In mergers and acquisitions (M&A), covenants are critical contractual provisions that outline specific obligations and restrictions for the parties involved. These clauses ensure that both buyers and sellers adhere to agreed-upon behaviors, safeguarding the transaction’s integrity from signing through closing and beyond.
Defining Covenants in M&A
Covenants in M&A agreements are promises made by the parties to either undertake certain actions (affirmative covenants) or refrain from specific activities (negative covenants). They are designed to maintain the value and operational stability of the target company during the interim period between signing and closing, and sometimes post-closing.
Types of Covenants
1. Pre-Closing Covenants
These covenants govern the conduct of the target company between the signing of the agreement and the transaction’s closing. Common pre-closing covenants include:
- Ordinary Course of Business: The seller agrees to operate the business as usual, maintaining consistent practices and avoiding significant changes without the buyer’s consent.
- No-Shop/No-Talk Provisions: The seller is restricted from soliciting or engaging in discussions with other potential buyers. However, public company boards may retain a “fiduciary out” to consider superior proposals if required by their fiduciary duties.
- Access and Information Sharing: The seller must provide the buyer with reasonable access to information and personnel for due diligence purposes, ensuring transparency and facilitating a smooth transition.
2. Post-Closing Covenants
These covenants apply after the transaction has closed, aiming to protect the buyer’s interests and ensure a seamless integration. Examples include:
- Non-Compete Agreements: The seller agrees not to engage in competitive activities for a specified period and within a defined geographic area, protecting the buyer’s newly acquired business.
- Non-Solicitation Clauses: The seller is prohibited from soliciting the target company’s employees or customers post-closing, preserving the buyer’s workforce and client base.
- Confidentiality Obligations: The seller must maintain the confidentiality of proprietary information, safeguarding trade secrets and sensitive data.
Importance of Covenants in M&A Transactions
Covenants serve several vital functions in M&A deals:
- Risk Mitigation: By restricting certain actions, covenants help prevent value erosion and unforeseen liabilities.
- Operational Continuity: Affirmative covenants ensure that the target company maintains its operations, preserving its value until the transaction closes.
- Legal Protection: Covenants provide legal recourse if a party breaches the agreement, allowing for remedies such as indemnification or termination.
Notable Examples from M&A Deals
While specific covenant details are often confidential, some high-profile cases illustrate their significance:
- AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC: In this Delaware case, the court examined whether the seller breached the “ordinary course” covenant by making operational changes during the COVID-19 pandemic. The court held that the seller’s actions were inconsistent with past practices, justifying the buyer’s termination of the agreement.
- Anthem-Cigna Merger: The failed $54 billion merger between Anthem and Cigna highlighted the importance of “hell or high water” clauses, which require parties to take all necessary actions to obtain regulatory approvals. Disputes arose over each party’s efforts, leading to litigation and the deal’s collapse.
Conclusion
Covenants are fundamental components of M&A agreements, delineating the responsibilities and limitations of the involved parties. By understanding and carefully negotiating these provisions, buyers and sellers can facilitate smoother transactions, protect their interests, and minimize potential disputes.