Monday, August 17, 2015

The Endless Shareholder Agreement

Congratulations to the Texas legislature for authorizing the Endless Shareholder Agreement.

Virtually every closely held private corporation should have a shareholder agreement to address, if nothing else, restrictions on transfer of the shares. Otherwise, you may find that one of your fellow shareholders has transferred his shares of the company's stock to the company's biggest competitor, or worse yet, your ex-wife!  Shareholder agreements are especially important for a corporation taxed as an S-corporation, because a transfer of shares to a person who is not eligible to be a shareholder of an S-corp can terminate the company's S-corp status and result in adverse tax consequences for the company's shareholders. Shareholder agreements can also address other issues, such as establishing a procedure for shareholders to buy or sell each other's shares (i.e., a buy-sell agreement), modifying shareholders' statutory voting rights or strengthening shareholders' information rights.

But for shareholder agreements adopted prior to September 1, 2015, there has been a trap for the unwary.  Under Section 21.102 of the Texas Business Organizations Code (TBOC),  shareholder agreements were only effective for ten years unless the agreement provided otherwise. Thanks to recently adopted S.B. No. 860, which amends Section 21.102 of the TBOC, however, the default assumption for shareholder agreements will flip on September 1, 2015.  Shareholder agreements adopted after that date will be effective forever unless the shareholder agreement provides otherwise. Shareholder agreements adopted before that date will continue to be subject to the 10-year limit under the prior law, unless the agreement provides otherwise.

The new law is probably more consistent with shareholders expectations and is therefore a step forward for Texas business law.       

Saturday, August 1, 2015

M&A and the Wisdom of Seinfeld - Vol. 2

George Costanza: That's why I'm different. I can sense the slightest human suffering.
Jerry Seinfeld: Are you sensing anything right now?

This is my second blog post in my occasional series on "M&A and the Wisdom of Seinfeld."  You can read my first blog on knowledge qualifiers here.  I'm a big believer in the notion that practically every aspect of our lives has been commented upon in a Seinfeld episode!

The exchange between George and Jerry above is a great example of the importance and utility of materiality qualifiers in an M&A transaction.  Materiality qualifiers help ensure that parties to an M&A transaction aren't unduly damaged by the slightest suffering.  Let me explain.

Let say BigCo wants to acquire TargetCo and the parties enter into an asset purchase agreement (APA) with a purchase price of $50 million. The APA includes numerous representations and warranties by TargetCo, including a representation that TargetCo's financial statements are true and correct in all respects.  Suppose also that one of BigCo's conditions to closing the APA is that all representations and warranties of TargetCo are true and correct in all respects. Finally, let's suppose the indemnification provisions of the APA permit BigCo to sue TargetCo for the breach of any representation or warranty, whether or not BigCo knew about the breach prior to the closing.  

Now assume that after the APA is signed but before the transaction closes BigCo determines that the amount of cash on TargetCo's balance sheet was misstated by $2.37.  Under a strict reading of the APA, BigCo can now weasel out of the deal and refuse to close!  One of TargetCo's representations and warranties was false, so one of the conditions to BigCo closing the deal cannot be satisfied, and BigCo can walk.

Suppose instead that TargetCo had represented and warranted only that its financial statements were true and correct "in all material respects."  Or suppose the closing condition only required representations or warranties to be true and correct in all material respects.  In either case, arguably the $2.37 misstatement would be deemed immaterial in the context of a $50 million transaction, and if BigCo wanted to walk the deal, it would be forced to try to find another reason to do so. 

Likewise, if TargetCo had added a materiality qualifier to the representation and warranty regarding the accuracy of its financial statements, or if the indemnification provisions of the APA included a materiality qualifier, TargetCo could avoid being sued for a breach of the APA as a result of the financial statement error (again, assuming the $2.37 misstatement was indeed immaterial with respect to the transaction).