Etiqueta: m&a

In the context of M&A transactions, one should never neglect the possibility that the buyer is aware that a representation and warranty is false or inaccurate and, despite this, chooses to sign the contract in order to make a claim against the seller. This is where prosandbagging and antisandbagging clauses come into play.

Where does the expression sandbagging come from

In the sport of golf, a sandbagger is a player who plays underhand, who plays below his real ability in order to gain an advantage over his opponent. Because by lying about his skills, a sandbagger gets a better handicap. This allows him to have more strokes and thus increases his chance of victory.

Similarly, in a corporate sale and purchase, the term sandbagging refers to the situation where the buyer becomes aware that a representation and warranty is false or inaccurate. This information can usually be obtained through due diligence, but can also be obtained in any other way. Despite this, he chooses to sign the M&A contract and then holds the seller liable.

What are prosandbagging and antisandbagging clauses

In view of this possibility, the two parties are increasingly regulating their position with regard to sandbagging in order to avoid future disputes. If a dispute arises, the judge or arbitrator will take into consideration the common intention of the parties.

These are the most commonly negotiated clauses in M&A contracts:

• The anti-sandbagging clause, which provides that the buyer may not recover for any non-performance of which he had or could have had knowledge. In other words, prior knowledge will prevent the buyer from claiming damages. This is the most common type of clause in Spain.
• The prosandbagging clause, which works the other way around and provides that the buyer’s right of indemnification is not limited by the knowledge he may have or may have obtained in the framework of the statutory audit. In other words, prior knowledge on the part of the buyer will not affect the seller’s liability.

How to act in the event of a prosandbagging dispute

Although the prosandbagging clause is common, there is no consolidated Supreme Court case law on its effectiveness. This requires a case-by-case analysis, taking into account all the circumstances of the transaction and what was agreed by the parties in the purchase contract.

If the buyer detects a contingency during the due diligence process and, under the cover of a prosandbagging clause, decides to claim the damage from the seller, he may invoke in his defence the autonomy of the will of the parties, the work of allocation and distribution of risks in the operations of these clauses or the assimilation of the clause to a promise of guarantee by the seller. In our opinion, the most advisable thing to do in these cases is to negotiate a reduction of the price or to agree on a specific indemnity. In the specific indemnity it will be important to regulate how the damage will be quantified if it materialises and to foresee the possibility of claiming the damage as soon as it can be quantified, even if there has not been an effective disbursement.

On the other hand, the seller can argue that the buyer’s action is contrary to contractual good faith, that it is an abuse of rights or that the buyer gave tacit consent to this contingency because he knew about it before signing the contract and did not demand a specific indemnity to cover it. In order to prevent such situations, we recommend that sellers deposit the due diligence information with a notary, so that they can prove exactly what information the buyer had access to.

Key clauses to manage the risk of the operation

These are clauses that require arduous negotiation between seller and buyer, as they play a significant role in the allocation of risks. Confianz’s team of M&A specialists has extensive experience in mergers and acquisitions and can accompany you throughout the entire process with maximum guarantees.

In M&A transactions, the choice of the transaction pricing mechanism is key. Until recently, the locked box mechanism was mainly used in the United States. In recent years, however, this methodology has gained increasing acceptance in Europe, especially in competitive processes with several potential buyers. This is because this system significantly simplifies the drafting and negotiation of the sales contract.

How does the locked box pricing system work

The locked box involves the establishment of a closed price, not subject to adjustment at closing with few exceptions. This price is fixed in the purchase contract by reference to previous financial statements, closed at the locked box date. This date is not established after the closing of the transaction but before.

Thus, at the time of signing, the risks of the business are transferred. The contract states that the company will continue in its normal course, but provides for certain restrictions that protect the buyer against a loss of value that may occur between the date of the locked box and the closing date.

What kind of leakages to avoid

This protection is articulated through the concept of leakage of value. Any transaction that involves the decapitalisation of the company is prohibited. For example, the payment of dividends, the cancellation or reduction of debts, the sale of fixed assets at below-market prices, etc. In practice, the buyer would be receiving less value than he has paid.

Hence the name locked box: from the moment the two parties agree on a fixed price the box must remain locked.

What leakages are allowed

Permitted leakages, which are transactions known to both parties in advance and which have already been taken into account in the fixed price, are also often defined in the contract as reasonable exceptions. For example, wages and remuneration established in employment or service contracts, payment commitments assumed in the ordinary course, etc.

It is also necessary to regulate the normal running of the business in the time between signing and closing of the transaction. During this period the seller continues to manage the day-to-day business. For this reason, it is common for the seller to charge the buyer a fee for this period. At Confianz we recommend agreeing an interest rate on the price.

Advantages of the locked box mechanism

• Avoid complex financial definitions, adjustment mechanisms, arbitration, etc.
• It provides price certainty.
• It saves time and costs by avoiding the need to close additional financial statements.
• It is more appropriate in competitive processes where several candidates are competing for the purchase, as the comparison of offers will be more homogeneous.

The locked box is generally considered to be a favourable pricing system for the seller, as it provides the certainty of a fixed price and avoids the occurrence of disputes in subsequent revisions.

Limitations 

However, the locked box method requires an in-depth analysis of the financial statements. If the locked box date is close to the annual financial close, the audited annual accounts will be used. Otherwise, the vendor will have to prepare ad hoc financial statements.

In both cases, however, thorough due diligence is required to ensure reliability. Therefore, it is not advisable to use it in situations where the buyer is unable to carry out in-depth due diligence.

It is no longer marginal. The introduction of sustainability criteria in M&A transactions has become a strategic issue for companies in all sectors worldwide. Companies have overwhelmingly come to the conclusion that adopting corporate sustainability commitments helps to bring the merger or acquisition process to a successful conclusion. And, in the long run, it contributes both to achieving their strategic objectives and to improving compliance with the United Nations Sustainable Development Goals (SDGs).

In today’s challenging regulatory environment, companies with a Corporate Responsibility and Sustainability strategy have a competitive advantage and are less vulnerable to changes in social, environmental or governance regulations.

A challenge for sellers and buyers/inverstors

The integration of sustainability criteria when evaluating a transaction provides greater certainty in estimating the value. However, it is essential that the seller provides a comprehensive assessment and conveys it accurately to the buyer or investor. Fine words are not enough. It is necessary to use mechanisms such as public domain searches or the use of business intelligence tools, which help to verify the required information with certainty.

The potential buyer now also faces a new challenge: to find a target that is not only attractive from a strategic and financial perspective, but also aligned with its own environmental, social and governance criteria.

Sustainability issues are embedded troughout the M&A process

Today, any M&A transaction involves an in-depth analysis of the asset that goes beyond the traditional legal, tax and financial issues. The influence of ESG (Environmental, Social and Governance) criteria is transversal throughout the entire process:

• In the due diligence phase. Analyses should now also include compliance with inclusion, diversity and equity policies. It is also necessary to identify potential legal risks on social and governance issues. Including how the target can provide its stakeholders with continuous monitoring of these issues. In addition, the strengths and weaknesses of the company’s sustainability agenda should be analysed and identified.

• In the structuring, negotiation and closing of the transaction. Corporate Responsibility and Sustainability metrics and objectives should be incorporated into the valuation process. Also consider the impact of environmental, social and governance factors on the market. And foresee the future evolution of regulatory conditions and the different regulatory scenarios that could occur. Because purchase or investment agreements should be adapted to mitigate the risks arising from the level of compliance with the ESG criteria of the target. For example with the inclusion of representation and warranty assurances, closing conditions and post-closing obligations. Aspects that must be maintained before and after completion of the M&A transaction are also increasingly included in contracts. For example, the so-called Harvey Weinstein clause, whereby the seller must indemnify the buyers or investors if any of the target’s management is exposed or involved in sexual harassment and abuse.

An added difficulty

In short, the generalised inclusion of sustainability criteria in M&A transactions is an added complexity factor throughout the negotiation process. The Confianz M&A advisory team is ready to accompany your company throughout this process.

Seeing the details of an M&A (merger and acquisition) process published in the press can greatly complicate negotiations. In any M&A transaction, it is essential to maintain confidentiality throughout the entire process until the M&A transaction closes with the signing of the sale and purchase agreement in front of a notary. And yet, a recent report by the global strategic communications advisory group H/Advisors reveals that one in three M&A deals of $2 billion or more is reported to the media before it has been officially announced.

After analysing 267 transactions in 2022, the study shows some clear trends as to which M&A deals are most likely to leak to the press:

• By region, deal negotiations in Western Europe and Asia-Pacific are more likely to leak before they are officially announced than deals taking place in the United States.
• By sector, the sectors with the highest leakage rates are aerospace, defence and consumer goods, with companies owning high-profile brands.
• Depending on the volume, large transactions with a value of USD 25 billion or more are leaked up to 80 per cent of the time.

At Confianz we cannot stress enough the importance of being prepared for this eventuality during an M&A process. These operations are complex events and any leak can have a negative impact on the negotiation. For this reason it is necessary to foresee a quick and professional response.

3 reasons why confidentiality is crucial in M&A processes

When handling any M&A transaction, confidentiality on the part of all parties is crucial. The reasons for this are manifold and include:

• Prevent competitors from taking advantage of any leaked information to try to take customers away from the company for sale.
• In the case of listed companies, to avoid falling share prices and speculative movements.
• Keeping partners and employees calm, so that they are not assailed by uncertainty, demotivation and/or talent drain.
• Protect the corporate reputation of all parties involved.

Relying on a single advisor is the best way to ensure confidentiality

Hiring a single law firm to handle the entire merger or acquisition process exclusively and carrying out all actions through it is the best way to avoid the publication of leaks in the press.

This exclusivity allows, among others:

• Ensure confidentiality. Because the fewer people who know the details of negotiations, the less chance there is of unwanted leaks.
• Optimise all efforts. Because if several intermediary parties are involved, it is easy to end up with contradictory conclusions.
• Work with a fluid and fast flow of communication. Because by limiting the number of actors in the negotiation, it is much easier to transmit information between all of them.

Having a specialised M&A advisor such as Confianz throughout the entire process is the best basis for a successful transaction.

Choosing the right advisor in an M&A transaction can be complicated. In such complicated negotiations, the human factor becomes fundamental. It is always best to turn to experienced professionals such as those at Confianz, who guarantee maximum discretion, absolute trust and impeccable professionalism. The studies and experience of our team, the satisfaction of our clients and our previous success stories are our best business card.

The year 2023 started with subdued M&A expectations due to rising interest rates and fears about the onset of a possible recession. Nevertheless, the number of transactions in the first six months has surpassed the pre-pandemic levels of 2019. Will the second half of the year see changes?

M&A market forecasts for the remainder of 2023

For the second half of the year, the market is showing signs that more interesting and transformative M&A opportunities will emerge. After a difficult start to the year, many things have changed in recent months: inflation and rising interest rates are slowing down, the US has weathered the debt ceiling crisis and artificial intelligence has emerged as the next big technological revolution.

Executives will continue to use M&A activity as a tool to reposition their businesses, drive growth and generate lasting results. For three reasons:

• The fall in the value of listed companies will create investment opportunities.
• Corporate restructuring will continue to pick up, which may lead to mergers and acquisitions of distressed companies. Retail, FMCG, real estate and industrials are the four sectors where most restructuring is expected.
• More stable interest rates will reduce uncertainty and make it easier to price transactions.

The rise of the mid-market in the second half of the year

The M&A market for the remainder of the year will be dominated by mid-size deals, which are more feasible in the current regulatory and financing environment. Executives are favouring mid-size deals because they are less affected by market volatility and face less regulatory scrutiny. They can also be transformational and accelerate growth if they are part of a well-planned strategy.

The push for artificial intelligence

By sector, the most active sector in the first half of the year was technology, media and telecommunications, which accounted for 28% of deals. New technologies are key to the transformation of companies; and artificial intelligence will create opportunities in the M&A market for both corporate groups and private equity funds.

In terms of value, the energy, power and natural resources sector led the ranking from January to June, with 23% of the total. Companies are increasingly looking to reduce their impact on the environment and are committed to zero net emissions strategies. The energy transition is already a reality and is generating enormous changes that open up opportunities for M&A transactions.

Tips for undertaking an M&A transaction now

Macroeconomic conditions will lengthen the negotiation periods for transactions and will make it necessary to deepen due diligence processes. The business situations that will emerge in the M&A market will be more complex and challenging for all parties.

In order to close a transaction and avoid price reductions, sellers must assume that buyers and their financing sources will devote more time and effort to analysing and studying the transaction. However, a common mistake we see quite often is that sellers and their banks set very aggressive sales terms. This can cause the transaction to fail.

We end with a word of advice: companies with strong balance sheets and liquidity would do well to seize the moment to make acquisitions now that difficult financing is reducing competition. At Confianz we are specialists in M&A transactions and can advise you throughout the process.

On 1 September, the new Royal Decree 571/2023 of 4 July on foreign investment will come into force. This antiopas regulation fixes some of the temporary measures that were approved during the pandemic to prevent the purchase of national strategic assets by foreign capital.

The main novelty is that administrative procedures are reduced and streamlined. Thus, the resolution period for authorising or vetoing investments is halved from six to three months. This period also includes consultations with the administration, which will have 30 working days to respond.

The antiopas shield

Let’s look back at how we got here. To do so, we must go back to March 2020, when the Executive implemented the so-called «antiopas shield». In this way, article 7 bis of Law 19/2003 established the obligation of prior permission from the government for non-EU investors intending to invest more than 500 million euros or to acquire more than 10% of a strategic company listed on the stock exchange. The reasons given were security, public order and public health. The aim was to prevent foreign capital from taking advantage of the stock market crashes that occurred during the COVID-19 pandemic to take over strategic Spanish companies.

In November of the same year, this measure was complemented by a transitional provision which established that the government should also authorise foreign direct investment by EU and EFTA companies in listed companies or even in unlisted companies if the investment exceeded 500 million euros. The aim was to prevent investors from circumventing the restrictions by simply setting up companies on EU territory.

Inflation and rising interest rates have meant that this regulation has been successively extended to the present day.

What’s new in the Antiopas Law 2023

Now the Executive has modified and developed the regime for foreign investment in Spain and, in particular, the investment control regime. These are some of the main novelties:

• The deadline for approving or vetoing investments is reduced from six to three months. This reduces and speeds up administrative procedures, one of the main complaints of companies and investors.
• It formalises the system of voluntary consultation which had already existed in practice. Through this voluntary procedure, investors can receive a confidential and binding response as to whether or not a given transaction should be subject to authorisation. The authorities will have 30 working days to respond. Otherwise, the interested party may submit an application for authorisation.
• The possibility of using the simplified procedure of 30 working days for transactions of less than EUR 5 million is eliminated.
• Internal restructuring within a group of companies and increases in shareholdings by investors already holding at least 10% in the Spanish company are not subject to the control mechanism if such increases are not accompanied by changes in control.
• In the case of investment through private equity funds, the person obliged to submit to control as the owner of the investment will be the management company, provided that the shareholders or beneficiaries do not legally exercise political rights or have privileged access to the company’s information.
• All investments of less than €1 million are no longer exempt. The threshold now varies depending on the sector of the company in which the investment is made. The energy sector, electronic communications, mining, strategic raw materials, etc. are particularly regulated.

Conclusions

Overall, we believe that this new regulation takes up in writing some interpretative criteria that were already being applied by the authorities and offers greater legal certainty in the market.

It is becoming increasingly common in M&A transactions between Spanish companies to take out a manifest and warranty insurance policy, also known as W&I Insurance in English-speaking countries, where these policies have always been more popular.

Its advantage is that this type of insurance allows the transfer to the insurance company of the risk derived from the obligation to indemnify the buyer for the possible lack of truthfulness and accuracy of the representations and guarantees given by the seller.

Let’s look at it in detail.

How responsibilities in mergers and acquisitions are assigned

From the date on which the actual transfer takes place, it is most common in an M&A transaction for the buyer to assume all the business risks inherent in the acquired business.

For his part, the seller is liable if he breaches agreed obligations, such as the non-competition obligation. Also for the lack of truthfulness and accuracy of the representations and guarantees that he has given in favour of the buyer in the contract of sale.

What is manifestation and warranty insurance

In contrast to this default allocation of responsibilities that is established by default in any merger or acquisition, manifestation and warranty insurance introduces a solvent third party, the insurance company, which assumes part of the risk.

The most common type of W&I Insurance policy is one in which the insurer assumes the risk arising from the seller’s obligation to indemnify the buyer for the lack of truthfulness and accuracy of the representations and warranties given by the seller.

What exactly are these representations and warranties? They are a set of statements concerning certain circumstances relating to the seller himself, the shares/shares being transferred and the business conducted by the company being transferred.

Transactions in which M&A insurance is frequently used

The first thing to do is to anticipate the need to take out an insurance policy for demonstrations and guarantees. In this way, we will be able to integrate it as another element within the negotiation. These are three of the cases in which it may be advisable to take out a policy of this nature:

• On the seller’s side, when the seller is a private equity fund looking for a clean exit and does not want to assume any liability for past contingencies.
• On the buyer’s side, in competitive processes, where several aspiring buyers submit their purchase proposals to the same seller. The introduction of a manifestation and warranty insurance in the offer can be an important advantage that can tip the balance in favour of one of the potential purchasers.
• In the formation of joint ventures, this type of insurance allows the new partners to neutralise the emergence of potential conflicts.

How to take out manifestation insurance and guarantees

Any insurer will require a thorough understanding of the transaction to be covered. To do this, it is best to first carry out a thorough due diligence on the business being bought and sold. In the absence of this step, the insurance company will require at least an analysis of the areas about which it does not have sufficient knowledge. Otherwise, it will exclude these areas from the policy coverage or may even refuse to underwrite the policy.

On the other hand, it should be borne in mind that drafting an insurance policy of representations and warranties requires a precise definition of certain concepts. For example: the concept of damage, the quantitative and qualitative thresholds of limitation of liability, the claims procedure, etc. To this end, it is essential to have  legal advice from a legal expert in M&A transactions involving representation and warranty insurance.