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THE MERGERS & ACQUISITIONS HANDBOOKA Practical Guide to Negotiated TransactionsFirst Edition

DIANE HOLT FRANKLE STEPHEN A. LANDSMAN JEFFREY J. GREENE

DLA PIPER

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T48802-MA Handbook cvr_2007.indd 1 10/1/07 9:37:25 AM

Print Date: November, 2007

This publication is designed to provide accurate and authoritativeinformation in regard to the subject matter covered. It is publishedwith the understanding that the publisher is not engaged in renderinglegal, accounting or other professional services. If legal advice orother expert assistance is required, the services of a competentprofessional should be sought.

— From a Declaration of Principles jointly adopted bya Committee of the American Bar Association anda Committee of Publishers.

This guidebook is part of Bowne’s SecuritiesConnectTM Library.

FIRST EDITION

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OAbout Bowne & Co., Inc.

Bowne & Co., Inc. (NYSE: BNE) provides financial, marketing andbusiness communications services around the world. Dealmakers rely onBowne to handle critical transactional communications with speed andaccuracy. Compliance professionals turn to Bowne to prepare and fileregulatory and shareholder communications online and in print. Marketerslook to Bowne to create and distribute customized, one-to-onecommunications on demand. With 3,200 employees in 60 offices aroundthe globe, Bowne has met the ever-changing demands of its clients for morethan 230 years. For more information, please visit www.bowne.com.

For up-to-date, relevant insight on securities, regulatory, andcompliance matters, please visit www.SecuritiesConnect.com.

About DLA PiperDLA PIPER has more than 3,400 lawyers in 25 countries and 64 offices

throughout Asia, Continental Europe, the Middle East, the United States, andthe United Kingdom. The firm’s global legal practice includes commercial,corporate, finance, human resources, litigation, real estate, regulatory andlegislative, technology, media and communications law. The firm’s clientsrange from multinational, Global 1000 and Fortune 500 enterprises toemerging growth companies.

DLA Piper is the only law firm with at least 1,500 lawyers on each side ofthe Atlantic. The firm’s unmatched global presence enables DLA Piperattorneys to meet the ongoing needs of clients in the world’s key economic,technology and governmental centers, including: Beijing, Brussels, Chicago,Frankfurt, Hong Kong, London, Los Angeles, Moscow, New York, Tokyo,Shanghai, Singapore, and Washington, D.C. For more information on DLAPiper, please visit the firm’s web site at www.dlapiper.com.

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About the EditorsDIANE HOLT FRANKLE is a partner in the Silicon Valley, California office

of DLA Piper and Co-Chair of the firm’s global Mergers & Acquisitions Group.Ms. Frankle specializes in mergers and acquisitions, corporate governance,and antitakeover counseling. She has represented numerous companies, bothbuyers and sellers, in asset deals, stock and cash mergers, tender offers,management buyouts and other complex acquisitions, and in implementingdefensive strategies. Ms. Frankle is a member of the American Bar Associa-tion’s Committee on Negotiated Acquisitions and Co-Chairs the Committee’sTask Force on Public Company Acquisitions. She speaks and writes regularlyin programs for both clients and practicing lawyers on mergers and acquisi-tions, corporate governance, the fiduciary duties of directors, and federal andstate securities laws. She is listed in the Best Lawyers in America, Who’s WhoLegal: The International Who’s Who of Business Lawyers, Chambers GlobalGuide and as one of Northern California’s Super Lawyers, for her mergers andacquisitions practice. Ms. Frankle received her J.D. magna cum laude fromGeorgetown University Law Center in 1979. After law school, she served aslaw clerk to Senior District Judge R. Dorsey Watkins, Senior District Judge ofthe United State District Court for the District of Maryland from 1979 to 1981.

STEPHEN A. LANDSMAN is a partner in the Chicago office of DLAPiper and is Co-Chair of the firm’s global Mergers & Acquisitions Group. Heengages in a general corporate, business counselling, and tax practice, withspecial emphasis in the area of mergers and acquisitions. Mr. Landsman hasextensive in-depth experience in numerous industries as lead counselrepresenting both purchasers and sellers in a wide variety of transactionsincluding public to public, private to public, private to private, leveragedrecapitalization, divisional or asset sales and joint venture/strategic alliancetransactions. Mr. Landsman has been a speaker on various corporate lawmatters and has been the author of several published articles in his field. In2007 the respected English research firm Chambers & Partners citesMr. Landsman in Chambers USA: America’s Leading Lawyers for Business.He has been designated an Illinois Super Lawyer in both 2005 and 2006 andis also listed in Who’s Who in America and Who’s Who in American Law.

JEFFREY J. GREENE is a partner in the Shanghai office of DLA Piper.He concentrates his practice in the areas of cross-border mergers andacquisitions, corporate and securities law. Mr. Greene regularly advises clientsin a wide variety of mergers, acquisitions and change of control transactions,and has led cross-border M&A deals in Australia, China, Finland, Germany,India, South Korea and the United Kingdom, among others. Mr. Greenefrequently presents to practicing attorneys on the areas of mergers andacquisitions. Before relocating to the firm’s Shanghai office, Mr. Greene prac-ticed in the firm’s Seattle, Washington office where he was named a “RisingStar” by Washington Law and Politics magazine from 2001 to 2006.

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AcknowledgementsEditorial:

Diane Holt Frankle Silicon Valley, CaliforniaSteven A. Landsman Chicago, IllinoisJeffrey J. Greene Shanghai, China

Contributing Authors:William H. Bromfield Seattle, WashingtonSulee J. Clay Washington, DCStephanie M. Decker Shanghai, ChinaTrenton C. Dykes Seattle, WashingtonFrancis J. Feeney, Jr. Boston, MassachusettsDanielle S. Fitzpatrick Seattle, WashingtonDiane Holt Frankle Silicon Valley, CaliforniaJeffrey J. Greene Shanghai, ChinaDavid M. Hryck New York, New YorkPurnima N. King San Francisco, CaliforniaPaolo Morante Baltimore, MarylandKathryn H. Ness New York, New YorkMichelle D. Paterniti Boston, MassachusettsThomas B. Reems Washington, DCRobb Scott San Francisco, CaliforniaJeffrey M. Shohet San Diego, CaliforniaChristian Waage San Diego, CaliforniaEric H. Wang Silicon Valley, California

Numerous partners, associates and other colleagues have contributedto this handbook. Our special thanks to Edward Batts, Joel Ginsberg,Lawrence Gold, Mark Hoffman, W. Michael Hutchings, Peter Lawrence,Albert Li, Laura Puckett and David Reitz.

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PLEASE READ THIS DISCLAIMER: This handbook is intended toprovide a general, informational overview to non-lawyers and is notintended to provide legal advice as to any particular situation. The laws,regulations and other rules applicable to each specific variation of the dealsdiscussed in this handbook are complex and subject to change. Experi-enced counsel should be involved in every aspect of the planning, struc-turing and negotiation of any M&A transaction, including the drafting andexecution of all transaction documentation.

Without limiting the generality of the preceeding disclaimer, thediscussion of the basic Internal Revenue Service rules and regula-tions relating to the taxation of business combinations is intended tobe a summary only. Such rules and regulations are extremely complexand evolving, and by definition are dependent on the specific facts ofeach particular case. Participants to business combinations mustconsult their tax advisors early and often when structuring M&Adeals.

The views in this handbook are those of the editorial staff and thecontributing authors only and do not necessarily reflect the views of DLAPiper.

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TABLE OF CONTENTS

Chapter 1 The Mergers and Acquisitions Process . . . . . . . . . . 1Why Buyers Buy and Sellers Sell. . . . . . . . . . . . . . . . . . . . . . 2Elements of Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2The Players . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4Acquisition Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5Time and Responsibility Checklist . . . . . . . . . . . . . . . . . . . . . 6Leveraging The Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Chapter 2 Letters of Intent & Term Sheets . . . . . . . . . . . . . . . . 9Letter of Intent Pros and Cons . . . . . . . . . . . . . . . . . . . . . . . . 10Binding or Non-Binding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10Elements of the Letter of Intent . . . . . . . . . . . . . . . . . . . . . . . 11

Chapter 3 The Nondisclosure Agreement . . . . . . . . . . . . . . . . . 13Understanding the Scope of Confidential Information . . . . . . . 14Use of Confidential Information . . . . . . . . . . . . . . . . . . . . . . . 15Non-Disclosure of Discussions. . . . . . . . . . . . . . . . . . . . . . . . 15Legally Required Disclosures. . . . . . . . . . . . . . . . . . . . . . . . . 16Return or Destruction of Materials . . . . . . . . . . . . . . . . . . . . . 17Non-Solicitation/Employment . . . . . . . . . . . . . . . . . . . . . . . . . 17Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18Choice of Law/Forum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Chapter 4 Legal Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . 21What Is Due Diligence and When Is It Performed? . . . . . . . . 21What Are the Objectives of Due Diligence? . . . . . . . . . . . . . . 21Overview of the Due Diligence Process . . . . . . . . . . . . . . . . . 22Who Is Involved and the Necessity of a Diverse Team of

Experts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24Due Diligence Request List . . . . . . . . . . . . . . . . . . . . . . . . . . 25Response to Due Diligence Request List . . . . . . . . . . . . . . . . 27Scope and Process of Review . . . . . . . . . . . . . . . . . . . . . . . . 29Results of Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

Chapter 5 Deal Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33Principal Deal Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33Stock Purchase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33Asset Acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34Mergers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35Considerations in Choosing a Structure . . . . . . . . . . . . . . . . . 39

Chapter 6 Definitive Acquisition Agreement . . . . . . . . . . . . . . . 47Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48Economic and Structural Provisions. . . . . . . . . . . . . . . . . . . . 48Representations and Warranties . . . . . . . . . . . . . . . . . . . . . . 52Interim and Post-Closing Covenants . . . . . . . . . . . . . . . . . . . 59

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Employee Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61Deal Protection Devices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62Conditions to Closing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67Miscellaneous Provisions. . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

Chapter 7 Indemnification & Contribution . . . . . . . . . . . . . . . . 69Why Indemnification? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69Acquisitions of Publicly-Traded Targets . . . . . . . . . . . . . . . . . 70Types of Indemnified Matters . . . . . . . . . . . . . . . . . . . . . . . . . 71Definitional Limitations on Indemnification . . . . . . . . . . . . . . . 73Monetary Limitations on Indemnification . . . . . . . . . . . . . . . . 74Other Limitations on Indemnification . . . . . . . . . . . . . . . . . . . 76Sole and Exclusive Remedy. . . . . . . . . . . . . . . . . . . . . . . . . . 77Indemnification Procedures; Dispute Resolution. . . . . . . . . . . 77Hold-Backs of the Purchase Price . . . . . . . . . . . . . . . . . . . . . 78Contribution Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

Chapter 8 Fiduciary Duties of Board of Directors . . . . . . . . . . 81Overview of Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . 81Heightened Fiduciary Duty . . . . . . . . . . . . . . . . . . . . . . . . . . . 89Fiduciary Duty Implications of Certain M&A Transaction

Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91Voting Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

Chapter 9 Stockholder Approvals and SecuritiesCompliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

Obtaining Stockholder Approvals . . . . . . . . . . . . . . . . . . . . . . 98Registration Statements For Buyer’s Securities . . . . . . . . . . . 104

Chapter 10 The Role of Investment Bankers in M&ATransactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

The Engagement Letter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107Fairness Opinions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112

Chapter 11 Hart-Scott-Rodino and Related RegulatoryMatters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

Brief History and Purpose of the Act . . . . . . . . . . . . . . . . . . . 115HSR Notification Requirements . . . . . . . . . . . . . . . . . . . . . . . 115Beyond Notification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124Beyond the HSR Act — Government Challenges Outside the

Statutory Context . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126Beyond the HSR Act — International Pre-Merger Notification

Requirements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126Chapter 12 Tax Considerations . . . . . . . . . . . . . . . . . . . . . . . . . 127

Taxable Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127Tax-Free Reorganization . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

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Annex Section . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-1Annex 3-A Mutual Nondisclosure Agreement . . . . . . . . . . . . . A-1General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-1Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-1Use of Evaluation Material . . . . . . . . . . . . . . . . . . . . . . . . . . . A-2Non-Disclosure of Discussions. . . . . . . . . . . . . . . . . . . . . . . . A-2Legally Required Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . A-2Return or Destruction of Evaluation Material . . . . . . . . . . . . . A-3No Solicitation/Employment . . . . . . . . . . . . . . . . . . . . . . . . . . A-3Standstill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-3Maintaining Privilege . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-5Compliance with Securities Laws . . . . . . . . . . . . . . . . . . . . . . A-5Not a Transaction Agreement . . . . . . . . . . . . . . . . . . . . . . . . A-5No Representations or Warranties; No Obligation to Disclose . . . A-5Modifications and Waiver . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-6Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-6Legal Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-6Governing Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-6Severability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-6Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-7Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-7Entire Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-7Counterparts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-7Annex 3-B Summary Checklist . . . . . . . . . . . . . . . . . . . . . . . A-9Definition of Confidential Information . . . . . . . . . . . . . . . . . . . A-9Use of Confidential Information . . . . . . . . . . . . . . . . . . . . . . . A-10Non-Disclosure of Discussions. . . . . . . . . . . . . . . . . . . . . . . . A-10Legally Required Disclosures. . . . . . . . . . . . . . . . . . . . . . . . . A-11Return or Destruction of Materials . . . . . . . . . . . . . . . . . . . . . A-11Non-Solicitation/Employment . . . . . . . . . . . . . . . . . . . . . . . . . A-12Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-12Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-13Miscellaneous Provisions Applicable to Providers and

Recipients . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-13Annex 4 Sample Due Diligence Checklist . . . . . . . . . . . . . . . A-15Annex 11 Certain HSR Exempt Transactions . . . . . . . . . . . . . A-41

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PrefaceThe term mergers and acquisitions, or “M&A”, refers generally to a

number of different types of transactions, including mergers, asset acquisitionsand stock purchases. While there may be some degree of overlap among thevarious transaction types, each deal and each deal type is its own uniqueanimal driven by certain practical and business considerations of the parties.

For example, on the sell-side, a company may look to an M&A deal toprovide liquidity to its founders or because it has reached the limits of itsability to grow organically. A would-be buyer, on the other hand, may bemotivated by the prospect of acquiring strategic technology, expandingproduct offerings, adding distribution channels or increasing market share.

Even under ideal circumstances, an M&A transaction will consume man-agement resources of both the prospective buyer and would-be seller. Conse-quently, the parties must have realistic expectations of the timing, structuring,regulatory and other related considerations. Because every transaction is dif-ferent, it must be approached from the vantage point of the specific facts andcircumstances at hand. In putting this handbook together, we endeavored tofocus on these practical matters and to use them as a backdrop for ourdiscussion of the legal considerations associated with doing an M&A deal.

This handbook addresses negotiated transactions only. As such, we donot consider hostile takeovers or other situations where the would-be buyerand would-be seller have not come together willingly to attempt to do a deal.With that said, a negotiated transaction is nevertheless an adversarial pro-ceeding. While all parties to the deal may be keenly interested in getting thedeal to closing, one should never lose sight of the fact that the parties havedifferent, competing and, generally speaking, conflicting interests.

While much of the information contained in this handbook regarding bothdeal structures and principal deal terms applies to transactions involving bothpublic and private companies on the buy and sell side, certain structuralconsiderations and deal terms may be significantly affected by whether theparties involved are publicly traded or privately held. Reference is made to thesedistinctions throughout the book only where relevant to a particular discussion.

Finally, although Federal securities and anti-trust laws may come intoplay in certain transactions based on the type of deal consideration or thenature of the parties, an M&A transaction is for the most part driven by thelaws of the particular state(s) in which the constituents are incorporated ordomiciled. Accordingly, this handbook is intended to be agnostic withrespect to particular state laws. However, because it is generally acceptedamong practitioners that Delaware law tends to offer the most comprehen-sive body of M&A and corporations law, and because a considerablenumber of the public companies in the United States are incorporated inDelaware, Delaware law is sometimes discussed for illustrative purposes.

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Chapter 1

The Mergers and Acquisitions Process

As we use the term in this handbook, the mergers and acquisitions(“M&A”) process describes the methods and arrangements by which aprospective buyer and seller consummate the purchase and sale of acompany. Through this process one party decides to buy and the otherdecides to sell at an agreed price and on agreed terms. To make such adecision, the parties have to reach some level of understanding of under-lying information. This information almost always includes proprietary infor-mation which can be obtained only with the consent of the parties.Moreover, it is the kind of information which the parties will disclose onlyafter they are relatively confident that a deal will follow. Accordingly, the partof the process by which the parties exchange information (referred to as“due diligence”) often parallels to some extent the part of the process bywhich the parties arrive at a conceptual price and deal structure (the “letterof intent” or “term sheet”) and by which the parties finally establish the price,the allocation of risk and other terms and conditions of the arrangement (the“definitive agreements”). The overall effort to bring about the transaction iscoordinated with a master checklist (the “time and responsibility checklist”).

This chapter provides an overview of the stages of the acquisitionprocess with reference to some of the tools that have evolved to manageeach stage. Mergers and acquisitions are generic terms that may refer to avariety of transactions, including asset purchases, stock purchases, merg-ers, share exchanges and the like. Except where the context indicatesotherwise, the term “acquisition” is used in the broad sense to encompassacquisitions and dispositions.

Entering the acquisition process is much like starting a marriage or anew job or other life altering event in that it involves a major commitment,and is best embarked upon after carefully considering the long-term goalsof all parties involved. If you make a bad hire or match, you are likely toregret it for some time, and it is likely to be expensive.

The acquisition process involves a large cast of insiders and consult-ants, some of whom may have conflicting interests. There are also regu-latory considerations that are usually routine if addressed in a timelymanner.

There are different kinds of buyers/sellers and different kinds of deals,and the motivation for doing deals are equally plentiful and varied.

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Why Buyers Buy and Sellers SellCompetitive Advantage. Although it is unusual, there are times when a

buyer will acquire a company primarily to keep someone else from buying it.

Strategic Considerations. Strategic buyers are the proverbial crownprinces of buyers because, by definition, they pay more. Generally, astrategic buyer pays what the company is worth to the buyer rather thanwhat it is worth on its own.

Cheaper to Buy Than Make. There are buyers for whom buying othercompanies is an everyday part of their businesses. These include buyers doing“roll ups,” which are usually companies operating in an industry that is con-solidating. Generally, these buyers intend to keep and operate the companiesthey buy. On the other hand, private equity funds (formerly referred to asleveraged buyout funds) and merchant banks typically buy companies with theintention of reselling them or taking them public within some predeterminedperiod of time. These professional buyers may be opportunistic or strategic,depending on the circumstances. Generally, they are experienced buyers withexperienced advisors. Historically, they do not overpay, but they also knowwhat they are doing and do not waste the seller’s time.

Risk Mitigation. There are times when the best way to resolve or avoida lawsuit is to buy the other party.

Elements of ValueIt can be fairly inferred from the different kinds of buyers and different

kinds of deals that the parties frequently go into the M&A process withdifferent goals and expectations. These differences often center around theelements of value. The deal values of the party with the greatest negotiatingstrength generally dictate deal structure.

• Price. In a cash deal, the price dynamic reflects common sense.Setting aside tax considerations, the higher the price, the better forthe seller and the worse for the buyer. However, where the currencyis the stock of a public company, this may not be true if the deal islarge enough to be noticed by the market. Ironically, if the marketthinks the price is too high (not accretive), the value of the marketprice of the stock received as the purchase price will fall after thetransaction. Unless the seller has been able to sell or hedge the stockbefore this fall takes place, the seller will end up receiving less totalvalue because the price was set too high at the outset.

• Tax and accounting consequences. Tax and accounting conse-quences depend on the deal structure. In an acquisition, the buyer

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The Mergers & Acquisitions HandbookA Practical Guide to Negotiated Transactions

acquires either the seller’s assets or the seller itself. (To makematters complicated, there is one kind of deal — under InternalRevenue Code Section 338(h) — in which the buyer acquires theseller but the transaction is taxed as if the buyer had acquiredassets.) Generally, the buyer pays for what is acquired either withits stock, cash, or a combination of both.

It is often possible to structure an acquisition as a tax-free reorga-nization. If the transaction is taxable, the gain may be taxed as eithercapital gain rates or ordinary rates. In addition, there are somepotentially scary tax complications, generally depending on how theseller has been formed and operated. For example, if the seller is anS corporation that converted from C corporation status, it may have“built in gain” that will be taxed. Or if the seller has issued stockoptions that vest, or bonuses that are earned upon a sale of thecompany, the “excess golden parachute” payment punitive excisetax must be considered. There may also be a punitive excise tax ifstock options were granted at less than fair market value.

The choices here are complicated and often binary (that is, what isgood for one party is likely to be bad for the other). Just as the sellerwants the highest cash price, the seller also wants to pay as little taxas possible. A tax-free deal sounds like it would be best for the seller,but cash is always taxed. If the proceeds are to be taxed, the sellerdoes not want them double-taxed (at the corporate level and again atthe stockholder level) and for this reason would prefer a stock saleover an asset sale. The seller would also prefer to be taxed at capitalgain rates. If the buyer is a taxpayer and sensitive to tax conse-quences, the buyer may want a portion of the purchase price paid inrespect of covenants not to compete, which can be expensed morequickly than purchase price, but which are taxed to the seller atordinary income rates. If the seller is more sensitive to impact orearnings (e.g., a pre-IPO company), it will not want the more rapidamortization for non-compete payments.

• Liabilities and the Allocation of Risk. If a buyer buys stock, it is buyingthe company rather than the company’s assets. The company bringswith it all of the known and unknown liabilities arising from the oper-ation of the business. The known liabilities are directly addressed, butmost buyers prefer to buy assets in order to avoid, to the extentpossible, the assumption of the seller’s contingent liabilities.

• Liquidity. The seller’s primary motivation for the sale of a successfulcompany is typically to convert an illiquid asset (the company) into a

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Chapter 1 - The Mergers and Acquisitions Process

liquid asset (cash or the buyer’s publicly traded stock). On the otherhand, depending on the circumstances, many buyers using stock tomake acquisitions are concerned about the potential impact of a bigblock of stock coming onto the market. As a consequence, if theacquisition is paid for with stock, the buyer often wants to restrict thesubsequent transfer or hedging of that stock.

The PlayersThere is a long list of players potentially involved in helping the parties

reconcile the elements of value applicable to their particular type of deal. Ingeneral, the constituencies include some or all of the following:

• Owners. One way or another, the owners/stockholders always get avoice in the disposition of a company. However, depending on theform of transaction, the owners may not get a direct voice in thedecision to acquire a company.

• Management. It is unusual to buy or sell a company without thecooperation of management.

• Employees. If management and the owners are satisfied, employeesas a group generally have only indirect, if any, influence. The excep-tions are where the employees are unionized, where the buyer andseller are relying on the employees to perform during a transitionalperiod, and where a large number of employees will lose their jobs(requiring compliance with state and federal plant closure laws).

• Third parties.m Customersm Lendersm Creditors

• Advisors.m Counsel (corporate, tax, regulatory, intellectual property, etc.)m Investment bankersm Valuation expertsm Accountantsm Escrow Agentsm Financial Printers

• Regulators.m Federal Trade Commission. The Hart-Scott-Rodino Act,administered by the FTC, applies only to large deals

m Securities Exchange Commission and State Securities Reg-ulators (in the event stock is part of the purchase price or one ofthe companies is publicly held)

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m Internal Revenue Service and State Tax Regulators

m Industry Specific Regulators

Acquisition ProcessThe big-picture goal of the acquisition process is to manage the players

so as to allow the proposed transaction to be completed on time and onbudget. Of course, this is easier said than done. In practice, a number of toolsand devices have been developed to manage the constituencies as efficientlyand effectively as possible toward the realization of this goal. For example,the due diligence (fact-finding) process is generally initiated and managedwith a due diligence checklist. These tools and their purposes are as follows:

Acquisition Tools Purpose

Time and ResponsibilityChecklist

Manage the overall effort bycoordinating the constituencies

Due Diligence Checklist Manage the process by which theparties exchange information

Letter of Intent (‘‘LOI”) orTerm Sheet

The part of the process by which theparties arrive at a conceptual price anddeal structure

Definitive Agreement The part of the process by which theparties finally establish the price,allocation of risk, and other terms andconditions of the arrangement

Earn-Out or PriceAdjustment

Contingent purchase price

Representations andWarranties and Scheduleof Exceptions

Allocation of risk as to underlying facts

Conditions to Closing Allocation of risk as to supervening facts

Post-Closing Covenants Obligations of the parties after closing

Indemnities Financial consequence of risk allocation

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Time and Responsibility ChecklistThe Time and Responsibility Checklist provides an overview of the

M&A process. It breaks down the deal into component parts. Responsibilityis then assigned and a schedule set for each part.

A typical Time and Responsibility Checklist includes the following:

• a list of each person who will have responsibility for some part of the deal(generally, the parties listed above in the discussion of constituencies);

• a list of each document or action required to complete the transac-tion, organized as described below:

m for each, an assignment of responsibility for drafting andreviewing that document or action;

m for each, a status report; andm for each, a due date.

Each document or action is further broken down with reference to thestage of the process, as follows:

• Actions Taken Prior to Signing Definitive Agreement:m term sheetm board approvalsm formation of newco (where an acquisition sub is formed)m business due diligencem legal due diligence

• Agreements and Documents to be Delivered at Signing, e.g.:

Asset Purchase Agreement (the Exhibits Differ for a StockPurchase Agreement and Merger Agreement)

m assumption agreementm bill of sale and assignmentm buyer’s closing certificatem contract assignmentm lease assignmentm seller’s closing certificatem trademark and patent assignmentm stockholder agreementm offer letters

• Pre-Closing Actions:

Company Stockholder Written Consentm Information Statement (provides disclosure to stockholders inconnection with soliciting consent to the transaction)

Third Parties Requiring Notice

Third Parties Requiring Consent

Allocation of Cash Consideration

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• Agreements and Documents to be Delivered at Closing:

Generalm Governmental Approvalsm Company Stockholder Approval for Asset Purchase

Deliverables/Actions; Conditions to Closingm Assumption Agreementm Bill of Sale and Assignmentm Contract Assignmentm Lease Assignmentsm Buyer’s Closing Certificatesm Seller’s Closing Certificatesm Trademark and Patent Assignmentm All Government Consents Obtainedm Third Party Consentsm Offer Lettersm Good Standing Certificates

The closing is the time when all documents, like consents and permits,must be delivered and proof of any necessary government filings, good standingcertificates and approvals are required. All ancillary agreements and certificatesmust also be delivered at the closing. It is obviously “crunch time.”

Leveraging The ProcessWhile M&A transactions come in a variety of shapes and sizes, and

vary from industry to industry, in negotiated transactions, the overall pro-cess by which the buyer and the seller look to consummate a transaction isfairly constant. Both the buyer and the seller should have a firmunderstanding of the process, as time, money and ultimately the deal itselfmay depend on it.

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8


Chapter 2

Letters of Intent & Term Sheets

How does a deal begin? Parties known to one another may from time totime undertake discussions about a potential tie-up. Often these discus-sions do not end up amounting to much. However, on some occasions theparties are serious enough about their discussions to want to memorializecertain key understandings in writing. Such a writing is generally referred toas a letter of intent — i.e., the parties’ expressed desire to go forward insome manner.

The terms “letter of intent,” “term sheet,” “memorandum of understand-ing” and “heads of terms” are generally synonymous in that they essentiallymake reference to the same type of document — i.e., an agreement inprincipal by a would-be buyer and would-be seller to further consider thepropriety of doing a deal. In some circumstances, a letter of intent and termsheet will be combined, with the letter of intent portion setting forth a high-level discussion of the transaction terms which are then set out with greaterparticularity in a term sheet (attached as an exhibit to the letter of intent).This is really a matter of personal preference as the substance of thedocument will be the same regardless of the form in which it is presented.For purposes of this chapter, the term “LOI” or “letter of intent” is usedbroadly to encompass all incarnations of such agreements in principal.

In many deals the first statement of deal terms will be in an LOI or termsheet; however, in some cases the parties may move from a generaldiscussion of proposed transaction terms straight to negotiation and doc-umentation of the definitive acquisition agreement.

While there may be compelling reasons for the parties’ decision toforego a letter of intent, in complex deals the parties are often better servedby taking the extra time to negotiate an LOI. Among other things, a letter ofintent provides the parties with a structure to their discussions and may setout the parties’ expectations as to how the deal negotiations will proceed.Moreover, a well-crafted LOI may streamline drafting and negotiation of thedefinitive acquisition agreement and as a result actually reduce transactiontime and expense.

While a letter of intent is not intended to function as the definitive acqui-sition agreement, to the extent the parties do have an LOI, it should not be socursory or high level in nature that the parties move forward without having atleast a general understanding of what the deal terms will ultimately look like.

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Letter of Intent Pros and Cons

Parties sometimes resist using letters of intent because, like thedefinitive acquisition agreement, the LOI is a negotiated document. Nego-tiating and drafting an LOI will invariably involve additional front-end timeand expense for the parties. Often the parties are reluctant to want to takethe “bloom off the rose” so to speak by having to undertake tough nego-tiations when they are just getting to know one another.

Additionally, either party may be reluctant to enter into an LOI for fear ofconceding a particular point that has not been fully vetted. This may be lessof an issue for the buyer because in all likelihood the buyer will have onlyundertaken limited, if any, due diligence up to that point and will typicallyreserve its rights to modify certain deal terms based on the results of its duediligence review.

Often the letter of intent will provide for a limited period of exclusivenegotiation between the buyer and seller. This is disadvantageous for theseller, but it is one of the primary reasons why buyers often insist that theparties execute an LOI.

Binding or Non-Binding

Generally, an LOI will be non-binding with respect to all but a fewcertain provisions. Typically, the binding provisions in an LOI will involve:

• confidentiality obligations of the parties;

• an exclusivity period (i.e., no shop) running to the benefit of thebuyer; and

• the right of the buyer to receive a termination or break-up fee in theevent the seller walks away from the deal.

If the parties have not previously entered into a confidentiality agree-ment, it would be prudent for them to do so at the time they undertakenegotiation of an LOI. Once an LOI has been executed, the parties’ focusgenerally shifts to the due diligence investigation, timing considerations andnegotiation of the definitive acquisition agreement. It is important not to letthe confidentiality agreement slip through the cracks.

Care should be taken to ensure that the LOI is truly non-binding, exceptas noted above, and does not inadvertently create a binding “agreement tonegotiate” definitive terms. In some jurisdictions courts have prescribed so-

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called “magic” language that expressly removes any such implicit duty tonegotiate.

Elements of the Letter of Intent

To some extent, the terms of the LOI will mirror what one would expectto find in the definitive acquisition agreement, only with less specificity. Atypical LOI will likely address at least the following:

• Assets/Stock — description of the assets (which may simply bedescribed as “all or substantially all” of the seller’s assets), or capitalstock to be acquired

• Acquisition Consideration — consideration to be paid by thebuyer in respect of the assets or stock of the seller (e.g., cash,stock, earn-out, etc.)

• Closing Conditions — specifies certain key closing conditions,such as voting agreements (and proxies), votes/consents required,required regulatory approvals, and required third party consents

• Closing Date — general timetable for completing the transaction

• Corporate Approvals — whether stockholder consents arerequired or whether a stockholder meeting will be called

• Due Diligence — the parties’ respective access to the books andrecords of the other party

• Escrow — amount of acquisition consideration to be escrowed orheld-back to backstop indemnification or other post-closing obliga-tions of the seller

• Governing Law — legal jurisdiction governing the terms of thetransaction, including the LOI

• Representations & Warranties — scope of the seller’s represen-tations and warranties (Note: because of the abbreviated nature ofthe typical LOI, parties often simply provide for “customary” repre-sentations and warranties, which may set the stage for disagreementduring negotiation of the definitive acquisition agreement)

• Structure — whether the transaction will be structured as a merger,asset acquisition or stock purchase

• Survival — length of time after closing that the parties’ representa-tions and warranties will survive

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Chapter 2 - Letters of Intent & Term Sheets

A more comprehensive LOI might also address other considerations,including:

• Board Representation — whether the seller would retain any post-closing representation on the board of the acquired entity

• Employment Agreements — if the buyer is to retain certain keymembers of management, the LOI may condition closing of the dealon the buyer’s ability to negotiate satisfactory employment agree-ments with such management members

• Fees and Expenses — any special fee arrangements among theparties

• Options — treatment of outstanding employee stock options uponconsummation of the transaction (Note: terms of the option plan andapplicable option agreements will need to be considered)

• Publicity — whether either party is permitted to announce the trans-action (typically the parties will agree to keep the LOI and proposedtransaction confidential)

• Registration Rights — buyer’s obligation to register any of its secu-rities used as acquisition consideration

• Tax Treatment — whether the parties intend for the transaction toreceive a certain tax treatment (i.e., tax free reorganization)

While there may be strategic or tactical considerations for the parties’decision to forego an LOI, if thoughtfully considered, a letter of intent mayprovide the parties an early indicator of whether there is indeed a deal to bedone.

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Chapter 3

The Nondisclosure AgreementThe nondisclosure agreement, often referred to as the NDA or con-

fidentiality agreement, is typically one of the first agreements to be enteredinto in an M&A transaction. The agreement is designed to protect theconfidentiality of information exchanged in connection with the transactionand during the course of one party’s due diligence review of the other party.

This chapter outlines a few of the more frequent issues encountered innegotiating a typical NDA for a merger or acquisition. Generally, the sellerprovides the buyer with confidential information. However, as noted above,the seller may also receive confidential information from the buyer. If thetransaction involves significant equity being issued by the buyer, bothparties may provide confidential information to each other. In such circum-stances, the concepts discussed below should be considered accordingly.

The NDA is usually prepared by the seller’s counsel or the seller’sfinancial advisor. Although the principal focus of the agreement is protectingconfidential information that the seller provides the buyer, the buyer mayalso have an interest in maintaining the confidentiality of information pro-vided during the course of negotiations. For example, the buyer may haveprovided confidential information to the seller in order to provide assur-ances of its ability to pay the consideration for the acquisition. If the buyer isissuing equity as consideration, the buyer may provide sensitive informationto the seller related to future business plans in order to demonstrate to theseller that the buyer and the seller make a good business fit, to assure theseller of its ability to develop the seller’s combined businesses in the future,or, if the buyer is issuing a substantial percentage of its equity as consid-eration, to satisfy the seller’s due diligence investigation of the buyer.

If both buyer and seller provide confidential information to each other, a“mutual” NDA will be needed. If the provision of confidential information isonly contemplated to be from the seller to the buyer, a “unilateral” NDA maybe used. In most instances, however, a mutual NDA will often still be usedbecause the buyer’s confidential information may be disclosed to the sellerat some point during the discussions, even if it was not originallycontemplated.

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Practical Tip: Tailoring the NDA to the Specific Deal

Parties will often mistakenly start with an NDA that is designed forproviding information to vendors or with a short-form NDA that is nottailored for M&A transactions. The parties should be careful to avoidthis mistake, because the NDA for an M&A transaction will containspecific provisions addressing matters not necessarily present inother situations. For the same reasons, the parties should avoidthe temptation to rely on an NDA previously used by the parties ina prior commercial arrangement.

Understanding the Scope of Confidential Information

One of the preliminary matters to review in any NDA is the scope of thedefinition of “confidential information.” The seller should carefully examinewhether the definition of confidential information sufficiently covers theinformation and materials it will provide to the buyer (and, to the extentapplicable, confidential information that may have been provided to thebuyer before the NDA was signed) to ensure that it does not inadvertentlyexclude information or materials intended to be confidential. In addition, theseller should be wary of “residual” clauses that allow the buyer, in its futureproducts or services, to use confidential information retained in the “mem-ory” of the buyer’s employees. On the other hand, the buyer typicallyattempts to limit the definition of confidential information so that it doesnot include information created or discovered by the buyer prior to, orindependent of, the seller.

If the buyer is a close competitor, the seller may have particularconcerns about providing highly sensitive information to the buyer (e.g.,pricing information, patent information or source code). Similarly, the buyermay not want to review such highly sensitive information because it mightexpose the buyer to future claims of misuse of proprietary information inviolation of the NDA or pose regulatory concerns. Therefore the parties maywant to consider carving out any subset of information that is extremelyconfidential to the seller. These items may be better addressed in a sep-arate NDA containing careful controls and procedures to limit the distribu-tion and access of information to those advisors or agreed-upon personnelof the buyer whom the seller reasonably believes will not exploit the infor-mation commercially.

Another issue that may arise is how to determine whether informationis confidential. The seller may want to remove any onerous legending

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requirements that would require the seller to mark written materials “con-fidential” or to reduce oral statements to writing. The potential pitfall of suchrequirements is that the seller may disclose confidential information assum-ing such information is protected when it is not in fact protected by the NDAbecause the seller inadvertently failed to legend the confidential informationor to summarize oral confidential information in writing. The buyer mayagree to waive these requirements, especially since such requirementsoften lead to a delay in receipt of due diligence materials due to the seller’sneed to carefully legend each document delivered or desire to limit accessto and control oral diligence discussions.

For evidentiary purposes, the seller should maintain a list or copy of allthe documents provided to the buyer and all persons to whom such doc-uments were delivered. This will also help the parties to keep track of whatwas previously provided so that duplicative requests for information can bereduced.

Use of Confidential Information

In addition to defining which information is confidential, it is importantthat the seller prevent the buyer from using the confidential informationprovided by the seller for any purpose other than evaluating the possibletransaction at hand. The seller may want to insist on language in the NDAstating that the confidential information is to be used solely for the purposeof evaluating the transaction and that no implied license is being granted toany of the seller’s intellectual property.

The seller may also want to protect its confidential information bylimiting the distribution of confidential information to a select group of thebuyer’s representatives. The seller may also consider a provision in theNDA that would allow the seller to hold the buyer liable for any improper useof confidential information by the buyer’s representatives. Alternatively, ifthere are heightened concerns about the sensitivity of the information, theseller may ask that confidential information be disclosed only to the buyer’srepresentatives listed on a separate schedule to the NDA and that suchpersons provide an acknowledgement, in writing, that they are bound by theobligations of the NDA.

Non-Disclosure of Discussions

Both the seller and the buyer often want to keep confidential the factthat discussions are taking place. Disclosure of such information couldcreate uncertainty among the seller’s suppliers, customers, vendors, and

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Chapter 3 - The Nondisclosure Agreement

employees, and if the seller is a publicly-traded company, result in adramatic change in the seller’s stock price. The buyer typically has con-cerns about the confidentiality of discussions for similar reasons, and, inaddition, will want to limit the seller from using the buyer’s interest in theseller to negotiate a potential sale to another party in order to avoidcompetitive bidding or to prevent disclosing the buyer’s potential businessstrategy to its competitors. However, in an auction context, the seller mayattempt to retain its ability to disclose the fact that the buyer is a bidder, or, tothe extent possible, to disclose the terms of any bid made by the buyer toother bidding parties. If the buyer needs financing to complete the trans-action, the buyer may negotiate an exception allowing it to disclose infor-mation to its financiers.

Practical Tip: What it Means to Not Disclose Discussions

• May not disclose that evaluation materials have beenexchanged

• May not disclose that discussions or negotiations are takingplace

• May not disclose the terms and conditions of such discussions

Legally Required Disclosures

In some situations, the buyer may be legally required to disclose confi-dential information to third parties in connection with legal proceedings. Toaddress this scenario, the seller should request either (i) the right to object tothe disclosure of any confidential information, or (ii) at the very least, the abilityto limit or control the scope of any court-ordered disclosure. The seller shouldalso insist that the buyer and its representatives notify the seller within a certainperiod of time of any legal proceedings that would require the disclosure ofconfidential information. The notification period should give the seller enoughtime to seek injunctive relief or some other protective order from an appropriatecourt. The seller may also want to request that the buyer fully cooperate or useits reasonable best efforts to cooperate with the seller in obtaining such a courtorder. If the seller is unable to obtain such equitable relief, the seller will wantlanguage stating that the buyer will only disclose confidential information that islegally required to be disclosed, in the opinion of its legal counsel.

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Return or Destruction of Materials

It is important to the seller that all written confidential information bereturned or destroyed by the buyer, together with all copies and derivativematerials, if the acquisition is not completed. However, the buyer may preferto destroy the confidential information, or certify to the seller that it hasdestroyed the confidential information because its representatives may havemade written notes on the documents or incorporated the content of thosedocuments into internal memoranda or business presentations. If the selleraccepts the buyer’s certification alternative, it should consider requesting thatthe buyer list the documents that have been destroyed. Some thought shouldbe given to the destruction of electronic data on the buyer’s computer harddrives and servers, as well as the tangible copies of confidential informationthat the seller supplied. In some circumstances, the buyer may ask that acopy of what was received be retained for archival/evidentiary purposes toprotect itself from being accused of using disclosed confidential information.If this is the case, a copy should be kept by outside counsel only.

Non-Solicitation/Employment

A prospective buyer may seek to interview the seller’s employees as it“kicks the tires” on its potential acquisition. This raises two concerns for theseller: (i) it may alert the seller’s employees of a potential acquisition,making it difficult for the seller to continue its normal course of business,and (ii) it may result in a situation in which the potential buyer decides tosolicit key employees rather than acquiring the entire company. The sellershould request language in the NDA prohibiting the buyer from soliciting orhiring the seller’s employees for some period of time (typically 6 months to2 years, one year being fairly common) and from soliciting or hiring formeremployees who may depart within some period of time (typically 3 to6 months). The buyer may resist this prohibition by arguing that it is alarge entity and that keeping track of the solicitation and hiring activities ofits human resources department will be difficult, if not impossible. As aresult, the buyer may ask to limit this provision to only “key” employees oremployees that the seller identifies during the due diligence process.Furthermore, the buyer may argue that general solicitations not directedat the seller’s employees should be carved out because the buyer has nocontrol over whether the seller’s employees receive or respond to generalsolicitations that may appear in newspaper publications or on the Internet.

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Term

The term of the NDA will depend on (i) the strategic value of theinformation to the seller, and (ii) how quickly such information may becomeobsolete. Some NDAs fail to include a “sunset” provision and are silent as tothe duration of the confidentiality obligations under the NDA. In such cases,the seller may argue that the confidentiality obligations, especially thoserelating to core technology that will not become obsolete, should neverterminate. However, the buyer should attempt to limit the NDA to a specificperiod of time (typically 1 to 5 years) because the seller’s proprietary know-how may become obsolete in several years and the buyer will not want to belimited by the NDA in making new technological developments. The buyermay suggest that the NDA terminate upon the earlier of (i) completion of thetransaction or (ii) within a period of time after signing or termination ofnegotiations if the transaction fails to close. If the seller is providing softwaresource code, it should consider asking for a carve-out provision excludingsource code from any time limits on protection.

Practical Tip: Avoiding Inadvertent Termination of the NDA

Generally, a definitive agreement will have a provision that statesthat the definitive agreement sets forth the entire understanding of theparties relating to the subject matter thereof, that it supersedes allprior understandings, and that all prior agreements are terminated.Make sure that the NDA is carved out from this provision so that theNDA is not inadvertently terminated.

Remedies

Another issue to consider in evaluating NDAs is the question of rem-edies. The seller will want to include some language from the buyeracknowledging and agreeing that monetary damages are insufficient toremedy a breach of the NDA and that the seller is entitled to injunctive reliefin addition to any other remedies. The seller may also request that the buyerpay any legal fees resulting from a breach of the NDA, but a provisionstating that the prevailing party will pay the legal fees may be a morereasonable compromise.

Choice of Law/Forum

With respect to a one-way NDA, the law and courts of the domicile ofthe disclosing party is typically provided for. Where both parties are making

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disclosures, this issue is frequently contentious. A possible compromise isto provide that the law and forum of the domicile of the disclosing party willcontrol with respect to disputes involving that party’s confidentialinformation.

While the NDA is typically one of the first agreements to be entered intoin an M&A transaction, it is often the most overlooked. When negotiatingand finalizing the NDA, the parties should carefully weigh the desire toproceed quickly with a transaction against the importance of assuring thatthe NDA adequately protects the parties’ interests. A sample form of amutual NDA is attached as Annex 3-A and a checklist of items to look forwhen reviewing an NDA is attached as Annex 3-B for your reference.

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Chapter 4

Legal Due DiligenceIn the context of an M&A transaction, the term “due diligence”

describes the process each of the parties undertakes to investigate theother before a final decision is made whether to proceed. It can be likened todating (or maybe an engagement) before marriage. The parties are stillfinding out about each other, and either can back out, though that is likely tobe unpleasant for one or both. Usually the buyer assures its investigation iscritical to permit it to decide to spend its cash or issue its securities to buythe seller. However, a savvy seller will be equally concerned about the buyerif the consideration is stock in the buyer or there is some strategic com-bination contemplated.

What Is Due Diligence and When Is It Performed?

Due diligence is not a formality. It is a critical part of any M&A trans-action because it allows a buyer or a seller to examine the business, legaland financial affairs of the other to confirm that it is getting what it thought itwas getting. The results should answer two important questions: (i) “Can orshould we do the deal?” and (ii) “On what price/terms do we want to do thedeal?” Due diligence may expose “deal breakers” (e.g., accounting issues,litigation, regulatory issues, tax issues, third party consent issues, etc.) thatcould materially change the anticipated benefits of the deal. At a minimum,discoveries can change the price/terms of the deal. At the worst, thediscoveries may prevent the deal from getting done at all.

Due diligence findings are also a critical concern in drafting the defin-itive transaction documents, in particular, the representations, warranties,covenants and disclosure schedules. Due diligence allows the parties toallocate the risks as they move forward.

What Are the Objectives of Due Diligence?

The objectives of due diligence vary depending upon:

• whether a party is the buyer or the seller;

• the buyer’s business purpose for the transaction (i.e. does the buyerplan to integrate operations following the closing, or will it strip downthe seller’s operations to assets); and

• the proposed deal terms, including the type of consideration that theseller would receive.

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For the buyer (or seller if the transaction contemplates a stock-for-stock exchange, “merger of equals,” or strategic combination), the objec-tives of due diligence may include the following, among others:

• accumulating sufficient information to validate the proposed valua-tion and to justify the business reasons for consummating the deal;

• learning more about the seller’s business and operations;

• uncovering and identifying the current and potential issues, prob-lems, risks and liabilities posed by the transaction;

• determining whether the seller’s business can effectively be inte-grated into that of the buyer; and

• identifying unused capacity and determining how such capacity canbe effectively utilized to produce synergies.

For a seller receiving cash consideration in the transaction, its focusduring due diligence will be on (i) what stockholder or third-party consentsare required to consummate the transaction; (ii) corporate, businessrecords, or contract clean-up issues; (iii) compensation, severance, orpersonnel matters; and (iv) arrangements where the consummation ofthe transaction would cause an undesirable effect on the seller, such asan event of default, a right of a third party to terminate a material obligationof the seller, or a trigger of a source code escrow obligation.

Overview of the Due Diligence Process

Due diligence is routinely time consuming and often complex. However,the process can be manageable and cost-effective if a party spends time inadvance creating a due diligence plan and forming a due diligence team.

The first step in the due diligence process (after, of course, finding adeal) is for the parties to enter into an NDA or confidentiality agreement.This agreement protects the subsequent disclosure of information that willbe provided to a buyer or seller in connection with the due diligence reviewof the other party. As discussed in greater detail in Chapter 3 (“TheNondisclosure Agreement”), a well-designed NDA accomplishes thefollowing:

• sets the ground rules concerning the disclosure and use of anyprovided information;

• defines the scope of the documents and materials that will bereviewed (for example, certain competitive or sensitive information

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may be initially excluded from the process until the parties progressfurther in the negotiations, or may be further subject to explicitscreening procedures);

• may include prohibitions on the solicitation of employees and other“standstill” provisions; and

• addresses the processes and ongoing obligations of the parties(including the return or destruction of confidential information) incase the deal falls through during the due diligence stage.

The next step in the due diligence process is assembling a duediligence team and assisting the individuals who will actually be performingthe due diligence to understand the type of transaction, the context of theproposed investigation, and the type of company that is being reviewed. Bydeveloping a general understanding of key features of the deal including itsscope, periods of review, and materiality thresholds common for deals ofthese types and in the applicable industry, as well as the expected timing ofthe transaction, the due diligence team can prioritize its review and struc-ture the campaign accordingly.

What information does the recipient need or want? In this step, theparties should broadly identify the scope of the documents they would liketo review and prepare a list of the requested documents and information(“due diligence request list”). This list, which also creates a mechanism foridentifying and cataloguing both the information requested and the infor-mation received, is usually very broad in the beginning of the due diligenceprocess. Upon finalizing the list of initial documents that the reviewing partywould like to receive, the due diligence request list is presented to the otherside, which then begins to compile, copy, and index the requestedmaterials.

Because due diligence is an evolutionary process, the review of onedocument may prompt an additional line of inquiry or a need for additionaldocuments on the same subject (e.g., supplemental due diligence requestsconcerning intellectual property, export, governmental contract, and envi-ronmental information matters). These supplemental due diligencerequests are common and an important part of the process.

Once the materials have been prepared and organized, the disclosingparty distributes the documents and materials to the reviewing party’s duediligence team. Historically, this distribution was made in person by deliv-ering the documents to a “data” or “war” room at the offices of the disclosingparty’s counsel. In such cases, the reviewing party’s due diligence team

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Chapter 4 - Legal Due Diligence

would perform its due diligence review in those offices. More recently,however, parties have begun to copy and mail (or email) due diligencedocuments to the reviewing party’s due diligence team and even post thematerials to secure online data rooms.

Once the diligence materials have been made available, the diligenceteams may spend hours or days reviewing such materials and compilingappropriate work product to memorialize their findings.

Practical Tip: Online Data Rooms

Online data rooms allow the reviewing party’s due diligence teamto review the documents in the comfort of their own offices, whichgenerally has the effect of decreasing the cost of the due diligencereview (i.e., there is no need to travel to remote locations to carry outthe review). However, convenience and potential cost reduction mustbe balanced against any issues that may result from the broaderdissemination of sensitive information.

Who Is Involved and the Necessity of a Diverse Team ofExperts

Every deal is different, and one of the first priorities in the due diligenceprocess is to assemble a diverse due diligence team. The team’s collectiveexpertise should cover the various business, legal, technical, and financialmatters unique to the seller and the deal at hand. This means not onlyassembling the appropriate legal team, but making sure that the buyer orseller has designated the appropriate in-house contacts to address ques-tions that may arise concerning financial, customer, marketing, technical/engineering, information technology/infrastructure, or personnel matters.

Although the primary lawyers on the deal will conduct much of the legaldiligence review, there are certain areas that will warrant a legal “special-ist’s” review. These areas include antitrust, corporate and securities, debtfacilities, environmental, executive compensation and employment, gov-ernment contracts or regulatory agencies, import and export, intellectualproperty, litigation, privacy, real estate and real property, and tax. Eachspecialist should have an integral role in creating the contents of the duediligence request list (or responding to the request list), reviewing materialrelated to the specialist’s subject matter, and drafting, reviewing and mod-ifying the portions of the definitive transaction documents relevant to thespecialist. In order to make the due diligence review by a specialist cost-

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effective, the specialist should be briefed on the objectives of the parties asdiscussed above.

The due diligence process is a collaborative effort and delegatingresponsibility will facilitate a more efficient and effective process, therebyproducing a higher quality result and reducing the probability that key issueswill be overlooked or improperly addressed or negotiated.

Practical Tip: Points of Contact

Consider having one point person each for the seller, its counsel,the buyer, and its counsel, whose task is fielding and responding to allrequests for additional due diligence material or information.

Due Diligence Request List

The due diligence request list (as prepared by the investigating party)is an important step in formulating the scope of a due diligence review.Although some may believe that this list is generic or “boilerplate,” a detailedand targeted request list can make the due diligence process more efficient,which may also lead to a more thorough and cost-effective review. Ingeneral, a due diligence request will include all material agreements,stockholder agreements, capitalization records, financial information, cus-tomer and supplier information and contracts, employee records, andbenefits plans.

Despite the general nature of the types of information that will berequested, the list itself should be fairly specific, and tailored to the specificdeal. It is better to make a targeted request for specific materials than it is tomake a general request such as, “Provide us with all material informationabout the company.” For example, asking for “all charter documents” or “allfinancing documents” is not as helpful or efficient as asking for “thecompany’s certificate of incorporation, its bylaws, and all amendmentsas now in effect” or “all loan agreements, credit facility documents, securityagreements, indentures, bonds, notes, and other evidences of short-termor long-term indebtedness, and all amendments, as now in effect.” This isparticularly the case with parties that are not experienced in handling duediligence requests and may not be familiar with the information generally.

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Practical Tip: When a Broad DiligenceRequest is Appropriate

A broad diligence request list may be appropriate when:

• the timeline is very tight (for example, a deal involving a publiccompany in a competitive situation or a situation in which therisks of a leak are high);

• the disclosing party has a large diligence team to respond to theentire request;

• the recipient has sufficient resources and personnel to handleand review the information upon receipt; and

• both parties have committed to completing the diligence pro-cess efficiently and expeditiously.

Whether the request is global or targeted, generic or detailed, it shouldbe tailored to the particular provider as much as possible. For example, ifthe provider is a public company, its SEC filings should be read before therequest is submitted. This will enable the recipient to identify particulardocuments (or potential documents) it might not otherwise be in a positionto ask for specifically.

Although this kind of customization is more difficult when the provider isa private company, it is not impossible. The recipient will likely have somespecific information about the provider (from firsthand knowledge or infor-mation from a website); and a modest amount of advance teamwork amongthose who have this information can help focus the request.

Practical Tip: When the Disclosing Party is Public

Review SEC filings (e.g., forms 10-K, 10-Q and 8-K) beforepreparing a diligence request.

Attached as Annex 4 is an example of what a comprehensive duediligence request list might look like. Please note that this form is merely astarting point. However, whether the form is used for a single global requestor staged focused requests, it should provide an itemized list of materialdocuments that are important in any due diligence review. The form may beused by provider and recipient alike as an inventory of documentsrequested and provided.

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Response to Due Diligence Request List

Once the team has been assembled, the due diligence request listitems have been delegated among team members, and the seller and itscounsel have had the chance to collect and review all of the itemsrequested, the seller’s counsel typically prepares a formal written responseto the due diligence request list.

In an ideal world, the seller would be able to produce all of the itemsrequested at once. In practice, however, and in order to keep the duediligence process moving forward, the seller will usually be unable toassemble all of the requested information and materials at once. In thesesituations, the parties will usually deliver a partial response and will followup with additional information as it is assembled. All materials delivered bythe seller should be accompanied by a written response and should beorganized to correspond with the due diligence request list (e.g., a responsethat addresses each requested document item-by-item). This will allow thebuyer and seller to more efficiently and effectively locate and review thedesired information and will make subsequent supplements or updateseasier.

Typically, commencement of the due diligence process will require thata large amount of information be located, reviewed, and produced in arelatively short period of time. In most cases, the buyer will require that theseller, and the seller will wish to, keep the potential transaction confidentialand not disclose its existence to the employee base. This reduces thenumber of people on the seller’s side available to help in the due diligenceprocess. As a result, most of the information gathering is done by a handfulof the seller’s personnel, who are oftentimes the high-level executives of theseller, or the seller’s legal counsel. Some of the information may need to becollected by or from employees who have yet to be informed of a potentialtransaction, and accordingly, production of such items may need to waituntil the likelihood of consummating the transaction is higher.

It is important that no due diligence material is produced to the otherside until counsel to the disclosing party has had the opportunity to screen,if not complete its review of, and organize, such material. A provider ofinformation should always memorialize what they send to the other side.Often, particularly in time-intensive situations, the provider responds to thedue diligence request with an “information dump”, where armfuls of doc-uments are grabbed from drawers and file cabinets, boxed up, and sentwithout first being inventoried.

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Practical Tip: Information Dumps May Have Bad Results

Among the unfortunate results of the “information dump”approach are

• potential disputes down the road over what was and was notprovided;

• potential inadvertent waivers of the attorney/clientprivilege; and

• potential disclosure of sensitive documents.

To minimize the risks of inadvertent disclosure, it is essential to estab-lish a control mechanism with respect to the review, organization, anddelivery of the documents by the provider and its evaluation by the recipient,and the creation of an accurate record of the documents so provided. Themost common approach is to designate a single person or a very smallgroup of people to act as a gatekeeper through which all documents mustflow. In certain situations, this approach may produce internal resistancebecause of concerns that such coordination will slow down the reviewprocess.

The due diligence process can be very disruptive to the operations of aseller. Because the buyer is trying to review a large portion of the seller’sbooks and records (and the information may not be readily organized andavailable), collection and review can be time-consuming and in turn divertthe attention of company personnel to matters other than the seller’s corebusiness objectives and operations.

Practical Tip: Source Code Protection and otherProprietary Information

For protection of source code or other highly confidential propri-etary information the seller may insist that the parties engage a third-party/independent organization tasked with evaluating the sourcecode base or other highly confidential proprietary information ratherthan delivering it directly to the buyer.

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Scope and Process of ReviewOnce documents have been delivered, the reviewing party may wish to

consider imposing some sort of control on the reviewing team as to theallocation and distribution of the documents. As discussed above, a full-scale due diligence review — particularly when the provider is a largecompany — will involve experts in many disciplines (for example, tax,accounting, intellectual property, employee benefits, environmental, andregulatory areas). Within each discipline, more than one reviewer willprobably be necessary. For instance, different people may be needed toreview federal and state tax issues, or patents and copyrights. In order tocontrol this process and track the documents that are being reviewed byvarious team members (in case the documents must be returned ordestroyed), a single individual responsible for each category of requestedinformation should be established. This procedure helps ensure that thereis a “closed loop” of identified individuals who know about the transactionand receive the documents for review.

Once an NDA has been signed, the due diligence request has beensubmitted, coordination procedures have been put in place on both sides,and the information has begun to flow, the real due diligence work canbegin: evaluating the information and its relevance to the potential trans-action. In this part of the process, the due diligence team will begin to reviewall the documents and materials provided to date, paying particular atten-tion to those issues that may impact the proposed terms in the definitivetransaction documents or the likelihood of consummation of the deal.

Much of the diligence review during this process is often performed byrelatively junior team members. As such, it is important for junior teammembers to raise potential problems to the more senior members of theteam as quickly as possible. Experience is the key to effectively analyzingand evaluating the results of a due diligence review. For example, an issuethat may be deemed to be “interesting, but immaterial” to a junior member ofthe due diligence team may be extremely material to a more senior personwho has firsthand knowledge of the problems associated with these situ-ations. In fact, such information may ultimately be linked to another issuethat, together, may be one of the most important issues to the buyer. Thus,coordination among reviewing team members is critical to success.

An equally important mechanism in the due diligence process is theexchange of information orally through site visits, interviews with management,formal presentations, and informal discussions. This part of the due diligencereview is often performed by the acquisition team and other principal employ-ees or consultants of the reviewing party. Generally, attorneys are not

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significantly involved in this process. In this step, members of management ofthe disclosing party may prepare and deliver detailed presentations that givean overview of the operations, prospects, and finances of the subject company.The acquisition team will then have the opportunity to talk to these individualsto “drill down” on the assumptions and statements made in the presentations.An important fact to remember in these situations is that presentation mate-rials, statements made in these meetings, handouts, and other materials willdirectly affect the scope and substance of the representations and warrantiesand the extent of indemnification obligations (if any) in the definitive acquisitionagreement. The buyer’s team will note any inconsistencies and inaccuracies inthese statements and use these facts to shift any risks relating to the state-ments to the seller and its stockholders under the representations, warranties,and covenants contained in the definitive agreement.

Results of ReviewThe results of the due diligence review will ripple through all aspects of

a proposed M&A transaction. A detailed summary of the due diligencereview, often called a due diligence memo, is usually prepared by counselas a way to organize, track, and manage which documents have beenreviewed, who reviewed them, and what issues or action items wereidentified. The due diligence memo may also become an important toolfor both the business and legal aspects of negotiating the final deal terms.

Once the parties have digested the results of their respective duediligence investigations, the last step in the due diligence process is makingcertain determinations:

• Can or should we do the deal?

• Do we still want to do the deal?

• Is the seller worth the valuation as originally proposed or should therebe a reduction in the purchase price?

• Should an alternative form of consideration or payment be consid-ered, such as an earn-out?

• To what extent should the scope of the representations and warran-ties be expanded?

• Is an adjustment to the indemnification and escrow term or amountnecessary?

• Should additional covenants or conditions to closing be added (e.g.,third-party consents, employee retention targets, required termina-tions (of contracts, customers, or personnel)?

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Practical Tip: Hot Issues in Due Diligence

Following is a list of “hot” issues that may arise during the courseof the diligence investigation, and which may impact the definitivetransaction documents:

• capitalization issues

• nonassignability clauses

• termination/default provisions

• change of control provisions

• employment/severance agreements

• discovery of “hidden” liabilities (i.e., litigation, environmental)

• discovery of provisions that conflict with the transaction orrequire consent/waiver

• non-competition or non-solicitation restrictions on the seller

• open source software

• privacy issues

• export control violations

• source code escrow arrangements

• acceleration of stock options

• 280G parachute payments or 409A issues

Assuming the parties wish to move forward with the deal, the duediligence memo and related documents are invaluable to the buyer inconfirming the contents of the disclosure schedules to the definitive agree-ment. Moreover, by maintaining an accurate record of all documents dis-closed pursuant to a due diligence request list, the seller may use this list inthe preparation of the disclosure schedules.

As mentioned above, the due diligence process continues until thetransaction is closed. The parties will continue to request, deliver, andreview information throughout this period. As such, the parties shouldrecognize that due diligence is an evolving process that will require asignificant time commitment on each of their parts.

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Chapter 5

Deal Structures

Principal Deal Structures

A business acquisition can take many forms. The optimal structure inany particular transaction will depend on a number of factors, such as thenature of the business, assets and liabilities being acquired, the economicsof the business deal, tax considerations, required third-party consents,securities laws considerations, and similar issues. Determining the optimalstructure for the acquisition is a critical step in every deal and must beaddressed early on in the transaction process, ideally at the term sheetstage.

The structure may affect the buyer and the seller very differently froman economic perspective and is therefore often an important part of earlybusiness negotiations. For example, a structure that is tax optimal to theseller may be less so for the buyer, and vice versa. The structure will alsoaffect the scope of the due diligence and disclosure process. For example,structure may impact the scope and nature of the liabilities the buyer willassume, or the consents required for contract assignment. Setting structurewill be a prerequisite to determining appropriate documentation for thetransaction. Finally, the structure chosen will have a significant impact onthe overall deal process.

The three principal categories of negotiated acquisition structures arestock purchases, asset acquisitions, and mergers.

Stock Purchase

In a stock purchase, the buyer negotiates directly with the target and itsstockholders to acquire the target’s outstanding shares of capital stockdirectly from each of the target’s stockholders. As consideration for theacquisition of the stockholders’ shares, the buyer may pay cash, its owncapital stock, debt, or other property. As with all acquisition structures,sometimes a combination of cash, stock, and/or other property may beused as consideration.

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The following illustrates a typical stock purchase structure:

STOCK PURCHASE

Before:

After:

B

S

StockholdersofS

Cash,Stock or OtherConsideration

Stock of S

B

S

Former Stockholders

of S

(if stock consideration)

Assuming B purchases 100%of S's stock

After the stock purchase has closed, the buyer will own whateverpercentage of the target’s stock is represented by the shares the buyeracquired. Importantly, the buyer may not acquire 100% ownership if somestockholders do not sell their shares. After the closing, the target willcontinue as it existed prior to the acquisition with respect to the ownershipof its assets and liabilities, its employees and the conduct of its business.

Asset Acquisition

In an asset acquisition, the buyer acquires certain enumerated assetsand liabilities of the seller in exchange for the buyer’s cash, stock, or otherproperty. The buyer only acquires those assets that are specifically listed inthe asset acquisition agreement and also only acquires those liabilities thatare explicitly assumed. As a result, this structure can provide greaterflexibility for the buyer if it seeks to limit its exposure to undesired orunknown liabilities or to acquire only those assets that are meaningful to it.

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For example, a buyer that is not interested in the seller’s entire busi-ness can limit the purchase to a discrete set of assets, such as a singlebusiness line or division, or an intellectual property portfolio. Similarly, abuyer could negotiate to leave behind a lawsuit or other class of liabilities,although the seller might only be willing to keep such liabilities if the seller isretaining other assets or has a plan for handling such liabilities. When abuyer acquires all or substantially all of a seller’s assets, the seller willtypically distribute the consideration that the buyer paid for those assets toits stockholders in advance of the seller’s liquidation.

The following illustrates a typical asset acquisition structure:

ASSET ACQUISITION

B

SStockholders

ofS

Cash,Stock or

Other

Consideration Assets

Distribution of Cash,

Stock or other

Consideration as part

of or after asset sale

After the asset acquisition transaction has closed, the buyer will ownonly those assets of the seller, and be responsible for only those liabilities ofthe seller specifically enumerated under the asset acquisition agreement.Importantly, the seller will continue in place as it existed prior to thetransaction — absent the business assets and liabilities sold to the buyer.

Mergers

A business acquisition may also be structured as a direct or indirectmerger, which is a creature of state statute and based on detailed statutoryrequirements that vary from state to state. As with stock purchases, merg-ers result in the buyer’s acquisition of the seller’s equity from the seller’sstockholders, and depending on the type of merger will often result in thecontinued existence of the seller as a separate legal entity. Unlike a typicalstock purchase, however, a merger does not require approval by each of theseller’s stockholders in order for the buyer to acquire 100% of the seller’sequity interests. Once the requisite vote of the seller has been obtained —

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Chapter 5 - Principal Deal Structures

e.g., a majority of the issued and outstanding shares of capital stock — amerger can be effected and the buyer will acquire 100% of the seller’soutstanding equity pursuant to the operation of the state’s merger statute.

Practical Tip: Appraisal Rights

Most states’ laws provide appraisal rights to stockholders who donot vote to approve a merger and who decline the merger consider-ation. These rights typically enable the non-consenting stockholdersto petition the court to cause the buyer to pay them a higher value fortheir shares than that offered in the merger.

Direct Merger

A direct merger occurs when the seller merges with and into the buyer,with the buyer continuing as the surviving entity. As demonstrated in thediagram below, the seller’s stockholders receive the merger considerationupon the consummation of the merger, which may be cash, stock, or otherproperty. A direct merger will generally require the approval of both theseller’s and the buyer’s stockholders under state law, which is one of thereasons it is a less-favored structure. The seller does not survive after theclosing as a separate entity, but is incorporated into the buyer.

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The following illustrates a typical direct merger structure:

DIRECT MERGER

Cash, Stock or

Other

Consideration

B S

StockholdersBStockholdersS

Merger

S Stock B Stock

B Stock

(if stock consideration)B Stock

B

StockholdersS StockholdersB

Surviving Corp = Buyer

Before:

After:

Indirect Merger

In an indirect, or “triangular” merger, the buyer establishes a mergersubsidiary to effect the acquisition.

In a forward triangular merger, the seller merges with and into thebuyer’s merger subsidiary, with the merger subsidiary surviving the merger.The buyer pays the seller’s stockholders consideration in exchange for thecancellation of the shares of the seller’s stock. After giving effect to themerger, the merger subsidiary survives as the wholly-owned subsidiary ofthe buyer. All of the seller’s assets and liabilities are deemed to have beentransferred from the seller to the merger subsidiary, which represents thecontinuing business post-merger.

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The following illustrates a typical forward triangular merger structure:

FORWARD TRIANGULAR MERGER

After:

B

MS(combined with S)

Former SStockholders

(if stock consideration)

B Stock

Surviving Corp = MS

Buyer forms

merger subsidiary

Before:

Cash, Stock or

Other

Consideration

Stockholders B

S MS

Merger

In a reverse triangular merger, the buyer’s merger subsidiary mergeswith and into the seller, with the seller surviving the merger as a wholly-owned subsidiary of the buyer. The buyer receives all of the seller’s out-standing stock in exchange for the merger consideration it pays the seller’sstockholders. This is often the favored acquisition structure for severalreasons, including the fact that the seller continues to exist after the closing,minimizing the need for contract assignments and other special efforts tocontinue the business.

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The following illustrates a typical reverse triangular merger structure:

REVERSE TRIANGULAR MERGER

Cash, Stock or

Other

Consideration

MSS

BStockholdersS

Merger

Before:

After:

Surviving Corp = Seller

B

S

(combined with

MS)

Former S

Stockholders(If Stock Deal)

B Stock

Buyer forms

merger subsidiary

Considerations in Choosing a Structure

A number of considerations are involved in choosing a deal structurefor a typical M&A transaction. Although these considerations vary greatlydepending on context, they generally fall into five principal categories:

• Business and economic considerations

• Corporate and securities laws and mechanics

• Allocation of liabilities

• The need for third-party consents or approvals

• Tax considerations

It is important to recognize that the considerations driving a particularstructure are dynamic and often overlapping, and in any given case theultimate choice may depend on an analysis of a number of competing

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factors. Moreover, as is discussed in more detail below, the buyer and theseller often have opposing interests in the choice of the structure, which cancontribute to significant complexity in the negotiations.

In addition, the structures are not rigid, and may be combined in acreative fashion to achieve a particular result. For example, a stock pur-chase in which the buyer acquires less than 100% of the seller’s outstand-ing stock may in some cases be followed by a “back-end” merger in order to“squeeze-out” minority stockholders who have not consented to sell theirshares. If the buyer acquires a certain percentage of outstanding shares(typically 90%) in the stock purchase step of the transaction, stockholderapproval may not be required to effect the back-end merger, which mayallow the buyer to use a stock purchase to acquire a company even when itis not able to directly acquire every last share. Similarly, combinations ofstructures may be used in order to gain favorable tax treatment in aparticular transaction, such as a “multi-step” merger implemented in anattempt to obtain favorable tax treatment while reducing some of thelimitations inherent in a typical merger.

Business and Economic Considerations

The nature of the seller’s business and the economic reasons for theacquisition typically influence the choice of structure. The most obviousexample is where the buyer is looking to acquire a line of business from theseller rather than the entire company. In this case, an asset acquisition is anobvious choice, because the buyer can enumerate which assets it isinterested in acquiring and leave behind those it does not want. In contrast,a buyer with a number of independent business lines may be interested inacquiring the seller’s entire business, but intends to run the businessseparately as one of several standalone subsidiaries. In that case, a stockpurchase or subsidiary merger are good choices.

The type of consideration the parties would like to use is anotherimportant factor that drives deal structure. While some sellers prefer theimmediacy, certainty, and liquidity of cash, others prefer taking an invest-ment in buyer’s stock if they believe the upside potential of the stock issignificant. On the buy-side of a transaction, a buyer may not have sufficientcash to use as consideration for the acquisition and may be unable to incuradditional debt due to financial covenants and existing debt loads. In thatcase, using its stock will be the obvious alternative from the buyer’s per-spective. As is described in more detail below, the type of consideration theparties choose will in turn influence the type of structure that can be used ina particular deal due to both legal and practical constraints, such as the

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limitations inherent in using cash in the context of a tax-free merger, as wellas securities law considerations.

Corporate and Securities Laws and Mechanics

• Corporate approvals

Different deal structures may require different types of board andstockholder approvals for both the buyer and the seller, and the practical-ities of obtaining such approvals in certain cases may dictate a specificstructure. In the case of board approvals, while a merger or substantialasset acquisition typically requires approval by the seller’s board of direc-tors as a matter of statute and corporate practice, and will require theapproval of the buyer’s board if the transaction is material to the buyer, astock purchase often does not require approval of the seller’s boardbecause the shares are acquired directly from the stockholders them-selves. If the buyer negotiates a contract with the seller in a stock purchasetransaction, however, the seller’s board will need to approve the agreement.

The need for target board approval is thus relatively universal, butstockholder approval is not always required. In the merger context, approvalby the seller’s stockholders is required to consummate the deal, but thebuyer will be able to acquire 100% ownership of the seller without firstobtaining every stockholder’s consent. Because a merger is a creature ofstate statute, each state’s merger laws will dictate the baseline level ofstockholder approval required in a merger in order for the buyer to con-summate the transaction, and typically the affirmative vote of a majority ofthe outstanding shares is required for such approval. In the stock purchasetransaction, in contrast, each stockholder must approve the sale of its stockin order for the buyer to obtain 100% control over the equity. For this reason,buyers typically only use a stock purchase structure with a purchase of adivision or the acquisition of sellers with few stockholders, so that the buyercan be sure to acquire the desired control over the seller with minimalholdouts and cost.

Approval by the seller’s stockholders may not be necessary for someasset acquisitions depending on the scope of the transaction. Typically, ifthe acquisition involves all or substantially all of the seller’s assets, stock-holder approval is required. State law requirements vary as to what con-stitutes “substantially all of the assets” and the approval required, and theserequirements should be reviewed carefully.

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On the buyer side, subject to the requirements of public stockexchanges and national markets with respect to publicly-traded buyers(e.g., the requirement that buyer’s stockholders approve any issuance ofshares in excess of a certain percentage of the buyer’s outstanding shares),the buyer’s stockholders would typically not need to approve an acquisitioneffected as a stock purchase, asset purchase, or indirect subsidiary merger.However, they would likely need to approve an acquisition effected by thedirect merger of the seller into the buyer.

Practical Tip: Contract and Charter Approval Require-ments May Be More Stringent than the Statute

Attention must be paid to any applicable contracts or charterrequirements that might require more stringent approvals than thosedictated by statute.

For example, investors’ rights agreements in the private companycontext often require approval of a discrete class or series of stock-holders that would not otherwise be required by state law — such asapproval rights on behalf of a series of preferred stock owned by aventure capital investor.

• Appraisal rights

Appraisal rights are another element of statutory corporate law thatvaries based on the nature of the transaction structure. For example,Delaware law provides that stockholders of unlisted companies who donot approve of a merger may exercise appraisal rights if they are dissatisfiedwith the consideration the stockholders are to receive in the merger. On theother hand, appraisal rights are not present in a stock purchase transactionbecause stockholders are required to agree to the sale of their shares inorder for such a sale to take place. Some jurisdictions provide for appraisalrights in connection with certain asset sales as well, although state lawvaries.

• Deal process and mechanics

The process and mechanics of effecting the transaction vary depend-ing on the deal structure, with mergers typically requiring more statemechanics because mergers are creatures of state law. The merger pro-visions of the various state corporation laws typically require the prepara-tion and filing of detailed documentation (such as articles of merger) with

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the Secretary of State or comparable state official in order to close thetransaction. These procedures can become more complicated when mul-tiple jurisdictions and state merger statutes are involved due to the locationof the buyer and the seller. In contrast, parties to asset acquisitions need toclarify any required mechanics with respect to transferring title to the assetsbeing sold, which can lead to some complexity depending on the assets andthe laws of the states involved. Because a stock purchase is effected forequity at the stockholder level, the corporate law mechanics involved aretypically the least onerous of the deal structures, at least where the target isa private company.

• Securities laws and mechanics

As discussed in Chapter 9, securities law considerations may impactthe choice of acquisition structure significantly. For instance, if a seller’sstockholders are not all “accredited investors,” the buyer may not be able totake advantage of an appropriate exemption from the registration require-ments under the Securities Act of 1933, as amended, in order to issue theseller’s stockholders shares of the buyer’s stock as consideration foracquiring their shares. In that case, the buyer may choose to pay cashat least to the non-accredited stockholders rather than go through the time-consuming and expensive process of registering the buyer’s stock. Secu-rities law requirements and mechanics could also make a cash deal fasterto close than a deal involving the buyer’s stock. There are additionalconsiderations if either the buyer or the seller are publicly traded.

Allocation and Assumption of Liabilities

By structuring a deal as an asset acquisition, a buyer can specificallyidentify which of the seller’s liabilities it wishes to assume and whichliabilities it wishes to leave behind. This determination is very importantto both sides and therefore will likely have a very significant impact on thenegotiation and valuation of the transaction. For example, a seller may bereluctant to retain a contingent liability once the business associated withthe liability is sold.

In contrast, a transaction structured as a stock purchase or merger, willresult in the buyer acquiring the seller’s equity ownership, and thus thebuyer will also assume responsibility for any and all liabilities inherent in theseller’s business.

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Practical Tip: Liability Protection

The buyer may look to certain mechanisms within the specificterms of the agreement to protect itself from the seller’s liabilities, evenwhere the buyer is acquiring all the seller’s stock, and thus acquiringall the seller’s liabilities.

For example, the buyer may seek indemnification from the sellerand/or its stockholders, and it may insist on a holdback and escrowwith respect to the deal consideration to ensure that funds are avail-able should liabilities arise after closing. See Chapter 7 for moreinformation on these techniques

A distinction also exists with respect to the type of stock acquisition. Ina stock purchase or indirect subsidiary merger, the seller continues after theclosing as a subsidiary of the buyer. In contrast, in a direct merger, the sellerand the buyer will become one entity, with their assets and liabilities pooledtogether in one enterprise. To the extent the buyer is concerned aboutliabilities from the seller’s business impacting its existing business andassets, it will likely prefer having the liabilities contained within a separatecorporate subsidiary rather than merged with its own business.

The buyer should not rely too heavily on the notion that it can simplywalk away from the seller’s liabilities by structuring a deal as an assetacquisition in which it picks and chooses the liabilities it wishes to assume.In some jurisdictions, courts have applied the “de facto merger” doctrine totreat a deal the parties had originally structured as an acquisition as amerger instead. As a result, the buyer was required to assume all of theseller’s liabilities.

Although uncommon, the risk that an asset acquisition will be rechar-acterized as a merger highlights the importance from the buyer’s perspec-tive — even in the context of an asset acquisition — that the buyer conductthorough due diligence and obtain appropriate representations and war-ranties and indemnification from the seller. There is also case law relating toliabilities associated with the business such as taxes, product liabilities andenvironmental claims that cannot be left behind in an asset acquisition

Need for Third Party Consents

In structuring transactions, parties seek to minimize the number of thirdparty approvals required to consummate the deal. Having to obtain thirdparty consents can delay and even prevent an acquisition from getting

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done, so it is important that the parties address assignment issues early inthe process.

An asset acquisition by definition involves the assignment of assetsbetween the seller and the buyer. Thus, parties to an asset acquisition mustcarefully review important commercial agreements the buyer is expecting toassume (such as license agreements, real estate leases, professionalservices agreements and the like) in order to confirm whether such agree-ments require the other party to consent to the assignment.

Because the forward triangular merger structure results in the sellermerging out of existence into the buyer’s acquisition subsidiary, suchtransactions also require special attention with respect to the need forthird-party consents.

In contrast, a reverse triangular merger and stock purchase are notlikely to trigger anti-assignment provisions in third-party contracts becausethe seller continues in existence as the surviving entity after the transactionhas closed and only the ownership of the seller changes hands. However,diligence must be conducted to determine if consents are required underspecific agreements due to “change of ownership” or “change of control”contractual provisions.

Practical Tip: Contract Assignment Provisions

In the absence of a specific provision in the contract explicitlydefining a stock purchase or merger as an assignment for purposes ofthe contract, state law generally provides that an assignment of theagreement has not taken place.

Tax Considerations

Tax considerations may in some cases be the most significant factor indetermining deal structure, and can also affect the overall economics of thedeal. The interests of the buyer and the seller may not be aligned in terms ofthe optimal tax approach, which can lead to significant negotiations aroundthis issue.

The seller’s preferred result from a tax perspective is often to eliminatethe payment of tax upon closing the transaction — preferably at both theentity and stockholder levels. Whether or not this is possible in a giventransaction will generally be determined by the structure of the transaction,

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the nature and amount of the consideration the seller will receive in thetransaction, and the nature of the seller’s entity (e.g., whether the entity is aC corporation or S corporation for tax purposes). Different rules applywhere sellers are LLCs or partnerships.

The buyer, on the other hand, often seeks to obtain a “step-up” in thetax basis of the seller’s assets in order to claim larger tax deductions fordepreciation later on. Generally, an asset basis step-up is only possible ifthe transaction is structured in such a way as to result in tax to both thetarget corporation itself and its stockholders. Chapter 12 contains a morein-depth discussion of some of the tax considerations inherent in an M&Atransaction.

While the buyer and seller’s preferences as to the best structure willoften conflict at any given price, it is sometimes possible to choose astructure which, together with a price adjustment, results in everybodycoming out ahead.

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Chapter 6

Definitive Acquisition AgreementBusiness acquisitions are typically documented by a comprehensive,

definitive acquisition agreement, as well as a variety of ancillary agree-ments that cover a number of substantive areas and address differentaspects of the deal. This chapter focuses on the key terms and provisions ofthe definitive acquisition agreement, particularly as they impact the nego-tiation and consummation of the transaction.

The title, scope and overall substance of the definitive acquisitionagreement will depend largely on the transaction structure. For instance,an M&A deal effected as a stock purchase will be governed by a “StockPurchase Agreement,” whereas a deal effected as a merger will be gov-erned by an agreement such as a “Merger Agreement” or “ReorganizationAgreement”. Most of the principal substantive differences among the var-ious types of definitive acquisition agreements relate to differences in theunderlying transactions, such as the need in a Merger Agreement to haveprovisions that deal with the statutory merger requirements arising fromapplicable state law. Moreover, even within each type of transaction struc-ture and agreement, there will always be substantive differences fromagreement to agreement that reflect the particular terms and idiosyncrasiesof the particular deal. Oftentimes these distinctions derive from differencesin the basic facts of the deal, such as the nature of the consideration beingpaid (e.g., cash vs. stock) and the nature of the business agreement beingstruck (e.g., whether or not there will be an escrow). Moreover, even wherethe underlying substance of two agreements is generally comparable, theremay be considerable variation in the order of presentation of the variousprovisions and the specific language relied upon to memorialize the busi-ness arrangement.

Nonetheless, despite the many differences that exist among definitiveacquisition agreements from one M&A deal to another, virtually all agree-ments in the negotiated acquisition context include the following basiccomponents:

• Definitions

• Economic and structural terms (i.e., form of transaction, purchaseand sale, pricing and related matters)

• Representations and warranties

• Covenants

• Deal protection devices

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• Closing conditions and termination rights

• Remedies and indemnification

• Miscellaneous provisions

Definitions

Given the complexity of M&A transactions and the resulting complexityof the definitive acquisition agreements themselves, most agreementscontain a separate section setting forth the principal defined terms in theagreement. This is often useful from an organizational and structuralstandpoint with respect to readability of the document. It is worth notingthat some of the defined terms that are used throughout the agreement arevery much substantive in nature and can have a real impact on theunderlying business deal. For instance, the definitions of “knowledge”and “material adverse change” can be critical to the parties’ basic riskallocation under the representations and warranties and indemnificationsections. For this reason, the negotiation of key definitions like these can becritical to the ultimate resolution of the transaction.

Economic and Structural Provisions

The first few sections of the definitive acquisition agreement generallycover the following key issues:

Purchase price amount and form

This section addresses the crucial issues of how much will be paid forthe business and what form the consideration will take. The nature of theconsideration to be paid will drive additional information and disclosure thatwill flow throughout the rest of the agreement. For instance, if the consid-eration includes buyer’s securities, the parties must address securities lawramifications — i.e., a seller receiving unregistered shares of buyer’s stockwill likely demand registration rights, which will be reflected within thedefinitive acquisition agreement and in a separate registration rights agree-ment. Alternatively, if the issuance of the buyer’s stock to seller is beingregistered, the definitive acquisition agreement will include provisions dic-tating the timing and other details of necessary securities filings, including aForm S-4 registration statement.

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Closing and payment mechanics

This section details such mechanics as how the payments will bemade — e.g., wire transfer — as well as when and where the closing willtake place. This section will also include descriptions of statutorily-drivenrequirements such as filing of articles of merger.

Identification of assets and liabilities

In the case of an asset acquisition, this section of the definitive assetpurchase agreement will contain a precise description of the assets to beacquired and the liabilities to be assumed, which is of critical importance tothe underlying substance of the deal.

Timing of payments and earn-outs

The parties may agree to pay consideration in installments, in whichcase the definitive acquisition agreement will detail the timing of ongoingpayments. In many cases, installment payments will be tied to futureperformance. These so called “earn-out” provisions detail the negotiatedperformance goals the successor company must achieve after the closingto trigger additional payment obligations from buyer to seller. A seller mightrely on an earn-out to maximize consideration where it believes the futureperformance of the business will be substantially better than its historicalperformance. The buyer may be able to lower its initial cash outlay, avoidoverpaying for future revenues, and use earn-outs as an incentive to retainand motivate key personnel of the seller after the closing. Properly drafted,earn-outs may provide incentives to continuing management and maximizevalue for both parties.

However, earn-outs are difficult to negotiate because of competingconcerns of the seller and buyer. The seller will be concerned about itsability to track the financial performance of the business post-closing in away that accurately reflects the seller’s contribution to the performance,whereas the buyer, particularly a strategic buyer, will seek the greatestflexibility in operating and integrating the acquired business. The partiesshould carefully consider how much time they will need to assess theseller’s performance while ensuring that they don’t motivate the seller’smanagement to maximize short term revenue at the expense of growth andsound long-term business planning. Earn-out provisions should includecarefully drafted statements about who controls the successor entity, themethod of operating the business after the closing and methods of account-ing for revenues, profits, losses and/or expenses, or other milestone

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Chapter 6 - Definitive Acquisition Agreement

determinants. Although earnouts represent a possible way to bridge thegap between an optimistic seller and a conservative buyer, these provisionsoften lead to disputes post-closing.

Purchase price adjustments

Many definitive acquisition agreements contain provisions to adjust thepurchase price upon review of final financial information about the perfor-mance of the business prior to closing, which is typically not available untilafter completion of the transaction. For example, parties may includepurchase price adjustments to reflect changes in the seller’s working capitalor stockholders’ equity in the period prior to closing that could not be verifiedin time to be reflected in the closing purchase price. This helps ensure thatthe actual performance of the seller through closing was appropriatelycaptured in the purchase price. When purchase price adjustments areincluded, the definitive acquisition agreement will typically contain mechan-ics of delivery and review of financial statements covering the metricsrelating to the purchase price adjustment, dispute resolution, time limitsfor bringing claims, payment of auditing fees, etc. The definitions of the keyterms and applicable accounting methods for determining the purchaseprice adjustment are critically important.

Holdbacks and escrows

The parties may agree to hold-back and/or escrow a portion of thetransaction consideration to cover the seller’s indemnification obligations,reductions in purchase price due to post-closing adjustments, or otherliabilities. In certain circumstances, the buyer may agree to escrow a portionof the consideration payable upon achievement of earn-out targets. If theparties agree to an escrow arrangement, the definitive acquisition agree-ment will contain some basic details concerning the escrow arrangementand the parties often also will enter into a separate escrow agreement with athird party that will govern the management and release of escrowed funds.In some cases a well-financed seller, whose business will continue after thetransaction, will not enter into an escrow arrangement and will have thedirect obligation to make any payments.

Exchange ratios caps and collars

If the consideration being paid by the buyer is shares of its public stock,the parties will sometimes include provisions to adjust the number of sharesbeing issued at closing based on fluctuations in the buyer’s stock pricebetween signing and closing in order to ensure some limits on changes to

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the underlying deal value. Negotiations over such adjustments can be keyto reaching agreement on the economics of the deal. The exchange ratiocan be “fixed,” that is, a set number of shares will be delivered at closingbased on a set ratio of shares of buyer stock to seller stock. This willproduce deal consideration that fluctuates on the value of buyer stock.Alternatively the exchange ratio could be floating if the transaction is acertain fixed dollar value of buyer stock, with the number of shares based onthe current market price typically measured over 5, 10 or 20 trading daysprior to closing of the buyer’s stock. This could result in a larger number ofshares being issued if the buyer’s stock price dips, resulting in potentiallyunattractive dilution to the buyer.

The risks related to the two types of exchange ratios can be mitigatedby a collar or cap, pursuant to which the transaction will either result in (i) afloating ratio becoming fixed or a number of shares becoming set at someagreed upon point, or (ii) providing walk away rights for the parties at suchagreed upon value. The buyer and seller will need to negotiate theseprovisions carefully, often requiring consultation with each party’s financialadvisors.

Purchase price allocation

The purchase and sale provisions in a definitive asset acquisitionagreement may allocate the purchase price between the business acquiredand the value of an agreement by the principals of the seller not to competewith the business. In some cases, courts are more likely to enforce a non-competition agreement if the party seeking enforcement can demonstratethat sufficient consideration was delivered. Parties may also specify howmuch of the purchase price should be allocated to goodwill. This allocationis economically important and often the parties have opposite tax resultsfrom any particular allocation, making this a critical negotiation.

Treatment of options and restricted stock

Merger agreements will typically contain a provision detailing thetreatment of the seller’s outstanding options to purchase seller’s stock inthe transaction, as well as unvested restricted stock, if any. For instance, inmany cases the buyer will assume the seller’s employee stock option planssuch that any unexercised options after the closing will become exercisablefor shares of the buyer’s common stock (after being adjusted for theapplicable exchange ratio in the merger). In other cases, such as wherethe seller’s outstanding options permit the seller to cancel any unexercised

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options in advance of a merger, the buyer and seller may agree to terminateany options that have not been exercised as of the closing.

Appraisal rights

Where applicable, a merger agreement will contain a provision detail-ing stockholders’ rights to seek appraisal remedies under applicable statelaw. The buyer will often insist that its obligation to close the transaction beconditioned on there not being more than a de-minimus percentage ofstockholders who pursue such appraisal remedies.

Representations and Warranties

The principal purpose of the seller’s representations and warranties is toset forth, as of a certain point in time, key facts about the seller and its businessthat the buyer considers to be material to the value of the business and itsdecision to go forward with the transaction. For instance, the seller will berequired to represent to the buyer that it has obtained all requisite corporate,contractual, and governmental consents necessary for the seller to sell itsbusiness to the buyer. Other representations will focus on the seller’s business,such as a representation stating that the seller has prepared its financialstatements in accordance with generally accepted accounting principles, or arepresentation that the seller has paid all of its taxes on time.

The drafting and negotiation of the representations and warrantiesmust be considered in close conjunction with the seller’s preparation anddelivery of schedules to the representations and warranties — known as“disclosure schedules” — that disclose any known exceptions to the state-ments being made by the seller in the representation and warranties. Forexample, if one of the representations requested by the buyer in theagreement is that the seller is not in breach of any material agreementsinvolving the license of software, but the seller knows that in fact it is inbreach under such an agreement, the seller would need to include in thedisclosure schedules a description of the nature and scope of the breach.By doing so, the buyer is put on notice that there is a potential liability andthe seller is complying with its obligation to disclose to the buyer all of thematerial facts about the seller and its business.

Although the buyer will obtain much of the information it requires todetermine whether to proceed with the transaction and on what termsthrough its due diligence review of the seller, the seller’s written represen-tations serve as a critical backstop for the buyer’s diligence by confirming, ina formal and legally binding manner, the information provided to the buyer.

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Together with the disclosure schedules, the representations and warrantiesalso serve as a critical mechanism for allocating risk between the partiesand they can be a significant source of liability for the seller should any of therepresentations and warranties prove to be untrue after the deal has closed.In addition to (and sometimes in lieu of) a standard breach of contractaction, the seller may be required to indemnify the buyer for breaches of therepresentations and warranties, which can be an especially powerfulweapon for the buyer where there is an escrow in place to support theseller’s indemnification obligations. The representations and warrantiesmay also impact the buyer’s obligation to close the transaction. The poten-tial impact on the closing of the transaction and on the seller’s future liabilityto the buyer provides an important additional incentive to the seller in thediligence process, helping to ensure that the seller is motivated to discloseall material information to the buyer.

Typical Seller representations and warranties

Although the actual representations and warranties in the definitiveacquisition agreement will vary from agreement to agreement, some of themore typical seller representations cover the following topics:

Consummation of the deal, e.g.:

• legal authority to complete the transaction, the nature of requiredconsents and approvals and legal and contractual non-contravention

• whether the seller owes any brokers’ or finders’ fees in connectionwith the transaction

Legal matters, e.g.:

• due organization, qualification

• outstanding capitalization, rights to acquire securities and relatedmatters

• subsidiaries

• litigation

• intellectual property ownership and infringement issues, includingwith respect to patents, trademarks, material licenses, etc.

• compliance with environmental laws and regulations

• compliance with laws

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Financial matters, e.g.:

• preparation of financial statements

• undisclosed material liabilities

• preparation and filing of tax returns, payment of taxes

• accounts receivable/payable

• inventory

Composition and conduct of the seller’s business, e.g.:

• title to and condition of assets

• conduct of business and absence of material adverse change sincelast balance sheet date

• material contracts and leases and absence of default relating tosame

• customers and suppliers

• provisions relating to any government contracts

• employee matters, including with respect to compensation, labordisputes, employee benefits, etc.

• title to and condition of real property

• real property leases

• transactions with affiliates

• insurance

• permits

• a “catch-all” 10b-5 representation certifying as to the completenessof the seller’s disclosure to the buyer

If unregistered securities of the buyer constitute part of the consider-ation in a stock purchase or merger, the seller’s stockholders should also berequired to make comprehensive investment representations that aredrafted to ensure that the transaction will qualify for an exemption fromregistration.

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Key issues involved in negotiating the seller’s representations andwarranties

• Who is required to make the representations on behalf of the seller?

The selling entity will almost always make representations and war-ranties to the buyer in the definitive acquisition agreement. In addition, thebuyer may ask any significant stockholders of the seller to make compre-hensive representations and warranties as well, particularly if they have asignificant operating role with the seller. At a minimum, if the seller’sstockholders are parties to the definitive acquisition agreement, such asin the context of a direct stock purchase, they will be required to makerepresentations relating to their ownership of their shares and their ability toenter into and perform the agreement.

The issue of who is making the representations and warranties on theseller’s side is related to the question of purchase price adjustments,holdbacks, escrows and other terms impacting risk allocation. The buyermay be more comfortable proceeding without stockholder representationsif a sufficient portion of the purchase price has been held back to satisfy anyindemnification claims.

• As of what date(s) are the representations and warranties made?

The representations and warranties are typically made as of signing ofthe definitive acquisition agreement. Moreover, in a typical transaction inwhich the closing takes place some period of time after signing of theagreement, the representations and warranties will also be “brought down”to the closing. In most cases, the mechanism for ensuring that the repre-sentations are valid as of closing is the inclusion of a closing condition thatthe representations and warranties that were originally made at signingmust also be true and correct as of the closing. In some cases, this “bring-down” may be qualified based on materiality, but that must be considered inthe context of the specific materiality qualifiers that exist within the repre-sentations themselves (i.e., the buyer will want to ensure that the seller’srepresentations are not subject to a “double-materiality” standard, that is, arepresentation already qualified as to materiality should not typically befurther qualified to be “deemed to be true in all material respects” or exceptwhere breach is not a “material adverse effect,” but instead is required to betrue without further qualification).

Additionally, a senior officer of the seller will be required to provide aclosing certificate certifying, on behalf of the seller, that the representationsand warranties are true and correct as of the closing. The seller may seek

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the right to qualify a representation or amend a corresponding schedulebased on changes between signing and closing to account for interveningevents or new information. If the buyer accepts the seller’s right to updatethe schedules, thus cutting off any indemnity claim for such updatedschedules, the buyer may be given the right to terminate the deal due tosuch changes.

• Materiality and knowledge qualifiers

Much of the negotiation throughout the representations and warrantieswill focus on the extent to which the representations will be qualified bymateriality considerations or considerations as to the seller’s knowledge.For example, most practitioners would agree that the seller should beentitled to rely upon a knowledge qualifier with respect to the typicalrepresentation as to “threatened” litigation — i.e., the seller will not beliable for failing to disclose any threatened litigation to the extent the sellerdid not know that litigation was in fact threatened against it. In a similar vein,most sellers would insist that they should not be liable to the buyer for failingto disclose liabilities that would not have a material impact on the seller’sbusiness, such as a risk that the seller may lose its contract with thecompany that provides it with water coolers for its employee lounge.

Negotiating the representations and warranties is in many ways anexercise in risk allocation, and the buyer will typically resist many of theseller’s requested qualifiers and insist on the seller bearing as much of therisk as possible. For example, while the seller would in all cases prefer tolimit a representation it makes regarding its compliance with its contractualobligations so that it only makes representations as to “material breaches”of “material agreements,” the buyer has every incentive to want the seller tomake a “flat” representation in which the seller represents that it is not inbreach of any agreement to which it is a party. That is, the buyer wants theseller to assume the full risk of any violations instead of forcing the buyer toprove materiality.

In addition to the broader issue of risk allocation that is reflected in thetension over the negotiation of materiality and knowledge qualifiers, sig-nificant negotiation can take place at the more granular level of what formsof knowledge and materiality qualifiers to use with respect to discreterepresentations. For instance, the parties may negotiate whether to usethe phrase “to the knowledge of seller,” as compared with “to the bestknowledge of seller,” or even “to seller’s best knowledge after due inquiry.” Arelated question is whose knowledge counts — while some agreements aresilent on how to determine whether the seller should be deemed to have

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had knowledge of something, others specify that the actual knowledge ofenumerated senior officers or employees of the seller must be used todetermine whether the seller is deemed to have had knowledge in a givencase or provide that knowledge of any employee is sufficient.

Similarly, the definition of materiality is often sharply negotiated invarious contexts throughout the agreement. Definitions of “material con-tracts” are often based upon a minimum dollar value. Another example isthe definition of “material adverse change,” which is often critical to deter-mining the import of various representations and warranties, including thestandard representation that there has not occurred a material adversechange since the balance sheet date. A typical negotiation point in thisdefinition is whether a material adverse change will be deemed to haveoccurred if the material change relates to the seller’s prospects, as opposedto its existing business. Forward-looking language like “prospects” injectsan element of subjectivity into the test for harm from a breach of a repre-sentation. Sellers might also seek to negotiate a set of events that are notdeemed material adverse effects, such as changes in the conditions in theeconomy or the industry or failures to meet internal projections. In each ofthese cases, the precise word or combination of words used may impact theeventual liability of the parties.

• Relationship of representations and warranties to indemnification

In most acquisition agreements, the representations and warrantiesare closely connected to the indemnification provisions, and the two sec-tions must be negotiated in careful conjunction with one another. Forinstance, the indemnification provisions may apply differently to differentrepresentations. Different treatment may include different survival periodsand different caps on liability. A brief overview of indemnification follows inthis chapter, while a more in-depth discussion of this topic is set out inChapter 7.

• Double materiality

The buyer should be wary of the effect of “materiality” qualifiersthroughout the definitive acquisition agreement, which may create a “dou-ble materiality” standard. For example, if one of the conditions to the buyer’sobligation to close provides that the seller’s representations and warrantiesmust be true and correct “in all material respects” as of the closing, the testwith respect to any representations that are qualified by materiality withinthe body of the representation itself, such as a representation that there areno material liens on any of the buyer’s assets, would have to breach twomateriality thresholds for the condition to fail. To avoid this issue, which

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creates an ambiguity, the definitive acquisition agreement is often drafted tomake clear that the materiality qualifier on the closing condition does notapply to any representation that as written is already so qualified. Similardouble-materiality issues can arise in connection with the indemnificationprovisions to the extent the Seller seeks to limit certain of its indemnificationobligations to material breaches.

• Public company sellers

In the public company context, the seller’s representations may bemore limited and will likely incorporate its filings with the Securities andExchange Commission.

Typical Buyer Representations

The definitive acquisition agreement will also contain the buyer’s rep-resentations to the seller, however, except for deals involving a “merger-of-equals,” the buyer’s representations and warranties will typically be lessdetailed than those given by the seller. If the buyer is issuing stock asconsideration in the acquisition, the buyer’s representations will be morecomplete regarding its business than if cash is the consideration.

Practical Tip: Effect of Mergers of Equals and StockTransactions on Diligence and Representations

In a true merger-of-equals, the distinctions between buyer andseller are less relevant — e.g., in a merger-of-equals, each entitywould likely be conducting the same basic level of diligence and beequally concerned about receiving comprehensive representationsand warranties from the other party. In a stock transaction, the sellerwill also typically do some diligence on the buyer, with the level ofdiligence and scope of representations from the buyer growing as thepercentage of the combined company represented by the transactiongrows in significance.

Typically, these representations will be limited to the basics, such asthose ensuring that the buyer has all necessary corporate and legalapprovals necessary to consummate the transaction, can do so withoutbreaching its existing agreements, is not a party to litigation that wouldimpact the transaction, and has not hired a broker in connection with thetransaction.

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Depending upon the deal and the nature of the consideration beingpaid, the buyer also may be asked to make representations regarding itsfinancial ability to complete the deal. If the buyer is issuing stock as part ofthe consideration, the definitive acquisition agreement should contain addi-tional representations regarding the due authorization and issuance of thesecurities. In some stock transactions, the seller also may ask the buyer tomake additional representations relating to its business, based on thenotion that the acquisition will in effect constitute an ongoing investmentby the seller’s stockholders in the buyer. The scope of the representationsdepends on the percentage of the combined company represented by thestock issued in the transaction.

Interim and Post-Closing Covenants

In contrast to representations and warranties that essentially serve asa “snap-shot” of the seller and its business at a particular moment in time,covenants govern the relationship of the buyer and seller over a certainperiod of time both before and after the closing of the transaction. Themajority of the key covenants cover the period between signing and closing,but some covenants continue in effect post-closing. Depending on thenature of the transaction, some covenants will be made by the buyer, someby the seller, and some by both parties. They take the form of agreementsby a party either to do something or to refrain from doing something.Depending upon the nature of the covenant, the parties may spend timenegotiating the extent of their obligation to perform certain undertakings —for example, the distinction between a party using its “best efforts” vs. its“reasonable commercial efforts” as compared to a flat obligation to dosomething.

Interim covenants

Interim — or pre-closing — covenants are undertakings by the buyeror seller to take or not take certain specified actions between the signing ofthe definitive acquisition agreement and the closing. Their principal functionis to preserve the status quo such that the parties can be assured that thebusiness the buyer is acquiring at closing will be substantially the same asthe business the buyer agreed to acquire upon signing the definitiveacquisition agreement. For instance, the seller will typically covenant notto sell a material amount of its assets. Another important purpose of interimcovenants is to ensure that the parties will take the necessary steps tocause the transaction to be consummated, such as using their best effortsto obtain all required regulatory consents necessary to close. Of course,

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interim covenants are only necessary to the extent there is a delay betweensigning and closing, which is the case in most significant M&A transactions.The reasons for a delayed closing are discussed further below in thediscussion of conditions.

Although they will vary from deal to deal, typical interim covenantsrelate to the following types of issues:

• Agreement by the seller to conduct business in the ordinary course,e.g., no capital expenditures in excess of a specified amount, nomaterial pay increases or bonuses, no dividends, no new hires, nocharter amendments or other transactions that would fundamentallyalter the nature of the business to be purchased, no sale of a materialamount of assets, etc.

• Seller providing the buyer with ongoing access to the seller’s records,facilities and employees and the buyer’s ability to conduct duediligence

• Agreement by parties to seek all necessary third party consents

• Confidentiality obligations of the parties, as well as agreementsrelating to public announcements of the deal

• Agreement by both parties to make Hart-Scott-Rodino anti-trustfilings (to the extent applicable)

• Agreement of the seller to deliver interim financial statements orcopies of regulatory filings

• Agreement of the seller to notify the buyer of certain events, such asthe seller becoming involved in new litigation

• Agreement of the seller to a no-shop or non-solicitation provision thatprohibits the seller from shopping the deal once it has beenannounced

Post-closing Covenants

Whereas pre-closing covenants relate solely to the period betweensigning and closing, post-closing covenants are undertakings by a partythat are to be performed after the closing has occurred. For example:

• Agreement of the seller (and/or its former executives) not to competewith the acquired business

• Allocation of deal expenses

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• Tax treatment and reporting

• Licenses and related provisions concerning technology and corpo-rate names

• Continuing access to information and preservation of books andrecords

• Registration rights where consideration includes unregistered secu-rities (such provisions may also be contained in an ancillaryagreement)

• Continuing or transition support services, particularly in the contextof an asset sale or the sale of a division or subsidiary

• Covenant of the buyer to provide indemnification and/or directorsand officers insurance to outgoing directors and officers

Employee Matters

Most definitive acquisition agreements contain provisions that addressthe treatment of employees in connection with the transaction, includingwith respect to employee benefits issues. For instance, in a reverse trian-gular merger in which the seller will remain in existence as the survivingcorporation after the merger, the agreement may require the buyer tocontinue the employee benefit plans in place prior to closing at the samelevels for some period of time post-closing. In asset acquisitions where thebuyer acquires all or substantially all of the assets of the seller, theemployee-related provisions are often especially important given that theemployees’ employment with the seller will terminate as of the closing andthe parties may need to account for the hiring of the employees by thebuyer. The seller may want assurances that the buyer will extend offers ofemployment to certain employees on certain terms and conditions, and thebuyer may want assurances that the seller will assist the buyer in hiringemployees that the buyer considers necessary to the ongoing business.

Regardless of the form of transaction, either or both parties will oftenmake the execution by the buyer of employment or consulting agreementswith key members of the seller’s management team a condition to theparties’ respective obligations to close the transaction. The negotiation ofthese arrangements can be difficult and time-consuming, particularlyaround the issues of equity, change of control provisions, severance terms,and the like. In addition, the specifics of noncompete provisions requestedby the buyer can be a sticking point in negotiations.

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Deal Protection Devices

A critical aspect of many M&A transactions, particularly deals involvingpublic company sellers, are the so-called “deal protection ” devices. Dealprotection devices are essentially anti-takeover provisions imposed by thebuyer to reduce the odds that a third party can come in and outbid the buyerafter the deal has been announced but before the stockholders of the sellerhave approved the transaction and the deal has closed.

There are many types of deal protection devices, including the follow-ing typical approaches:

• No-shop/no-talk clauses seek to limit the ability of the seller to solicit,negotiate with, and in some cases provide information to, competingbidders once the definitive acquisition agreement has beenexecuted.

• Termination — or “break-up” — fees can be used to compensate thebuyer with cash in the event the definitive agreement is terminatedprior to closing for reasons such as the failure of the seller’s stock-holders to approve the deal because the seller’s board receives andrecommends a superior bid.

• Voting Agreements obligate certain stockholders of the seller to votetheir shares in favor of the consummation of the deal with the buyer,making it more likely that stockholder approval for the buyer’s dealwill be obtained.

• Commitment to call a stockholder meeting requires the seller’s boardto submit the buyer’s deal to the seller’s stockholders, even if theseller’s board withdraws its recommendation to vote in favor of thedeal.

• Stock options give the buyer the right to acquire a large percentage ofthe seller’s stock — typically no more than 19.9% — under certaincircumstances related to the emergence of a competitive bidder forthe seller.

A key element of the no-shop/no-talk provision mentioned above is the“fiduciary-out” provision, which serves to mitigate the impact of the no shopcovenant by giving the seller’s board some flexibility in responding to andpursuing competing proposals, if it concludes that its fiduciary obligationsrequire it to do so. There are many variants of fiduciary-out clauses pro-viding for more or less discretion and flexibility for the seller’s boarddepending on their formulation: The fiduciary out might permit a seller’s

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board to break a “no-talk” restriction by providing information in response tounsolicited proposals. Another provision will typically allow the board towithdraw its recommendation to its stockholders under some conditions,including the determination that fiduciary duties are at issue. In some cases,a fiduciary-out termination right is drafted to permit the seller’s board toterminate the definitive agreement and walk away from the deal entirely.

Even if the target board has a fiduciary-out clause, however, dealprotection devices can form a substantial impediment to the efforts of a thirdparty bidder to acquire the seller after it has announced a deal with thebuyer. For this reason, courts have limited the ability of intended buyers andsellers to use these devices — i.e., they may not be “preclusive. It isimportant to note, that the appropriateness of protection devices in anygiven case must be considered based on the totality of the terms and thecircumstances surrounding the transaction; there are many variables thatcan affect how a court in retrospect may view a given transaction, and manyof them depend on the specific facts underlying the deal.

Due to both the importance of deal protection devices to a giventransaction and the complexity of the applicable law, both the buyer andthe seller should very carefully consider their alternatives before agreeing toany package of deal-protection devices. Chapter 8 looks at deal-protectiondevices in more detail.

Conditions to Closing

A closing condition is a condition that must be satisfied in order for oneor both parties to be obligated to close the deal. The condition might takethe form of either an affirmative action by either party to the agreement or bya third party, or the absence of an action or event. Failure or inability tosatisfy a condition to a party’s obligation to close will give that party the rightto terminate the transaction without any further obligation or liability.

Most agreements contain separate conditions to each party’s obliga-tion to close, as well as common conditions to both parties’ obligations. Forinstance, under almost all circumstances, the buyer will have as a conditionto its obligation to close some variant of the conditions that the seller’srepresentations and warranties must be true and correct at closing. Alter-natively, conditions to both parties’ obligation to close will likely include therequirement that there not be any court order enjoining the parties’ con-summation of the deal.

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Of course, closing conditions are only necessary to the extent there is agap in time between signing the definitive agreement and closing the deal.There are numerous reasons why transactions are effected throughdelayed closings, but they principally fall into three broad categories: theneed for regulatory approvals, the need for stockholder approvals, andpragmatic deal considerations.

• Regulatory: There are many possible regulatory causes for delayedclosings. For example:

• Depending upon the size of the transaction and the size of theparties involved, the parties may need to make antitrust noticefilings under the Hart-Scott-Rodino Act, which typically requires aminimum 30-day waiting period before the transaction can beconsummated (assuming no early termination). In some cases,the notice filing might trigger a more involved antitrust review,which could further delay the transaction.

• In a stock-for-stock transaction that involves the issuance of reg-istered shares by the buyer, the buyer will be required to file aregistration statement with the SEC and will need to obtain SECapproval before the shares can be issued.

• Stockholder approval: Where stockholder consent is required, oneor both parties may need to convene a meeting of stockholders inorder to approve the transaction. This is most typical where there arenumerous stockholders and obtaining a written consent is not prac-tical — or is not permitted by the applicable charter documents orstate law. Where a meeting of stockholders is required, it cannot takeplace until sometime after the definitive agreement has been signed.

• Deal considerations: Often business and legal issues related to thedeal are the principal reasons behind a delayed closing. For example:

• Buyer must complete aspects of its diligence investigation of theseller that it was not able to complete before the parties signed upthe definitive agreement (but note that in most cases the buyer andseller are both well-advised not to enter into the definitive agree-ment until buyer has substantially completed its diligence review);

• Parties must obtain certain contractual consents, such as a con-sent of the seller’s primary bank, landlord, principal customer,etc.; or

• Buyer must obtain financing to fund the deal consideration.

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In transactions where a delayed closing is necessary, both parties mustensure first and foremost that the conditions that created the need for thedelayed closing are satisfied before the closing can take place — forinstance, if a Hart-Scott-Rodino notice filing is required, as further dis-cussed in Chapter 11, the deal cannot close until the notice period hasexpired or been terminated, or Hart-Scott-Rodino approval has otherwisebeen obtained. Once a delayed closing is mandated, however, the partiesalso must ensure that the passage of time does not alter the deal that theyagreed to when they signed the agreement. This latter necessity is ofprimary importance to the buyer, which will want to know that the seller’sbusiness is substantially the same when they close the transaction as it waswhen they signed up the deal sometime earlier.

As with most M&A deal terms, the nature of the closing conditions in aparticular deal will by necessity depend upon both the structure of thetransaction and the specific facts underlying that deal. For instance, con-tractual consents are less likely to be necessary in deals structured asreverse triangular mergers, so it is in turn less likely that obtaining con-tractual consents will be a material closing condition of either party in areverse triangular merger. Similarly, issues unearthed in the due diligenceprocess will often impact the drafting of the closing conditions in a particulardeal. With that said, the following are typical conditions that appear reg-ularly in a variety of different transactions:

• performance or satisfaction of pre-closing covenants reflected in thedefinitive agreement;

• continued truthfulness of representations and warranties;

• satisfaction of regulatory requirements, such as HSR clearance;

• there having been no law, regulation or court order seeking to enjointhe transaction;

• obtaining governmental and third party contractual consents;

• obtaining stockholder approval(s);

• no material adverse change with respect to the seller or its business;

• entering into any required ancillary agreements (e.g., escrow agree-ment, registration rights agreement, voting agreement, employmentagreements and noncompetes, etc.);

• delivery of requisite legal opinions;

• delivery of other closing documents and certificates.

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It is also important to recognize the relationship between the closingconditions and the interim covenants discussed above. Whereas covenantsof the seller contractually prohibit it from taking certain actions prior toclosing — or require it to take certain actions — in order to protect thebuyer’s interest in the transaction between the signing and closing, a closingcondition with respect to the seller’s compliance with such covenants willenable the buyer to walk away from the deal if in fact the seller breaches acovenant. For instance, if the seller were to breach a covenant prohibiting itfrom selling a material portion of its assets before closing by selling animportant product line that the buyer expected to acquire in the transaction,the buyer not only would have a possible claim against the seller for breachof contract (and likely indemnification as well), but also would have the rightto terminate the agreement and walk away from the deal because it was nolonger getting what it had bargained for. In some deals, the buyer might alsobe entitled to a break-up fee due to such breach and termination.

Two types of conditions are worth some further discussion: the con-ditions that representations and warranties be true and correct; and thematerial adverse change condition. Each typically engender negotiation.

The condition that the seller’s or buyer’s representations and warran-ties be true and correct is subject to negotiation over two significant issues:how significant a breach might result in failure of the condition, and when isthe truth of representations measured? Representations must generally betrue subject to some materiality standard. Thus representations must betrue “in all material respects” or “except where inaccuracies in the aggre-gate do not result in a material adverse effect”. The difference betweenthese standards can be significant. In addition, often the representationsmust be true both at signing and closing; while in some transactions therepresentations must simply be true at closing, or less frequently at signing(a so called “hell or high water” deal). These terms may affect the parties’obligations to close the deal after a business setback has occurred. Theseller’s representations can be considered many separate conditions forthe buyer, all of which must typically be true or not materially false in anyway that harms the seller’s business in order for buyer to be obligated toclose.

The “no material adverse change” condition is another condition onwhich buyer might argue no obligation to close on the occurrence of anegative event in seller’s business subsequent to the signing of the agree-ment. In some agreements buyers negotiate for a condition that there be nomaterial adverse effect on seller’s prospects, a forward-looking conditionthat is difficult to measure. Sellers often negotiate carve outs to the

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definition of what is a material adverse effect, like effects arising fromeconomic or industry conditions, effects arising from the agreement, suchas loss of employees, customers or suppliers, or failures to meet projectionsor “street” estimates. In each case the buyer will seek to limit such carveouts, if accepted at all, by requiring that the effects not disproportionatelyaffect the seller, that the effects be directly related to the agreement or thatthe underlying causes of a failure to meet a projection not be carved out ofthe definition.

The importance of these two types of conditions, the truth of repre-sentations and the material adverse change condition, is that changes inthe seller’s business between signing and closing will often trigger theseconditions. Accordingly, these are the conditions most likely to be assertedif a buyer chooses to walk away from a transaction. The facts and circum-stances surrounding the transaction and the parties’ intent may becomematerial to the resolution of any dispute.

Indemnification

Indemnification provides a post-closing remedy for losses sustained bya party after the closing of the transaction as a result of breaches of theparties’ representations, warranties and covenants. The indemnificationprovisions are crucial to understanding the real risk allocation between thebuyer and seller under the agreement. We discuss indemnification at lengthin Chapter 7.

Termination

In transactions with a delayed closing, the definitive agreement willcontain termination provisions that set forth the terms by which either orboth of the parties can terminate the agreement and walk away from thedeal before closing. The termination section is closely related to both thecovenants and the closing conditions and must be considered together withthose provisions. For instance, a breach by a party of a covenant willtypically allow the non-breaching party to terminate the agreement and walkaway from the deal. An example of this would be when the buyer terminatesthe agreement because the seller failed to satisfy its covenant to obtain animportant customer consent, the receipt of which was a condition to thebuyer’s obligation to close. Note that, from the buyer’s perspective, a well-drafted agreement would also give the buyer the right to waive the breachand go through with the closing, while still preserving its right to recoverfrom the seller for the breach.

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Although they differ from transaction to transaction based on thenature of the covenants, conditions, and other relevant deal points, thefollowing are examples of occurrences that will typically give rise to the rightof one or both parties to terminate the agreement:

• if both parties agree to terminate;

• if the transaction has not closed by a certain date (a “drop dead”date)(provided that a party that was responsible for the transactionnot closing in time due to willful failure to perform a required covenantshould not be entitled to terminate under such provision);

• in the event of the inaccuracy of representations and warranties or abreach of covenants in a manner resulting in a failure of the condition,typically after some cure period;

• if required stockholder approval has not been obtained;

• if closing the transaction would violate any nonappealable final order,decree or judgment, or any law; or

• by the buyer, if the seller has experienced a material adverse changein its business.

As is the case with the relationship between the closing conditions andthe representations and warranties, the parties must be careful to considerthe possible impact of materiality qualifiers throughout the representationsand warranties and covenants on the parties’ potential termination rights.For example, the buyer will likely resist a formulation that results in the sellerhaving the benefit of a double-materiality standard, such as when a rep-resentation that is by its terms qualified by a materiality standard must alsobe materially breached in order for the buyer’s termination right to apply.

Miscellaneous Provisions

As with the vast majority of corporate transactional documents, thedefinitive acquisition agreement will include a number of provisions underthe heading of a “miscellaneous” section, such as provisions related togoverning law, notices, methods of dispute resolution, successors andassigns, severability, payment of expenses, amendment and the like.Although many of the so-called miscellaneous provisions approach “legalboilerplate” and are not of real interest to the parties, some — such asprovisions addressing governing law, dispute resolution, and expenses —can become of critical importance in the event the transaction does notclose or otherwise results in a dispute between the parties.

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Chapter 7

Indemnification & Contribution

Chapter 6 discussed how the definitive acquisition agreement willinclude representations, warranties and covenants of the parties that serveas conditions to the parties’ respective obligations to close the transactionscontemplated in the agreement and as risk allocation devices between thebuyer and the seller. Generally, the indemnification obligations of the partiesin the definitive agreement provide the mechanism through which theparties can recover damages in the event of a breach of a representation,warranty or covenant.

Why Indemnification?

If a post-closing event occurs or a pre-closing fact or circumstance isdiscovered that causes damage to the seller, its business or the buyer (byvirtue of its post-closing ownership of the seller or its business), the buyerwill bear the risk of loss associated with this event, fact or circumstanceunless it has a contractual right of indemnification or some other cause ofaction. To understand the need for indemnification rights it is helpful to knowthe alternative avenues of recovery.

Breach of contract claims may be available to the buyer where theseller fails to comply with its obligations under the definitive agreement. Onemajor drawback to breach of contract claims is the fact that parties tolitigation generally bear their own legal fees and expenses. Thus, even if thebuyer is successful on the merits of a breach of contract claim, it generallywill not be “made whole” in light of the legal fees and expenses incurred torecover damages from the seller.

Tort claims such as fraud may also be available to the buyer in certaincircumstances. Major drawbacks to tort claims include the fact that proving theelements of a tort claim is often difficult and that the time involved in success-fully concluding tort litigation is often considerable. Further, as with breach ofcontract claims, a buyer who brings a tort action generally will not be able torecover its legal fees and expenses incurred with respect to the litigation.

To avoid the drawbacks associated with breach of contract and tortclaims, the buyer generally relies on rights of indemnification in the definitiveacquisition agreement. In most acquisition transactions other than acquisi-tions of public companies, the seller and/or its stockholders will provide atleast some level of post-closing indemnification protection to the buyer.

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What Is Indemnification?

A typical indemnification provision will require one party to “defend,indemnify and hold harmless” the other party from all “damages” that resultfrom a breach of the agreement or some other event or circumstance. Inother words, the indemnifying party will pay or reimburse the indemnifiedparty for any damages that its suffers with respect to matters included withinthe scope of the indemnification provision. The definition of “damages” willgenerally include legal fees and expenses associated with pursuing theindemnification claim or defending the indemnified party against a third-party lawsuit. This is done to make the indemnified party whole from thelosses it suffers.

The indemnification obligations in the definitive agreement are con-tractual rights. As such they are defined and limited by the provisions of thedefinitive agreement. Indemnification rights are typically subject to numer-ous qualifications and limitations which are discussed below. Bear in mindthat a culpable act of a party may not be a prerequisite for recovery under anindemnification provision. The parties to a definitive acquisition agreementare free to agree to indemnification for any event or circumstance, regard-less of whether it is the subject of a representation, warranty or covenant.Thus indemnification is a highly effective means to allocate risk between thebuyer and seller, without regard to the malfeasance of a party.

Acquisitions of Publicly-Traded Targets

When the buyer acquires a publicly-traded target, it will rarely be able tonegotiate for post-closing indemnification from the selling stockholders.The market’s resistance to post-closing indemnification rights in the publiccontext and the difficulties involved with seeking damages from a large anddisparate group of stockholders generally preclude the buyer from raisingthe issue with the seller. Nevertheless it may be possible for the buyer tonegotiate for post-closing indemnification rights under certaincircumstances.

For instance, in a “going private” transaction where the seller’s stock isnot widely held and a small group of controlling stockholders hold a sig-nificant majority of the outstanding shares, the buyer may be able tosuccessfully negotiate indemnification rights. The logistics of dealing withcontribution rights from selling stockholders may be manageable in thiscontext. The question will ultimately be decided by the negotiating leverageof the buyer and the seller.

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Types of Indemnified Matters

There are several types of matters for which indemnification rights aretypically provided in a definitive agreement. Often the limitations andqualifications on the indemnification rights will vary depending on the typeof matter in question.

Representations and Warranties

The representations and warranties in the definitive agreement serveboth as conditions to the parties’ obligations and as a method for allocatingrisk among the parties. As discussed earlier, in addition to the parties’ otherdue diligence efforts, they will look to each other to reaffirm their under-standings regarding the buyer, the seller and its business by makingrepresentations and warranties in the definitive agreement. If it turns outthat any of the representations and warranties are not true as of the signingof the definitive agreement and/or as of the closing, the parties will generallyhave a right to walk away from the transaction.

However, most agreements provide that immaterial breaches do notgive rise to a walk away right, but do allow the aggrieved party to make anindemnification claim after the closing to the extent damages are suffered. Ifthe parties close the acquisition and thereafter it is discovered that arepresentation or warranty was breached, and as a result of that breachthe other party suffered damages, then the aggrieved party will generally beable to bring an indemnification claim.

A typical definitive acquisition agreement will require the seller to makemany representations and warranties regarding itself, its business and itslegal ability to consummate the contemplated transaction. Particular atten-tion may be paid to specialty areas such as tax, real property, environ-mental, intellectual property, employee benefits and labor matters. Onearea of negotiation is the time period after closing for which indemnificationis available, or the “survival period.” Standard representations might survivefor a period such as six months to three years, depending on the industryand specifics facts of the parties. Specialty representations such as tax,environmental, benefits, etc. might survive for longer periods, such as twoto six years, or for the period of the statute of limitations for the particulartype of claim.

The buyer’s representations and warranties in the definitive agreementwill generally be more limited. The seller will want to know the buyer has thelegal and financial ability to close the contemplated transaction. As

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Chapter 7 - Indemnification & Contribution

discussed, much of the legal negotiation with respect to the definitive agree-ment will center around the scope of the seller’s representations andwarranties.

Covenants and Agreements

Besides the principal obligation of the parties to consummate thetransactions contemplated by the definitive agreement, there will be severalother covenants (or undertakings) among the parties in the definitiveagreement. These agreements will generally be organized into pre-closingcovenants and post-closing covenants. Pre-closing covenants will focus onthe actions necessary to close the transaction, such as cooperation with thebuyer’s due diligence efforts, coordination with respect to required thirdparty consents, and perhaps deal protections for the buyer such as “noshops” and “break-up fees” for the period between signing and closing.Post-closing covenants will generally include agreements between theparties regarding information rights and the transition of benefit plansand employees to the buyer. The buyer will frequently obtain restrictivecovenants as well such as non-competition, non-solicitation and non-dis-closure provisions.

Pre-Closing/Post-Closing Actions

The buyer will often try to obtain indemnification for any action that wastaken by or with respect to the seller and its business prior to the closing.This request is usually resisted by the seller as it in effect expands the scopeof liability that was negotiated in the representations and warranties. If theseller is unsuccessful in resisting this demand, it will sometimes argue for areciprocal right, i.e., indemnification for all actions taken by or with respectto the seller and its business after the closing. The buyer will generally resistthis request as well as it can be used by a seller to circumvent the negotiatedrisk allocations in the representations and warranties.

Specific Areas of Concern

In addition to indemnification for representations, warranties and cov-enants, the buyer will generally require separate indemnification rights forcertain areas of concern, regardless of whether a representation or war-ranty was breached. For instance, the buyer will almost always haveindemnification rights with respect to the disclosed tax liabilities of theseller prior to the closing. The buyer also frequently obtains separateindemnification rights with respect to disclosed environmental andemployee benefit plan liabilities of the seller prior to the closing. If during

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due diligence the buyer identifies any specific areas of concern, such as athreatened or existing litigation matter, the buyer will usually negotiate for aseparate indemnification for such item as well. The buyer will also oftenseek indemnification for transaction expenses and dissenters’ rights claims.The buyer will frequently require that any negotiated limitations on indem-nification, discussed below, will not apply to these special areas of concern.

Definitional Limitations on Indemnification

The buyer and the seller generally negotiate several limitations andqualifications regarding their respective indemnification obligations. Theselimitations and qualifications are usually discussed with respect to theseller’s indemnification obligations, since the majority of the representa-tions, warranties and post-closing covenants are obligations of the seller.

Scope of the Indemnified Parties and Indemnifying Parties

Perhaps the first limitation to negotiate is who will give indemnificationrights under the definitive agreement. Usually all of the parties to thedefinitive agreement grant indemnification rights with respect to theirrespective representations, warranties and covenants. But if one party isuncomfortable with the credit risk associated with another party, it maynegotiate for an indemnification right from a more credit worthy affiliate,such as the parent of the party to the agreement. Sometimes a minoritystockholder may be able to negotiate for limited or no indemnificationobligations if the buyer is satisfied with the credit risk of the majority,controlling stockholder.

Another threshold limitation to negotiate is who will be a beneficiary ofthe indemnification rights under the definitive agreement. Usually all of theparties to the definitive agreement will be beneficiaries of the indemnifica-tion obligations of the other parties. But it is not uncommon for other, relatedparties to also be entitled to indemnification. The parents, subsidiaries,officers, directors and employees of the parties to the definitive agreementare frequently included within the scope of the indemnified parties. Some-times the lawyers, accountants and lenders of the parties are also included.Some provisions provide that any affiliate of a party is included within thescope of the indemnified parties.

Scope of the Indemnified Breaches

Post-closing breaches of representations, warranties and covenantswill be included within the scope of indemnified matters in most definitive

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agreements other than an acquisition of a publicly-traded entity. The treat-ment of pre-closing breaches is less uniform. The seller frequently is able toexclude breaches which are disclosed prior to signing and sometimes willbe able to exclude breaches which occur after signing but before closing, solong as the breach does not rise to the level where a closing condition isunfulfilled. This type of arrangement sometimes calls for a hard decision bythe buyer: either close the transaction and waive its ability to seek damagesfor the disclosed breach or walk away from the transaction. See thediscussion below regarding prior knowledge or “anti-sandbagging.”

Scope of Damages

The scope of the damages recoverable for indemnified matters is acritical provision to negotiate. The seller will seek to put limitations on thetypes of damages available, and will frequently seek to negotiate a limitationthat prohibits recovery of any type of damages other than actual damagessuffered. The buyer, on the other hand, typically counters that if it is able todemonstrate to a judge that it is entitled to other types of damages, such asconsequential, lost profits and punitive damages, it should be able torecover these damages as well. Many buyers will negotiate hard for con-sequential damages (such as lost profits) that are reasonably foreseeable,as these are frequently the only damages suffered due to breaches ofrepresentations and warranties related to the seller’s customers and mate-rial contracts. The parties will also negotiate the definition of damages andmay exclude damages based on diminution in value, damages calculatedas a multiple of earnings and punitive damages from the definitiveagreement.

Monetary Limitations on Indemnification

It is common for the seller to seek to impose monetary thresholds andlimitations on its indemnification liabilities. Sometimes the buyer will alsoobtain the benefit of the negotiated limitations.

Baskets, Deductibles and Mini-Baskets

Baskets and deductibles are minimum thresholds that must beexceeded by the aggregate amount of all losses claimed by an indemnifiedparty before it is entitled to indemnification. If the provision is expressed as abasket, then once the threshold has been met, the party entitled to indem-nification will be able to recover all of its losses related to the indemnifiedmatters, including the losses below the threshold. If the provision is

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expressed as a deductible, then the indemnified party will only be able torecover its losses in excess of the threshold. Baskets and deductibles havethe effect of shifting some initial portion of the risk of loss from the indem-nifying party to the indemnified party.

A related concept is the mini-basket. With mini-baskets, if the damagesclaimed by an indemnified party do not exceed the negotiated threshold,then the indemnifying party does not have to indemnify for the loss, and theamount of the loss is disregarded for subsequent determinations of whetherthe basket or deductible has been reached. The theory behind mini-basketsis that there is some threshold level of losses that is de mininis, and that anindemnifying party should not be forced to investigate such claims becausethe time and costs greatly outweigh such “nuisance” claims. Most buyersresist mini-baskets and argue that their purpose is already served by themateriality thresholds negotiated in the representations and warranties.

Caps

Caps are maximum limitations on the obligations of an indemnifyingparty. If an indemnified party’s losses exceed the negotiated cap, then theindemnified party will only be able to recover its losses up to the cap (andsubject to any baskets or deductibles).

Carve-Outs

It is common for buyers to negotiate to “carve-out” from the baskets,caps and other limitations certain types of indemnification obligations.However, indemnified parties generally do not want to create a situationwhere an indemnifying party has an economic incentive to breach a pro-vision of the definitive agreement because its indemnification exposure isless than its anticipated economic gain by breaching the agreement. This isparticularly important in the context of obligations like non-competitioncovenants. Where the parties end up is almost always impacted by theindividual facts of the transaction, as well as the parties’ relative negotiatingpower.

Materiality Qualifiers

As noted, certain representations and warranties will have materialityand knowledge limitations within their text. These limitations may also affectwhether a representation or warranty has been breached for purposes ofindemnification obligations. The buyer may argue, however, that materialityand knowledge limitations should be disregarded for purposes of

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determining whether a breach giving rise to indemnification has occurredon the theory that the presence of a basket coupled with these limitationscreates a “double materiality” limitation and is “unfair” to the indemnifiedparty. If these limitations apply to the determination of the indemnificationright, they nevertheless typically do not act as a limitation on damages oncethe breach has been established.

Other Limitations on Indemnification

In addition to definitional and monetary thresholds and limitations,many definitive agreements contain one or more of the following limitations.

Prior Knowledge (Anti-Sandbag)

Anti-sandbag provisions provide that an indemnified party is not enti-tled to indemnification for any matters that it knew about prior to closing.The seller frequently negotiates for these provisions arguing that the con-tract should provide an incentive for the buyer to raise any such mattersprior to closing so that the parties can negotiate a resolution of the issuebefore the deal is closed. Buyers object to these provisions as unnecessaryto compel the buyer to discuss a problem with the seller — which naturallyhappens during the due diligence process — and because the real purposeof the provision seems to be to create a procedural hurdle for makingindemnification claims. The buyer argues that the seller will always claimthe buyer had prior knowledge of the matter if an indemnification claim ismade, and that the buyer will be forced to spend time and money refutingthis argument and will be forced to prove a negative (i.e., lack ofknowledge).

Prior Resolution (Purchase Price Adjustment)

Purchase price adjustment provisions are intended to ensure that anindemnified party does not recover twice for the same indemnified matter.The problem arises where the matter in question is the subject of a balancesheet reserve and/or purchase price adjustment and an indemnificationcovenant. For instance, if there is a $100,000 reserve for doubtful accountson the closing balance sheet which reduces the purchase price and arepresentation in the definitive agreement that the accounts receivable willbe collected, and if it turns out that $100,000 of receivables are not col-lectible, the buyer arguably should not be entitled to any indemnification forlosses because the purchase price delivered at the closing already

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compensated the buyer for this loss via the reserve. To allow the claimwould effectively be a “double dip” in the seller’s eyes.

Insurance Proceeds

Another common provision that is requested by the seller and resistedby the buyer is the concept that the losses recoverable by an indemnifiedparty should be reduced by the amount of any insurance proceeds actuallyreceived with respect to the indemnified matter. As with the purchase priceadjustment, the indemnifying party’s concern is that the buyer should notrecover more than the losses suffered on account of an indemnified matter.The buyer will typically agree to such provisions provided that they take intoaccount any increases in the cost of insurance caused by the matter, suchas premium increases or drop of coverage.

Tax Benefits

The seller may negotiate for a provision that provides that the lossesrecoverable by an indemnified party should be reduced by the amount ofany tax benefits actually received or recognized with respect to the indem-nified matter. As with the purchase price adjustment and the insuranceproceeds provisions, the indemnifying party’s concern is that the buyershould not recover more than the losses suffered on account of an indem-nified matter. However, measuring the tax benefits actually received onaccount of an indemnified matter can be quite difficult, at best.

Sole and Exclusive Remedy

Many definitive acquisition agreements provide that indemnificationunder the escrow is the sole and exclusive remedy of a party with respect toan indemnified matter unless there is fraud, in which case the limitations aregenerally not applicable under the terms of the agreement.

Indemnification Procedures; Dispute Resolution

In addition to defining the types of matters for which indemnification isavailable and the limitations on the damages recoverable through indem-nification, definitive acquisition agreements typically provide the proceduralmechanics for bringing and resolving an indemnification claim.

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Disputes Between the Parties

Many definitive acquisition agreements distinguish between third-partyclaims and disputes between the parties to a contract when negotiating theindemnification procedures. If the dispute does not involve a third-partyclaim, then the ground rules established at the time of the signing of thedefinitive agreement regarding how the parties will resolve their disputescan be used to speed the negotiation and dispute resolution procedures inthe agreement. Required periods of negotiation, mediation, arbitration andtraditional litigation are all tools that are available to the parties to theagreement.

Third Party Disputes

Resolving indemnification claims regarding third party disputes aremore problematic. Each of the parties will want to control the disputeresolution process with the third-party and use its own lawyers and otherprofessionals. Each of the parties will want to have a say in the resolution ofthe dispute, particularly if any fault is admitted or if any precedent isestablished. The indemnifying party will many times negotiate to controlthe dispute and its resolution, subject to the indemnified party’s ability toparticipate at its own expense and to veto any settlement requiring it toadmit fault or pay damages.

Special Matters

Certain substantive areas such as tax and compliance with environ-mental laws will frequently have additional procedures that govern indem-nification claims. These tend to be fairly technical and are usuallynegotiated directly by the relevant experts.

Hold-Backs of the Purchase Price

To secure the indemnification obligations of the seller and/or its stock-holders under a definitive agreement, buyers frequently require a hold-backfrom the purchase price. The form of the hold-back may be an escrow of aportion of the purchase price, a contractual deferral of the obligation to pay aportion of the purchase price until some date in the future, a promissorynote for a portion of the purchase price, or some combination of theforgoing. In order to secure the seller’s performance of its indemnificationobligations, the hold-back usually will be coupled with a right of set-off thatwill allow the buyer to forgo payment of the deferred portion of the purchaseprice in the amount of the damages suffered. Sellers often resist the buyer’s

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efforts to obtain the right of set off, although hold backs are quite common.Another key question is whether the escrow is the exclusive remedy forindemnification. Sellers will often negotiate for the escrow to be the sole andexclusive remedy, while buyers will resist such term, which is effectively acap.

Contribution Agreements

Contribution agreements are entered into by parties who share jointand several liability for an obligation. When there are two or more sellers in atransaction, they will frequently enter into a contribution agreement to clarifyhow they will allocate responsibility for indemnification claims among thesellers for any liabilities that arise post-closing under the definitive agree-ment. Usually sellers will bear responsibility pro rata based upon theirrespective ownership interests with respect to representations, warrantiesand covenants that are made on a joint and several basis, while imposing allof the liability on the applicable seller with respect to representations,warranties and covenants that are made on an individual basis.

The contribution rights of the sellers allow them to go against theassets of the other sellers to the extent that they are forced to pay the buyerfor an amount under the definitive acquisition agreement in excess of theirallocated responsibility under the contribution agreement. In order tosecure the contribution obligations of the sellers, contribution agreementsfrequently require a portion of the deal proceeds be set aside in an escrow.

Limitations on the parties’ indemnification rights and obligations onboth the upside and the downside are typically one of the most heavilynegotiated aspects of the indemnification section of the definitive acquisi-tion agreement, with the parties often constructing complex and elaborateprovisions in order to establish an overall risk allocation scheme that issatisfactory to them.

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Chapter 8

Fiduciary Duties of Board of DirectorsA board of directors considering whether to commit the corporation to

an M&A transaction owes fiduciary duties, including duties of care andloyalty, to the corporation and its stockholders. It is essential, therefore, thatdirectors considering M&A transactions understand and engage in strongcorporate governance practices and ground their decision-making in agood-faith, disinterested, well-informed and well-documented process.

In M&A transactions involving “interested” directors, directors mustengage in a process to assure that the duty of loyalty is satisfied. In theevent of the sale of control of a corporation or transactions withdeal-protection devices, directors may have heightened fiduciary duties.

Overview of Fiduciary Duties

The Business Judgment Rule

The common law “business judgment rule” reflects the recognition bythe courts that businessmen, not judges or stockholders, run corporations.The rule provides an important defense to sustain well reasoned, informedand good faith business decisions by the board. The Delaware SupremeCourt has summarized the rule as follows:

“The business judgment rule ‘is a presumption that in making a busi-ness decision, the directors of a corporation acted on an informedbasis, in good faith and in the honest belief that the action taken was inthe best interests of the company.’ ...A hallmark of the business judg-ment rule is that a court will not substitute its judgment for that of theboard if the latter’s decision can be ‘attributed to any rational businesspurpose’...” Unocal Corp. v. Mesa Petroleum Co., (Del. 1985).

To have the benefit of the business judgment rule, directors mustdemonstrate that they have met the duty of care, the duty of loyalty and theduty to act in good faith.

Duty of Care

Generally, directors have a duty to act in good faith and with reasonablecare. Directors must exercise the degree of care that a reasonable person ina like position would exercise under “similar circumstances.”

The Delaware Supreme Court explained this duty in the context ofmergers as the duty “to act in an informed and deliberate manner indetermining whether to approve an agreement of merger before submittingthe proposal to the stockholders.” Smith v. Van Gorkom (Del.

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1985)(emphasis added). In determining whether a board has met its duty ofcare, the legal test is whether a board availed itself of all reasonablyavailable material information about the subject of the decision.

The extent and nature of a board’s review and ultimate determinationconcerning a proposed M&A transaction may vary depending on, amongother things, the nature of the deal, its importance to the corporation, thesize of the corporation and certain timing considerations. The duty of carerequires directors to observe a process to make an informed decision.Thus, a court’s review does not turn on whether a proposed transactionultimately turns out to have been unwise, a mistake of judgment or detri-mental to the corporation, but rather on whether the directors’ actions inreaching a decision on the proposed transaction evidence an appropriatedegree of rationality, diligence, consideration and deliberation.

Van Gorkom, however, has made it clear that the business judgmentrule’s protection in the context of M&A transactions requires directors toprove that there was a decision making process that was designed to allowthe directors to be informed and consider all reasonable alternatives. In thatcase, the court determined that a corporation’s directors were liable forbreaches of their duty of care for making an uninformed decision eventhough there was no evidence of interested directors, personal gain, badfaith or fraud.

The facts of Van Gorkom are illustrative:

Jerome Van Gorkom, the Chairman of the Board of Trans UnionCorporation, commenced discussions with a potential acquirer of TransUnion without consulting with his board. Only after reaching terms for thesale of Trans Union did Mr. Van Gorkom call a special board meeting toconsider the transaction. The directors were not provided notice regardingthe purpose of the meeting and were not provided materials, such as termsheets, proposed valuation reports or transaction documents to review inadvance of the meeting.

Since Mr. Van Gorkom had also negotiated the terms of the proposedtransaction with only limited involvement from senior management, mostsenior management members first found out about the proposed saleduring a meeting for senior management called an hour before the boardmeeting was to be held.

During the meeting with management, the senior management team,with the exception of the two executives who had assisted Mr. Van Gorkomwith negotiating the terms of the deal, expressed a strong negative reaction

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to the proposed transaction. Nonetheless, the board meeting went aheadas scheduled.

During the board meeting Mr. Van Gorkom provided the board anoverview of the transaction — which ran approximately twenty minutes.Trans Union’s Chief Financial Officer, who opposed the transaction at themanagement meeting, stated that he could not indicate if the price was fairbut that the price per share offered was “at the beginning of the range” of afair price (it was noteworthy that Mr. Van Gorkom had actually suggestedthe sale price to the potential buyer but did not disclose this fact to theboard).

After just two hours of meeting time, the board approved the transac-tion without ever reviewing the definitive acquisition agreement. Mr. VanGorkom signed the definitive acquisition agreement later that evening. Intotal, the board

• received little advance warning of the meeting,

• held only brief deliberations and discussions of the proposedtransaction,

• did not consult with or consider the advice of experts,

• did not review material transaction agreements, and

• disregarded the obvious hesitancy of members of senior manage-ment regarding the proposed transaction.

With these facts in hand, the court concluded that Trans Union’s directorshad breached their fiduciary duty of care.

Directors considering proposed M&A transactions must not presumethat the business judgment rule will offer an absolute shield of protection.Rather, they should take reasonable efforts to ensure a process thatdemonstrates that they have reached a conclusion in a good-faith, well-informed and well-documented manner.

Practical Guidelines for Considering the Duty of Care

While the determination as to whether a board has met its fiduciaryduties in the context of an M&A transaction will always be made by a courtvested with the benefit of 20/20 hindsight, practical guidelines on how a

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Chapter 8 - Fiduciary Duties of Board of Directors

board may satisfy its duty of care can be distilled from case law andcorporate statutes, and include the following:

• Know Your Business — Directors should have a working knowledgeof the business of the corporation as well as its products, plans andpotential problems.

• Haste Makes Waste — The board should avoid not only haste, butthe appearance of haste, in approving an M&A transaction.

• Decisions regarding M&A transactions should be made only afterdirectors have had a full opportunity to digest all available materialinformation.

• Directors should receive information in sufficient time to review itadequately.

• Important and complex transactions, such as a sale of the corpo-ration, generally will require more than one board meeting.

• No Substitute for Diligence — Directors should review and considercarefully all available material information, and the board shouldcarefully review all relevant documents, including the definitive acqui-sition agreement, prior to authorizing their execution.

• Obtain Expert Advice — Directors should consider the advice ofadvisors or experts, including outside legal counsel and/or thecorporation’s investment banker, chosen with reasonable care (notethat the board may not entirely delegate its responsibilities or thedecision-making process to third parties). A board should considerwhether persons providing information regarding a proposed acqui-sition are potentially biased due to severance arrangements, feearrangements or otherwise. Directors should also be convinced thatthe advisors to the board are competent, were chosen with reason-able care and are providing sound advice.

• Look Beyond the CEO — Directors should consider the advice of thecorporation’s other officers and employees who would be expectedto have relevant information on the subject.

• Ask Questions — Directors should ask questions and actively probeand test all information presented to them, judging its reliability andaccuracy and understanding it fully, and review all issues important tothe directors’ conclusion.

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• Be Cognizant of Conflicts — The board should ensure that “inter-ested” directors recuse themselves from the discussion and thedecision.

• Leave a Thoughtful Record — The record of the board’s delibera-tions should be documented carefully and completely.

Neither the presence nor absence of any one of these factors is likely tobe dispositive of a director’s compliance or breach of his or her duty of care.Instead, courts will consider whether a director has given thoughtful con-sideration to the issues, and will review methods of inquiry and sources ofinformation available to and employed by the director. Courts have, how-ever, been more likely to conclude that directors have failed to meet theirduty of care when they have acted hastily or as passive participants withoutcarefully examining information provided by management and experts.

Duty of Loyalty

In addition to the duty of care, directors have a fiduciary duty to makedecisions based on the “best interests” of the corporation and its stock-holders and not their own personal interests. This duty of loyalty is intendedto prohibit “self-dealing” by directors and generally requires that directorshave an absence of personal financial interest in the matters they approve.

Directors are not viewed as “interested” simply because they maybecome directors of the combined entity, or because they are stockholdersor option holders. In contrast, a director who also serves as an officer oremployee of the corporation, or who is a member of a firm receivingsubstantial revenue from the corporation, whether or not in the particulartransaction, may be viewed as having a self-interest not shared equally byall stockholders. There may be employment agreements with managementdirectors which should be considered in determining if self-dealing trans-actions exist.

A person who is a director of both the target corporation and a pro-spective buyer has a conflict of interest, as the director owes a duty of loyaltyto each corporation. This director is required to keep information of eachcorporation confidential, but is also obligated to provide material informa-tion in his possession to each board on topics he knows are being con-sidered. A director in this circumstance must recuse himself from anydiscussion about a potential transaction for either company, and cannotserve as an agent of either company without breaching his duty to one orthe other corporation.

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All possible transactions or relationships that might influence a direc-tor’s decisions concerning an acquisition, including relationships with otherprospective acquirers, should be fully disclosed to the board as a whole.Courts have found that a board has met the requirement of independencewhere a majority of the board consists of independent outside directors.

Practical Tip: Conflicts of Interest are Not InherentlyImproper But Require Good Process

Today, transactions that present conflicts of interest involving adirector are not viewed as inherently improper. Courts will insteadinquire as to the manner in which the board addressed the conflict ofinterest to determine if the board’s decision was improperly influencedby the interests of any interested directors or other corporate parties.

When an interested director transaction has not been approved by amajority of informed and disinterested directors, courts may disregard thebusiness judgment rule and instead apply the “entire fairness analysis” —which shifts the burden to the parties who entered into the transaction toprove that the transaction was fair to stockholders. As such, the entirefairness analysis is based not on whether directors acted in bad faith butwhether, in the absence of arms-length negotiation and bargaining, thetransaction, viewed objectively, is in fact fair and reasonable.

In the M&A context, the parties to the transaction will be required toshow that the transaction was the product of both fair dealing and fair price.

Practical Guidelines for Considering the Duty of Loyalty

The involvement of disinterested, independent directors in approvingan M&A transaction can increase the likelihood that a board’s decision willreceive deference under the business judgment rule or will survive theheightened scrutiny attendant in cases involving sale of controltransactions.

For boards comprised of a majority of disinterested, independentdirectors this protection can be found by having the interested minorityabstain from approving or negotiating the deal. Care must be taken toensure the special interest is fully disclosed to the board by the interesteddirector(s). When a majority of the board is interested and/or not indepen-dent, or in cases where management is actively working with the buyer,

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however, the board may wish to form a special committee comprised ofuninterested and independent directors and delegate to the committee theauthority to review and negotiate the terms of the proposed transaction.

Use of Special Committees

An effective special committee must:

• consist of members who are truly independent from the mattersunder consideration,

• have the power to act independently,

• have access to all relevant material information, and

• engage in arms-length negotiation of the transaction terms.

When a board creates a special committee it is important that thecommittee both be involved in the transaction and have the authority andpower to negotiate and ultimately disapprove the transaction. The com-mittee, moreover, should be involved throughout the entire process of theproposed transaction and not just at the initial or term sheet level or in theinitial efforts to choose one suitor from a field. Critically, a special committeemust also have a clear conception of its role in the deal negotiation andapproval process and must be aware that its members have the authority toultimately disapprove the deal. A special committee is not effective if it isused only as a “rubber stamp” for a transaction negotiated by the man-agement or interested directors.

To ensure that the committee members are fully informed regarding thetransaction, and have independent advice on strategy and tactics fornegotiations, the courts have held that special committees require theirown set of financial and legal advisors separate from those advising theboard. The special committee should have the power to select theseadvisors and the advisors should report directly to the committee.

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Practical Tip: An Effective Special Committee TakesPlanning

The use of a special committee may be an invaluable tool toaddress duty of loyalty concerns but requires advance planning,additional time to accommodate the special committee’s separatedeliberations and the costs associated with retaining separate advi-sors for the committee.

Alternatives to Special Committees

When a board is comprised of a majority of disinterested directors, itmay seek to address the potential influence of interested directors throughthe following means:

• Approval by Disinterested Directors — When a director faces apossible conflict of interest, such director should:

• submit such action or decision for approval by the disinterestedmembers of the board, and

• provide such disinterested directors or committee with full disclo-sure as to the nature of the conflict of interest.

• Recusal from Board Discussions — Where a conflict of interest isinherent, the most prudent course of action for an interested directormay be to withdraw from participation in both the voting upon theissue (in order to achieve disinterested board member approval) aswell as the board’s discussion of the matter.

• Stockholder Approval — The board may choose to:

• submit the action or decision for approval by the stockholders ofthe corporation (excluding any shares that might be held by theinterested director or affiliate), and

• provide the stockholders with full disclosure as to the nature of theconflict of interest and the terms of the transaction in question.

Such stockholder approval (with full disclosure) may also bring aninterested director transaction within the scope of applicable statutorysafe harbors for interested party transactions.

In all cases, during the board meeting at which the potentially “inter-ested” transaction is presented for approval, directors should thoroughly

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review and discuss the proposed transaction, analyze and question theinternal and outside reports prepared in connection with the board review,ensure that open issue items are addressed, and reflect in the minutes thediligent deliberations in which the board members had been engaged.

Heightened Fiduciary Duties

Directors have heightened duties and a restricted range of action inM&A transactions in two situations — those that will result in a sale ofcontrol of the corporation or in transactions involving deal-protectiondevices. In such instances, the conduct of the board with respect to aproposed transaction is judged under an “enhanced scrutiny” standard.

Where the directors have determined that a sale of “control” or breakup of the company is “inevitable,” their duty is “the maximization of thecompany’s value at a sale for the stockholders’ benefit.” Revlon, Inc. v.MacAndrews & Forbes Holdings, Inc., (Del. 1986) “In the sale of controlcontext, the directors must focus on one primary objective — to secure thetransaction offering the best value reasonably available for the stockhold-ers.” Paramount Communications v. QVC Network, Inc., (Del. 1994). A cashmerger or other business combination in which stockholders are cashedout, or in which a stockholder or affiliated group of stockholders of the buyercontrols the continuing entity, is generally viewed as a “sale of control.” Thisis because such a transaction represents the stockholders’ only opportunityto receive a control premium. Thus, an acquisition transaction that isprimarily a cash transaction is judged under the Revlon standard, and ifthe directors decide to pursue a sale of the company for cash the board’sobligation is to obtain the best available terms for the stockholders.

Not every merger is a “sale of control.” Delaware courts have held that a“stock-for-stock” merger, where a majority of the shares in the combinedentity will continue to be held after the merger by a “fluid aggregation ofunaffiliated shareholders representing a voting majority,” is not a sale ofcontrol. Of course, even in a stock-for-stock merger, a board must continueto exercise due care, reviewing all reasonably available information con-cerning the transaction and other alternatives.

Even when a board is subject to Revlon duties, no one method ofobtaining the best value is required, and the board has reasonable latitudein determining the method of sale most likely to produce the highest valuefor all the stockholders. The clearest method to assure that the directorshave obtained the “best” available price is to conduct a public auction of thecompany. Nevertheless, the courts have recognized that such an auction

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damages the company, perhaps irretrievably, in the event a deal cannot bemade with potential buyers, and adversely affects the company’s ongoingoperations during the auction process. Perhaps as important, the courtsrecognize that most bidders are unwilling to expend the time and effort on apossible acquisition merely to serve as a “stalking horse” for another bidder.

Accordingly, Delaware courts have sometimes accepted as reason-able directors’ reliance on a “market check” in which private inquiries to themost likely bidders have been made, or where the transaction has beenpublicly announced far enough in advance so that competing bidders mayhave a reasonable opportunity to express interest. Moreover, Delawarecourts have held that in determining the adequacy of the offer in a sale ofcontrol, directors may approve a transaction without employing an auctionor a market check, so long as they are able to demonstrate that theypossessed a “body of reliable evidence” on which to base their decision.QVC Network, Inc. v. Paramount Communications, Inc., (Del. Ch. 1993),citing Barkan v. Amsted Industries, (Del. 1989), affirmed (Del.1994). InBarkan, the court noted there is “no single blueprint” for obtaining thenecessary evidence to satisfy Revlon duties. However, Delaware law is stilldeveloping as to what constitutes sufficient “reliable evidence” on compar-ative value.

In one Chancery Court case, the judge explained that although a target“negotiated with a single bidder, it bargained hard and made sure thetransaction was subject to a post-agreement market check...” In rePennaco, Inc. Shareholders Litigation, (Del. Ch. 2001). In a recent case,however, the Chancery Court noted that “[a]lthough the directors have achoice of means they do not comply with their Revlon duties unless theyundertake reasonable steps to get the best deal.” In re Netsmart Technol-ogies, Inc. Shareholders Litigation, (Del. Ch. 2007).

In the Netsmart case, the Chancery Court noted the obligation of theboard or committee to control every aspect of the process, including thediligence process, to maximize value, and also criticized the special com-mittee in that case for failing to consider seriously possible strategic buyers.The target company board developed a process with their banker seekingonly private equity buyers, and relying on a post-signing market check asthe means to determine if other interest, including interest from strategicbuyers, existed. The Netsmart case signals the Delaware courts’ view that ifa board decides to pursue a cash sale of the company, the directors areobligated to take “reasonable efforts to maximize the return to ... investors.”This recent case confirms earlier cases permitting the board to use a“market check” of likely buyers rather than a full-blown auction, but requires

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the board to use its business judgment to develop a process that will enablea market check for logical buyers, and notes that reliance on a post-signingmarket check is not per se reasonable. The Chancery Court noted the“potential utility of a sophisticated and targeted sales effort,” tailored to “afew logical buyers” and the use of a banker with industry connections tomarket the company. The Court further elaborated that a board can legit-imately consider the risks to the company from going to a broad group ofpotential buyers, but that the risk must be real and weighed against theboard’s duty to obtain the best available price and terms. The board mustmake a “genuine and reasonably-informed evaluation of whether a targetedsearch might bear fruit.”

Exclusivity Agreement

A prospective buyer will sometimes propose an exclusivity agreementto a target, arguing that the buyer does not want to be a stalking horse and isunwilling to undertake significant expense in diligence efforts and negoti-ation of an acquisition agreement without such an exclusivity agreement.These types of arrangements are subject to significant scrutiny by thecourts, particularly in a cash transaction, given the board’s duty to maximizestockholder value, and should be evaluated with caution. These arrange-ments should not be entered into without board approval and only afterconsidering all the factors relevant to the arrangement, including the like-lihood of other bidders, the duration and extent of any market checkundertaken, the amount of time requested for exclusivity, the status ofnegotiations relating to price and terms and the relative attractiveness of theoffer compared to other alternatives reasonably available to the company,the risk of losing the transaction at hand in the event exclusivity is notgranted and any other relevant factors.

Fiduciary Duty Implications of Certain of M&A TransactionTerms

The board’s approval of certain transaction terms, no matter how welldiscussed or considered, may itself constitute a breach of the directors’fiduciary duties. In particular, the board’s approval of certain types of no-shops, termination fees, breakup fees and voting agreements, and othersuch deal-protection devices have been subject to scrutiny by courts. In atransaction involving these “deal protection” devices, the courts haveapplied a two prong test for determining whether a board has breachedits fiduciary duty. The first prong of the test is that the directors must havehad a reasonable belief that the takeover bid posed a danger to the

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corporation. The second prong of the test is that there must have been areasonable relationship between the threat of takeover and the actualdefensive tactics adopted by the board.

No-Shop Provisions

No-shop provisions are protective mechanisms used in M&A transac-tions that seek to reassure a prospective buyer that the seller will not accepta competing offer, by prohibiting the seller from soliciting other bids ornegotiating with other potential buyers. No-shop provisions reduce the riskto the potential buyer that a proposed transaction in which it has investedsubstantial time, energy and costs will be used as a stalking horse. No-shopprovisions may also benefit the prospective seller by inducing the prospec-tive buyer to enter agreements for M&A transactions despite the risks thatthe deal may not get done.

Directors have a fiduciary duty to carefully review and consider no-shop provisions because the provisions may have the effect of precludingcompeting bids that might offer greater value to the stockholders. In sale ofcontrol transactions, no-shops provisions will generally only pass muster ifthey are:

• found to be reasonably necessary to induce an offer that the boardreasonably believes is the best available bid, and

• drafted so as to contain a “fiduciary out” clause.

Fiduciary out clauses permit boards to consider unsolicited offers,provide other unsolicited suitors with information, accept competing offersand withdraw recommendations to the stockholders if the failure to do sowould result in a breach of the directors’ fiduciary duties.

The buyer can seek to limit fiduciary outs in a number of ways. Themost common way is to require that the seller’s board first conclude that thealternative transaction on which the board seeks to exercise its fiduciary outis a “superior proposal”. The seller can negotiate the definition of “superiorproposal” so that it is only triggered by a bid that is financially or strategicallybetter then the buyer’s offer or more likely to actually be consummatedbased upon on a good faith determination of the board and/or supported bythe advice of a nationally recognized financial advisor that such offer isindeed a “superior proposal” as well as advice of legal counsel that failure toaccept the new offer would result in a breach of the directors’ fiduciaryduties. A prospective buyer can also negotiate the fiduciary out to include aprovision that requires the seller to provide the buyer with advance notice of

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the competing offer and granting the original prospective buyer the right tomatch the new offer.

Termination and Breakup Fees

Termination and breakup fees are financial penalties that must be paidby one party to another party to a proposed M&A transaction upon theoccurrence of certain events that result in the transaction failing to close.Such fees usually are triggered by:

• the seller’s decision to exercise its fiduciary out under a no-shopclause and pursue a superior proposal; or

• the seller’s board’s withdrawal of its recommendation or failure toreaffirm such recommendation upon the announcement of anotheracquisition proposal; or

• an alternative transaction is announced and subsequently the targetstockholders do not approve the transaction and within some periodsuch as 6-18 months after termination of the merger agreement thetarget enters into a definitive agreement for an acquisition proposalor is acquired; or

• breach of the no shop.

Termination and breakup fees are generally permissible if required bythe target to induce the buyer to enter into the agreement. A board’sdecision to approve termination and breakup fees, however, is subject toheightened scrutiny and may lose the protection of the business judgmentrule when the size of such fees becomes so large as to preclude bids whichmight offer substantially greater value to the stockholders.

Directors determining whether to approve termination and breakupfees in an M&A transaction thus must carefully consider both the size of thefee and the events triggering its payment. There is no clear guideline as tohow large is too large, but court approved fees have generally rangedbetween 1.0% to 4.5% of transaction value. Courts have said that there isno “one size fits all” percentage but the terms must be considered in theparticular fact pattern to determine if the fees are preclusive to an alter-native bidder.

The timing and triggering events for termination and breakup fees alsomerit careful attention by directors. If a fee is triggered by a seller’s mereprovision of information to a potential suitor who makes an acquisitionproposal deemed by the target board to be reasonably likely to lead to a

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superior proposal, this would be of particular concern. The board should beable to discuss with a prospective buyer in that case whether the offer is infact superior. The board generally should not fear losing the deal in handand having to pay a termination fee in connection with exploratory discus-sions with a suitor who may offer greater value to the stockholders, so longas the offer is unsolicited. In a recent Chancery Court decision, the ViceChancellor favorably commented on a termination fee structured to ensurethat stockholders “would not cast their vote in fear that a “no” vote alonewould trigger the fee; the fee would be payable only if the stockholders wereto get a better deal.”

Voting Agreements

A prospective buyer will often try to “lock-up” an M&A transaction byobtaining a commitment from the stockholders, typically holders of 5% ormore of the voting stock and management stockholders, that the stock-holders will

• vote in favor of the proposed transaction,

• vote against any proposal adverse to the buyer’s, and

• agree to certain restrictions on transfers of their shares until thetransaction is approved and consummated.

The lockup typically takes the form of a voting agreement between thebuyer and the seller’s stockholders and grants an irrevocable proxy. Votingagreements containing lockup provisions warrant particular scrutinybecause they commit stockholders to vote in favor of a transaction eventhough a more favorable offer may arise and without regard to the fact thatthe board may have chosen to exercise a fiduciary out.

Voting agreements may implicate directors’ fiduciary duties becausedirectors are required to approve the agreements in certain instances. Forexample, the applicable corporate statute may require corporations andthus their boards to approve any lockup agreement in an M&A transaction towhich the voting securities of the corporation are subject.

Whether a voting agreement contains an unreasonable lockup, theapproval of which by a director constitutes a breach of fiduciary duty, canhinge on the degree of the lockup and its preclusive effect on other offers. Ifthe voting agreement locks up too many of the seller’s stockholders suchthat it creates a preclusive block on any other transaction, courts have held

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that the board’s approval of such a voting agreement will constitute a breachof fiduciary duties.

Under Delaware law, if a merger agreement contains a “force the vote”provision (under which the seller’s directors are required to submit a pro-posed transaction to a stockholder vote even if the board subsequentlychanges its recommendation), then it is illegal under Delaware law to alsohave a voting agreement with a majority of the corporation’s stockholders tovote in favor of the transaction. Delaware courts have held that the couplingof a “force the vote” requirement and voting agreement that locks up amajority of the voting shares effectively precludes any competing bids forthe seller and that by permitting the corporation to be subject to suchprovisions, the seller’s directors may be in breach of their fiduciary duties bynot negotiating a fiduciary termination right.

Directors must ensure that any board approved voting agreementcontaining a “force the vote” provision also provides for a fiduciary termi-nation right or not govern so many shares as to preclude any other trans-actions. Exactly where this preclusive threshold lies is unclear (courts havefound 33.5% of the outstanding voting stock to be sufficiently preclusive incertain circumstances while finding that a 40% lockup was not truly lockedup).

In summary, arrangements such as “no shop” clauses, “break up” fees,stockholder voting agreements, and “force the vote” provisions may bejustified under Delaware law if the board determines that the defensiveprovision is necessary to obtain a favorable merger proposal, but only if theprovisions, taken as a whole, do not preclude the board’s consideration of amore favorable transaction for the stockholders. Recent Delaware casesmake it clear that these types of “lockup” provisions are not to be enteredinto without significant board scrutiny and a determination that the provi-sions are reasonably tailored and actively negotiated to protect theenhanced value inherent in the transaction and not to preclude all com-peting deals.

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Chapter 9

Stockholder Approvals and Securities LawCompliance

The parties to an M&A transaction will have to determine whethereither party will need to obtain stockholder approval for the completion ofthe transaction. This is most often an issue for the seller in the transaction,but depending on the deal structure and consideration to be paid in thetransaction, the buyer may also need to seek stockholder approval.

Stockholder consent requirements are usually driven by the laws of thestate of incorporation of the subject corporation or its charter documents(i.e., certificate/articles of incorporation and/or bylaws). For example,Section 251 of the General Corporation Law of Delaware requires that amerger agreement between domestic stock corporations be submitted tothe stockholders of the constituent corporations for approval at an annual orspecial meeting for such purpose. Note that in Delaware, if a buyer uses asubsidiary corporation to make the acquisition, the parent corporation is nota “constituent” corporation. In addition, the charter documents of the sellermay require additional consents from a separate class or series of shares,e.g., from holders of a majority of the outstanding preferred stock (this typeof requirement is most often found in the charter documents of privatelyheld companies).

Another source of a requirement for stockholder approval may be thelisting agreement or governance requirements of a stock market orexchange such as the New York Stock Exchange (NYSE), American StockExchange (AMEX) or the Nasdaq Global Market (Nasdaq). Even in anacquisition of a private company there might be a requirement on the buyerside in connection with the issuance of the buyer’s stock as considerationfor the acquisition.

The requirements under stock exchange rules for stockholder approvalvary, but generally approval is necessary for transactions in which the buyerwill issue, or has the potential to issue, 20% or more of its outstandingcommon stock, or if the issuance will for some other reason impact thecontrol of the buyer. The NYSE, AMEX and Nasdaq each have specificrules in effect in this regard, and the rules need to be carefully reviewed todetermine application to the particular transaction. The impact of theserequirements and the determination of whether they are applicable to a dealcan be especially tricky in a transaction where the acquisition considerationis based on a fluctuating per share price, or if the number of shares canincrease as the function of an earn-out provision. The buyer may include acap on the number of shares that may be issued in the transaction toeliminate a need for buyer stockholder approval. Even in a situation where

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the buyer first raises money in a financing transaction (in which the 20%limitation does not apply) in order to make a subsequent cash acquisition, ifthe number of shares sold in the financing transaction constitutes 20% ormore of the outstanding common stock, Nasdaq generally takes the posi-tion that such transaction would require stockholder consent.

Obtaining Stockholder Approvals

Timing

Obtaining stockholder approval usually takes place after the partiessign the definitive acquisition agreement and should be a condition to theclosing of the proposed transaction. The buyer and seller will want to besure that they have a fully negotiated transaction before going to stock-holders for consent. This is especially the case where the seller is a publiccompany and the consent solicitation material, or proxy statement, ispublicly filed with the SEC, as discussed below.

The period of time required for the stockholder consent process canalso vary greatly in length depending on whether the buyer and seller bothneed stockholder consent and whether the seller is a public or privatecompany.

Practical Tip: Stockholder Approval Covenants

The parties typically include covenants within the definitive acqui-sition agreement concerning the use of “commercially reasonable” or“best” efforts to obtain requisite stockholder consents and to prepareand file with the SEC any related materials as soon as practicableafter the signing of the agreement.

Voting Agreements

To mitigate the risks of the parties not being able to deliver requiredstockholder consents, and therefore not being able to close the deal, theparties may use voting agreements. Voting agreements, if used, are typ-ically required of the seller, but when both parties are required to obtainstockholder consents, they may be reciprocal. As discussed in Chapter 8, avoting agreement is used to contractually bind a stockholder to vote in favorof the proposed transaction and to vote against any alternative transaction.The stockholders asked to sign voting agreements are typically limited tothose with a significant amount of stock.

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As noted in Chapter 8, the use of voting agreements is subject tojudicial scrutiny because of the restrictions that voting agreements mayimpose on the ability of the board to fulfill its fiduciary duty to maximize valueto stockholders. In a private company acquisition, buyers often avoid thisissue by requiring the target to deliver consents of stockholders to approvethe transaction at the signing of the definitive agreement, or require stock-holder approval to be obtained prior to the buyer entering into the acqui-sition agreement. Note also that entry into voting agreements may alsorequire the buyer and/or subject stockholder to file with the SEC a Form 13Dwith respect to changes in beneficial ownership of the seller’s stock.

The Process

The process by which the parties to an M&A transaction obtainrequired stockholder consents will depend in large part on their status aseither a privately held or a publicly traded corporation and the nature of theconsideration being paid in the transaction. In any case, the parties will wantto be sure to provide to their stockholders information sufficient to make aninformed decision as to whether to consent to the transaction.

If the party seeking stockholder consent is a publicly traded corpora-tion, it will include this information in a proxy statement that is filed with theSEC. If the party seeking consent is a privately held corporation, it mayprepare an information statement that is not filed with the SEC, but whichincludes most, if not all, of the information that would be contained in a proxystatement filed with the SEC. If the buyer is issuing stock in the transaction,and is not registering the stock with the SEC under Form S-4, the buyer willneed to find another exemption from registration, such as Regulation D orRule 3(a)(10) and in these cases the buyer will need to comply with theinformation requirements of either Regulation D or of the state securitieslaws governing the fairness hearing under Rule 3(a)(10).

The Proxy Statement

Once the definitive acquisition agreement is signed by the parties, thepreparation of the proxy statement begins in earnest. It is important to notethat the securities laws define the term “solicitation” broadly, which createsproblems for the constituent corporations trying to communicate about theproposed transaction after announcement of the transaction and prior tothe filing of the proxy statement. Under Regulation MA, the SEC haspermitted companies to speak about the transaction prior to the filing ofthe proxy statement, but the trade-off is that the corporation must file all“solicitation” materials with the SEC on the date of first use with a legend

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Chapter 9 - Stockholder Approvals and Securities Law Compliance

indicating that they are additional soliciting materials. The judgment call asto whether press releases, investor presentations or employee presenta-tions are additional material required to be filed requires careful analysisand should be considered with the assistance of legal counsel.

Schedule 14A under the Securities Exchange Act of 1934 outlines theinformation to be disclosed in a proxy statement concerning a transactionbeing submitted for stockholder consent. This information may include:

• Description of the Transaction — A description of the basic mechan-ics and effects on the constituent corporations of the mergertransaction

• Background of the Transaction — A chronological description of thefacts and circumstances behind the proposed transaction and howthe parties came to sign the definitive agreement

• Reasons for the Transaction — A description of reasons that theboard deems the proposed transaction to be in the best interests ofthe corporation and its stockholders

• Recommendation of the Board of Directors — A statement as to theboard’s recommendation whether or not to approve the transaction

• Fairness Opinion — A description and background behind any fair-ness opinion rendered by financial advisors as to the fairness of theproposed transaction to the stockholders from a financial point ofview

• Interests of Officers and Directors in the Transaction — Disclosureregarding the interests of the officers and directors of the corporationin the transaction, including deal consideration, change of controlpayments, severance, employment arrangements, etc.

• Appraisal or Dissenters Rights — A description of any appraisal ordissenters rights available to stockholders that do not vote in favor ofthe transaction

• Material Tax Consequences — A discussion of the tax impact of thetransaction on the stockholders of the subject corporation

• The Definitive Acquisition Agreement — A description of the materialterms of the definitive acquisition agreement, including mechanicsand effects, consideration, representations and warranties, cove-nants, conditions to closing and termination rights and effect oftermination

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The corporation seeking stockholder consent will need to file the proxystatement with the SEC in preliminary form at least ten days prior todistributing the materials to the stockholders. These preliminary proxymaterials are subject to review and comment by the SEC. The SEC willpromptly advise the corporation if it intends to review the preliminary proxymaterials. If the SEC advises that it will not review the materials, thecorporation is free to distribute the definitive proxy materials to its stock-holders and concurrently file them with the SEC. If the SEC comments onthe preliminary proxy materials, the corporation may be required to fileamended proxy materials or may be able to make requested changes in itsdefinitive proxy statement. In the event the SEC elects to review thepreliminary proxy materials, it may take thirty days to receive commentsand forty-five to sixty days to complete the review and comment process,sometimes longer. Accordingly, it is prudent to file the preliminary proxymaterials well in advance of the anticipated mailing date of the definitiveproxy materials to stockholders. A filing fee is required with the filing of aproxy statement and is generally equal to one 50th of one percent of theaggregate value of the transaction.

If instead the transaction is being accomplished without a filing with theSEC, the target company will have to determine the material informationrequired to disclose the transaction; it is advisable to consider the types ofinformation deemed material by the SEC in making this determination. If thebuyer is issuing stock, the buyer will also need to determine that all materialinformation is provided to the target stockholders for their determination asto whether to approve the transaction. Regulation D sets forth informationrequirements for the sale of securities, and state securities laws mayprovide information requirements, particularly if the buyer is relying onan exemption from registration under Section 3(a)(10). State case law mayalso provide further rules on information to be provided to stockholders.

Once the definitive proxy statement has been completed, it will bemailed to the stockholders. State corporate law and the corporation’scharter documents will establish the time frames for delivery of notice ofthe stockholder’s meeting concerning the transaction. The notice period isgenerally no less than twenty days and no more than sixty days prior to thestockholders’ meeting. The notice is usually included as part of the proxystatement. In order to ensure that stockholders have sufficient time toreceive and act upon the proxy materials, the corporation will want todistribute the materials as far in advance of the meeting date as permitted.

Recently, electronic distribution (via Internet and e-mail) of proxymaterials has become available and is encouraged by the SEC, subject

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to certain requirements and constraints. These methods help increase theefficiency and decrease the costs of the proxy solicitation process. How-ever, care should be taken to comply with both federal securities laws, withrespect to disclosure and delivery, and state laws, with respect to votingprocedures.

Proxy Solicitors

To help ensure that the required stockholder consent to the transactionis obtained, the publicly traded corporation seeking consent will oftenemploy a proxy solicitor. Proxy solicitors can be particularly helpful dealingwith brokerage houses that hold large numbers of shares in “street name”.The role of the proxy solicitor becomes more important in a transaction thatis contentious or not universally viewed as a positive event for thecorporation.

The Stockholders’ Meeting

The time and location of the stockholders’ meeting will have beenincluded in the notice of meeting and proxy statement and may be held atthe offices of the corporation or at any other facility that is adequate toaccommodate the stockholders. Oftentimes, a corporation will choose tohold the stockholders’ meeting at an off-site location to minimize disruptionsamong employees. However, if the proposed transaction is generallyviewed as a positive event, the corporation may want to encourageemployee attendance and participation. Given that many stockholders willsimply complete and return their proxy card, rather than appear at themeeting to vote in person, frequently only stockholders that live in thevicinity of the meeting will attend. Attendance can be expected to increasein a contentious transaction.

In addition to the stockholders, senior management and some or all ofthe members of the board of directors will attend the stockholders’ meeting.This gives the stockholders the opportunity to ask questions and obtainfeedback from management and the directors concerning the issues raisedby the proposed transaction.

The corporation will also appoint an inspector of elections to tabulatethe votes cast at the meeting in person and by proxy and to certify theresults of the vote. The inspector of elections is usually a representative ofthe corporation’s transfer agent, but may be another independent thirdparty. In most cases, the corporation will also have its legal counsel attendthe special meeting to address any voting or procedural issues. Presence of

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legal counsel may be particularly important in the context of an unpopular orcontested transaction.

Once it has been determined that a quorum is present at the meetingeither in person or by proxy, the vote will proceed. Thereafter, the inspectorof elections will tabulate the votes to determine if the requisite stockholderconsent was obtained. Oftentimes, corporations will include as a proposalin the proxy statement the adjournment of the meeting if deemed necessaryto facilitate the approval of the proposed transaction, including to permit thesolicitation of additional proxies if there are not sufficient votes at the time ofthe meeting to approve the transaction.

Information Statements and Written Consents

As noted above, if the corporation seeking stockholder consent to aproposed transaction is a privately held corporation, the process will likelybe simpler and faster than a public corporation. Depending on the circum-stances of the transaction, the information requirements for the stockholdersolicitation may be substantially the same as those for a proxy statement orsomewhat less. Either way, the corporation should strive to provide as muchinformation as practicable on which the stockholders can base their deci-sion whether or not to consent to the deal. The simple fact that thecorporation will not be required to file the information statement with theSEC and potentially deal with a review and comment period will greatlystreamline the process.

The other factor that will simplify the stockholder consent process by aprivately held corporation is that the stockholders of many privately heldcorporations are permitted by the charter documents of the corporation orapplicable state corporate law to act by written consent in lieu of a meeting.In this circumstance, the corporation can save the expense and time of astockholders meeting and circulate a written consent with the informationstatement. As noted above, a buyer may insist that a private seller provideconsents sufficient to approve the transaction at the time of signing of adefinitive agreement. This will be possible if the affiliates of directors andofficers knowledgeable about the transaction hold sufficient shares toapprove the transaction. In most states, if approval by written consent isobtained by less than unanimous vote, the other stockholders must benotified “promptly” of the stockholder approval. Alternatively, a target mightmail an information statement to all stockholders on the date of signing ofthe definitive agreement and accept consents from those stockholders whohave sufficient knowledge of the transaction at the date of signing.

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Registration Statements for Buyer’s Securities

As noted above, if the buyer proposes to use its own securities as theconsideration for the transaction, it must either register those securities withthe SEC or have an available exemption from registration in order todistribute the securities to the seller’s former stockholders at the closingof the transaction. The buyer’s securities will normally be registered onForm S-4, if no exemption from registration is available. The prospectuscontained as part of the registration statement becomes a proxy statementfor the seller’s stockholders meeting and is usually referred to as a proxystatement/prospectus. In the event the consent of the buyer’s stockholdersis also required (e.g., due to stock listing requirements), the same docu-ment may be used as a proxy statement for the buyer’s stockholder’smeeting.

The information requirements of Form S-4 are voluminous and require,in addition to all of the information contained in a proxy statement, detailedinformation regarding the businesses of the corporations, financial infor-mation, stock ownership information and much more. Incorporation byreference to SEC filings is permitted subject to various requirements,and legal counsel should be consulted about the preparation of the proxystatements/prospectus.

Alternatively, buyers may rely on Regulation D or Rule 3(a)(10) for anexemption from registration; as noted above, each of these exemptions hasrequirements as to information and procedures for seeking stockholderapproval.

Given the timing considerations and overall importance to the parties’ability to close the deal, an early assessment of the stockholder approvaland securities registration requirements for a proposed transaction is key.

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Chapter 10

The Role of Investment Bankers in M&ATransactions

Up to this point, we have assumed that the prospective buyer and sellerunilaterally found each other and commenced acquisition discussions.While a prospective seller may have a sense of who in its market is apotential buyer and vice versa, even the most sophisticated company isunlikely to fully grasp the universe of prospects, valuation issues, marketdeal terms and the like. That’s where outside advisors such as lawyers,accountants and, in particular, investment bankers add value to a trans-action. Accordingly, this chapter focuses on considerations in engaging aninvestment banker in an M&A transaction, as well as what to consider whenengaging a banker.

• Bankers come in all shapes and sizes.

Investment bankers and deal brokers can help a prospective selleridentify and attract prospective buyers and vice versa. Oftentimes, a bank-ing firm will, on its own volition, identify potentially synergistic transactionsand present such potential deals to either the potential buyer or seller in thehopes of being engaged by one party. Because they are immersed in theworld of M&A transactions, investment bankers typically have a deepindustry knowledge that even seasoned managers can benefit from. There-fore, beyond the introductory step of identifying a willing buyer and a willingseller, bankers have other key roles to play as well. For example, a bankercan:

• develop the sales process for a target company or the acquisitionprocess for a serial buyer;

• provide advice not only on deal terms but also deal psychology;

• help a buyer or seller determine how to bridge a valuation gap, oridentify solutions to issues arising in due diligence;

• assist a seller who is concerned about a deal term by thinking ofalternatives that may address the issue;

• identify terms that might be traded to achieve the parties’ goals inorder to get a deal done; and

• advise a buyer or seller when a deal is simply too difficult to close thegap between the parties.

Despite considerable consolidation, by some estimates, there aremore than 2,000 companies in the U.S. offering investment banking ser-vices. Larger banks, particularly those at the upper end of the market

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referred to as in the ‘bulge bracket’, tend to have expertise in a broader arrayof industries and may also be able to assist with buyer financing andinternational transactions. Smaller regional banks may focus on specificindustries within their particular region; while boutique investment banksoften maintain a national and even international focus in a particularindustry. Some firms structure and find deals for clients but do not adviseon the transaction itself. These so-called “deal brokers” can also be helpfulparticularly for smaller transactions that may not be of interest to largerbanks.

The reputation of an investment bank with a prominent name can bringcredibility to a proposed transaction. Note that the company’s managementwill be working with a particular lead banker and his or her team. Therefore,it is important to know which bankers management will be working with andfind those individuals who have the expertise and approach the company isseeking. If the company is hiring a banker for an M&A transaction, it willwant to consider the firm’s credentials and experience in mergers andacquisitions rather than just its general experience.

• Fees

Fees vary among investment banks and deal brokers. Smallerbanks, regional and boutique banks and brokers typically offer lower fees,and larger banks may have minimum fees. Therefore, consider the level ofoutside advice and fees that are appropriate for the deal. A companycompleting a series of small “roll-up” transactions may prefer to allow itsown managers to identify, structure and negotiate the deals, and only turn toan outside expert for advice on a merger of equals or other significanttransaction.

Who Should Choose?

In most instances the managers of the company interview and hire orsuggest to the board that the company hire a particular investment bank.However, the board should consider retaining this decision or delegating thedecision to a special committee when the transaction brings significantfinancial gain to management, controlling stockholders or inside directors.Removing these interested individuals from the engagement process willenhance the actual and perceived independence of the investment bankerand its advice.

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Directors who rely on the advice of outside advisors with links tointerested parties leave themselves open to arguments that they did notproperly inform themselves about the proposed transaction.

A company can benefit from talking to investment bankers early in thetransaction process, even in an interview setting, but should balance thebenefit of early advice against any need it may have to maintain confiden-tiality prior to engagement of the banker.

The Engagement Letter

After a company selects an investment banker to assist in an M&Atransaction, the banker will deliver the bank’s standard form of engagementletter tailored to the particular engagement and setting forth the financialterms. Engagement letters are negotiated, and a company should involvecounsel familiar with these types of arrangements. Because the investmentbanker will be a key member of the transaction team and will be workingwith management and outside legal counsel for several months, negotiatingthe engagement letter can be a delicate process. The negotiators shouldmodify the letter where appropriate to reflect the interests of the companyand eliminate overreaching in the bank’s form but also demonstrate anunderstanding of and sensitivity to the banker’s legitimate concerns. Thegoal is an engagement letter that aligns the interests of the company andthe investment bank.

Covered Transactions

The first section of the engagement letter will describe the “transac-tions” for which the investment banker will be paid a fee. The initial draft ofthe letter will likely contain broad language defining the included “transac-tions” as any sale of stock or assets. The scope of this language wouldinclude a transaction for even one share of stock or a single piece ofinventory. Thus, while the investment banker has a legitimate interest insecuring its right to receive its fee, it is important that the letter accuratelyreflect the economic realities of what the company is intending to accom-plish in the deal — e.g., an M&A transaction involving all or a materialportion of a company’s stock or assets. Because there is often a minimumfee payable upon a qualifying transaction, the sale of a percentage of thecompany’s stock or assets triggering a fee should be evaluated in light of theminimum fee’s relationship to the expected fee for a complete transaction.

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Chapter 10 - The Role of Investment Bankers in M&A Transactions

The company should also exclude routine business transactions thatmight meet the technical definition of a qualifying transaction such as:

• licensing its intellectual property in the ordinary course of business;

• borrowing money or issuing equity to lenders or stockholders outsidethe transaction; or

• other transactions unique to the company.

The company should review the company’s charter, securities and anystockholders agreement to determine whether there are any transactionsthat should be excluded.

Investment bankers do not like to share the risk that a deal will fall apartafter a term sheet is signed, however, they generally accept that they shouldreceive the success fee only if the deal is actually consummated. Conse-quently, the appropriateness of any language providing for a success feeupon the signing of a term sheet or letter of intent should be thoughtfullyconsidered.

If the company was investigating or shopping the transaction beforehiring the investment banker, it must decide whether the potential buyers ortargets it previously identified will trigger a payment to the investmentbanker. If the negotiations are advanced, the company may wish to excludethese parties from an included transaction. The tension in this situation isthe banker’s concerns that it will lose its success fee because of theexclusions. The company may also consider allowing a banker to earn afee for these buyers or sellers as well, particularly when a significantamount of work remains to be done. One compromise approach is toprovide for a discounted fee if the identified buyer or target becomes theultimate counterparty to the deal.

Scope of Services

The services the investment banker will provide should be spelled outin sufficient detail to insure both that the company knows how much supportit can expect from the banker and to limit those services to the specifictransaction. Engagement letters often specify that the banker is the “exclu-sive” banker for the transaction, which is acceptable so long as thatexclusivity does not carry over into other assignments. Bankers oftenrequest that that they be retained for follow-up transactions and financingor to complete a partial transaction.

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Fees

The fee section will attract considerable attention from both the com-pany and investment banker and presents a key opportunity to align theinterests of the company and banker. The most common fee arrangement isa success fee formulated as a percentage of the total transaction value.When a banker represents the seller, the percentage typically increases asthe sale price exceeds the expected price. Thus the banker has an incentiveto seek the highest sale price for the seller and will be less tempted topromote a low bid.

This practice reverses a long-standing approach, in which the per-centage of the transaction value paid as a fee decreased as the size of thetransaction increased. Minimum fees and fees paid even if a transactiondoes not close are appropriate when the banker will do a significant amountof work and a transaction is not seen as likely to occur. Bankers oftenrequest these fees to protect themselves against risks in completing a dealidentified by the banker that is unraveled by something outside the banker’scontrol. To avoid disputes at the end of the transaction, the engagementletter should specify that any deposit made by the company is creditedtoward the final success fee.

Investment bankers prefer to be paid their entire expected fee in onelump sum at closing, but the sale consideration is often paid over time andmay be contingent on meeting certain “earn-out” targets such as annualEBITDA or revenue targets. If a portion of the purchase price is subject to anearn-out, the fee should typically be paid and the base calculated when theconsideration is finally determined and actually received by the company.Fees on sale consideration held by an escrow agent should also typically bepaid when the money is released from escrow.

How Fees Are Measured

An investment banker’s success fee will typically be measured as apercentage of the aggregate consideration in the transaction. Aggregateconsideration is often defined very broadly to include not only obviousconsideration such as cash or stock but other arrangements includingpayments for services, rent, separate real estate transactions and contin-gent payments.

This broad definition evolved to protect the investment bankers fromattempts by companies to exclude consideration from the fee base byrecasting it as a side payment or part of a separate transaction. Tradition-ally, assumed debt is also included in the aggregate basis in asset sales,

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and that trend has expanded to include the target’s debt in a stock trans-action. Whether bonuses and payments to managers should be included inthe base depends on whether they are intended to be part of the sale pricebut merely structured as a payment to managers. This situation is mostlikely to occur when the stockholders are also the managers of a company.

Expenses

The company will typically agree to the investment bank’s request forreimbursement of “reasonable” expenses but may establish a cap beyondwhich the banker must request permission to incur any additionalexpenses.

Conflicts and Confidentiality

Investment banks often work for more than one company in an indus-try. Further, a bank and its affiliates may hold the stock of the company or aproposed buyer in the accounts of its customers or trade in the stock of thecompany. While these arrangements are often permitted, in some indus-tries, companies are more sensitive to banks representing their competitorsor dealing in their stock, and each company must negotiate these items withits banker.

Banks may wish to represent more than one bidder for a company in aformal auction, and companies typically prohibit multiple representationsunless there is an irreplaceable advantage for using that particular bank.

Some investment banks will also seek permission to take the some-what less controversial step of representing the seller and providing financ-ing to the buyer in an M&A transaction. This can occur as “stapled financing”in which the seller’s investment banker offers the same financing to everypotential buyer or on an ad hoc basis.

While the banker’s initial draft of the engagement letter will likelyexplain the banker’s procedure for protecting and not sharing informationwith its affiliates and third parties, these internal provisions do not protectthe company if information is accidentally or intentionally released. There-fore, the company should add a duty on the part of the banker to maintainthe confidentiality of the company’s information.

Duration of Engagement and Tail Periods

The investment banker is likely to request that the company use itsservices for as long a term as possible. However, given that most M&A

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transactions can be accomplished within six months, and a deal may beperceived as “stale” if shopped for a longer period of time — a flexiblemonth to month or a fixed term of six to twelve months is an appropriatearrangement for most engagements. A company will not want to be obli-gated to continue working with an investment banker if the transaction is notprogressing and the company does not wish to continue the relationship.

The company will want an express right to terminate the banker’sengagement after the initial period has expired. However, following termi-nation, the engagement letter will likely provide for a “tail period” of someduration (a negotiated point) in which the banker will still earn its fee if thetransaction that it was hired to negotiate occurs. This arrangement isostensibly to protect the good work of the banker when a transaction isslow to materialize or delayed. This approach, however, will often preventthe company from pursuing similar transactions on its own or hiring differentinvestment bankers. Therefore, a better approach is to negotiate a shortertail period and limit the qualified transactions to ones solicited by the banker.This standard can be tightened to include only those counterparties thatwere:

• contacted by the banker;

• expressed an interest in the transaction; and

• executed the confidentiality agreement.

Intermediate positions agreeable to both parties can also be negotiated.

Indemnification

Companies generally agree to indemnify the investment bank againstlosses arising from the bank’s representation of the company. The compa-ny’s obligation to indemnify will exclude losses caused by the bank’s willfulmisconduct, gross negligence or bad faith. Often companies will alsoattempt to exclude indemnification for losses resulting from the bank’sordinary negligence, but this term is accepted by banks only in rarecircumstances. In any event, the company will want the ability to controlthe defense of any indemnifiable litigation and restrict the bank from settlingwithout consent of the company.

What happens in the situation in which the company and investmentbank are both involved in litigation but no liability is ultimately found? Whopays for the bank’s litigation costs? Generally the company is required topay for litigation costs unless the investment bank is found to be the causeof the liability through its willful misconduct, gross negligence or bad faith.

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Finally, the company will also be asked to waive any claims arising fromthe bank’s representation except, again, those resulting from the bank’swillful misconduct, gross negligence or bad faith.

Fairness Opinions

A fairness opinion is a letter from an outside investment banker to acompany’s board of directors stating that the consideration the company orits stockholders is receiving or paying in a transaction is “fair from a financialpoint of view.” Fairness opinions may also address other aspects of thetransaction — e.g., the board may seek outside confirmation that anunusual or complicated structure is financially fair.

The primary function of a fairness opinion is to help directors demon-strate that they have met their fiduciary obligation to act in the best interestof stockholders. Courts have created the “business judgment rule,” which isalso codified in some statutes, to grant directors protection from liabilitywhile managing a company. The rule is a presumption that in making abusiness decision, the directors of a corporation acted on an informedbasis, in good faith and in the honest belief that the action taken was in thebest interest of the company and its stockholders. A fairness opinion canhelp demonstrate that the directors were informed and acting in good faithwhen approving an M&A transaction and refute a claim that the directorsshould be liable for alleged losses resulting from the transaction.

After having fallen out of favor over a period of years, in 1985, inresponse to a decision from the Delaware Supreme Court, companies,public companies in particular, rekindled their affinity for fairness opinions.That case was the Van Gorkom decision, which is discussed at some lengthin Chapter 8.

In Van Gorkom, the court determined that the directors of a targetcompany failed to meet their fiduciary obligation to the stockholdersbecause they had not informed themselves of the relevant facts by useof information reasonably available to them. The court elaborated that theboard’s consideration of a fairness opinion would have supported anargument that they were informed. Thus despite the court’s further clari-fication that a fairness opinion from an independent banker is not a legalrequirement, directors often request opinions to demonstrate that they wereinformed and to place themselves squarely within the protections of thebusiness judgment rule. The letters serve a second purpose of educatingshareholders voting to approve a proposed merger, and as described later,

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are often summarized or included in proxy materials delivered tostockholders.

Advance and Retreat

After the Van Gorkom decision, fairness opinions were viewed by manyas a requirement for target boards, and their popularity may have underminedtheir integrity. Recently, fairness opinions have run into criticism causingcompanies and investment banks to reevaluate their opinion practices. Mostof these criticisms stem from the relationship between investment banks andtheir clients. In an acquisition, investment banks will often provide more thanone type of service to a company. The bank may be hired to find a suitabletarget or buyer, underwrite the financing of the transaction or give otherstrategic advice. An investment bank earns up to ten times more fees forthese services than for preparing a fairness opinion, and these larger fees areoften contingent on a successful conclusion of the transaction. If the sameinvestment bank is asked to prepare the fairness opinion for the transaction, ithas an incentive to produce a favorable opinion regardless of the underlyingevidence or risk losing substantial success fees for its acquisition work. In othercases, banks may advise more than one party in a transaction, which createsan incentive to justify the transaction to all parties since it has already deemedit advisable.

Fairness opinions have also been criticized for the variety of valuationmethods and assumptions used. In the most favorable light, the array ofvaluation methods: discounted cash flow, value of the company’s assets ifsold separately, multiples of revenue or EBITDA, comparable transactions,and other methods, is necessary to give bankers latitude to use the mostappropriate valuation methodology for the transaction and industry. It isworth noting, however, that even when a fairly objective valuation method,such as discounted cash flow, is employed it can produce different resultsbased on the assumptions that are used in the formula.

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Make the Fairness Opinion Count

Practical Tip: Effective Fairness Opinions

If the directors desire the benefit of a fairness opinion, they shouldbe sensitive to the inherent shortcomings of such opinions and createa process that will render an opinion on which they can justifiably rely.

The board should be sensitive to:

• the general reputation of the investment bank;

• the experience and training of the opinion team;

• whether the valuation methodology is appropriate and if the selectionof that methodology is adequately explained;

• whether the assumptions in the valuation are appropriate;

• who hired the investment banker — to avoid pro-management bias,the board should consider hiring and supervising the banker directly;

• to whom does the banker report — is a special disinterested com-mittee of the board necessary to avoid the influence of interesteddirectors; and

• whether the fee is sufficient to compensate the banker for a thoroughopinion.

Ultimately, in deciding whether to request a fairness opinion, who willdeliver it and what methodologies will be used, the board must balance itsneed for reliance on the opinion against the cost of the opinion. A publiccompany has the option of including a fairness opinion in any proxy mate-rials submitted to shareholders in connection with a transaction and in aregistration statement for shares to be issued as consideration in themerger, and the SEC’s rules require a public company to describe anyfairness opinion it receives. Thus, when a challenge to the transaction isexpected, it is not only important that the fairness opinion be the profes-sional work of an independent investment banker, it must be perceived assuch by the courts and those who will criticize the transaction.

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Chapter 11

Hart-Scott-Rodino and Related RegulatoryMatters

The Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the “HSRAct” or the “Act”) was enacted to enable the federal antitrust enforcementagencies to detect and deter potentially anticompetitive M&A transactionsbefore they occur. While the purpose of the Act is fairly straightforward, thestatutory scheme is a maze of technical tests and “triggers” that typicallyrequire specialized expertise for accurate interpretation. This chapter offersa high-level roadmap through the HSR Act and related regulatory require-ments, but should not be considered an all-inclusive guide to the Act.Obtaining the advice of specialized counsel to address the HSR Actimplications of specific M&A transactions is recommended.

Brief History and Purpose of the Act

In 1914, Congress passed the Clayton Act to prohibit, among otherthings, mergers and acquisitions that may “substantially lessen competi-tion” or “tend to create a monopoly.” The Clayton Act created a specific legalbasis to challenge potentially anticompetitive business combinations incourt, but did not provide federal enforcement agencies with a mechanismto detect such combinations before they occurred. This left the agenciesfacing substantial practical difficulties in seeking to undo mergers andacquisitions long after consummation, giving rise to market inefficienciesthat often were seen to outweigh the potential competitive benefits ofenforcement.

The HSR Act was enacted in 1976 to address that problem by requiringparties to transactions meeting certain thresholds to notify the federalagencies in advance, and to await the expiration of a statutory waitingperiod before consummating the transaction. Thus, the HSR Act gave theFederal Trade Commission (“FTC”) and the Antitrust Division of the UnitedStates Department of Justice (“DOJ”) a window of opportunity to reviewcertain potentially anticompetitive M&A transactions and, when appropri-ate, file a lawsuit to prevent consummation of those that may substantiallyreduce competition or tend to create a monopoly.

HSR Notification Requirements

Reportable Transactions

The HSR Act generally applies to acquisitions of voting securities,assets, or non-corporate interests that satisfy the so-called “Size-of-Trans-action” test and, if applicable, the so-called “Size-of-Persons” test. In an

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effort to keep pace with changes in the gross national product, the FederalTrade Commission revises the thresholds to be applied under these testsannually (effective at the end of February). This chapter uses the thresholdseffective as of February 21, 2007.

Size-of-Transaction Test

Under the Size-of-Transaction test, no transaction is reportable unless,as a result of it, the acquiring person will hold assets, voting securities, ornon-corporate interests of the acquired person valued at more than$59.8 million. When, as a result of the transaction, the acquiring personwill hold voting securities, assets, or non-corporate interests of the acquiredperson valued above $59.8 million but not above $239.2 million, then thetransaction is reportable only if the Size-of-Persons test is also satisfied.

Size-of-Persons Test

As noted above, the Size-of-Persons test only comes into play if thetransaction is valued above $59.8 million and not in excess of $239.2 million.When it applies, the Size-of-Persons test is generally satisfied if either theacquiring person or the acquired person has annual net sales or total assetsequal to or greater than $119.6 million and the other person has annual netsales or total assets equal to or greater than $12 million. When the acquiredperson is not engaged in manufacturing and the acquiring person hasannual net sales or total assets equal to or exceeding $119.6 million, thenthe annual net sales of the acquired person are irrelevant and the Size-of-Persons test is satisfied only if the acquired person has total assets equal toor exceeding $12 million.

Joint Ventures

The formation of a joint venture or other corporation may be subject tothe Act. In such a formation, the entity to be formed is treated as an acquiredperson and the entities or natural persons contributing to the formation aredeemed acquiring persons. Only these acquiring persons, and not theentity to be formed, may be subject to a filing requirement, and the waitingperiod will begin to run only when all contributors that are required to file doso. The reportability of each contributor’s “acquisition” of the voting secu-rities, assets, or non-corporate interests of the entity to be formed must beanalyzed separately under the Size-of-Transaction and Size-of-Personstests summarized above. Generally, the size of the acquired person con-sists of all assets being contributed to the venture.

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When the joint venture to be formed is an unincorporated entity, thetransaction is reportable only if, as a result of it, at least one person willcontrol the new entity.

Multiple Reportable Transactions

Certain transactions give rise to more than one reportable acquisition,each requiring separate reporting and the payment of a separate filing fee.Two examples of transactions giving rise to multiple filings include acqui-sitions in which the consideration consists, at least in part, of the stock of thebuyer, giving rise to a potentially reportable acquisition of the buyer’s stockby one or more sellers; and so-called “secondary” acquisitions, in which theacquiring person buys a target that in turn holds a reportable amount ofvoting securities in a company outside the target’s person, thereby causingthe acquiring person to make a reportable acquisition of that outsidecompany’s stock.

Exempt Transactions

The HSR Act contains a number of specific exemptions and confersupon the FTC the power to create additional ones by regulation. As a result,there is a wide variety of exemptions that may apply to a particular trans-action. Some of the most frequently used exemptions are summarized inAnnex 11.

Reporting an M&A Transaction

Notification and Report

The HSR Act generally requires the “ultimate parent entity” of eachacquiring and acquired person in a reportable transaction to file a Notifi-cation and Report Form with the FTC and the DOJ, and to certify theperson’s present intention to carry out the subject transaction. Subject tocertain exceptions, in order to make such a filing the parties must haveentered into a written agreement, at least in principle, to proceed with aparticular transaction. Generally, a letter of intent to proceed towards aspecific transaction is sufficient to support an HSR filing, but the executionof such a letter does not mandate that a filing be made at that stage. In fact,there is no deadline for filing under the HSR Act — if a transaction isreportable, however, the HSR Act prohibits consummation until the nec-essary filings have been made and the applicable waiting period (discussedbelow) has been observed.

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Chapter 11 - Hart-Scott-Rodino and Related Regulatory Matters

The Notification and Report Form requires the submission of bothdocuments and information. Notably, in addition to basic information aboutthe transaction and the parties, the form requires each person to submit:

• information about revenues derived in a “base” year (currently2002) and in the most recent year (these must be categorized byNAICS code at varying levels of detail);

• information regarding the parties’ corporate structure and securitiesholdings;

• information concerning the acquiring person’s acquisitions in theprevious five years in the same industries in which the target isactive; and

• certain SEC filings, annual reports, and recently prepared balancesheets.

In addition, the parties must submit certain documents, known as “4(c)”documents after the relevant item on the form, containing informationrelevant to the competitive analysis of the transaction. Item 4(c) seeks

“all studies, surveys, analyses and reports which were preparedby or for any officer(s) or director(s)...for the purpose of evaluatingor analyzing the acquisition with respect to market shares, com-petition, competitors, markets, potential for sales growth or expan-sion into product or geographic markets...”

The definition covers any type of “document,” ranging from an informale-mail or hand-written note to a lengthy and carefully prepared report. It islimited, however, to documents that relate to the specific transaction underscrutiny. The agencies are particularly attentive to Item 4(c) and the con-sequences of noncompliance can be severe, including significant monetarypenalties and injunctive relief against the transaction. It is therefore imper-ative for filing persons both to conduct a thorough search for 4(c) docu-ments and to create a reliable paper trail of having done so.

The item 4(c) requirement also raises issues with respect to documentcreation, because the agencies often rely on 4(c) documents to form theirinitial impression of the competitive effects of a transaction. For this reason,it is essential to use great care in preparing analyses (or even descriptions)of the proposed transaction. Parties to transactions that may raise sub-stantial competitive issues are well-advised to engage antitrust counsel inthe early stages of deal negotiation, in order to develop a successfulregulatory strategy and review all documents relating to the acquisition,

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such as board materials, press releases, public announcements and inter-nal assessments.

Confidentiality

All submissions made by acquiring and acquired persons to the anti-trust agencies under the HSR Act are confidential (even with respect toother filers in the same transaction) and not subject to the Freedom ofInformation Act (“FOIA”). An exception to this general rule occurs when theparties request early termination of the waiting period (as discussed below)and that request is granted. In such cases, the fact that early terminationwas granted to a transaction between an identified acquiring person and anidentified acquired person is published in the Federal Register and on theFTC’s Website. By contrast, no public announcement is associated with theexpiration (as opposed to the early termination) of the waiting period.Because only the grant of early termination of the waiting period is disclosedto the public, in some cases parties may prefer not to request earlytermination in order to avoid the risk of premature disclosure.

Although HSR Act submissions are not subject to FOIA, in casesraising substantial competition issues certain documents and informationsubmitted under the Act eventually may enter the public domain as a resultof becoming part of the record in a court action brought by the agencies toenjoin the transaction. The Act’s confidentiality provisions also do notprevent access to the information by Congress.

Transactions that raise competitive concerns also present uniquechallenges from the standpoint of confidentiality because the agencies willcontact third parties — such as customers or competitors — in the contextof investigating such transactions. While the agencies are not permitted toreveal that an HSR filing has been made, the nature of their inquiries mayvery likely tip off third parties that a particular transaction is about to occur.For this reason, parties to transactions that may raise competitive issuesoften choose to initiate the HSR process only after entering into a definitiveagreement.

Confidentiality concerns can also arise vis-à-vis other filers in the sametransaction. Preparing an HSR filing often requires counsel for the variousparties to consult with each other with respect to limited aspects of the Formand documents to be produced. Similarly, counsel to parties in a transactionthat is likely to raise competitive issues will need to communicate with eachother, and possibly with each other’s clients and expert economic consult-ants, in advance of the filing in order to prepare and implement a defense

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strategy. Because HSR filings are made in anticipation of the possibility thatthe government may sue to enjoin the transaction, the joint defense priv-ilege typically attaches to all such communications regardless of whether aspecific written agreement is executed to that effect. Nevertheless, partiesto transactions that are likely to raise competitive issues are well-advised toformalize a joint defense agreement in written form during the early stagesof preparing their respective HSR filings.

Filing Fees

The acquiring person in a reportable transaction is responsible forpaying the applicable filing fee. Although the rules permit filers to split thefee, the common practice is for one party, typically the acquiring person, topay the entire applicable fee and seek separate reimbursement from theother party(ies). This minimizes confusion and ensures that the appropriatefee is linked to the corresponding transaction.

The amount of the filing fee depends upon the size of the transaction,and the relevant thresholds are also subject to annual adjustment by theFTCO. The following table shows current transaction value thresholds andthe corresponding filing fees:

TRANSACTION VALUE FILING FEE

Greater than $59.8 million, but less than$119.6 million $ 45,000

$119.6 million or more, but less than$597.9 million $125,000

$597.9 million or more $280,000

Waiting Period

The Act prescribes a waiting period (typically 30 days) during which theparties may not consummate the acquisition. The waiting period is intendedto maintain the competitive status quo while the agencies analyze whetherthe proposed transaction may substantially lessen competition in anyrelevant market. The start of the waiting period is usually triggered bythe agencies’ receipt of complete filings from each person that is required tomake one for the transaction in question. If a transaction raises no com-petitive issues, the agencies may simply let the waiting period expire withoutfurther action. Upon expiration of the waiting period, the parties may closethe transaction without any form of official “clearance” by the agencies.

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The parties also may request early termination of the waiting period bychecking the appropriate box on the Notification and Report Form. A singlefiling person’s request for early termination is sufficient to trigger theagencies’ review and possible grant of the request and, as discussedabove, the grant of early termination is published in the Federal Registerand on the FTC’s Website. Therefore, parties wishing to maintain theconfidentiality of the transaction must ensure that no person making afiling in connection with the transaction requests early termination. If earlytermination is requested and granted, the grant typically comes two to threeweeks after all filings required for the particular transactions are received bythe agencies.

Don’t Jump the Gun

While the HSR Act proscribes formal consummation of a reportabletransaction prior to the expiration, or early termination, of the waiting period,certain conduct by the parties short of actual consummation can also bedeemed to transfer “beneficial ownership” of the voting securities, assets, ornon-corporate interests of the acquired person to the acquiring person, andthereby to violate the Act’s waiting period provisions. This type of conduct isknown as “jumping the gun” and can lead to severe consequences, includ-ing substantial monetary penalties and injunctive relief against the partiesand the transaction.

In addition to the HSR Act, the parties’ conduct prior to closing mustalso comply with the substantive provisions of the Sherman Act, whichprohibits collusion among competitors. Indeed, the Sherman Act requiresthe parties prior to closing to consider one another as separate, indepen-dent entities (and competitors, if appropriate), and to continue to deal witheach other accordingly. For example, the Sherman Act requires partiesprior to closing not to share with each other certain information (such asdetailed, competitively sensitive information about customers, prospectivestrategic plans or current and future pricing) that would put the owner of thatinformation at a competitive disadvantage vis-à-vis the other party(ies) inthe event that the deal falls through.

The antitrust agencies also understand, of course, that the success ofmost mergers and acquisitions depends on meticulous due diligence andthe ability to plan in advance for a smooth transition post-closing. Theagencies recognize, therefore, that a flexible, fact-specific approach isrequired in the application of the rules that govern the parties’ conductduring the HSR waiting period and, more generally, during the periodbetween the signing of the deal documents and closing. It is also broadly

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understood that the range of permissible conduct in this context increasesas the closing draws nearer and conditions precedent to closing are sat-isfied, making consummation increasingly likely. Because the permissibilityof particular conduct depends heavily on the specific circumstances of eachcase, reliance on the advice of specialized counsel in this context isparticularly advisable.

Certain clear “DOs” and “DON’Ts” nevertheless emerge against thisbackground. The following is a list of the major ones, but it is not intended,and should not be taken, as a substitute for the advice of counsel underspecific circumstances:

• DON’T:

• Transfer beneficial ownership of assets from one party to the other;

• Commingle the business or assets of the two parties;

• Take part in the business decisions of the other party;

• Allocate customers;

• Jointly negotiate with or sign agreements with customers;

• Jointly market specific products to customers;

• Coordinate pricing;

• Agree to terminate any product lines or implement other outputrestrictions;

• Begin joint product development;

• Agree to eliminate a marketing or promotional program;

• Share current and/or future pricing information and/or strategies;

• Share internal planning documents; and

• Share competitively sensitive cost information.

• DO:

• Plan for a successful transition without actually implementing ituntil after closing;

• Create specialized teams — possibly consisting, if practicable, ofthird party consultants — to handle particular transition planningor due diligence tasks, and create firewalls to protect competitivelysensitive information;

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• Jointly inform customers about the impending transaction, without,however, jointly marketing specific products to customers orreaching joint agreements with customers; and

• To the extent necessary, exchange aggregate — not specific —customer or product information.

Practical Tip: Diligence and Transition Planning

One way to ensure thorough due diligence and a successfultransition without running afoul of the antitrust laws is to make surethat due diligence and transition personnel for each company aredifferent from the personnel involved in daily business operations.

What are the consequences of non-compliance?

In a word: severe.

Failure to report an otherwise reportable transaction, gun-jumping,failure to produce all 4(c) documents, and other HSR Act violations cancarry stiff penalties. The antitrust agencies can seek fines of up to $11,000per day of non-compliance and drastic injunctive relief, including retroactiverelief like the undoing of the transaction and “disgorgement” of unlawfulmonopoly gains.

The HSR Act and rules also punish efforts to structure or analyzetransactions in particular ways solely for the purpose of avoiding an HSRfiling. The agencies condemn such “creative” practices as “devices foravoidance” and will disregard them, deeming the parties to the transactionto be in violation of the Act unless and until compliance is achieved. Heavyfines can also be imposed for engaging in such practices.

For example:

• To settle gun-jumping allegations by the Department of Justice,Gemstar-TV Guide agreed to pay a fine of $5,676,000. See UnitedStates v. Gemstar-TV Guide International Inc., 2003 WL 21799949(D.D.C July 11, 2003).

• The Hearst Trust agreed to pay a $4 million fine for failure to disclosecertain 4(c) documents in connection with its acquisition of Medi-span. United States v. The Hearst Trust and The Hearst Corp., Civ.No. 01-2119 (D.D.C. Oct. 10, 2001).

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• Smithfield Foods, Inc. was fined $2 million for failing to report itsacquisition of voting securities of IBP, Inc. (total exposure was almost$5.5 million). United States v. Smithfield Foods, Inc. Civ. No. 04-526(D.D.C. Nov. 12, 2004).

Beyond Notification

What Does the Government Do with the Information Provided?

During the statutory waiting period, one of the agencies (either the FTCor the DOJ) takes the lead in analyzing the transaction to determinewhether it may substantially lessen competition or tend to create a monop-oly. In the vast majority of cases, the agency will determine that thetransaction does not raise competitive concerns. In these cases, theagencies will either let the waiting period expire or, if requested by theparties and appropriate, will grant early termination of the waiting period.Upon expiration or early termination of the waiting period, the parties arefree to proceed to closing as far as the HSR Act is concerned.

Additional Requests for Information and “Second Requests”

In some (relatively few) cases, an agency will identify one or moreaspects of the transaction that, in the agency’s view, may harm competitionand warrant further investigation. In these cases, as a first step the agen-cies typically request some additional information from the parties on avoluntary basis during the pendency of the waiting period. These requestsfor voluntary production of information are designed to address specificconcerns identified by the agencies and may include, among other things,requests for more detailed product or service information, capacity andlocation of facilities, sales information, top customers, suppliers, and com-petitors, industry or market analyses, and strategic business plans. Theagencies very likely will contact customers to elicit their views about thestate of competition in relevant markets. The agencies may also request tospeak with one or more company representatives on an informal basisabout specific issues.

Generally, it is in the parties’ best interest to respond promptly andeffectively to these informal requests for voluntary production in order toaddress the agencies’ concerns before the end of the initial waiting period.Indeed, parties to transactions that may raise serious competitive issuesare well-advised, with counsel’s assistance, to identify in advance the likelyareas of agency concern, to prepare documents and presentation materialsto address those concerns, and to anticipate the agencies’ likely requests

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for voluntary production of information in order to respond as promptly aspossible. The reason for this is that, if the agencies’ concerns are not put torest within the initial waiting period, the agencies will pursue the investi-gation by issuing a formal Request for Additional Information or Documen-tary Material, otherwise known as a “Second Request.”

A Second Request is an extensive and considerably burdensomerequest for documents and narrative responses that, among other things,extends the waiting period for most types of transactions until 30 days afterall parties have “substantially complied” with its demands. This usuallytranslates into at least a several-month delay in the HSR review processand indicates the agencies’ belief that the transaction may have seriousdetrimental effects on competition. While the parties can, and usually do,negotiate the scope and timing of a Second Request, the burden of com-pliance remains a heavy one. It is not unusual for a submission in responseto a Second Request to include tens or even hundreds of thousands ofpages of documents and extensive and detailed narrative responses, and toimpose considerable costs on the parties in the way of diverted resourcesand very substantial professional fees for attorneys and expert economicconsultants. The investigation that accompanies a Second Request is alsolikely to require a company to produce one or more employees to discussrelevant issues in person with government lawyers.

What if the transaction may “substantially lessen competition?”

At any time during the HSR review period, the antitrust agencies canchallenge the legality of the transaction in court by filing a complaint allegingthat consummation likely would lessen competition substantially or tend tocreate a monopoly. The agencies likely also would request, and very likelyobtain, a preliminary injunction preventing the transaction from closing untilthe legal process had run its course.

By way of relief, the agency most likely would seek either to block thetransaction altogether or to dilute its perceived anticompetitive effects bycompelling the parties to divest (or, in appropriate cases, license) certainassets to a third part or parties. In the absence of a compromise orsettlement, the parties and the government would proceed to litigate theantitrust claims, which are widely recognized as being among the mostexpensive and time-consuming varieties of litigation.

Most frequently, however, the impending threat of litigation against thegovernment leads the merging parties either to abandon the transactionaltogether or to seek a compromise before a lawsuit is filed. The nature of

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such a compromise is obviously closely tied to the specific facts of theindustry and transaction in question, but often involves some form ofdivestiture to a third party.

There is also the possibility, of course, that either before, during, or as aresult of issuing a Second Request, the investigating agency will concludethat the transaction does not raise substantial antitrust concerns and willnotify the parties of its present intention not to take further action.

Beyond the HSR Act

“Government Challenges Outside the Statutory Context”

While the HSR Act provides the federal antitrust agencies with aframework to review certain transactions and the opportunity to raise atimely challenge in court, the Act does not limit the agencies’ ability tochallenge any transaction in any way. In other words, the federal agen-cies — and the offices of the state attorneys general — are generally free tofile a lawsuit against both a transaction that was not reportable under theHSR Act and against a transaction that was reported and went through theHSR process without challenge. The only limitations on these types ofchallenges are of a practical nature. Absent the HSR statutory scheme,governmental agencies may find it inefficient or impractical to challengetransactions after consummation or to learn about unreportable transac-tions in time to act effectively.

“International Pre-Merger Notification Requirements”

Today, approximately 68 national and regional jurisdictions around theworld have some form of merger notification law, most of which includecompulsory filing and waiting period provisions similar to the HSR Act andmay carry penalties for noncompliance.

Parties to transactions involving non-U.S. assets or companies arewell-advised to seek the advice of specialized counsel to determine inadvance whether the transaction in question may be subject to one or morenon-U.S. merger notification regimes.

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Chapter 12

Tax Considerations

Taxable Transactions

The following are the basic rules that apply to the taxation of businessacquisitions in the absence of a valid tax-free structure. Generally speaking,a taxable transaction from the seller’s standpoint can have very beneficialresults for the buyer.

Taxable Asset Sale

• The seller recognizes gain on the sale of its assets and its stock-holders will recognize gain on the distribution of any proceeds fromthe sale. Thus, an asset sale results in two levels of tax on the sellerside if proceeds are distributed, an unfavorable result for the sellerand its stockholders if significant appreciation exists.

If the seller in an asset acquisition is an S-corporation, any income orgain realized on the sale will be passed through to the S corporation’sstockholders and taxed directly to the stockholders, avoiding thecorporate-level tax. Generally, only one level of tax is paid whereassets of an 80%-owned subsidiary are acquired.

The result may not trouble the seller if it has substantial net operatinglosses (NOLs).

• The buyer will receive a step-up in basis of the assets it acquired fromthe seller, enabling the buyer to take greater depreciation on theassets acquired. This can be a significant benefit for the buyer on agoing-forward basis.

• A taxable forward direct merger transaction or forward-triangularmerger is treated for tax purposes as an asset sale.

Taxable Stock Purchase Transaction

• In a taxable stock purchase transaction, the individual stockholderswho sell their shares to the buyer will be taxed on any gain theyrealize on the sale of their shares. The seller will not realize any taxunless a 338(h)(10) election is made, which causes the transactionto be treated as if it were an asset sale. This election is only allowableif the seller is an S corporation (i.e., flow-through treatment is avail-able) or is an 80%-owned subsidiary.

The buyer will not get a step-up in basis of the seller’s assets unlessa 338(h)(10) election is made.

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• A taxable reverse-triangular merger is treated for tax purposes as astock purchase.

Tax-Free Reorganizations

To qualify as a tax-free reorganization under the Internal RevenueCode and related IRS rules and regulations, several requirements must besatisfied. Two of the most important requirements are, broadly speaking,that the buyer must continue the seller’s business in some form and that theseller’s stockholders must continue to hold on to the shares of buyer stockthey received in the transaction (the so-called “continuity of interest” test).

In practice, a critical factor in whether the deal will receive tax-freetreatment is the nature of the consideration the seller and its stockholdersreceived. Under some tax-free reorganization structures, only stock may bepaid, whereas in others some non-stock consideration (also known as“boot”) may be permissible. In other words, the type of tax-free reorgani-zation the transaction is structured as will dictate the amount of cash thatcan be paid in the deal. Under no circumstances, however, will tax-freetreatment be available if more than 60% of the total value of the deal is incash or property other than buyer stock.

In a valid tax-free reorganization, the seller’s stockholders will notrecognize any gain on the sale of stock and the seller will not recognizegain with respect to its assets, except that tax must be paid by the stock-holders on the value of any non-stock consideration paid. Thus, a “tax-free”deal will in reality often result in some tax to the selling stockholders to theextent cash is involved. With respect to the portion of their stock for whichthe stockholders received tax-free treatment, they will “carry over” theirbasis in that old stock to the new buyer stock they obtain in the transactionand will subsequently realize taxable income or loss only on a taxabledisposition of those shares. A buyer will not be able to obtain a step-up in thebasis of the seller’s assets in the event of a valid tax-free reorganization.

The following transactions may be treated as “tax free”reorganizations:

• Type A — Two-party direct statutory merger where at least 40% ofthe consideration is buyer stock. If structured properly, this transac-tion will be tax-free to the seller’s stockholders and the seller, exceptto the extent of any non-stock consideration.

• Type B — A stock purchase where the entire consideration is votingstock of the buyer. No consideration other than voting stock is

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permitted in a Type B reorganization, although cash received in lieuof fractional shares will not be considered boot. If structured properly,this transaction will be tax-free to the seller and its stockholders.

• Type C — buyer issues voting stock in exchange for substantially allof the seller’s assets. If the buyer issues non-stock consideration, thesum of the consideration other than voting stock and liabilitiesassumed cannot exceed 20% of the total consideration. Per IRSguidelines, the buyer should obtain assets representing at least 90%of the fair market value of the seller’s net assets and at least 70% ofthe gross assets the seller holds immediately prior to the transaction.This transaction will be tax-free to the seller and its stockholders,except to the extent of any non-stock consideration.

• Forward Triangular Merger — Consideration in a forward triangularmerger generally includes up to 60% non-stock consideration. Thenewly formed subsidiary must acquire substantially all of the seller’sassets under the same 70-90 test as for a Type C reorganization.This transaction will be tax-free to the seller’s stockholders, except tothe extent of any non-stock consideration.

• Reverse Triangular Merger — Permissible consideration is deter-mined under a complex rule requiring that “control” of the targetmust be acquired in exchange for voting stock of buyer. In practice, if(1) the buyer doesn’t already own any target stock, (2) the target hasonly one class of stock, and (3) all stockholders receive the same mixof consideration per share, this translates into a requirement that80% of the total consideration be in the form of voting stock. Theseller must have substantially all assets after the transaction underthe same test as for a Type C reorganization. This transaction will betax-free to the seller’s stockholders, except to the extent of any non-stock consideration.

A few additional points worth noting:

• So-called “multi-step” tax free reorganizations can under some cir-cumstances enable the parties to effect a reverse-triangular mer-ger — and thereby take advantage of some of the key benefitsinherent in that structure, such as the continuity of existence ofthe seller that reduces the need for third-party consents — whileincluding up to 60% boot in the deal rather than the usual 20% limit.One example of a multi-step reorganization involves a standardreverse-triangular merger, followed by an upstream merger of sellerinto buyer.

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Chapter 12 - Tax Considerations

• Other provisions in the tax code permit tax free transactions that areless relevant in the business sale context, such as spin-offs or splitups, recapitalizations and re-incorporations achieved through down-stream mergers.

• Parties seeking to structure a transaction as a Type B or C reorga-nization or a reverse triangular merger must in some cases takegreat care to ensure that any stock consideration delivered willqualify as voting stock.

• The Internal Revenue Service rules and regulations relating to tax-ation of business combinations are extremely complex and evolving,and are dependent on the specific facts and circumstances of eachparticular case. Participants to M&A transactions must consult theirtax advisors.

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Annex 3-A

Mutual Nondisclosure Agreement

This Mutual Nondisclosure Agreement (this “Agreement”) by and between, a corporation, and , a corporation (each

a “Party” and collectively, the “Parties”), is dated as of the latest date set forth onthe signature page hereto.

1. General. In connection with the consideration of a possible nego-tiated transaction (a “Possible Transaction”) between the Parties and/ortheir respective subsidiaries (each such Party being hereinafter referred to,collectively with its subsidiaries, as a “Company”), each Company (in itscapacity as a provider of information hereunder, a “Provider”) is preparedto make available to the other Company (in its capacity as a recipient ofinformation hereunder, a “Recipient”) certain “Evaluation Material” (asdefined in Section 2 below) in accordance with the provisions of thisAgreement, and to take or abstain from taking certain other actions ashereinafter set forth.

2. Definitions.

(a) The term “Evaluation Material” means information concerning theProvider which has been or is furnished to the Recipient or itsRepresentatives in connection with the Recipient’s evaluation of aPossible Transaction, including its business, financial condition,technology, operations, assets and liabilities, and includes allnotes, analyses, compilations, studies, interpretations or otherdocuments prepared by the Recipient or its Representatives whichcontain or are based upon, in whole or in part, the informationfurnished by the Provider hereunder. The term Evaluation Materialdoes not include information which (i) is or becomes generallyavailable to the public other than as a result of a disclosure by theRecipient or its Representatives in breach of this Agreement,(ii) was within the Recipient’s possession prior to its being fur-nished to the Recipient by or on behalf of the Provider, providedthat the source of such information was not bound by a confiden-tiality agreement with, or other contractual, legal or fiduciary obli-gation of confidentiality to, the Provider with respect to suchinformation, or (iii) is or becomes available to the Recipient on anon-confidential basis from a source other than the Provider or itsRepresentatives, provided that such source is not bound by aconfidentiality agreement with, or other contractual, legal or fidu-ciary obligation of confidentiality to, the Provider with respect tosuch information.

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(b) The term “Representatives” shall include the directors, officers,employees, agents, partners or advisors (including, without limi-tation, attorneys, accountants, consultants, bankers and financialadvisors) of the Recipient or Provider, as applicable.

(c) The term “Person” includes the media and any corporation, part-nership, group, individual or other entity.

3. Use of Evaluation Material. Each Recipient shall, and it shall causeits Representatives to, use the Evaluation Material solely for the purpose ofevaluating a Possible Transaction, keep the Evaluation Material confiden-tial, and, subject to Section 5, will not, and will cause its Representatives notto, disclose any of the Evaluation Material in any manner whatsoever;provided, however, that any of such information may be disclosed to theRecipient’s Representatives who need to know such information for the solepurpose of helping the Recipient evaluate a Possible Transaction. EachRecipient agrees to be responsible for any breach of this Agreement by anyof such Recipient’s Representatives. This Agreement does not grant aRecipient or any of its Representatives any license to use the Provider’sEvaluation Material except as provided herein.

4. Non-Disclosure of Discussions. Subject to Section 5, each Com-pany agrees that, without the prior written consent of the other Company,such Company will not, and it will cause its Representatives not to, discloseto any other Person (i) that Evaluation Material has been exchangedbetween the Companies, (ii) that discussions or negotiations are takingplace between the Companies concerning a Possible Transaction or (iii) anyof the terms, conditions or other facts with respect thereto (including thestatus thereof).

5. Legally Required Disclosure. If a Recipient or its Representativesare requested or required (by oral questions, interrogatories, other requestsfor information or documents in legal proceedings, subpoena, civil inves-tigative demand or other similar process) to disclose any of the EvaluationMaterial or any of the facts disclosure of which is prohibited under Section 4above, such Recipient shall provide the Provider with prompt written noticeof any such request or requirement together with copies of the materialproposed to be disclosed so that the Provider may seek a protective orderor other appropriate remedy and/or waive compliance with the provisions ofthis Agreement. If, in the absence of a protective order or other remedy orthe receipt of a waiver by the Provider, a Recipient or its Representativesare nonetheless legally compelled to disclose Evaluation Material or any ofthe facts disclosure of which is prohibited under Section 4 or otherwise be

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liable for contempt or suffer other censure or penalty, such Recipient or itsRepresentatives may, without liability hereunder, disclose to such requiringPerson only that portion of such Evaluation Material or any such facts whichthe Recipient or its Representatives is legally required to disclose, providedthat the Recipient and/or its Representatives cooperate with the Provider toobtain an appropriate protective order or other reliable assurance thatconfidential treatment will be accorded such Evaluation Material or suchfacts by the Person receiving the material.

6. Return or Destruction of Evaluation Material. If either Companydecides that it does not wish to proceed with a Possible Transaction, it willpromptly inform the other Company of that decision. In that case, or at anytime upon the request of a Provider for any reason, a Recipient will, and willcause its Representatives to, within five business days of receipt of suchnotice, destroy or return all Evaluation Material in any way relating to theProvider or its products, services, employees or other assets or liabilities,and no copy or extract thereof (including electronic copies) shall beretained, except that Recipient’s outside counsel may retain one copy tobe kept confidential and used solely for archival purposes. The Recipientshall provide to the Provider a certificate of compliance with the previoussentence signed by an executive officer of the Recipient. Notwithstandingthe return or destruction of the Evaluation Material, the Recipient and itsRepresentatives will continue to be bound by such Recipient’s obligationshereunder with respect to such Evaluation Material.

7. No Solicitation/Employment. Neither Recipient will, within one yearfrom the date of this Agreement, directly or indirectly solicit the employmentor consulting services of or employ or engage as a consultant any of theofficers or employees of the Provider, so long as they are employed by theProvider and for three months after they cease to be employed by Provider.A Recipient is not prohibited from soliciting by means of a general adver-tisement not directed at (i) any particular individual or (ii) the employees ofthe Provider generally.

8. Standstill. [Note: Delete this section if target Company is notpublicly-held or likely to be publicly-held in the near future] EachCompany agrees that, for a period of one year after the date of thisAgreement, unless specifically invited in writing by the other Company,neither it nor any of its affiliates (as such term is defined under the Secu-rities Exchange Act of 1934, as amended (the “1934 Act”)) or

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Annex 3-A - Mutual Nondisclosure Agreement

Representatives of such Company (acting in any capacity other than as anadvisor in any of the following cases) will in any manner, directly orindirectly:

(a) effect, seek, offer or propose (whether publicly or otherwise) toeffect, or cause or participate in, or in any way assist any otherPerson to effect, seek, offer or propose (whether publicly or oth-erwise) to effect or participate in:

(i) any acquisition of any securities (or beneficial ownershipthereof) or assets of the other Company or any of itssubsidiaries,

(ii) any tender or exchange offer, merger or other business com-bination involving the other Company or any of its subsidiaries,

(iii) any recapitalization, restructuring, liquidation, dissolution orother extraordinary transaction with respect to the other Com-pany or any of its subsidiaries, or

(iv) any “solicitation” of “proxies” (as such terms are used in theproxy rules of the Securities and Exchange Commission) orconsents to vote any voting securities of the other Company;

(b) form, join or in any way participate in a “group” (as defined underthe 1934 Act) with respect to the securities of the other Company;

(c) make any public announcement with respect to, or submit anunsolicited proposal for or offer of (with or without condition),any extraordinary transaction involving the other Company or itssecurities or assets;

(d) otherwise act, alone or in concert with others, to seek to control orinfluence the management, Board of Directors or policies of theother Company;

(e) take any action which might force the other Company to make apublic announcement regarding any of the types of matters setforth in (a) above; or

(f) enter into any discussions or arrangements with any third party withrespect to any of the foregoing.

Each Company also agrees during such period not to request the otherCompany (or its directors, officers, employees or agents), directly or indi-rectly, to amend or waive any provision of this Section 8 (including thissentence).

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9. Maintaining Privilege. If any Evaluation Material includes materialsor information subject to the attorney-client privilege, work product doctrineor any other applicable privilege concerning pending or threatened legalproceedings or governmental investigations, each Company understandsand agrees that the Companies have a commonality of interest with respectto such matters and it is the desire, intention and mutual understanding ofthe Companies that the sharing of such material is not intended to, and shallnot, waive or diminish in any way the confidentiality of such material or itscontinued protection under the attorney-client privilege, work product doc-trine or other applicable privilege. All Evaluation Material provided by aCompany that is entitled to protection under the attorney-client privilege,work product doctrine or other applicable privilege shall remain entitled tosuch protection under these privileges, this Agreement, and under the jointdefense doctrine.

10. Compliance with Securities Laws. Each Recipient agrees not touse any Evaluation Material of the Provider in violation of applicablesecurities laws. [Note: Delete this section if Provider is not publicly-held or likely to be publicly-held in the near future]

11. Not a Transaction Agreement. Each Company understands andagrees that no contract or agreement providing for a Possible Transactionexists between the Companies unless and until a final definitive agreementfor a Possible Transaction has been executed and delivered, and eachCompany hereby waives, in advance, any claims (including, without limi-tation, breach of contract) relating to the existence of a Possible Transactionunless and until both Companies shall have entered into a final definitiveagreement for a Possible Transaction. Each Company also agrees that,unless and until a final definitive agreement regarding a Possible Trans-action has been executed and delivered, neither Company will be under anylegal obligation of any kind whatsoever with respect to such PossibleTransaction by virtue of this Agreement except for the matters specificallyagreed to herein. Neither Company is under any obligation to accept anyproposal regarding a Possible Transaction and either Company may ter-minate discussions and negotiations with the other Company at any time.

12. No Representations or Warranties; No Obligation to Disclose. EachRecipient understands and acknowledges that neither the Provider nor itsRepresentatives makes any representation or warranty, express or implied,as to the accuracy or completeness of the Evaluation Material furnished byor on behalf of such Provider and shall have no liability to the Recipient, itsRepresentatives or any other Person relating to or resulting from the use ofthe Evaluation Material furnished to such Recipient or its Representatives

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or any errors therein or omissions therefrom. As to the information deliveredto the Recipient, each Provider will only be liable for those representationsor warranties which are made in a final definitive agreement regarding aPossible Transaction, when, as and if executed, and subject to such lim-itations and restrictions as may be specified therein. Nothing in this Agree-ment shall be construed as obligating a Company to provide, or to continueto provide, any information to any Person.

13. Modifications and Waiver. No provision of this Agreement can bewaived or amended in favor of either Party except by written consent of theother Party, which consent shall specifically refer to such provision andexplicitly make such waiver or amendment. No failure or delay by eitherParty in exercising any right, power or privilege hereunder shall operate as awaiver thereof, nor shall any single or partial exercise thereof preclude anyother or future exercise thereof or the exercise of any other right, power orprivilege hereunder.

14. Remedies. Each Company understands and agrees that moneydamages would not be a sufficient remedy for any breach of this Agreementby either Company or any of its Representatives and that the Companyagainst which such breach is committed shall be entitled to equitable relief,including injunction and specific performance, as a remedy for any suchbreach or threat thereof. Such remedies shall not be deemed to be theexclusive remedies for a breach by either Company of this Agreement, butshall be in addition to all other remedies available at law or equity to theCompany against which such breach is committed.

15. Legal Fees. In the event of litigation relating to this Agreement, if acourt of competent jurisdiction determines that either Company or itsRepresentatives has breached this Agreement, then the Company whichis, or the Company whose Representatives are, determined to have sobreached shall be liable and pay to the other Company the reasonable legalfees and costs incurred by the other Company in connection with suchlitigation, including any appeal there from.

16. Governing Law. This Agreement is for the benefit of each Com-pany and shall be governed by and construed in accordance with the laws ofthe State of applicable to agreements made and to be performedentirely within such State.

17. Severability. If any term, provision, covenant or restriction con-tained in this Agreement is held by any court of competent jurisdiction to beinvalid, void or unenforceable, the remainder of the terms, provisions,covenants or restrictions contained in this Agreement shall remain in full

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force and effect and shall in no way be affected, impaired or invalidated, andif a covenant or provision is determined to be unenforceable by reason of itsextent, duration, scope or otherwise, then the Companies intend andhereby request that the court or other authority making that determinationshall only modify such extent, duration, scope or other provision to theextent necessary to make it enforceable and enforce them in their modifiedform for all purposes of this Agreement.

18. Construction. The Companies have participated jointly in thenegotiation and drafting of this Agreement. If an ambiguity or question ofintent or interpretation arises, this Agreement shall be construed as ifdrafted jointly by the Companies and no presumption or burden of proofshall arise favoring or disfavoring either Company by virtue of the author-ship at any of the provisions of this Agreement.

19. Term. This Agreement shall terminate three years after the date ofthis Agreement.

20. Entire Agreement. This Agreement contains the entire agreementbetween the Companies regarding the subject matter hereof and super-sedes all prior agreements, understandings, arrangements and discus-sions between the Companies regarding such subject matter.

21. Counterparts. This Agreement may be signed in counterparts,each of which shall be deemed an original but all of which shall be deemedto constitute a single instrument.

IN WITNESS WHEREOF, each of the undersigned entities has causedthis Agreement to be signed by its duly authorized representatives as of thedate written below.

Date:

[COMPANY NAME] [COMPANY NAME]ADDRESS FOR NOTICE: ADDRESS FOR NOTICE:

By:

Name:Title:

By:

Name:Title:

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Annex 3-B

Summary Checklist

Definition of Confidential Information

Providers should

n Confirm that the definition of “confidential information” sufficientlycovers the information and materials to be provided (and, to theextent applicable, confidential information that may have beenpreviously provided).

n Consider removing legending requirements (that any written mate-rials be marked “confidential” or that oral statements be reduced towriting and so marked to be considered confidential) to avoid acci-dental failures to legend leading to unprotected confidentialinformation.

n Consider having any subset of extremely confidential informationbeing supplied (such as pricing information, patent information, orsource code) carved out and addressed separately under a specialNDA implementing careful controls and procedures to limit thedistribution and access of the information to those advisors oragreed upon personnel of the recipient whom the provider believescannot exploit the information commercially, especially where therecipient is a close competitor.

n Remove any “residual” clause that allows the recipient to use, infuture products or services, any information retained in the memoryof the recipient’s employees that was obtained by reviewing theconfidential information.

Recipients should

n Confirm that the exclusions from what is considered confidentialinformation properly reflect the principle that information should notbe protected if it was created or discovered by the recipient prior to,or independent of, any involvement with the disclosing party.

n Consider removing legending requirements to avoid overly burden-ing the due diligence process.

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Use of Confidential Information

Providers should

n Confirm that there exists language limiting the use of the confiden-tial information to the contemplated purpose (evaluation of thespecific transaction) and not for any other purpose.

n Confirm that there exists language clarifying that no license is beinggranted to the recipient or its representatives to use the confidentialinformation except for the specific purpose of evaluating the trans-action, and that no license is being granted to any of the provider’sintellectual property.

n Confirm that the recipient is responsible/liable for its representatives’proper use of the confidential information to the extent that the providerdoes not request such representatives to be parties to the NDA.

n If the provider is a publicly traded company, confirm that the recip-ient will not use confidential information in violation of applicablesecurities laws.

n Consider implementing controls and procedures to limit the distribu-tion and access of the information if there is extremely confidentialinformation being supplied or if the recipient is a close competitor, butwhere these factors do not rise to the level of affording treatment ofthe more sensitive portion under a special NDA.

n Confirm that there exists language clarifying that information pro-vided does not constitute any representation or warranty of theprovider but that such representations and warranties are limited towhat is provided for in the definitive agreement.

Non-Disclosure of Discussions

Providers should

n Confirm that the NDA contains language clarifying that the fact thatdiscussions are taking place between the parties regarding thetransaction is confidential, especially if the provider is a publiclytraded company.

n If the provider is the selling company in an auction context, attemptto retain some limited ability to disclose the fact that the recipient isbidding or, to the extent possible, to disclose the terms of any bidmade by recipient.

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Recipients should

n Confirm that the NDA contains language clarifying that the discus-sions between the parties regarding the transaction are confidential,including the identity of the parties and the terms of any bid if therecipient is the acquiring company.

n If the recipient is the acquiring company and needs financing for thetransaction, obtain a carve-out allowing information to be disclosedto financiers.

Legally Required Disclosures

Providers should

n Consider requiring the recipient to fully cooperate with the providerin obtaining any applicable protective orders if requested.

Recipients should

n Confirm that there exists an exception to the NDA allowing therecipient to disclose information that is legally required to bedisclosed.

Return or Destruction of Materials

Providers should

n Confirm that there exists language providing for the return ordestruction of any written confidential information provided.

n If a copy is to be retained for archival/evidentiary purposes, confirmthat it will be kept by outside counsel.

Recipients should

n Consider ensuring outside counsel the right to retain one copy forarchival/evidentiary purposes.

n Confirm that the recipient is permitted to destroy or certify destruc-tion of information to satisfy its obligations.

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Annex 3 -B - Summary Checklist

Non-Solicitation/Employment

Providers should

n Confirm that the NDA contains language providing for protectionagainst the recipient’s soliciting of the provider’s employees forsome amount of time (typically 6 months to 2 years, with one yearbeing fairly common) as well as against soliciting former employeeswho recently departed (typically three to six months is common).

n The recipient may argue strongly against this because it is a largeentity that will have difficulty keeping track of solicitation and hiringactivities. If this occurs, consider this alternative: limiting interactionbetween both parties’ employees by restricting which provideremployees the recipient will be allowed to contact.

Recipients should

n Consider a limiting provision that would apply only to “key” employ-ees or employees of the provider who were identified to the recipientduring the diligence process.

n Confirm that there exists a carve-out for general solicitation notdirected at provider employees.

n Consider removing this provision altogether if it concerns a largeentity that would have difficulty keeping track of solicitation andhiring activities.

Term

Providers should

n Consider language providing that the NDA does not expire, as whatis confidential now may need to remain just as confidential yearsfrom now.

n Consider setting an unlimited term for trade secrets recipients.

n Consider limiting the NDA to a specific time period (typically 1 to5 years).

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Remedies

Providers should

n Confirm that there exists language having the recipient acknowl-edge and agree that monetary damages are insufficient to remedybreach of the NDA, and that the provider is entitled to equitable reliefin addition to any other remedies.

Miscellaneous Provisions Applicable to Providers andRecipients

Privileged Information. Consider language stating that disclosure isnot deemed to have waived or diminished attorney-client privilege, attorneywork-product protection, or any other privilege or protection applicable tothe confidential information that relies upon a form of the joint defensedoctrine. Note that the effectiveness of this provision is not certainthat.

Binding Agreement. Confirm that language exists clarifying that theNDA does not constitute an agreement to enter into or even negotiate atransaction, as sometimes courts have found an agreement to negotiateabsent such language.

Standstill Provisions. These provisions are only applicable where thetarget company is publicly traded or likely to be public soon, and, due to theircomplexity, should be carefully reviewed by sophisticated M&A counsel.

No Shop. The seller should delete provisions restricting it from shop-ping as these are not typically agreed to until at least a term sheet or basictransaction terms are agreed upon.

Export. If the providers have a particular concern about providingtechnical information to non-U.S. persons, they should consider adding aprovision ensuring that a recipient complies with applicable export laws.

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Annex 3 -B - Summary Checklist

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Annex 4

Sample Due Diligence ChecklistMEMORANDUMTO: *FROM:DATE:RE: Due Diligence Request List

In connection with the proposed acquisition of seller (the “Company”),[ ], as legal counsel to the buyer, will need to review the documentsdescribed on the attached list. References in the list to the “Company”should be deemed to include the Company, its subsidiaries and theirrespective predecessors. When you provide requested documents or infor-mation to us, please indicate in the spaces provided whether the documentor other requested information has been previously provided, is currentlybeing provided, is available for review at [your offices or the Company’slocal office].

Please note that additional documents may be requested during thecourse of our review of the Company. If compiling any of the requesteditems would be impracticable or unduly burdensome, please let us knowand we would be happy to discuss the items with you.

In the event of any questions or comments, please do not hesitate tocontact at .

[BUYER CODE NAME]’S PRELIMINARY REQUEST FOR DUEDILIGENCE MATERIAL FROM [SELLER CODE NAME]

“A” = Access to materials provided“P” = Copy Previously provided“H” = Copy provided Herewith“N” = Not applicable

“E” = Available through EDGAR (Identify by filing type, approx. date offiling, exhibit no.) [NOTE: Delete if Seller is private; also delete Sec-tions 19 through 21 below]

1. BASIC CORPORATE DOCUMENTS

[ ] (a) Legal entity structure, including name, physical location andfunction of all divisions, subsidiaries or affiliated entities.

[ ] (b) Certificate or Articles of Incorporation and Bylaws, includingall amendments.

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[ ] (c) Minutes of all meetings and written consents of board ofdirectors, Board committees and other committees and stock-holders, including copies of notices of all such meetings wherewritten notices were given and all written waivers of requirednotices.

[ ] (d) List of all states and foreign countries where property is ownedor leased or where employees are located, indicating in whichjurisdictions the Company is qualified to do business andindicating principal business activity at each location.

[ ] (e) List of states and foreign countries in which the Companycontemplates undertaking business operations, either directlyor through other parties.

2. STOCKHOLDER INFORMATION

[ ] (a) Samples of common and preferred stock certificates, deben-tures and any other outstanding debt or equity securities.

[ ] (b) The Company’s stock books.

[ ] (c) Lists of all current owners of shares, including address, num-ber of shares owned, dates of issuance and full payment, theconsideration received by the Company and applicable stoptransfer orders or restrictive legends.

[ ] (d) List of all options, warrants and other rights to acquire equitysecurities, including date of grant or issuance, exercise orconversion price, number of shares, vesting schedule andnames and addresses of holders.

3. AGREEMENTS REGARDING SECURITIES

[ ] (a) Stock option plans and forms of option agreements whichhave been used.

[ ] (b) Copies of all warrants, including all amendments.

[ ] (c) Stock purchase agreements and any related documents.

[ ] (d) Any other documents relating to sales of securities by theCompany, including any private placement memoranda orother offering circulars.

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[ ] (e) Any agreements and other documentation relating to repur-chases, redemptions, exchanges, conversions or similartransactions involving the Company’s securities.

[ ] (f) Permits, notices of exemption and consents for issuance ortransfer of the Company’s securities and other evidence ofqualification or exemption under applicable state blue skylaws.

[ ] (g) Forms D or any other evidence of qualification or exemptionunder the Securities Act of 1933, as amended.

[ ] (h) Employee stock ownership plans, stock purchase plans orsimilar plans and forms of agreements which have been used.

[ ] (i) Copies of any voting trust, buy-sell or other similar agreementcovering any of the Company’s securities.

[ ] (j) All agreements containing registration rights or assigning suchrights or any other rights (including preemptive rights, rights offirst refusal, etc.) granted with respect to the capital stock of theCompany.

4. OTHER MATERIAL CONTRACTS

[ ] (a) Convertible, senior or other debt financings, if any.

[ ] (b) Bank line of credit or loan agreements and guarantees, includ-ing any amendments, renewal letters, notices, etc.

[ ] (c) Description of any default by any party under any contract orcommitment affecting the Company or its property, or anycircumstance which might reasonably be expected in thefuture to give rise to such default.

[ ] (d) All outstanding leases of real and personal property, includingequipment leases.

[ ] (e) All agreements entered into by the Company or any of itssubsidiaries relating to a material acquisition or disposition ofassets or stock and schedules of exceptions thereto.

[ ] (f) Material contracts (over $ ) with suppliers, contract manu-facturers or customers, including OEM and similar agreements.

[ ] (g) List of major suppliers, indicating total and type of purchasesfrom each supplier during the last two fiscal years and the

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Annex 4 - Sample Due Diligence Checklist

current fiscal year, any key suppliers not subject to supplyagreements, sole source suppliers and any subcontractedwork.

[ ] (h) Model or standard sales or license agreements, if used by theCompany.

[ ] (i) Agreements for loans to key employees, and any other agree-ments with officers, directors, employees and consultants,whether or not now outstanding.

[ ] (j) Schedule of insurance policies in force covering property of theCompany and any other insurance policies in force (such as“key man” policies).

[ ] (k) Partnership, product development and joint venture agree-ments, if any.

[ ] (l) All security agreements covering the Company’s assets.

[ ] (m) All agreements or proposed agreements with distributors,dealers and sales representatives.

[ ] (n) Indemnification agreements.

[ ] (o) Research and development agreements.

[ ] (p) All agreements, or proposed agreements pursuant to whichthe Company licenses any of its proprietary rights or islicensed by any third party to any proprietary rights.

[ ] (q) All agreements concerning the sharing of R&D facilities orsimilar agreements.

[ ] (r) List and copies of any intercompany agreements with affiliatedentities relevant to the development, use or commercializationof the Company’s technology (as defined below).

[ ] (s) Copies of standard forms of purchase orders, quotations andorder acknowledgments relevant to the Company’s technology.

[ ] (t) Description of any provisions that purport to restrict the Com-pany’s ability to compete with respect to the Company’s tech-nology, whether by agreement, court order, or otherwise.

[ ] (u) List and copies of all source code, manufacturing, develop-ment or other form of escrow agreements, whether internal or

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third party escrow accounts, which relate to the Company’stechnology and to which Company is a party.

[ ] (v) Other material contracts.

5. PRODUCTS, MANUFACTURING AND COMPETITION

[ ] (a) List of principal products and, for each product, (i) shortdescription of the product, (ii) principal competitive prod-ucts, (iii) principal customers and (iv) sites wheremanufactured.

[ ] (b) List of third party developers showing total and type of projectfor each developer.

[ ] (c) List of third party software duplicators and manual publishers,if any.

[ ] (d) Copies of any non-competition agreements of the Companyor employees.

[ ] (e) List of the top 20 customers of the Company, indicating thetypes of products and the amounts of each purchased.

[ ] (f) List of service and support contracts.

[ ] (g) Company-financed customer purchase agreements.

[ ] (h) Price lists, catalogues and brochures for the Company’sproducts.

[ ] (i) Forms of warranties and guarantees provided to customers.

[ ] (j) List of major risks, in rough priority, of technical problems orlimitations which current and planned product lines mayencounter.

[ ] (k) Description of any significant customer relationship termi-nated or suspended within the last three years.

6. GOVERNMENTAL REGULATIONS

[ ] (a) Permits for conduct of business, including licenses, franchisesand concessions, if any.

[ ] (b) All certificates, permits, etc., evidencing compliance with spe-cific regulations, including environmental and workers healthand safety regulations.

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[ ] (c) List and description of any government regulations (federal,state, local or foreign) of whatever kind (safety, labor, envi-ronmental, etc.) which have special application to the Com-pany’s business.

[ ] (d) Copies of all material filings, applications and correspondencewith, all documents relating to investigations or reviews con-ducted by, and all demands, notices, requests for information,approvals, authorizations, determinations, rulings or ordersreceived from, any federal, state, local or foreign governmen-tal agencies.

[ ] (e) Description and status statement of all pending or threatenedregulatory, judicial or administrative actions relating to regu-latory matters.

[ ] (f) Any material agreements, correspondence, undertakings, orunderstandings between the Company and any regulatorybody.

[ ] (g) Access to the Company’s files relating to regulatory matters;copies of reports of any inspections, surveys or audits,whether generated internally or by regulatory authorities orother third parties.

7. TAXATION

[ ] (a) Provide all federal, state, local and foreign income and fran-chise tax returns of Company filed for the last three fiscalyears and all such returns for any prior year that is still subjectto audit or adjustment.

[ ] (b) Identify all jurisdictions in which sales and use tax returns arefiled by Company including a summary by jurisdiction of totalsales and use taxes paid during the last three fiscal years.Please provide details with respect to any significant changesto this list of filing jurisdictions since incorporation.

[ ] (c) Provide a schedule by jurisdiction of all property taxes paidduring the last three fiscal years.

[ ] (d) Identify any excise tax returns filed by the Company for theproduction, sale and distribution of product; identify all juris-dictions where the Company is subject to VATor a similar tax.

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[ ] (e) Provide any private letter ruling or other letter ruling obtainedfrom the IRS or any state, and each application for any ruling(including any pending ruling) pertaining to Company.

[ ] (f) Provide summary results of all tax examinations and audits(federal, state and foreign) pertaining to Company (includingincome, sales and use, employment, and property tax) com-pleted within the last five years (or still outstanding) includingcopies of all revenue agent reports, closing agreements, orother correspondence from or to any taxing authority address-ing issues raised in the examination.

[ ] (g) Identify all material intercompany transactions within the lastthree fiscal years, including transactions between U.S. andforeign affiliates of the Company, as well as transactionsbetween the Company and its stockholders, if not providedelsewhere.

[ ] (h) Provide all tax sharing agreements, tax indemnity agree-ments, and transfer pricing agreements pertaining to theCompany.

[ ] (i) Provide a list of states in which more than [$100,000] productsor services were sold within each of the last three fiscal years.

[ ] (j) Provide a list of all states in which independent contractorsperform any sales, marketing or product support activities(including installation, repair or warranty service) on behalfof the Company.

[ ] (k) Provide a schedule of federal and state net operating losscarryforwards and tax credit carryforwards, including years ofexpiration.

[ ] (l) Provide a description of any tax contingency reserves on theCompany’s balance sheet and any work papers explainingsuch tax reserves.

[ ] (m) Identify any pending claims for refund of any tax, fee or similaritem.

[ ] (n) Describe any material tax planning strategy or tax sheltertransaction implemented within the last 5 years and provideany related correspondence.

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8. LITIGATION AND AUDITS

[ ] (a) All management letters or special reports from the auditor andresponses thereto concerning internal accounting controls inconnection with any current audit and the audits for the lastthree fiscal years.

[ ] (b) Settlement documents, if any.

[ ] (c) Decrees, order and judgments of courts or governmentalagencies with respect to the Company.

[ ] (d) Description of any warranty claims which have been madeagainst the Company or any related partnership or joint ven-ture and the resolutions of such claims.

[ ] (e) List of pending, asserted or threatened lawsuits or otherclaims or investigations, together with short summary of theclaims and related facts.

9. EMPLOYEES AND MANAGEMENT

[ ] (a) Description of any significant labor problems the Companyhas experienced.

[ ] (b) Management and Organization chart.

[ ] (c) Description of any material transactions since inception withany “insider” (i.e., any officer, director, or owner of a substan-tial amount of the Company’s securities) or any associate ofan “insider.”

[ ] (d) Copy of form of any invention and confidentiality agreement toprotect trade secrets and list of any officers, directors, employ-ees or consultants who have not signed such agreements.

[ ] (e) Summary of standard employee benefits (vacation, sickleave, sabbatical, medical insurance, life and disability insur-ance, etc.)

[ ] (f) A list of the amount of cash compensation (including as sep-arate items the amount of salary, bonus, commission anddeferred salary pursuant to any plans) and other forms ofcompensation (such as car allowances, forgiveness of loansand other perquisites) paid to each of the Company’s officersand directors for services rendered in the last full fiscal yearand to be paid in the current fiscal year.

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[ ] (g) Description of commissions paid to managers, agents, orother employees for the last fiscal year and to be paid inthe current fiscal year.

[ ] (h) Founders agreements, “golden parachute” and other changeof control or severance agreements, if any.

[ ] (i) Summary of worker’s compensation claims made.

[ ] (j) Personnel policies, manuals and handbooks.

[ ] (k) Number of employees by department.

10. EMPLOYEE BENEFITS

[ ] (a) Copies of all 401(k) and other qualified pension and profitsharing plan documents, all amendments, summary plandescriptions, adoption agreements, trust agreements, admin-istrative services agreements, group annuity contracts, res-olutions, IRS opinion/determination letter, last three yearsnondiscrimination and compliance testing and last five yearsForm 5500.

[ ] (b) Copy of group health plan document and Summary PlanDescription (SPD), last three years Form 5500.

[ ] (c) Copy of Section 125 Plan document, SPD (include dependentcare plans, health flexible spending accounts, etc.) and lastthree years Form 5500.

11. FINANCIAL INFORMATION

[ ] (a) Financial, operating or business plans and projections, includ-ing underlying assumptions.

[ ] (b) Backup data for revenue forecasts by product and/or marketsegments and estimates of the Company’s market share ineach.

[ ] (c) Balance sheet account reconciliations and specific supportingdetail: cash, receivables and unbilled receivables, sales-typeleases, inventory, prepaids, fixed assets, reserves and accru-als, sales tax, deferred income, debt, stock reconciliations.

[ ] (d) Financial statements for past [three] fiscal years, and interimfinancial statements covering each completed quarter of cur-rent fiscal year.

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[ ] (e) Most current balance sheet and income statement.

[ ] (f) Quarterly projected financial statements for the next threefiscal years.

[ ] (g) Quarterly analyses of sales and cost by major market seg-ments/product lines for the current year to date and the nextthree fiscal years.

[ ] (h) Reserves analyses as of the end of the last fiscal year and lastfiscal quarter.

[ ] (i) Comparison of budget to actual (summary and detail) for lastfiscal year and current fiscal year to date.

[ ] (j) List of all recorded or unrecorded contingent liabilities as of theend of the last year and at the latest available date.

[ ] (k) Capital budget.

[ ] (l) Cash report and cash flow projections.

[ ] (m) Brief description of cash investment practices and policiesand status of current cash balance investments.

[ ] (n) Brief description of any foreign currency transactions, practiceand policies.

12. MARKETING INFORMATION

[ ] (a) Internal market size and growth projections (by units anddollars) for each market segment.

[ ] (b) Market share data (by units and dollars) for the Company andany competitors, both current and historical.

[ ] (c) Any external/independent analysis of market size, growth andshare data.

[ ] (d) List of principal competitors by market segment.

[ ] (e) Any recent analysis of competitors.

[ ] (f) Any customer survey data which has recently been collected.

[ ] (g) All current product and marketing literature.

[ ] (h) Any noncompetition agreements or other agreements restrict-ing the Company’s business activities.

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[ ] (i) Market research, marketing studies, long- and short-term stra-tegic plans and valuation analyses prepared by the Companyor third parties for the Company.

13. GOVERNMENT CONTRACTS

[ ] (a) All Government Contracts, including all modifications andattachments, and any Cooperative Agreements under anyGovernment technology transfer program, e.g. CRADAS,which has not been “closed-out” by the Government, includingany contracts which have been fully performed but for whichthe Company has not received final indirect cost rates (the“Government Contracts”).

[ ] (b) All representations and certifications signed for each Govern-ment Contract, including any “secondary” certifications underthe Procurement Integrity Act executed by personnel “sub-stantially involved in the procurement.”

[ ] (c) Any and all Small Business Subcontracting Plans draftedand/or approved for each Government Contract.

[ ] (d) Any Cost Accounting Standards Disclosure Forms submittedwith or applicable to a Government Contract.

[ ] (e) Any “Advance Agreements” pertaining to a Government Con-tract regarding the allowability or allocability of contract costs.

[ ] (f) All Cost or Pricing Data submissions for each GovernmentContract (SF 1411 and accompanying materials).

[ ] (g) Descriptions of the Company’s internal system and practicesused for gathering cost or pricing data, including practiceswith regard to conducting “final sweeps” and establishing “cut-off-dates” for submission.

[ ] (h) List and briefly describe any audit conducted and audit find-ings for each Government Contract, including pre-award andpost-award audits, and provide any DCAA or other auditreports in the Company’s possession relating to the Govern-ment Contracts.

[ ] (i) List technical data provided under the Government Contractswith:

(1) Unlimited Rights;

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(2) Government Purpose (License) Rights

(3) Limited Rights

[ ] (j) List computer software provided under the Government Con-tracts with:

(1) Unlimited Rights

(2) Government Purpose (License) Rights

(3) Limited Rights

[ ] (k) List of any restricted rights computer software incorporatedinto non-commercial Government products.

[ ] (l) Any Requests for Equitable Adjustment (REA’s) or claimssubmitted under any Government Contract, including allbackup material provided by the Company to the Government,and any Government responses to such REA’s or claims.

[ ] (m) List of Firm Fixed Price or Other Fixed Price GovernmentContracts currently in a cost-overrun position, and a briefdescription of the magnitude and cause of such cost overrun.

[ ] (n) List and brief description of any Government claims of any sortasserted against the Company, e.g., defective cost or pricingdata, deductive changes, false certifications, etc.

[ ] (o) Any terminations for convenience settlement proposals/claims submitted under any Government Contract, and a briefdescription of the status of any such proposal/claim.

[ ] (p) List of any Government Contracts terminated for Default andany accompanying claims by the Government for excessreprocurement costs.

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14. EMPLOYEE BENEFIT MATTERS

[ ] (a) List of any employee benefit plans sponsored or maintainedby or for the Company, including pension, profit sharing, stockbonus, incentive stock option, nonqualified stock option, stockpurchase, restricted stock, stock appreciation rights, savings,401(k), nonqualified deferred compensation plans and allwelfare benefit plans.

[ ] (b) With respect to each qualified profit sharing, 401(k), moneypurchase pension, stock bonus, employee stock ownership,defined benefit pension and/or multiemployer pension plansponsored or maintained by or for the Company:

[ ] (1) Copies of all plan documents, trust agreements, planamendments and/or adoption agreements;

[ ] (2) Certified resolutions of the Board of Directors adopt-ing the Plan, adopting Plan amendments and/ordelegating fiduciary responsibility to any person(s)or entities;

[ ] (3) Copies of the last three years nondiscrimination andcompliance tests (e.g., ADP/ACP, 415, 410(b),402(g)).

[ ] (4) Copies of the five most recent Forms 5500, includingall schedules, attachments and audit reports, if any;

[ ] (5) Copies of any third party funding contracts, includinggroup annuity contracts, insurance contracts, invest-ment fund contracts, investment managementagreements;

[ ] (6) Copies of the most recent summary of plan accountsprepared by the plan recordkeeper, or, if a definedbenefit plan, the most recent plan benefitsummaries;

[ ] (7) Copy of the most recent summary plan descriptionand any summary of material modifications distrib-uted to plan participants;

[ ] (8) Copy of the most favorable determination letter oropinion from the Internal Revenue Service;

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[ ] (9) Copy of the two most recent Summary AnnualReports and information as to dates of distribution;

[ ] (10) Copy of beneficiary designation form;

[ ] (11) Copies of written notice of tax consequences (Sec-tion 402(f) notice) provided to participants, distri-bution request forms, election and waiver formswith respect to qualified joint and survivor annuitiesand qualified preretirement survivor annuities, ifapplicable;

[ ] (12) Copies of employee stock ownership plan loandocuments, including promissory notes, pledgeagreements, escrow agreements, and any otherdocument or agreement prepared in connectionwith an exempt ESOP loan or transaction underTreasury Regs. § 54.4975-7 or § 54.4975-11;

[ ] (13) Copies of the two most recent actuarial reports, ifapplicable;

[ ] (14) Copies of PBGC-1 and Schedule A for part twoyears;

[ ] (15) Copy of fiduciary bond;

[ ] (16) Information regarding any defined benefit planfunding deficiency or multiemployer plan with-drawal liability assessment, including informationas to the amount of the funding deficiency or with-drawal liability, the original due date, the date thedeficiency or withdrawal liability was satisfied, cop-ies of Form 5330 and proof of payment (canceledcheck) and copy of notice distributed to employeesdisclosing a funding deficiency; and

[ ] (17) Copies of any pending or previous IRS or DOL auditinquiries/examinations or related correspondence.

[ ] (c) With respect to each welfare benefit plan sponsored or main-tained by the Company (including all health, medical, dental,life insurance, dependent care reimbursement, pretax pre-mium, health care reimbursement, section 125 flexible ben-efit, disability, accidental death and dismembermentinsurance, severance, vacation, retiree health and group legal

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plans and any plan that otherwise satisfies the definition of awelfare benefit plan under the Employee Retirement IncomeSecurity Act):

[ ] (1) Copy of the plan document or contract under whichbenefits are provided;

[ ] (2) Copy of the summary plan description and any sum-mary of material modifications distributed toemployees;

[ ] (3) Copies of the Form 5500s, including all attachmentsand schedules, for the past three years;

[ ] (4) Copy of COBRA notice (both initial and qualifyingevent) and written procedures;

[ ] (5) Copy of or information concerning any promise toextend benefits under the plan to retirees;

[ ] (6) Copies of all written communications to participantswithin the past two years concerning the plan;

[ ] (7) Copies of HIPAA notices and certificates; and

[ ] (8) Copies of Cancer Rights Act notices.

15. PROPERTY, FACILITIES, PERMITS AND ENVIRONMENTALMATTERS

[ ] (a) List and description of all real property owned or leased by theCompany; location, character and general nature of opera-tions conducted at each location; nature of the title held, andany mortgages, liens or encumbrances on the property; titledocuments confirming ownership; report by public notary (incivil law countries) or other person authorized to conduct titlesearches.

[ ] (b) List, with brief description, of all material personal propertyowned, leased or otherwise used by the Company.

[ ] (c) List of all facilities currently owned, leased or otherwise usedby the Company, including location, square footage, spaceavailable for expansions, presence of any known above-ground or underground chemical or fuel storage tanks orsumps, and brief description of lease/use terms (if applicable)

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and current and prior usage (including use by other ownersand tenants, if known).

[ ] (d) Schedule of property, plant and equipment by category includ-ing gross asset value, accumulated depreciation, range ofdepreciable lives, depreciation methods and market value/replacement cost estimates (if available).

[ ] (e) Summary of all outstanding capital purchase commitments.

[ ] (f) For material properties and facilities: deeds, mortgages,deeds of trust, title insurance policies, title reports, surveys,certificates of occupancy and appraisals and valuations; UCCsearches in relevant states; judgment searches in relevantstates; description of other liens, encumbrances and zoningrestrictions.

[ ] (g) List of all facilities formerly owned, leased or otherwise usedby the Company, including location, square footage, presenceof any known aboveground or underground chemical or fuelstorage tanks or sumps, dates of ownership/lease/use, andbrief description of usage (including use by other owners andtenants, if known).

[ ] (h) List, including maximum quantity onsite at any one time andbrief description of usage, of all hazardous materials/wastescurrently or previously (if known) stored, used, transported,generated, manufactured, treated, discharged, or disposed inconnection with the Company’s business. Provide MSDSforms for listed items, if available.

[ ] (i) List, and brief description of status, of all permits, licenses,certificates, and other governmental approvals (collectively,“Permits”) held or needed by the Company in connection withits business or properties owned, leased or otherwise used bythe Company, including Permits relating to environmental,hazardous materials/wastes, and worker health and safetymatters.

[ ] (j) All claims, demands, notices or requests for information, andresponses thereto (collectively, “Notices”), given to or receivedfrom any agency or other person regarding any matters con-cerning the environment, hazardous materials/wastes, orworker health and safety, including any Notices of potentialresponsibility for environmental contamination.

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[ ] (k) List, and brief description of status, of environmental, hazard-ous materials/wastes, or worker health and safety problems,injuries, conditions or issues known to the Company concern-ing the Company’s business or any facility or property owned,leased or otherwise used by the Company, and including anyenvironmental contamination conditions and any known orpotential violations or non-compliance with applicable laws,rules, regulations or Permits.

[ ] (l) List, and brief description of status, of spills, leaks, or otherunauthorized discharges of hazardous materials/wastesoccurring in connection with the Company’s business or atany property or facility when owned, leased or otherwise usedby the Company.

[ ] (m) List, and brief description of status, of all pending or threat-ened criminal, civil, regulatory, judicial or administrativeactions or proceedings relating to the environment, hazard-ous materials/wastes, or worker health and safety matters.

[ ] (n) Any reports, summaries or evaluations regarding mattersrelated to worker health and safety, the environment or haz-ardous materials/wastes, including assessments or audits,whether internal or external, and any sampling results fromany hazardous materials/wastes, soil, air or water related tothe Company’s business or any facilities or property owned,leased or otherwise used by the Company

[ ] (o) List, with brief description of status, any environmental inves-tigation or remediation which the Company or another party isconducting, has completed, or which may be required (ifknown) in connection with the Company’s business, or anyfacility or property owned, leased or otherwise used by theCompany.

[ ] (p) List, with brief description of status, any modification, removal,repair, closure or installation of equipment or improvements,including equipment or improvements related to hazardousmaterials/wastes, which the Company or another party isconducting or which may be required (if known) in connectionwith the Company’s business, or any facility or propertyowned, leased or otherwise used by the Company.

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16. TECHNOLOGY AND PROPRIETARY RIGHTS

[ ] (a) List and copies of all patents and applications pending, held orbeing prosecuted by the Company in the United States orelsewhere, with descriptive titles, numbers, jurisdiction, andcopies of all correspondence to or from examining authoritiesor other parties regarding such patents and patentapplications.

[ ] (b) List of all copyright registrations and applications related to allintellectual property and intellectual property rights used inconnection with the Company’s business or necessary for itsbusiness as presently conducted and as currently proposed tobe conducted (collectively, “Technology”) pending, held orbeing registered by the Company in the United States orelsewhere, with descriptive titles, numbers, and jurisdiction.

[ ] (c) List of all trademarks, registered or unregistered, used inconnection with the Technology, whether or not owned byor licensed to the Company, with a description of products orservices associated therewith, and numbers, jurisdiction, sta-tus of any registration applications pending, if any.

[ ] (d) List of all categories of Technology (whether or not patented orpatentable), together with a brief description of how each suchTechnology was developed or acquired.

[ ] (e) List and copies of all license agreements and sublicenseagreements related to the Technology pursuant to whichthe Company licenses any technology or intellectual propertyrights to or from third parties, including model or standardsales or license agreements (including shrink-wrap or click-wrap licenses).

[ ] (f) List and copies of all agreements related to the Technologypursuant to which the Company has assigned any technologyor intellectual property rights to, or obtained any technology orintellectual property rights from, third parties, including withoutlimitation intellectual property assets transferred into the Com-pany at or in connection with its formation or spinoff. Alsoinclude a description of all interests, whether direct or indirect,whether through ownership or otherwise, of any founder, offi-cer, director, former officer or former director in the technologyand/or intellectual property relevant to the Company, and

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copies of Company’s standard form of agreements withfounders, directors, officers and advisory board members,if applicable.

[ ] (g) List and copies of all agreements pursuant to which theTechnology are distributed or marketed by third parties,including without limitation all sales representative, referral,reseller, value-added reseller, original equipment manufac-turer and all other distribution agreements.

[ ] (h) List and copies of all joint ownership, research and develop-ment agreements which relate to the Technology and towhich the Company is a party, including for each such rela-tionship a description of the ownership and rights to anydeveloped technology, and any payment or financial obliga-tion with respect to such developed technology.

[ ] (i) List and copies of all agreements pursuant to which productsor components related to the Technology are manufacturedor assembled by, or pursuant to which the Company acquiresproducts or components for products from, third parties.

[ ] (j) List of engineers and other employees who have participatedin or contributed to the development of the Technology, a briefdescription of their roles, and copies of their resumes or otherevidence of previous job history.

[ ] (k) List of all non-employees (individuals and entities) who par-ticipated in any Technology development for the Company,including information concerning each project, the amountand type of services performed and whether each suchperson has executed an assignment of rights in intellectualproperty to the Company.

[ ] (l) Copies of the Company’s standard form of agreements withemployees and independent contractors regarding inven-tions, and a list of all employees and all independent con-tractors who have executed the agreements, and a list of allemployees and all independent contractors who have notexecuted the agreements.

[ ] (m) Copies of confidentiality, non disclosure, and assignment ofinvention agreements, between the Company and employ-ees, and between the Company and independent contrac-tors, the contents of which differ from those set forth in the

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standard form, including a description of any work or inven-tions excluded from such agreements.

[ ] (n) Copies of the Company’s standard form of confidentiality andnon disclosure agreements, between the Company and per-sons or organizations other than employees and independentcontractors, and a list of persons or organizations who haveexecuted the agreements.

[ ] (o) Copies of confidentiality and non disclosure agreements,between the Company and persons or organizations otherthan employees and independent contractors, the contents ofwhich differ from those set forth in the standard form.

[ ] (p) All documents, correspondence, memos, and other papersrelating to the Company’s written policies on intellectual prop-erty, including trade secrets and proprietary information.

[ ] (q) Copies of all security agreements pursuant to which a lenderor creditor has taken a security interest in specific intellectualproperty assets or “general intangibles” which relate to theTechnology.

[ ] (r) Uniform commercial code filings, or other state and federalfilings, that relate in any way to the Technology.

[ ] (s) Law firm(s) handling patent, trademark, copyright and otherintellectual property matters for the Company, and any sub-sidiary, and contact person name, address and phonenumber.

[ ] (t) All documents, correspondence, memos, notes, and otherpapers relating to any Technology development by the Com-pany that involves the derivation or use of specifications ortechnical information derived from the products of third parties.

[ ] (u) Listing of all open source software applications, programs,packages, or libraries that have been used by Company todevelop any of the Technology, or that have been incorpo-rated into the Technology, along with a copy of the accom-panying license for such open source applications.

[ ] (v) All documents, correspondence, memos, notes, and otherpapers analyzing or assessing the validity or scope of any ofthe Company’s copyrights, patents, or trademarks whichrelate to the Technology.

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[ ] (w) Description of any development projects relevant to the Tech-nology currently underway, including scope, personnelinvolved in the development and status.

[ ] (x) Description of all Company trade secrets and related know-how necessary or useful to conduct the business of theCompany and/or to utilize the Technology.

[ ] (y) List and copies of all other information, documents and agree-ments relating to the Technology not covered by this list butwhich would, in the Company’s judgment, be material toevaluation of the Technology by prospective buyers thereof.

PLEASE NOTE: If the Company uses a standard format for any of thesetypes of agreements, please provide only a single copy of that formatand any negotiated versions with material deviations from that format.

17. DEFENSE AND PROSECUTION OF INTELLECTUAL PROP-ERTY CLAIMS

[ ] (a) All documents, correspondence, pleadings, memos, notes,and other papers relating to any pending or threatened intel-lectual property litigation or claim against the Company con-cerning the Technology, or any other assertion, suggestion, orinquiry by a third party that the Company and/or the Tech-nology is infringing its intellectual property rights.

[ ] (b) All documents, correspondence, pleadings, memos, notes,and other papers applicable to any dispute or litigation withany third party (including without limitation customers,employees, suppliers and competitors) relating to ownership,use or commercialization of the Technology.

[ ] (c) Materials referred to during the process of developing anyTechnology that is the subject of any pending or threatenedlitigation, claim, assertion, suggestion, or inquiry.

18. EXPORT MATTERS

[ ] (a) Copies of correspondence with, submissions to, or docu-ments received from the Bureau of Industry and Security(formerly Bureau of Export Administration), Office of DefenseTrade Controls, or Office of Foreign Assets Control, includingbut not limited to any requests for advisory opinions, com-modity jurisdiction requests, commodity classification

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requests, applications for export licenses and responsesthereto (including notices of intent to deny, return withoutaction notices, and denials), export licenses, “is informed”letters, reports filed pursuant to the Export AdministrationRegulations or an export license, requests for documentsor other information, voluntary disclosures, pre-charging let-ters, charging letters, warning letters, and documents reflect-ing settlement of alleged export control violations.

[ ] (b) Copies of correspondence with or submissions to the Depart-ment of Justice, Federal Bureau of Investigation, or any othergovernment agency related to any export or domestic releaseof any technology or software.

[ ] (c) List or product matrix identifying the Export Commodity Clas-sification Number (ECCN) or U.S. Munitions List classificationthat applies to each of the items produced or sold by theCompany internationally. Separately identify any items thatcontain or utilize cryptographic functionality (encryption).

[ ] (d) List of the license authority used to export each item exportedby the Company, with copies of any required supportingdocumentation (e.g., letters of assurance to support use ofLicense Exception TSR).

[ ] (e) List of the countries to which Company exports or hasexported any items.

[ ] (f) List identifying Company products, technology, or servicesthat are: (i) on the United States Munitions List; (ii) havesubstantial military applicability; or, (iii) are specially designedor modified for military purposes, regardless of whether suchitems are exported. Please indicate whether the Companyhas registered with the Office of Defense Trade Controls.

[ ] (g) List of foreign national employees (and their countries ofnationality) whose job responsibilities include or requireaccess to technical information or software related to thedesign, development or production or use of the Company’sproducts. For the purposes of this request, a foreign nationalemployee is any employee who is not a U.S. citizen, a lawfulpermanent resident alien, an asylee or a refugee.

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19. SEC AND NASDAQ [NYSE] FILINGS AND RELATED MATERIALS

[ ] (a) All reports and other documents filed with the SEC (e.g., 10Ks, 10 Qs, proxy statements, registration statements, pro-spectuses, etc.) within the last [three] fiscal years and anyinterim period, all exhibits and schedules filed therewith orincorporated therein, other than documents that are availablevia EDGAR.

[ ] (b) Comment letters or other correspondence from the SEC, ifany, and responses thereto.

[ ] (c) Any other filings or submissions made by the Company withthe SEC within the last [three] years.

[ ] (d) Filings and submissions made with The NASDAQ Stock Mar-ket [the New York Stock Exchange] and any correspondencewith The NASDAQ Stock Market [the New York StockExchange] within the last [three] years.

20. PUBLIC FINANCIAL REPORTING

[ ] (a) Reports or “management letters” received by the Companyfrom independent accountants or consultants during the pastfive years relating to accounting or tax policies or financialcontrol procedures of the Company and any managementresponses thereto.

[ ] (b) Any written documentation of internal control over financialreporting and disclosure controls and procedures, as suchterms are defined in the rules of the SEC.

[ ] (c) Any written documentation of management’s assessment ofthe effectiveness of the Company’s internal control over finan-cial reporting; a description of any material changes that haveoccurred since the end of the last period covered in theCompany’s periodic reports filed with the SEC or are expectedto occur in the future.

[ ] (d) Any written correspondence between the Company’s auditcommittee and its management, auditors, outside counsel ordisclosure committee during the past three fiscal years andany subsequent period; any disclosures to audit committeesince that date of (a) significant deficiencies or material weak-nesses in internal control over financial reporting and (b) fraud

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involving management or other employees with significantrole in internal control over financial reporting.

[ ] (e) Any minutes or similar documentation of the activities of theCompany’s disclosure committee, if any, during the past threefiscal years and any subsequent period.

[ ] (f) Any report prepared by independent auditors pursuant toSection 204 of the Sarbanes-Oxley Act.

[ ] (g) A description of any reports made pursuant to Section 307 ofthe Sarbanes-Oxley Act or the Company’s whistleblowingpolicy, and the Company’s response to such reports.

[ ] (h) If the Company restated its financial statements in the last fivefiscal years or in any subsequent period, furnish a descriptionof the relevant facts pertaining thereto.

21. SEC FILINGS

[ ] (a) All reports and other documents filed with the Securities andExchange Commission (e.g., 10-K’s, 10-Q’s, proxy state-ments, registration statements, prospectuses, etc.) withinthe last two years, all exhibits and schedules filed therewithor incorporated therein and all correspondence from the SECwith respect thereto, to the extent not available in completeform through EDGAR.

[ ] (b) Copies of all reports or communications to security holdersduring the last two years.

22. GENERAL

[ ] (a) List and description of all actual or potential conflicts of inter-ests that the Company’s directors, officers or employees haveor may have due to their relationship with any competitor ofthe Company, any supplier of goods or services to the Com-pany, any distributor of the Company, any customer of theCompany or any other person or entity which has any interest,financial or otherwise, in the Company.

[ ] (b) List and description of all transactions between the Companyand any stockholder, director, officer, employee or affiliate ofthe Company (or any entity or person formerly having the

A-38


status thereof, including amounts and names of partiesinvolved) during the past three years.

[ ] (c) Description of all current or proposed loans to officers ordirectors or other arrangements covered by Section 402 ofthe Sarbanes-Oxley Act (including those that to which anexemption may apply).

[ ] (d) Any director and officer questionnaires submitted within thepast five fiscal years.

[ ] (e) Copies of all director and officer liability insurance policies.

[ ] (f) List and description of all material insurance claims submittedby the Company in the past two years.

[ ] (g) All press releases issued during the last 12 months withrespect to the Company or its business (if not available onthe Company’s website).

[ ] (h) Copies of the Company’s principal business plans for the lastthree years.

[ ] (i) All legal opinions received by the Company during the last twoyears.

[ ] (j) List of parties, if any, whose consent to this transaction will berequired and copies of relevant documents.

[ ] (k) All documents and information not covered by other items onthis list disclosing material information concerning theCompany.

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Annex 11

Certain HSR Exempt TransactionsFollowing is a discussion of certain types of transactions that are

generally exempt from the HSR filing requirements. Antitrust Counselshould be consulted when determining whether a particular exemptionmay be applicable.

• Acquisitions of Goods and Realty in the Ordinary Course ofBusiness

Acquisitions of goods and realty in the ordinary course of business aregenerally exempt from the HSR Act. Sales of new goods are generallyconsidered to be “in the ordinary course of business,” as are sales of certaincurrent supplies and certain used durable goods.

• Acquisitions Solely for the Purpose of Investment

The HSR Act and rules exempt certain acquisitions made by theacquiring person “solely for the purpose of investment.” The existence ofthe requisite intent under this exemption is a fact-intensive inquiry basedupon the circumstances of each case.

• Acquisitions of Certain Real Property Assets

The HSR rules generally exempt acquisitions of “new facilities,” usedfacilities acquired by lessees from lessors under certain conditions, “unpro-ductive” real property, office and residential property, hotels and motels(except ski facilities), certain “recreational land,” certain “agricultural prop-erty,” and retail rental space and warehouses (except in connection with theacquisition of a business to be conducted on the property).

• Acquisitions of Foreign Assets or of Voting Securities of aForeign Issuer

An acquisition by a U.S. person of assets located outside of the UnitedStates is exempt from the HSR Act unless the assets generated sales “in orinto the United States” in excess of $56.7 million (as adjusted) in the mostrecent year.

Similarly, an acquisition by a U.S. person of the voting securities of aforeign issuer is exempt from the HSR Act unless the foreign issuer hadsales in or into the United States in excess of $56.7 million (as adjusted) inthe most recent year. Whether sales in a particular case should be deemed“in or into the United States” depends upon the particular circumstances ofthat case.

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• Acquisitions of Voting Securities of, or Non-corporate Interestsin, Entities Holding Assets the Acquisition of which Is Exempt

The HSR rules generally exempt an acquisition of voting securities ofan issuer, or an acquisition of non-corporate interests in an entity, when thatissuer or entity, together with all entities that it controls, holds assets theacquisition of which is exempt.

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DLA PIPERDLA Piper is a global legal services organization, the members of

which are separate and distinct legal entities, with offices across Europe,Asia, the Middle East and United States. Over 3,400 lawyers across64 offices and 25 countries provide a broad range of legal services throughthe firm’s global practice groups. The firm is relationship driven and built tomeet the ongoing legal needs of its clients, wherever they choose to dobusiness.

www.dlapiper.com

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Bratislava, Slovak RepublicT: +421 2 5920 2123F: +421 2 5443 4585

Cape Town, South AfricaT: +27 (0) 21 481-6300F: +27 (0) 21 481-6388

Johannesburg (Sandton), South AfricaT: +27 (0)11 290-7000F: +27 (0)11 290-7300

Madrid, SpainT: +34 91 319 12 12F: +34 91 319 19 40

Stockholm, SwedenT: +46 8 701 78 00F: +46 8 701 78 99

Bangkok, ThailandT: +66 2 686 8500F: +66 2 670 0131

Dubai, UAET: +971 4 363 6900F: +971 4 363 6901

Kyiv, UkraineT: +380 (44) 490 95 75F: +380 (44) 490 95 77

Birmingham, United KingdomT: +44 (0) 8700 111 111F: +44 (0) 121 262 5794

Edinburgh, United KingdomT: +44 (0) 8700 111 111F: +44 (0) 131 242 5555

Glasgow, United KingdomT: +44 (0) 8700 111 111F: +44 (0) 141 204 1902

Leeds, United KingdomT: +44 (0) 8700 111 111F: +44 (0) 113 369 2949

Liverpool, United KingdomT: +44 (0) 8700 111 111F: +44 (0) 151 236 9208

London, United KingdomT: +44 (0) 8700 111 111F: +44 (0) 20 7796 6666

Manchester, United KingdomT: +44 (0) 8700 111 111F: +44 (0) 161 235 4111

Sheffield, United KingdomT: +44 (0) 8700 111 111F: +44 (0) 114 270 0568

Atlanta, United StatesT: (404) 736-7800F: (404) 682-7800

Austin, United StatesT: (512) 457-7000F: (512) 457-7001

Baltimore (Downtown), United StatesT: (410) 580-3000F: (410) 580-3665

Baltimore (Mount Washington),United StatesT: (410) 580-3000F: (410) 580-3001

Boston, United StatesT: (617) 406-6000F: (617) 406-6100

Chicago, United StatesT: (312) 368-4000F: (312) 236-7516

Dallas, United StatesT: (214) 743-4500F: (214) 743-4545

East Brunswick, United StatesT: (732) 590-1850F: (732) 590-1860

Easton, United StatesT: (410) 820-4460F: (410) 820-4463

La Jolla, United StatesT: (858) 638-6806F: (858) 456-3075

Las Vegas, United StatesT: (702) 737-3433F: (702) 737-1612

Los Angeles (Century City), United StatesT: (310) 595-3000F: (310) 595-3300

Los Angeles (Downtown), United StatesT: (213) 330-7700F: (213) 330-7701

Minneapolis, United StatesT: (612) 524-3000F: (612) 524-3001

New York, United StatesT: (212) 335-4500F: (212) 335-4501

Northern Virginia, United StatesT: (703) 773-4000F: (703) 773-5000

Philadelphia, United StatesT: (215) 656-3300F: (215) 656-3301

Phoenix, United StatesT: (480) 606-5100F: (480) 606-5101

Raleigh, United StatesT: (919) 786-2000F: (919) 786-2200

Sacramento, United StatesT: (916) 930-3200F: (916) 930-3201

San Diego (Downtown), United StatesT: (619) 699-2700F: (619) 699-2701

San Diego (Golden Triangle), United StatesT: (858) 677-1400F: (858) 677-1401

San Francisco, United StatesT: (415) 836-2500F: (415) 836-2501

Seattle, United StatesT: (206) 839-4800F: (206) 839-4801

Silicon Valley, United StatesT: (650) 833-2000F: (650) 833-2001

Tampa, United StatesT: (813) 229-2111F: (813) 229-1447

Washington, D.C., United StatesT: (202) 861-3900F: (202) 223-2085

Lusaka, ZambiaT: +260 1 236319F: +260 1 236478

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Austinph: 512-514-6092

Bostonph: 617-542-1926

Buenos Airesph: +54-1-14-815-2231

Calgaryph: 403-221-9400

Carsonph: 310-608-6200

Century Cityph: 310-282-8800

Charlotteph: 704-339-0000

Chicagoph: 312-707-9790

Clevelandph: 216-621-8384

Columbusph: 614-221-8384

Dallasph: 214-651-1001

Denverph: 303-296-6677

Detroitph: 313-964-1330

Frankfurt am Mainph: +49-69-97-14-760

Hong Kongph: 852-2526-0688

Houstonph: 713-869-9181

Indianapolisph: 317-977-2910

Irvineph: 949-476-0505

Londonph: +44 (0)20-7551-5000

Los Angelesph: 213-627-2200

Luxembourgph: +352-47-17-55

Mexico Cityph: +52-55-5255-0052

Miamiph: 305-371-3900

Milanph: +39-02-76-36-21

Milwaukeeph: 414-278-1170

Minneapolisph: 612-330-0900

Montréalph: 514-395-1850

Nashvilleph: 615-251-5400

New Orleansph: 504-525-4367

New Yorkph: 212-924-5500

Palo Altoph: 650-858-1800

Parisph: +33-1-43-16-51-40

Philadelphiaph: 215-557-1870

Phoenixph: 602-223-4455

Pittsburghph: 412-281-3838

Rio de Janeiroph: +55-21-2103-0500

San Antonioph: 800-527-4107

San Diegoph: 858-623-9200

San Franciscoph: 415-362-2300

Seattleph: 206-223-0725

Secaucusph: 201-271-1000

Seoulph: +82-2-761-9506

Singaporeph: +65-6536-6288

South Bendph: 574-251-4000

St. Louisph: 314-621-7400

Tampaph: 813-222-8600

Tokyoph: +81-3-5283-3300

Torontoph: 416-383-4545

Vancouverph: 604-685-8545

Washington D.C.ph: 202-783-9191

WWW.SECURITIESCONNECT.COMSecuritiesConnect™

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THE MERGERS & ACQUISITIONS HANDBOOKA Practical Guide to Negotiated TransactionsFirst Edition

DIANE HOLT FRANKLE STEPHEN A. LANDSMAN JEFFREY J. GREENE

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