers in that period. This is entirely in keeping with the philosophy that risk passes to the purchaser from signing, and the advantages for the seller in using a “locked box” include the ease with which bids can be compared, price certainty (as there is no post-closing adjustment) and control over the pricing process.
Although the use of locked boxes is increasing in the U.S., it is still common to have a closing balance sheet prepared after the transaction closes. Unlike the locked box mechanism, and depending on the precise formula utilized in any particular adjustment formula, the seller retains the commercial risk and reward until closing, the seller has less control over the pricing process and the price is likely to be subject to a post-closing adjustment and potential dispute based on the closing accounts.
Scope of Warranties: There is an expectation in English law governed deals that sellers will give less extensive warranty coverage than in the U.S. The style of the warranties also tends to be more general in nature and not as comprehensive as in U.S. deals.
Repetition Bring Down of Warranties: In the UK, it is unusual for warranties to be repeated at closing although, as a compromise, sellers may agree that a small number of fundamental warranties, such as title and capacity, are brought down to closing. In the U.S., the practice is generally to require warranties and representations to be repeated at closing, subject to MAE and materiality qualifications.
Disclosure: The style and substance of the disclosure process differs between UK and U.S. documents. Under a UK SPA, the seller’s disclosure against warranties is typically contained in a separate disclosure letter, rather than the schedules to the sale agreement itself, which is often the case in the U.S. Most importantly for the seller, a UK disclosure letter will contain a mix of general and specific disclosures against the warranties. Even the specific disclosures are normally deemed to qualify all warranties and not just the specific warranty to which they relate. In addition, in auctions it would be usual for the entire contents of the data room and of any vendor due diligence reports to be deemed to be generally disclosed against the warranties. In the U.S., the buyer will usually allow specific disclosures in respect only of each warranty against which the disclosure is made and any other warranty as to which such disclosure is readily apparent. General disclosures are far less common and not typically accepted by buyers.
Indemnities: In the U.S., in a transaction where the representations survive, the buyer would usually enjoy express contractual indemnification, for breach of warranties and representations. In most U.S. deals, involving both a private equity buyer and seller, the buyer’s exclusive source of recovery (if any) for such indemnification is recourse against an escrow funded with an amount equal to five to ten percent of the equity value (absent unusual circumstances). This escrow is typically paid over to the seller once the representation and warranties expire, subject to reserved amounts for any pending claims. As a corollary, in the U.S., in these types of sell-side private equity deals, the seller’s representations and warranties and other agreements can survive for as little as the first anniversary of the closing or alternatively, the completion of the first audit cycle under the buyer’s ownership.
In the UK, such express contractual indemnification is much less common, other than in relation to tax or other specifically identified risks for the target business e.g. environmental. The purchaser’s remedy for breach of a warranty in a UK SPA would therefore usually be a contractual claim for damages with a duty to mitigate losses and a requirement for any damage to be reasonably foreseeable. Some U.S. deals actually end up with a similar result, notwithstanding the express contractual indemnification due to waivers by buyers of consequential damages and a contractually imposed duty to mitigate.
Specific Performance: Whilst, in broad terms, U.S. and UK courts apply the same tests when deciding whether to grant an order for specific performance, (i.e., damages would be an inadequate remedy), it is probably more difficult to get an order for specific performance in the UK than in the U.S. where it is typically an enforceable remedy on properly crafted stock deals. Since 2008, specific performance has become a fairly standard buyer remedy in private equity deals, though the scope of such specific performance can vary meaningfully deal by deal.
Limits on Liability: Financial thresholds, caps and baskets are common under both UK and U.S. SPAs, though, in some circumstances, a UK agreement may contain more extensive general limitations on the seller’s liability than in the U.S. It is also worth noting that private equity sellers in the UK rarely stand behind business warranties in an SPA. In those circumstances a purchaser is reliant upon warranties received from management (up to negotiated caps and with thresholds) and, if it chooses to take it out, insurance. Any management liability of this kind is extremely rare in the U.S., perhaps reflecting a calculation that a law suit against one’s new management team (assuming a private equity buyer) is a flawed remedy.
Completion deliverables are likely to be more extensive in the UK than in the U.S. Furthermore, the covenants to which the target business and seller are subject in the period between signing and closing are likely to be significantly more extensive in the UK than in the U.S., again reflecting the fundamental difference of when the risk of ownership transfers in the U.S. versus the UK.
These differences demonstrate why sellers have a strong interest in ensuring that international deals are being done under UK law. However, in making tactical decisions about the choice of law, sellers should be mindful of the likely pool of purchasers. If they are predominantly U.S.-based, sellers may find it difficult to insist on the use of UK-style stock purchase agreements for assets based outside of the UK. However, in transactions outside the UK where they are competing with European and UK bidders, U.S. private equity buyers should recognize that accepting UK style approaches may be required in order to be competitive and should weigh the risks accordingly.