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Asset Purchase Agreement terms (more)…

By February 12, 2011January 19th, 2022Buying a Practice, Selling A Practice

This is the fourth in a series of blog posts about purchasing or selling dental assets. In my first blog, I talked briefly about the letter of intent that parties to these agreements usually enter into prior to negotiating an asset purchase agreement. In my second blog, I talked about some of the things to keep in mind when negotiating an asset purchase agreement – such as risks, due diligence, and negotiating. In my last blog, I’ll discuss some of the terms you would find in a general asset purchase agreement – such as introductory clause, background, definitions, assets, purchase price, representations and warranties, etc. In this blog, I’ll be addressing three big issues that come up in every asset purchase agreement: the covenants, indemnification, closing conditions, and closing.

Covenants

Covenants are promises that parties give in the asset purchase agreement. They have certain purposes. But at the end of the day, for the transaction to close, the parties must give these promises. For example, typical covenants that parties give include:

  • keeping the deal (existence and content) confidential;
  • delivering closing documents (e.g. list of assets being purchased, financial statements, etc.);
  • continuing the business during the period from when the agreement of purchase and sale is signed to the closing period;
  • not making material changes to the business (e.g. not selling the assets that are going to be purchased!);
  • get consents/authorizations from third parties (e.g. landlord, government, licensors, etc.); and
  • not soliciting or entertaining solicitations from other parties (this is the exclusivity provision we discussed before in the context of the letter of intent).

When you’re dealing with a share purchase agreement, the covenants will be different in nature because the entire business – and not just the assets of the business – are being purchased. So the covenants would normally be related to the seller, the seller’s shares, the seller’s company, and the business of the company.

Indemnification

What if it turns out that a party violates a representation, warranty, or covenant? What if the assets purchased were never owned by the vendor but were being licensed instead (which means that the vendor couldn’t legally sell it since it didn’t own it)? What if some of the assets to be purchased were sold by the purchaser immediately before the deal closed, but this wasn’t discovered until later? Well, in these situations, in order to mitigate the risk, the parties will want to have an indemnification from the other party. An indemnification is more or less a promise to pay the other party for certain things in case it does something wrong. Here, something wrong means a violation of a representation, warranty, or covenant. Generally, the vendor will be liable for things that occur pre-closing, and the purchaser will be liable for things that occur post-closing. Generally, it’s the purchaser who will be on the losing end of things because it gets into a situation for which it was not ready (e.g. a problem with the state of the assets, the ownership of the assets, etc.). It may be a strategy for the purchaser to withhold some of the purchase price in escrow until a certain event has taken place or time has passed. This will help mitigate the amount of damage that the purchaser will be subject to in case of a breach by the vendor.

Now, it’s a good thing to keep in mind that, as you’re negotiating indemnification provisions, there are a number of factors that can impact the strength of the indemnification. For example, will the representations and warranties be limited in time (so that an indemnification claim cannot be brought for a breach of those things after the time has passed)? Also, will there be the minimum amount of damage necessary for an indemnification claim to be brought? Finally, will there be a maximum amount of liability imposed on a party in the event that an indemnification claim is actually brought? These are all good things to think about when you’re negotiating the indemnification provision.

Conditions of Closing

Now, in order for the asset purchase transaction to close on time, there are a number of conditions that need to be met. These essentially relate to the representations, warranties, and covenants that the parties gave. For example, third-party consent will be needed. Closing documents will need to have been provided. There shouldn’t have been any breach of a covenant (e.g. the assets being purchased were SOLD by the vendor). If these conditions aren’t met at the time of closing, then the deal can’t close! It will either have to be delayed (upon mutual agreement) or the parties will walk away.

Closing

Closing happens at a very specific time on a very specific date. That time and date can surely be changed. But in effect, it’s the time that the transaction occurs. Now, there are generally two types of ways in which the closing is realized. First, everything gets done in one day. There is no interim period from the time the asset purchase agreement is signed to the time of closing. It’s all happening on the same day. So on that day, ALL of the agreements and documents are entered into and delivered, the purchase price is paid, and the purchaser takes possession of the assets. This is referred to as “Same Day Closing“.

Now, not everything is capable of happening all in one shot. There may be delays and time needed to get third-party consents, run certain checks against the vendor and the assets being sold, and review documentation. So what happens is that the parties will sign an asset purchase agreement that contemplates everything closing on a specific date (or as the parties may otherwise agree in writing, for example). After signing, but before closing, the parties will run around and do their diligence, get third-party consents, prepare all of the paperwork, etc. Then, on closing, the parties will meet up, exchange closing documents, and the purchase price will be paid by the purchaser in exchange for taking possession of the assets.

DMC