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Report on a session of the Corporate and M&A Law Committee at the IBA Annual Conference, Seoul
Tuesday 24 September 2019
Rabindra Jhunjhunwala Khaitan & Co, Mumbai
Hans Witteveen Stibbe, Amsterdam/London
Alyssa Caples Cravath Swaine & Moore, London
Cornelia Topf Gleiss Lutz, Frankfurt
Myong-Hyon (Brandon) Ryu Shin & Kim, Seoul
Tim Gordon Gilbert + Tobin, Sydney
The session addressed various developments in the current mergers and acquisitions (M&A) markets that the practitioners on the panel had identified as particularly relevant in the current environment. After a brief introduction of the topic of the panel and the speakers, the panel started by discussing developments in the terms and practice in deals.
Cornelia Topf started the discussion by describing how break-up fees, reverse break-up fees, deposits and other deal certainty mechanisms are being dealt with in the current market in Germany. Break-up fees (reverse or not) are often agreed in an early stage of a transaction (in the letter of intent (LOI)), in particular to cover costs and efforts made in the sales process. Break-up fees can be structured in such a way that they provide for a contractual penalty or a lump-sum compensation in the event of break-down of negotiations. Depending on the target and the obligations under the LOI, including to pay the break-up fee, the LOI may require it to be notarised under German law to make the break-fee commitment binding. As to the ultimate deal documentation, it was noted that between 2015 and 2017, ten per cent of private M&A transactions featured a seller break fee. According to a study on global trends in private M&A, 19 per cent of the deals included a reverse break fee, often with regard to the non-fulfilment of certain closing conditions in the purchaser’s risk sphere (such as merger control clearance) and, on average, the fee amounted to six per cent of the deal value. Myong-Hyon (Brandon) Ryu noted that break-up fees and reverse break-up fees are used in Korea, though not as often as in other jurisdictions. An interesting feature is that not only liquidated damages but also a penalty is allowed under Korean law for the termination of a purchase agreement for breach. This represents a stark contrast to the United States and other common laws.
Topf subsequently spoke about buyer’s knowledge in indemnification for representations (‘reps’) and warranties breaches. She noted that the German Civil Code provides that the buyer’s knowledge of a ‘defect’ in the purchased item excludes the liability of the seller and that this would also apply in case of a sale of an enterprise. However, the applicability of this provision may be excluded and often is. In most cases the sales and purchase agreement (SPA) specifically stipulates what knowledge of the buyer shall be relevant to exclude seller’s liability. In most cases, the SPA provides that the buyer shall be deemed to have knowledge of certain facts (eg, all matters fairly disclosed in the data room or other material submitted by the seller and its representatives in the course of the transaction, including in management presentations).
Ryu commented that Korean courts had been split on, and there had been uncertainty over, buyer’s knowledge and its implications in the context of indemnification. However, the Korean Supreme Court ruled in 2015 that a buyer in an M&A transaction may claim damages for the seller’s breach of its reps and warranties even where the buyer knew of the breach at the time of signing. Express anti-sandbagging provisions would likely be found enforceable in Korea.
The panel subsequently discussed disclosure schedules, disclosure letters and other ways of disclosing information. Ryu started out by noting that similar to the US, Korea is more of a disclosure schedule jurisdiction, with the typical use of disclosure schedules (in which specific disclosures corresponding to particular reps and warranties) are commonly used. He added that general disclosures (eg, public filings) are not allowed normally and that documents and information in the virtual data room (VDR) normally are not deemed disclosed. Topf clarified that in Germany, disclosure schedules (as part of the SPA) and disclosure letters are both common practice. In most cases, disclosure against warranties is made through schedules directly to the respective warranty. As in most continental European countries, it is typical that the data room is deemed disclosed. However, this is often restricted to a certain level of quality of such disclosure, for example, fairly disclosed in a way that a reasonable and experienced buyer can detect the risk and make its own risk assessment. According to studies, continental Europe differs here from other regions: in around 90 per cent of the deals, the data room is deemed to be disclosed; in Asia, the average is only 71 per cent.
Alyssa Caples commented on the increased use of strategies using warranty and indemnity insurance deals (W&I), with pricing reductions and lower deductibles; drop-down features for deductibles after 12 months; policies with no seller indemnity; and the use of tax structuring insurance on deals. W&I is increasingly available for larger transactions. Ryu commented that W&I insurance is still a rather nascent area of interest in M&As in Korea, but sellers hoping for a clean exit, particularly private equity sponsors, are increasingly interested in W&I insurance. The sell-buy flip, which is quite common in jurisdictions with general use of W&I is gaining popularity also in Korea. Topf commented that in Germany the proportion of deals using W&I insurance continues to rise. According to a recent survey, 14 per cent of all deals across Europe are covered by a W&I insurance policy (an increase of five per cent since 2016), with it usually being an insurance cover for the buyer. W&I insurance is discussed in most of the transactions in Germany as an option to bridge the gaps, although, ultimately, it is not always used. Also, bidders from what can be considered more conservative jurisdictions, for example China, are getting used to W&I insurance and are willing to use it. In Europe, there are a large number of transactions with a so-called ‘stapled W&I process’, in which private equity (PE) sellers actively deploy the tool to structure an exit based on the liability transfer to the W&I insurance market. With regard to trends in the terms of the W&I insurance, in Europe, we see, for example:
W&I insurance with zero-liability for seller;
greater flexibility on deal terms;
damages – can now also include lost profits (not possible for a long term);
synthetic W&I protection – warranties covered by the insurance are broader than given by seller; and
data room disclosure can be excluded.
The panel then addressed developments in purchase price clauses. Topf observed that purchase prices with adjustments as of closing/effective date are again increasing versus locked box concepts/fixed purchase prices. While in 2010 only 34 per cent of deals in European countries contained a purchase price adjustment, the number in 2017 was 48 per cent. However, it was also noted that between 2015 and 2017 there was a (slight) decrease in the number of purchase price allocation (PPA) clauses because of the seller-friendly environment. The locked box is still a customary request, in particular from PE sellers. Earn-outs are more typical for venture capital and for M&A in a restructuring environment. In terms of payment security, an escrow of up to 20 per cent of the purchase price has not been an unusual request.
The panel then briefly discussed developments in the public deal regulatory environment. Ryu observed that in Korea – unlike in European countries, Hong Kong and many other jurisdictions – a mandatory tender offer is not triggered by the acquirer buying a certain percentage of stake in a listed company. Most public M&A transactions involve acquiring a controlling stake from a major shareholder, followed by a tender offer (to acquire additional shares) and, sometimes, voluntary de-listing and squeeze-out. Ryu further explained that Korea has five per cent and ten per cent disclosure requirements and that stake-building is possible, but that five per cent is an important milestone due to the five per cent disclosure requirement. Alyssa commented on the proposed new approach to disclosure of pro forma financial statements in the US, including with respect to synergies. In addition, in the US there are new trends in appraisal rights actions and cost considerations (including pre-judgment interest) for defendants to litigate. Caples further commented on developments around the Committee on Foreign Investment in the United States (CFIUS). Under the Foreign Investment Risk Review Modernisation Act (FIRRMA), there is an expanded scope to cover acquisitions of control of US businesses by foreign persons, which also has implications for non-controlling interests in US businesses – effectively, a broadening view of what constitutes national security. There is a pending review of a pilot programme for mandatory reporting in critical technology companies. The impact includes forced divestitures and abandoned deals; and lower cross-border activity generally. Topf expanded on developments in German Foreign Investment Control. The German Federal Ministry for Economic Affairs and Energy (Bundesministerium für Wirtschaft und Energie), has the power to review, restrict or prohibit direct and indirect acquisitions of voting rights in German entities by foreign investors exceeding certain thresholds. There is also sector-specific foreign investment control, for which clearance is required – it protects the military and crypto-technology industries, for instance. The review standard is whether the acquisition constitutes a serious threat to fundamental national security interests.
Lastly, in the short remaining time, the panel briefly spoke about developments in ‘legal tech’, with Tim Gordon taking the lead, using some illustrative slides, in describing some of the technology that his firm has been developing.
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