Wednesday, April 18, 2012

Legal Issues When Buying a Business: Exclusivity (Part #1)

If you are buying a business, regardless of the scope of the operations and purchase price, there are a number important legal issues you need to consider before signing the purchase agreement.   The next several installments of the blog will address the issues that a buyer should address when purchasing a business.  The first installment in the series discusses the role of the Exclusivity Agreement when considering the potential transaction and the terms that should be included if the parties agree to exclusivity while the due diligence is conducted and the purchase agreement is being negotiated.

1.  What is an Exclusivity Agreement/No Shop?

An Exclusivity Agreement or No Shop is a separate agreement or a provision in an Letter of Intent between the seller of a business and the potential buyer prohibiting the seller from seeking to transfer the business or assets to anyone else during a defined period.  In simple terms, the seller cannot shop around the business or assets during the prescribed period. 

2. If You are the Buyer, You Should Demand Exclusivity.

If you are considering the purchase of a business or its assets, you should demand exclusivity for a reasonable period necessary to complete due diligence, negotiate and finalize the purchase agreement.  As a purchaser, you want to preclude the seller from using your proposed deal as an opportunity to shop around the business.  Without the exclusivity restrictions, the seller can freely seek a better offer from a third party or even create a bidding war between you and another interested buyer.  The minute you begin engaging in due diligence and enter the process of negotiating the purchase agreement, you not only will be incurring substantial costs in terms of actual out-of-pocket expenses (business advisers, lawyers, accountants, etc.), but also the intangible loss of time and the inevitable distraction to your current business operations.  The seller's initial reaction to a demand for exclusivity may be to refuse to enter into a No Shop, in which case you need to decide whether to demand exclusivity as a non-negotiable condition.  If the seller is refusing to agree to exclusivity, another approach is to let the seller know you are exploring other similar businesses -- assuming this is a viable argument -- and you will simply switch your efforts to other potential opportunities.

3.  What is the Proper Place for the Exclusivity Terms. 

The exclusivity terms can be incorporated as a provision of a Letter of Intent (i.e., the No Shop Clause) or as a stand-alone agreement.  Generally, however, the LOI is not a binding agreement but rather a road map for the potential transaction.  Therefore, the LOI should clearly state that notwithstanding its non-binding nature, the provisions of the No Shop Clause (exclusivity, term and remedies, as discussed below) are binding on the parties.  

4.  What are the Essential Terms of the Exclusivity Provision/No Shop Clause?

The exclusivity agreement should be carefully drafted, but that does not mean it needs to be complicated; instead just make sure there is a clear and concise agreement/clause that defines (a) the Term (period) of the exclusivity, (b) the remedies in the event of a breach by the Seller, and (c) governing law/forum for disputes and enforcement.

           (a)  Term:  The exclusivity agreement should set a clear time period that commences on signing the agreement and terminates in a specific number of days.  Often, parties will agree to ninety days for the exclusivity period, but whatever the period be sure if you are the purchaser that there is sufficient time to conduct due diligence, draft and negotiate the purchase agreement. 

          (b)  Remedies for Breach:  The No Shop should expressly set forth the remedies available to the potential buyer in the event of a breach.  The remedies can include a right to equitable relief (such as an an injunction), a right to damages or (as I often prefer) a stated amount for liquidated damages which reimburses the potential buyer for reasonable costs of due diligence, attorney's fees and other reasonable costs.  The remedies provisions should require the seller reimburse the buyer for attorney's relating to enforcement of its rights and a waiver of any bond (i.e., deposit of a bond with the court) that may otherwise be required to seek equitable relief.

         (c)  Forum:  Include a governing law clause and forum selection provisions so that you can require the breaching seller to defend any claim in a convenient forum.  Also, since the buyer is looking for ease of enforcement of its rights in event of a breach of the no shop, incorporate a provisions allowing for service of process by regular mail (to the extent permitted by the law of the jurisdiction where the seller is located in the case of a foreign party).

5.  Exclusivity is Not the Same as a Requirement to Sell.

In the same way it is important to understand what a No Shop is, it is equally important to understand what it is not.  The exclusivity required by a No Shop is not the same as an obligation for the seller to complete the transaction and sell the business or assets.  The exclusivity requirement only precludes the seller from marketing the sale of the business or entertaining other offers during the exclusivity period. While you should include language requiring the seller provide the potential buyer a reasonable opportunity for the to conduct the due diligence, in reality if the seller decides not to proceed it can let the exclusivity period expire without executing a binding purchase agreement.  This does not mean the exclusivity agreement has no value, as in fact it is an important aspect of negotiating the purchase of a business (or the assets of the business) because it prevents the seller from shopping your potential deal while giving the parties the opportunity to finalize the transaction.  

The next installment in this series discussing issues relating to buying a business willexamine transactions involving the purchase of stock of the seller compared with a purchase of the business assets.

Disclaimer: The discussions in this blog do not constitute legal advice nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters. 

No comments:

Post a Comment