Friday, 4 December 2015

SPA Series Part 10: Negotiating M&A Deals in Finland - Conditions Precedent, Merger Control and Miscellaneous

So next in our blog we move forward to conditions precedent (or CP clauses as these are called). The substance of these CP clauses consists of the items that need to be satisfied before the deal is actually done and transaction completed. When these conditions precedent are completed, then you can have a closing and finally after all closing formalities, and of course champagne, title to the shares passes from the seller to the purchaser. We will in our next blog talk about an issue whether to have a simultaneous or separate signing and closing so we do not go there yet, but save that fascinating topic for later date. The main concern for the seller is in CP terms is that if these are too flexible, these give to a buyer a way out of the deal or exit so to speak without incurring any liability so one needs to be careful. But do you know what are the typical conditions precedent that seller or buyer should require?

As to the seller I would say that at the minimum there should be reference to approvals by the Competition Authorities, or a waiver that merger clearance is not needed. This could be expanded to cover other licenses and regulatory approvals, as well as violations of laws, judicial orders or similar.

Regarding merger control I think it is also worth explaining how this Finnish system works. So the applicable law in Finland is the Competition Act (No. 948/2011) (the Competition Act), which entered into force on 1 November 2011, which mainly harmonize the Competition Act with EU rules. The meaning of the merger control is to protect the effective competition in the Finnish market and control particularly such concentrations which results in creation or strengthening of a dominant position. The procedure in merger control matters is that the Finnish Competition and Consumer Authority (FCCA) investigates a concentration in the first stage and either clears it or submits a request to the Market Court to prohibit it. Clearing of the concentration may be subject to conditions. This is an area were we have lots of interesting clauses like “hell or high water” or similar and perhaps I write on these separately at some point. The Market Court shall investigate the case on the basis of FCCA’s request and it has also an authority to review appeals made from FCCA’s decisions. The decisions made by the Market Court can be further appealed to the Supreme Administrative Court. FCCA’s investigation right depends on the turnover threshold set in the Competition Act. Parties are obligated to make concentration notification if the combined aggregate worldwide turnover of the parties exceeds €350 million and the aggregate turnover in Finland of each of at least two of the parties exceeds €20 million. Parties must file the notification prior to the implementation of the concentration. Filing of the notification is made free of charge but sanctions are possible if the transaction is closed before clearance of concentration. The fine which can be up to 10 percent of the total turnover of the relevant undertakings will be imposed by the Market Court on the basis of FCCA’s request.

Another typical condition precedent for the seller is that there shall have occurred no breach of the buyer’s undertakings. There could be a discussion whether this breach should be material or not or whether this breach is incapable of being remedied. Finally, financing for the Purchaser and all corporate authorizations and resolutions to be secured and reviewed before the signing of the Agreement could be one to be require as well.

In case of the Buyer these conditions precedent typically arise from due diligence investigation and these might cover wide variety of situations so this list is not in any way exhaustive. The same as mentioned above for the Seller apply here as well, but in addition, there could be for example:

  • Approvals from third parties are satisfactorily acquired which could include whatever approvals there are from the transfer of governmental licenses to change of control - approvals in material agreements;
  • The representations and warranties of the Seller herein contained having been true and correct as of this date and continuously until the closing;
  • The related agreements have been signed (e.g., transition services, distributions or delivery agreements or similar) 
  • There could be classical MAC –clause (so no “Material Adverse Change” having taken place between signing and closing, as naturally if there were material adverse change the buyer might want to walk away);
  • Key employees could be required to sign new agreements, lock-in agreements or similar;
  • The Company has not received, e.g., claims or terminations relating to most important agreements typically referred to as “Material Agreements”; and
  • Many others depending on the situation.

In IP-intensive deals there is often a need to fulfill some loopholes like require assignments IP rights to the company retrospectively from the owners, employees or partners. I have a good example on the last one when we advised one venture capital investor in the Finnish game-sector company some time ago. There was a situation that most parts of the software engine that was running target company’s online game were coded by the founders of the company prior to the time the company was incorporated. Here we did not find a single document that would have granted the company any right to use such code not to mention a document in which copyright and all intellectual property rights should be assigned to the company. Gladly they were able to secure retrospective assignments as conditions precedents and the deal went forward. Finally, while these are conditions precedent, these are still something that the buyer should be allowed to waive these rights if they wish to proceed.

Hopefully this helps someone and I wish all of you very pleasant weekend!



Friday, 20 November 2015

Greetings from Housewarming Parties of TRUST!

Dear All,

This time I thought that I share something completely different and I go back in time to last week's Thursday when we had TRUST's first housewarming parties. I was so impressed to see so many of you there. Here are these few lines from my speech in which I also tell a bit about us to those of you who do not know us yet and for those who participated I hope it brings to your mind good memories.

"Hei, olen Jan Lindberg ja haluan toivottaa kaikki ystävämme sekä muut rakkaat ihmiset lämpimästi tervetulleiksi asianajotoimisto TRUSTin tupareihin.

Meillä on mahtava ilta tulossa. Teitä onkin jo viihdyttänyt DJ Hammeri ja myöhemmin illasta esiintyy myös Anssi Kela, joista molemmat ovat ainakin luvanneet esittää juuri tähän tupaantulijaistilaisuuteemme sopivaa musiikkia. Lisäksi paikalla on oma kvintettimme eli viisikkomme, jonka esittelen hieman myöhemmin.

As we also have some non-Finnish-speaking friends here, I shall continue in English.
As some you might know, the history of trust goes all the way back to the misty and dark Harry Potter like surroundings of Oxford University some 13 years ago, where we studied with Mika, and thought for the first time that it would be great to create something of our own. As is well visible also here today, we have wanted to keep the Oxford theme visible in Trust’s brand and image as well, since it reminds us of our roots and academic vibe as well as represents our passion for solving complex problems.

After many steps and a few side-steps we ended up with the current set-up, and I belive at this stage it is a good time to introduce our team. So I let this handsome young stallion next to me introduce himself but here somewhere is Kiira, Jenni and the backbone of our office Maija.

We have many reasons to celebrate today. More precisely, not only do we celebrate our ”almost three year birthday” and new premises here at Forum, but we also want to celebrate your enormous support to us, and thank you as we would not be where we are today without your encouragement and recommendations.

Our road will continue and it definitely looks promising. An example of this a recently received piece of news, that we have been exclusively selected in one respected publication as the M&A law firm of the year in Finland, but more information on this will follow early next year. Now I hope to you all not only excellent but also magical evening!"

This was not part of the speech, but I want to use this opportunity to thank SKM Photo for great pictures, Marja Oinonen for all help -  tip for all those in need of a top notch project leader and marketing professional Marja is looking for new opportunities at the moment, DJ Hammeri - awesome beats and sounds, Alexandra Finckenberg-Widner of Cakehouse for excellent catering, Luiano for wines, Nina and other good people at Business Meeting Park - for all support and help, as well as our top star of the evening Anssi Kela - you rock!

Best wishes and finally thank you for those who celebrated with us,


Friday, 30 October 2015

SPA Series Part 9: How to Negotiate M&A Deals in Finland - Escrow Arrangements, Set-Off and Other Similar Tricks

It is once again time to continue our blog posts, and this time we have chosen a topic that surely interests most of those involved in M&A deals, namely escrow arrangements.

As many of you know, escrow agreements aim to secure buyer's right to monetary compensation in case of claims and to provide protection for the due fulfilment of the seller's post-closing obligations. Typically, this protection is needed after the seller has already received his or her compensation, as without an escrow or similar arrangement the seller could comfortably lay back and say "if they (the buyer) want their money, let them sue me, and let the buyer work for his or her money”. 

Before going into more detail on escrow agreements, let us take a bit wider view on the matter and see what possibilities a buyer has in this regard already in the SPA that does not refer to an escrow arrangement. In any case this issue has been discussed in all our deals at TRUST and included in one form or another in the documentation.

As it often happens in real life, the buyer might predict already in the negotiation phase that there could be problems in the future requiring him or her to present a claim for monetary compensation to the seller. Here the question naturally is: how could the buyer consider these? 

Obviously, one possibility is that the parties agree on some deferred payments on top of the initial cash component, where the initial cash component would be payable upon closing and the deferred payments later on, in which case the buyer would merely set-off his or her claims against such deferred payment. However, as is well known, set-off is not always available as it requires, among others, mutual claims and that both amounts (the payment of the purchase price and claim) have fallen due, which is not always the case. For instance, there might be a situation where a part of the deferred payments should be paid within the near future but at the same time the buyer sees that there are several potential claims resulting in liability for the seller, which are not yet due. To avoid the problem, it might be advisable for a prudent lawyer representing the buyer to try to expand the scope of set-off a bit in the SPA, e.g., as follows: 

"If at the time any deferred cash price or earn-out purchase price is or will be due to be paid to any of the sellers, any claim or receivable by the buyer against any of the sellers under this agreement (such claim a "Counter-Claim") may be set off by the buyer or withheld by the buyer until the Counter-Claim becomes due and payable in respect of such Counter-Claim. The sellers hereby waive all their rights to receive such deferred cash price or earn out purchase price up to the amount of the withheld amount (until settled) and, in case of set-off, up to the actual set-off amount. Any withheld sum under this Section shall not carry interest..."

Here, the buyer expands the scope of set-off by adding a right to withhold, enabling the buyer to wait until the preconditions for the set-off are present.

As regards traditional escrow arrangements, where a portion of the purchase price is delivered to a third party stakeholder, it usually comes down to the question of what would be the correct amount transferred to an escrow amount. Typically, the buyer, in whose interest the arrangement is usually made in the first place, wishes to have an as large an amount as possible in the escrow and for as long time as possible, while the view of the seller is quite the opposite.

Unfortunately, it is however often the case that there is no guidelines for determining the amount, unless there are elements in the case that support a certain level, such as identified risks and their possible monetary outcome if realized. In the absence of such specifics, one could always use figures that reflect the market practice, if available. As regards the term of the escrow, one could present a few general rules that are often accepted: 1) it is never longer than indemnification period; and 2)  one seldom sees periods significantly less than one year. Finally, an additional point to consider is whether the escrow amount covers all claims or only the representations and warranties in the SPA, but that is another matter subject to negotiations, and depends on the position and power of the parties in the negotiations.

To provide some guidance, let us briefly summarize the structure and content of a typical escrow agreement. 

Firstly, the background section could be, for example, as follows:

"The parties entered into a share purchase agreement on _________2015 (the "SPA") by which the seller has agreed to sell and the buyer has agreed to purchase shares in _______________.
Pursuant to the SPA it has been agreed that the escrow amount (USD 15,000,000) will be paid at closing into the escrow account with the escrow agent.

The escrow amount shall be held as collateral for partial satisfaction of the seller's obligations and potential claims against the seller and it shall be paid out by the escrow agent in accordance with the terms of this escrow agreement and the SPA.

This escrow agreement sets forth the terms on which the escrow agent will hold and administer the funds to be held in escrow pursuant to the SPA."

After background or the "WHEREAS" clauses, the agreement usually states that an interest-bearing escrow account shall be opened. Here one should pay attention to the fact that recently the applicable interest rates have been negative, and there have been interesting discussions whether one should actually pay something to banks, but typically banks have waived these negative interests. Who is entitled to interest is also of course relevant. A point which is evidently in the sellers interest as without the escrow, the money would "work for them", but also something that the buyer's typically do not present automatically in their first drafts. 

The technical release of the escrow funds is typically determined on the basis of the separate escrow agreement. In this regard, it is worth noting that it is definitely in the buyer's interest that the funds are released only upon joint instruction by both parties, thereby excluding the possibility of the funds being released automatically, e.g., on the basis of a certain time period having lapsed (regardless of, e.g., pending claims). However, there seems to be a trend that in any case banks are more and more reluctant to accept automatic releases and nowadays mutual release is often required. There might be variations between the banks, but this has been our experience from the past deals and this development naturally negatively affects the Sellers. 

When determining the time for releasing the escrow funds, it is typically in the buyer's interest to accept the release only after the audited annual accounts following closing have been prepared, and the time limits for presenting claims have lapsed (we will return to these time limits in our future postings, so we encourage you to stay tuned!).
In order to provide additional protection, the escrow account may also be subject to a pledge. A pledge may be recommended e.g. in in distressed deals where there might be financial difficulties lurking behind the corner, and a pledge would secure the release. Also, especially if mutual release applies, a pledge in the escrow account (tilipantti in Finnish) might prove to be handy depending naturally under what conditions such pledge may be realized.

To give you some more practical tips, the beginning of the pledge section might look, for example, like this:

"Effective as of the date of the closing, the seller as a continuing security for any claims and indemnities under the SPA hereby unconditionally and irrevocably pledges to the purchaser, as a first ranking security, all of its rights and interests in the escrow account, including the escrow amount.
At any time upon or after the issuance of an arbitration decision or any other binding and final judgment referred to in section X to the benefit of the buyer, the buyer may to the fullest extent permitted by applicable laws enforce all of its rights hereunder as well as any other rights which a pledgee may have under applicable laws, and for this purpose dispose of the escrow account, including the escrow amount (or any part thereof), in any manner at its discretion. The pledge created hereunder and all obligations of the seller in relation thereto shall continue in full force from the date of the closing until the closing of the escrow account..."

Hopefully this gives to you a good background on the matter and helps you navigate through tricky post-closing claims you might have in your pocket.

Splendid Autumn for everybody and I hope to see as many of you as possible in our house warming party on 12th November (remember to register from here!). See you soon!



Sunday, 18 October 2015

Liability of the Board of Directors in a Company Facing Economic Difficulties

TRUST's Parties' getting Closer 12 November 2015
Splendid autumn for everyone! At Trust, everything is going well and our house-warming parties are getting closer. If you have not received an invitation, do not panic, just check all your mail bozes and if you still do not find it, send me an e-mail ( and I will send to you an invitation. We have awesome artist playing like Anssi Kela,  Italian wines and good food - you do not want to miss this! 
To our real topic, as we have been advising some Boards lately in companies facing economic difficulties, I thought that I share a few words about this governance topic from director's liability point of few if it could also help others. Naturally this topic is requires further attention to details depending on the particular case, but at least this gives to you an overview of the different options. At the same time I must say that while my M&A blog has been on hold, but we have actually written a few additional posts so I will also publish those shortly.
If a company is going through economical difficulties, it has, in practice, three options: 1) to file for restructuring 2) to file for bankruptcy or 3) to continue its business operations. If the company has lost its equity, the company must notify this to the trade register without undue delay, and the management of the company has an emphasized duty of care. Failure to file the notification has not been deemed a very significant matter in the court praxis regarding directors’ liability, but it is more important what actions the board takes, if the company is in economic difficulties and whether such actions lead to an increased debt burden or weaken the position of the creditors. Consequently, the management is under an obligation to take active measures to correct the situation or to improve the financial position of the company. If they fail to do so, they should generally file for insolvency proceedings. This is important, as continuing the business without corrective actions may lead to personal liability of the members of the Board of Directors of the company as well as that of its other management (including the CEO). Therefore, the management of a distressed company should be extremely alert in the event of loss of equity and other financial difficulties.
The purpose of this memorandum is to outline, at the general level, these possible liabilities under the Finnish law, and the different options a company not having adequate financing or capital could have, without providing an overall understanding of the matter or going too much into detail.
Liability of the Board
According to Section 23 of Chapter 20 of Limited Liability Companies Act (the “Act”), if the Board of Directors of a company notices that the company has negative equity, the Board shall at once make a register notification to the trade register on the loss of share capital. The purpose of such notification is to bring the economic situation of the company to the attention of the company’s debtors. If the Board neglects the notification, this might lead to the personal liability of the company’s Board of Directors and management under Section 1 of Chapter 22 of the Act, if a debtor or another contracting party suffering credit loss can show that it would not have given credit to the company had it known of the loss of equity. The referred Chapter stipulates the following:
“Liability of the management
(1) A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall be liable in damages for the loss that he or she, in violation of the duty of care referred to in chapter 1, section 8, has in office deliberately or negligently caused to the company.
(2) A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall likewise be liable in damages for the loss that he or she, in violation of other provisions of this Act or the Articles of Association, has in office deliberately or negligently caused to the company, a shareholder or a third party.
(3) If the loss has been caused by a violation of this Act other than a violation merely of the principles referred to in chapter 1, or if the loss has been caused by a breach of the provisions of the Articles of Association, it shall be deemed to have been caused negligently, in so far as the person liable does not prove that he or she has acted with due care. The same provision applies to loss that has been caused by an act to the benefit of a related party, as referred to in chapter 8, section 6(2).”
Furthermore, in order to prevent inappropriate and damaging business and to maintain confidence in the business, among others, a person involved in the management of a company (for example as a member of its board) may be imposed a ban on business operations under the Finnish Act on Ban on Business Operations. This requires that the person in question has essentially failed in performing his statutory obligations related to the business, or if he is found guilty of criminal procedure that cannot be considered minor. It is also required that his activities as a whole are regarded as detrimental to the creditors, contractors, public finance, or sound and effective economic competition. The ban prevents its subject from, e.g., engaging in business activities for which the Accounting Act provides for an accounting obligation, being a partner of a general partner or a limited partnership's general partner or a member of the board of a company, as well as establishing a limited liability company, or otherwise to acting in a comparable business operations position. The duration of the ban varies between 3 to 7 years.
If a company’s financial difficulties turn into permanent insolvency, then the company should file for bankruptcy. Some pressure to make the appropriate filings is created by the fact that continuing to run the business of an insolvent company may be deemed as debtor’s dishonesty under Section 1 of Chapter 39 of the Criminal Code, in relation to which the punishment varies between a fine and 2 years of imprisonment. Therefore, it is not recommended to wait that a creditor files for the bankruptcy of the debtor company – at least not for a very long time. The decision on filing for bankruptcy is made by the Board of Directors with simple majority.
Also, according to Section 12 of Chapter 4 of the Credit Data Act, which is applied to registers to which credit data companies enter credit data, which they then provide to others (usually against payment), the credit data registers are entitled to enter information regarding a person’s participation in companies, as well as these companies’ payment default situation, bankruptcy, and similar economic situations. The entry regarding bankruptcy may be in the register for a period of five years. Furthermore, as stipulated in Section 27 of Chapter 6 of the same act, this information may, subject to the fulfillment of specified requirements, be used in the credit rating of a company in which that person is involved. It is our estimation, however, that these requirements would not be fulfilled in the case at hand with the assumption that the company has been up and running for several years and its accounting has been made and filed appropriately. On another note, it is possible that this information be used also in other relations, such as when establishing a new company, or when applying for a personal loan, etc. as the information is publicly available to any interested party.
Restructuring of Enterprises
To the extent the company is in a position to be rehabilitated and it fulfills the requirements under the Restructuring of Enterprises Act, the company could, instead of bankruptcy, file for restructuring. This could be recommended if the debtor company’s business is profitable, but it has so much debt that it cannot pay them in the agreed schedule. The restructuring proceedings creates costs, and thus is not recommended if the company is for example very small.
A member of the Board of Directors of a company going through economical difficulties should pay special attention to the company making the appropriate filings an taking the necessary actions in accordance with the above and also otherwise actively act with due care in fulfilling his or her obligations as outlined above. Continuing the business without corrective actions and/or otherwise not acting as required by the law may lead to personal liability of the members of the Board of Directors of the company as well as that of its other management (including the CEO). Next we continue with M&A themes, but hopefully we meet in our parties so see you there!

Wednesday, 9 September 2015

UPC Ratification Progresses in Finland

Greetings everyone, I just thought that I share this if someone has missed this important piece of European patent law reform and advancements in Finland!

In February this year, the Ministry of Employment and Economy of Finland set up a Working Group to make preparations for the ratification of the Unified Patent Court Agreement (“UPC Agreement”). The resulting memorandum has now been published, including a draft for a Government Proposal, which covers actions to be taken for its implementation in Finland, as well as clarification as to how national legislation would need to be changed to make it compatible with the provisions of the UPC Agreement. It was proposed in the memorandum that the Parliament would ratify the Agreement. Following this, ratification is expected to take place by the end of 2015. The below quote is from the press release published by the Ministry of Employment and Economics on the matter:

“According to the proposal — provisions of the agreement that are of legislative nature shall be brought into force by an Act of the Finnish Parliament. The working group has also drafted necessary amendments to the Finnish legislation on patents, including the necessary measures for implementing the regulations governing the European patent with unitary effect. According to the proposal a new chapter would be added to the Patents Act. This chapter would include provisions on the European patent with unitary effect.”

The Agreement contains provisions on the scope and limitations to the exclusive right conferred by a patent. The relevant provisions in the Patents Act would be amended with a view on achieving uniformity with the provisions of the  Agreement. The proposal also includes amendments to procedural legislation that clarify the division of competence between national courts and the Unified Patent Court as well as the necessary amendments to legislation on enforcement and criminal sanctions.”

The proposal of the Working Group can be found from: here, worth checking out!

Tuesday, 30 June 2015

Should interim injunction decisions for utility models follow patents? (MAO:434/15, 18 June 2015)?

Inspired by several Finnish companies, like many other interest groups, having expressed their concern regarding the level of renewal fees of the Unitary Patent, I thought of writing about a slightly different protection regime that provides not only fast but also low-cost protection for technical inventions, namely, utility models. First I have a question for all of you interested in IP enforcement and interim injunctions: do you think that interim injunctions in cases involving utility models should be granted on grounds and standards different to those applicable to patents? If you do not have a view on this, see what the Finnish Market Court considers and as we will see the main emphasis is on the so-called ‘claim requirement’:

Hope you like it and and now until next time!



Tuesday, 23 June 2015

Do you think that set-off and netting are important for the effective functioning of the international finance?

I found this old article from my files and thought that I share this as it brigs to my mind good memories from Oxford times and lectures with amazing Philip Wood of Allen & Overy. I had fun writing this and hope you enjoy (reading with your own discretion and no guarantees on substance, and mistakes are all attributable to the undersigned).

There are three general types of set-off and netting. To begin with, there is insolvency set-off in which case the party sets-off his claim against his insolvent counter party. The second type is close-out netting in which case the parties cancel and set-off open executory contracts. Finally, in settlement netting debts or fungible claims under executory contracts are set-off provided that they fall due or are delivered during the same day. I first focus on general policies underlying set-off and netting in different jurisdictions and then analyse these different aspects in connection with the above-mentioned classification. I then turn to the question whether or not set-off and netting are important for functioning of the international finance.

One of the most fundamental distinctions in this question can be illustrated with reference to different approaches to ‘cherry-picking’. Term cherry-picking itself means the question whether or not the solvent party has the right to cancel and set-off the losses and gains in its open executory contracts or whether the insolvency administrator may choose selective performance. Jurisdictions can be roughly divided into two categories on the basis of how they approach this issue in other words to those which consider cherry-picking as unjust and those which think that it is justified. The former approach can be classified as pro-creditor, which allows insolvency set-off, or like in the case of England, it even mandatory. In addition, pro-creditor view considers rescission clauses valid in the event of insolvency. The latter approach on the other hand tries to maximise the debtor’s estate by allowing selective performance. Rescission clauses having an effect on insolvency are usually expressly nullified. This latter approach could be said to apply in Napoleonic countries while the former in Anglo-American and Roman-Germanic legal families.

As already mentioned above, in insolvency set-off the parties may set-off mutual claims. If the solvent party is not allowed to set-off, his exposure to insolvent party will increase. Naturally this risk is taken into account in the risk assessment of the bank increasing the cost of credit. Controversially, it could be argued that set-off itself make rehabilitations process more difficult because it diminishes the debtor’s assets generally, which may be needed not only for future business but also as a security in the process itself. At least in some circumstances, the rehabilitation process might maximise the creditor income and in addition to that provide some other positive externalities like saved jobs. In financial terms this issue is extremely difficult whether pro-creditor or pro-debtor approach should be preferred and it will become even more difficult if the effects of set-off on systemic risk are taken into consideration.

On the other hand, it can be argued that set-off violates creditor equality, because only one creditor is paid at the expense of the others. From this respect this is a question whether creditors should be treated pari passu. The Napoleonic pro-debtor system sees this issue from the perspective of quasi-security and deems set-off as an unpublished security interest. At the end of the day the question of equality issue turns to the issue what is considered as just. Should the creditor have the right to set-off or should the debtor or her successor have the right to selective performance for example in close-out netting depends on moral value-judgements connected with the socio-economical culture of the legal system in question.

In the third type, the parties agree that monetary obligations in the same currency or the same type are netted provided that they fall due or delivery on the same day in order to reduce settlement risk. The actual conflicting policies are already explained above, but it should be borne in mind that in this case both approaches purport to protect the same underlying interest: reduce transaction costs not only trough legislation and carve-out arrangement but also trough voluntary agreement-based system like ISDA.

Set-off and netting are important especially due to their financial effects, but what is the best way to implement and organise the whole system remains to be the key question. When comparing these two categories one faces with the problem of finding appropriate measures for measuring the financial effects of insolvency set-off in pro-debtor and pro-creditor systems or to prioritise different values behind these financial choices. This distinction is however merely a question of effectiveness since it is conceivable to argue that both systems facilitate the objectives of the international finance.

Sunday, 10 May 2015

SPA Series Part 8: How To Negotiate M&A Deals In Finland - Earn-Outs

Dear All,

I know it would be interesting to read a bit about bulletproof earn-out clauses but I first have to tell some news from our firm. These days, we have a new website that we are very proud of (see here). In addition, another issue is that we are nominated among the noted M&A firms in Chambers Europe 2015 for the first time. I first of all would like to thank all of you who have voted for us. It is an honour to be in the same category with the leading heavyweight transaction law firms. Already this year we have represented clients in several deals, such as acquisition of Sports Tracking Technologies Oy by Amer Sports Corporation (link to press release) or divestment of private cloud business of F-Secure to Synchronoss Technologies for 60MEUR (link to press release), not to mention energy sector deals with Vapo relating to acquisition of district heating systems (link to press release). Anyway, we have been very fortunate and blessed with great team, which is now expanding with a new member joining to our ranks by the end of summer. The name I will still keep as a secret but this way we ensure that we are able to serve our growing clientele even better. But to the real thing, do you know how to write bullet-proof earn-out clauses? If your answer is no, then you came to the right place!

An earn-out clause is a payment structure, which means that part of the purchase price is connected with the future performance. So typically there is an initial payment on completion of the acquisition and a number of subsequent deferred payments, which are spread over an agreed period post-completion. In a sense this mechanism is contingent for certain events taking place, which creates a challenge for the drafter. One example could be the following: 

“The Purchaser shall pay the Purchase Price in a following manner: ….Provided that the agreed financial targets are reached in the Company, the Seller shall be entitled to an additional payment for the Shares of the amount of EUR____________ (Earn-Out). The Earn-Out shall be calculated in accordance with Appendix X.

The calculation of the Earn-Out shall be based on the annual accounts of the Company for the financial year X, which accounts shall be prepared in accordance with the Accounting Principles. The Earn-Out shall be paid by the Purchaser to the Seller in euros in immediately available funds within X days following the date when the determination of the Earn-Out is deemed final and binding.” 

And naturally there should also be a mechanism to solve disputes if there are disagreements.

What are the advantages and disadvantages of an earn-out? The main point probably is that earn-out enables more precise valuation of the target. This comes with the prices as the control that buyer can exercise during the earn-out period is typically limited. So there is an interesting balancing exercise to be made between the short and long term plans of the Company but for the seller this mechanism might enable higher price even in a situation when there are doubts as to the actual profitability and performance by the contemplated buyer.

Some points on drafting these clauses:

  • The Earn-Out is most often calculated by reference to EBIT, but turnover or net assets could also be used. Not very common though;
  • If you are using several purchase price mechanics simultaneously, see that there is no overlap, e.g., if the project closing is delayed (like overlap between adjustments and earn-out);
  • Profits should be carefully calculated and considered and one issue that relates to this is that accounting principles should be precisely defined. This is a point that the seller and buyer see differently and, as an example, the buyer may want the one-time so-called windfall profits to be taken out; 
  • For the seller, it is preferable to have a model in which there is no "all or nothing" approach but carry-forwards and backs between years if there is a longer period;
  • The responsibility as to who prepares the accounts is also relevant and here we refer to a price adjustment blog that we already discussed;
  • There almost certainly must be provisions relating to the management of the business during the earn-out period and some typical vetoes could include, for example, the right to hire new employees, the right to use subcontractors, board structure, remunerations, the right to promote employees according to the Company’s performance evaluation process. On the other hand, the buyer typically wishes to ensure that capital expenditure is not deferred to drive short-term performance;
  • How synergies are treated is also an important and difficult issue, such as more affordable access to capital, insurances. Buyers may resist these due to the fact that these are difficult to quantify;
  • The relationship with the overall structure of the representations and warranties and indemnities should be defined. So what happens if an event is a warranty claim, indemnification and affects an earn-out in the same time. A point worth considering whether there is a possibility for double-recovery;
  • Also set-off criteria is worth considering and whether there is a need to have withholding rights to expand the scope of set-off that would be ordinarily available under law; and
  • Taxation is something that should always be considered and in particular if you connect the earn-out with employment condition to avoid unpleasant employer payment surprises.

Hope this gives you a head start if you have been unfamiliar with these earn-outs in the past. Next I will focus on escrow payments and new posting coming by the end of this month. We have also started a book project around these M&A themes which will be released in the autumn, but more information on that to follow.

Lovely beginning for your spring week and hope to be in touch with you soon,