By UpCounsel Corporate Attorney Lara Lavi

This is the second part of a two-part series on asset purchase agreements. Click here to read Part 1, Asset Purchase Agreements: 10 Things That Can Go Wrong.

Preamble and Recitals

The first paragraph of an APA is known as the Preamble. It usually names the agreement, introduces the parties and sets forth the effective date of the contract. More often than not, it will also create defined terms for each of these, such as the “Seller” and the “Purchaser.”

Immediately after the Preamble, the Asset Purchase Agreement often contains a series of statements beginning with the word “WHEREAS”. These are known as the Recitals. Unlike most of the rest of the agreement, the Recitals are not generally meant to be binding on the parties. Instead, they lay out the intentions of the transacting parties and provide context to anyone later attempting to interpret the APA.

Article 1: Definitions

Article 1 of most APAs provides an alphabetical list of definitions of important (usually capitalized) terms used throughout the agreement. These definitions do not function as stand-alone terms and conditions but are instead incorporated into other operative provisions throughout the contract. For example, Article I might provide definitions for the terms “Affiliate,” “Law” and “Person.”

Although you may be tempted to gloss over these definitions under the belief that they are immaterial, boilerplate or difficult to interpret in the absence of context, they are critically important and may substantially alter the effect of the provisions in which they are used. Some, such as “Liabilities,” “Material Adverse Effect” or “Seller’s Knowledge” (or their equivalents) are used throughout the contract and may be the subject of extensive negotiations. Others, such as “Acquired Assets,” “Acquired Business,” “Assumed Liabilities,” “Retained Assets” and “Retained Liabilities” are central to the terms of the transaction, as they determine exactly what each party is and is not getting in the deal.

In addition to the list of definitions, this Article will frequently also contain cross-references to terms that are defined elsewhere in the Asset Purchase Agreement and a section devoted to rules of construction applicable to the contract.

Article 2: The Transaction

Article 2 of a standard APA usually provides the specific terms of the sale. It contains language to the effect of:

“In accordance with the provisions of this Agreement and except as set forth in Section 2.2 [governing Excluded Assets], at the Closing, the Seller will sell, convey, assign, transfer and deliver to the Purchaser, and the Purchaser will purchase and acquire from the Seller, free and clear of all Encumbrances other than Permitted Encumbrances, all of the Seller’s right, title and interest in and to all of the Seller’s properties and assets of every kind and description, whether real, personal or mixed, tangible or intangible, and wherever located, used [exclusively] in the Acquired Business.”

There will be similar provisions relating to Excluded Assets to be retained by the seller, Assumed Liabilities to be taken by the buyer and Excluded Liabilities, which remain with the seller. In addition, Article 2 sets forth the purchase price, any purchase price adjustments (such as an adjustment to account for variations in target net working capital at closing) and documents and other things that must be exchanged between the parties at closing. These will include the purchase price, of course, and bills of sale, assignment and assumption agreements, intellectual property assignments, real property transfer documents and so on, as well as any legal opinions, employment agreements, escrow agreement and other ancillary documents.

Article 3: Seller Representations and Warranties

Article 3 of most Asset Purchase Agreements contains representations and warranties from the seller about the target business. As discussed in a prior post, representations and warranties are statements of past or present fact relating to the business, assets, liabilities, properties, condition, operating results, operations and prospects of the acquired assets made by one party in an M&A transaction to another. Inaccurate representations and warranties may result in the incurrence of liability by the party that made the statements.

Here’s a long list of subjects that may be addressed by seller representations and warranties:

  • organization and good standing
  • authority and enforceability
  • absence of conflicts
  • capitalization and ownership
  • financial statements
  • books and records
  • accounts receivable and accounts payable
  • inventories
  • absence of undisclosed liabilities
  • absence of certain changes and events
  • assets (including sufficiency of assets)
  • real property
  • intellectual property
  • material contracts
  • tax matters
  • employee benefits
  • employment and labor
  • environmental, health and safety
  • compliance with law
  • legal proceedings
  • customers and suppliers
  • product warranties
  • product liability
  • insurance
  • related-party transactions
  • guarantees
  • brokers and finder’s fees
  • solvency
  • full disclosure

Few, if any, transactions will include all of these representations and warranties, and many of them overlap at least in part.

Article 4: Buyer Representations and Warranties

Article 4 usually contains reciprocal representations and warranties from the buyer to the seller. (Occasionally, these are included within another section of Article 3 along with the seller representations and warranties.) If the buyer is issuing shares as all or part of the purchase price, then its representations and warranties will mirror those of the seller fairly closely. More often, though, the buyer is paying cash and its representations and warranties are consequently significantly more limited in scope. After all, cash is cash.

Buyer representations and warranties frequently cover some combination of the following topics:

  • organization and good standing
  • authority and enforceability
  • absence of conflicts
  • governmental consents
  • legal proceedings
  • financing
  • brokers and finder’s fees
  • independent investigation

Article 5: Covenants

Assuming your deal has a gap period between signing and closing, as most do, Article 5 of the APA will contain covenants (i.e., promises to do or refrain from doing something) governing the parties’ activities during this time as well as after closing.

There’s usually an “Access and Investigation” covenant through which the seller promises to permit the buyer to access the acquired business and its books and records prior to closing. Among other things, this enables the buyer to continue planning for and implementing its integration of the acquired business during the gap period.

This Article will also require the seller to operate the acquired business prior to closing in the ordinary course consistent with past practices. Such provisions sometimes include long lists of specific actions required to be taken (or prohibited from being taken) by the seller. Generally speaking, the more comprehensive and specific the list, the more favorable it is to the buyer. These conduct of business provisions help preserve the business in the form expected by the buyer and maintain it in a condition that is similar to what it investigated through due diligence.

In addition, Article 5 usually requires the seller to notify the buyer of certain material developments impacting the acquired business or the transaction. The goal here is not only to ensure real-time information flow to the buyer about its soon-to-be-owned business, but, depending on how the provision is written, to enable the buyer to declare a material breach of the APA or failure of a closing condition if it has been notified of a breach or failed condition.

Article 5 will generally also contain a covenant requiring the parties to exercise certain efforts to consummate the transaction, including obtaining regulatory approvals and securing third party consents. Such approvals and consents are particularly important in asset transactions, given the requirement to convey ownership of each asset individually from one entity to another, which is significantly more likely to be prohibited by, or require approval under, applicable law and contracts than an indirect transfer via sale of stock.

Other covenants you may encounter in Article 5 include provisions governing:

  • confidentiality
  • no-shops
  • public announcements
  • preparation of interim financial statements
  • seller cooperation with financing
  • customer communications
  • employee matters
  • fraudulent conveyance law and satisfaction of seller obligations to creditors
  • indemnification and insurance
  • non-competition
  • non-solicitation
  • treatment of shared assets and intercompany arrangements
  • use of the seller’s retained names and marks
  • handling of mail and other communications and
  • production of witnesses and attorney-client privilege

Article 6: Closing Conditions

Again assuming the deal has a gap period between signing and closing, the Asset Purchase Agreement will include conditions precedent that must be satisfied or waived before each party will be required to consummate the transaction. Among other things, these will generally require that the other party’s representations and warranties will have been true when made and remain true at closing, and they will require that the other party will have complied with its pre-closing covenants. As you might expect, all required regulatory approvals and third-party consents will need to have been secured, as well. Frequently, a buyer will also require as a condition precedent that the acquired business will not have experienced a material adverse change—an adverse change in the acquired business that is consequential to its long-term earnings power. Occasionally, a buyer may be able to negotiate for a requirement that it will have secured financing or satisfactorily completed its due diligence examination of the target, too.

Article 7: Indemnification

Another APA Article will provide for indemnification rights, which entitle each party to be compensated by the other for losses suffered on account of a breach of any of the other party’s representations, warranties and covenants. Indemnification may also be extended to losses arising from specific causes, such as an identified environmental condition. The seller will usually provide indemnity for losses incurred by the buyer as a result of “Retained Liabilities,” as well, and the buyer will offer a reciprocal indemnity with respect to “Assumed Liabilities.”

This Article will not only outline each party’s basic rights to indemnity. It also typically:

  • establishes a survival period for representations and warranties after which claims for breach cannot be brought
  • sets limits on indemnification, including a threshold or deductible and a cap
  • if applicable, outlines the use of any funds deposited in escrow for indemnification
  • lays out procedures to be followed to make indemnification claims and to handle third party claims
  • indicates the extent to which indemnification is a party’s exclusive remedy for breaches
  • clarifies how losses should be calculated for purposes of any recovery.

Article 8: Termination

The conditions to closing contained in Article 6 would be pointless without an associated right to terminate the APA and the transaction if any of those conditions aren’t satisfied or waived. Every APA thus contains an Article describing each party’s termination rights, which often include not only termination due to failure of a condition but also termination by mutual consent, termination by the buyer if the acquired business has suffered a material adverse effect, termination by either party if the transaction is enjoined or fails to obtain necessary governmental or third-party consents or termination by either party if the deal hasn’t closed by a specified deadline.

In addition, this Article explains the effect of termination, usually that some provisions of the APA will survive termination (e.g., governing confidentiality and miscellaneous provisions), that one party may owe a termination fee or expense reimbursement to the other and that the parties will remain responsible for any pre-termination breaches.

Article 9: General Provisions

Finally, virtually every APA will contain an Article dedicated to miscellaneous provisions governing a variety of subjects, including expenses, governing law, notice, dispute resolution, expenses, severability, counterparts, assignment, amendment and more.

Other Articles

Aside from the more common sections described above, many Asset Purchase Agreements contain Articles devoted exclusively to other topics, including taxes, employment and labor and environmental matters. Such additional Articles will usually only appear in an APA if their subject matter is particularly important and requires a more fulsome approach than it would otherwise receive.

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About the author

Lara Lavi

Lara Lavi

Lara Lavi is a new media/entertainment law attorney, an entrepreneur, an entertainment company executive, a business development specialist, a film and TV producer & writer, and a professional award winning singer-songwriter. (She is also the proud mother of her teen-age son Cameron that is perhaps her most cherished identity). Ms. Lavi has over 35 years experience in the music and entertainment business on both sides of the desk and microphone. Much of Ms. Lavi’s law practice focuses on the convergence of law, new media, marketing and entertainment law specifically in music, film, television, gaming and literary sectors of the entertainment business.

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