The growth of cross-border UK and US M&A

Answer

The Office of National Statistics reported that cross-border mergers and acquisitions (M&A) have grown in recent years. One of the constant themes of mid-market M&A in the UK is the significant activity generated by US-based buyers acquiring British targets. Despite the economic uncertainties and turmoil ongoing in both countries, transactions are continuing to complete. The stream of acquisition activity in the UK, which is being initiated by corporate and financial US buyers, is giving rise to the question as to which particular law and market practice should be adopted in cross-border transactions.

A key decision for a seller is the choice of governing law and market practice for the transaction documents. While the seller could simply choose the governing law and market practice of the jurisdiction with the closest nexus to the target company, it may not be the best, nor most tactical choice from a legal perspective.

The UK and US have very similar general principles, such as:

• the freedom to contract;
• caveat emptor; and
• no positive duty to negotiate in good faith.

There are, however, some fundamental differences. There’s a general perception that UK law and practice favours the seller (with the risk passing on exchange, more limited warranties and wider disclosures), while the US approach favours the buyer (with risk not passing until completion, more extensive warranties and limited disclosures). While this article is by no means exhaustive, it’ll outline some of the key differences which are worthy of consideration on transactions that have both a UK and US element to them.

'Completions' v 'closings'

UK deals are generally structured so that the deal and business risk pass to the buyer at exchange. This means that conditions in share purchase agreements (SPA) are often limited to legal or regulatory matters. Any risk on US deals typically doesn't transfer until 'closing', and therefore agreements regularly contain more significant conditions. A frequently negotiated provision in a US SPA is the material adverse change (MAC) clause. MAC clauses are designed to enable a purchaser to decline to complete a transaction if the economic position of the target materially and adversely deteriorates between fixed points in time. MAC clauses are much less common in UK SPAs. In the limited cases where a MAC clause is agreed, it’s often drafted to be invoked only in narrow circumstances specifically relating to the target.

Buyer's knowledge

Typically, in the UK, where a buyer has actual knowledge of something prior to completion which may constitute a breach of warranty, they’re precluded from bringing a claim in respect of it. Sometimes you do see an attempt to use 'pro-sandbagging' clauses preserving the right to bring a claim in this instance, but stringent analysis of the facts would be needed to ascertain if such a provision would be effective. As a result, this formulation of wording is generally seen as off-market.

In the US, the position is ambiguous and differs between states. In New York, for example, there’s often an attempt to include ‘pro-sandbagging language’ by the buyer: to preserve the right to bring contractual claims, as far as possible, even if they result from issues known to it prior to close. It’s the opposite in the UK, demonstrated by the more common approach of 'anti-sandbagging', whereby the buyer confirms it’s not actually aware of any issues constituting a breach prior to close.

Warranties and representations

In US transactions the statements about the target company will be termed 'representations and warranties'. These two terms are used interchangeably without affecting the remedies available to the buyer if one of those statements proves to be false. In the UK, however, whether a statement is classed as a representation or a warranty will impact the potential remedies available to the buyer if that statement turns out to be false. If the untrue statement is a representation, the buyer may be able to set the contract aside or claim damages calculated on a tortious basis. If a warranty is breached, this gives rise to a simple claim for contractual damages. The warranties on both US and UK deals will generally cover similar areas of the target's business, however, US buyers expect to receive greater warranty cover.

Warranty and indemnity insurance

Warranty and indemnity insurance is common in the UK market and is particularly favoured by private equity sellers. It’s also been an increasing feature of the UK market, especially over the last five years. Coverage is comprehensive in the US and can even give the seller exposure to no more than a dollar of liability. Coverage in the UK is generally less comprehensive than in the US in that it’ll not cover specific indemnities or warranties given on an indemnity basis.

Disclosures

UK-style SPAs are usually accompanied by a separate disclosure letter which is what qualifies the warranties. This’ll contain both general disclosures (publicly available information) and specific disclosures cross-referenced to the warranties. By contrast, US disclosures are contained in a schedule to the acquisition agreement rather than a separate letter. It’s rare for a US buyer to accept general disclosures.

Pricing

The use of a locked-box mechanism is now a common feature in UK private M&A transactions. The purchase price is set by reference to an agreed balance sheet, struck at an agreed date in advance of signing. The equity price paid by the buyer at closing is essentially calculated by adding cash and deducting debt and debt-like items represented on that balance sheet from the headline price. The seller will confirm in the acquisition agreement that it’s not received any value or benefit from the target (referred to as ‘leakage’) in the period between the locked-box date and signing and is then restricted from doing so in the period between signing and closing.

In contrast, while the locked-box mechanism is used in the US, it’s more usual for US private M&A transactions to use closing accounts as the mechanism to determine price. In other words, the buyer would pay a purchase price at the closing of the transaction that’s calculated based on an estimate of the target’s working capital or net assets as at the closing.

Womble Bond Dickinson (WBD) is a transatlantic law firm that has 30 locations across the UK and US and is also a member of the market-leading international network of law firms – the Lex Mundi. WBD's prominent US presence has meant that the UK and US offices often come together to work on transactions with parties from across the states and the UK. WBD has a proven ability to deliver international transactions and call on resources and know-how in over 120 jurisdictions, meaning the cross-border work in which the transatlantic law firm is involved goes beyond US/UK transactions.

Ian Wildish is a trainee solicitor in the corporate finance team at Womble Bond Dickinson.