Company for SaleIt is probably clear to everyone who follows our blog consistently that we truly believe business teams in middle-market companies should be empowered to wade through many contract negotiations on their own. Negotiating the sale of your company is not one of them.

The sale of your company is a major, and probably the ultimate, transaction for any business owner.  In addition to having many opportunities to generate a higher total payment, the sale of your company, regardless of the value of the company, may come with many potential and unexpected liabilities. You don’t want to be that sucker who is left holding the bag when the buyer negotiated a deal that gives it all the upside with plenty of downside protection.

As the owner of a middle-market company, you should expect your attorney to help put more money in your pocket for the sale of the company by advising on the following:

  • the structure of the sale (e.g., a stock sale versus an asset sale versus a merger);
  • ways to bridge valuation gaps by way of an earn-out, royalty fee on retained assets, rolling over seller stock into buyer stock, creative tax structuring or other mechanisms;
  • negotiation of post-sale continued involvement in the company through employment agreements, consulting terms, or additional perks such as health care premiums or paid expenses; and
  • minimizing taxes paid on the sale by ensuring a tax-efficient structure, an appropriate purchase price allocation and consideration of all other tax implications that will affect your post-tax proceeds.

The risks to you as a seller of your middle-market company are at times even greater than your upside.  This is unfortunately even more accurate when the buyer has an attorney but the seller does not have one.  Some of the risks that we protect our clients against include the following:

  • permitting the buyer to hold back sales proceeds (i.e., retained by the buyer) rather than placing them in escrow with an independent escrow agent;
  • leaving more funds than necessary under the circumstances in escrow and for longer than necessary;
  • costs and fees of obtaining third party consents or transfer taxes;
  • handing over cash (pretty close to literally) because of the purchase price adjustment mechanism and agreed-upon working capital target;
  • giving broad representations and warranties without limiting them to those specified in the agreement rather than any oral statements;
  • taking on all costs related to employees’ terminations;
  • uncapped indemnification on all representations and warranties rather than on certain limited ones;
  • allowing potential liability for breaching representations and warranties to remain outstanding longer than necessary;
  • proper handling of protected customer data (especially if in the health care and financial services industries);
  • assuring that the buyer lives up to its promises if it assumes obligations, such as lease payments or warranty obligations; and
  • giving too broad of a right to set off future payments against obligations (including disputed obligations) owed by the seller to the buyer.

As you can tell, we just need a chance to work a little magic and protect you where it can hurt the most.  For attorneys like us who deal with these issues on a regular basis, it is straightforward to negotiate these issues on behalf of our clients. It is not that straightforward for business owners and executives of middle-market companies who do not have the same experience. Therefore, when entering into a life-changing transaction, such as the sale of a company, middle-market companies should engage good, experienced M&A counsel.  It will make the transaction easier and more likely to close while increasing the post-tax dollars and lowering the risk for the business owners.

We are back to finish up our list of top ten commercial contract terms that middle-market companies should negotiate, which we started in Part I and Part II.  These commercial contracts terms are ones that are commonly overlooked but very important.

#7 – Governing Law and Venue

The governing law provision will determine what law will be used to interpret the contract. Please don’t use the law of a jurisdiction that has nothing to do you with the contract or any of the parties to the contract.  It will not be enforceable.

In certain situations, the choice of governing law may have important implications.  The importance of the governing law provision depends on the type of contract being negotiated and certain provisions that may be included in the contract.  For example, a company that wants an employee to agree to a non-compete likely wants the laws of a state other than California to apply, which may be difficult in some situations.  Often, a company based in California cannot select the law of another state to govern a non-compete. That being said, at times, even a company based in California could get away with it but, hopefully, you don’t get yourself in trouble with an unenforceable non-compete for a California employee.

The venue provision will determine where a party to the contract can be sued by the other party.  If you love traveling to remote places or someone else’s home field, then feel free to ignore the venue provision. Otherwise, make sure that you agree to a venue provision that is convenient for you and makes sense from a legal perspective.  Also, remember that the parties cannot select just any venue – it must be one permissible under applicable laws.  You always have the option of not including a venue provision, in which case the party commencing the lawsuit can, subject to certain legal limitations, file the complaint anywhere.

#8 – Assignment

The assignment provision in a contract will either permit or not permit one or both parties to transfer the contract to an unrelated party.  If the contract says nothing about an assignment, then it can be transferred to another party.   The key thing to keep in mind is that you always want to have the right to transfer the contract to an affiliated company or when you sell the company.  If you do not negotiate for that right, which is typically not difficult, then you limit your rights down the road in ways that can be costly.

Don’t let fancy lingo trip you up.  You may see references to both “assignment” and “change of control” in the contract. They have different meanings.  An assignment means that the company directly transfers the contract to another party.  A change of control means that someone who controls the company transfers his or her ownership in the company.  Only under limited circumstances, such as when a company is essentially a one-man (woman?) show and the other party needs that person to be involved, would it make sense to have a change of control provision. If you are that one person, then avoid agreeing to it.

#9 – Attorneys’ Fees

The attorneys’ fees provisions is a two-edged sword – a sharp and potentially expensive sword. An attorneys’ fees provision will typically state that the person who loses litigation over something in the contract will pay the attorneys’ fee of the other person (in addition to other costs incurred).  If that provision is not in the agreement, then each party, regardless of who wins the litigation, will pay for his or her own fees.  Since we assume that all our readers and clients are awesome, perfect people who would never do anything wrong, we recommend including an attorneys’ fees provision in all your contracts.

#10 – Entire Agreement

The entire agreement provision (also referred to as an integration provision) is maybe the most boring of all provisions in a contract.  However, it is important.  Most people think that getting an email or verbal commitment from another party to a contract is meaningful in court but that is rarely the case.  The purpose of the entire agreement provision is to address that exact situation and ensure that a court will not look at any communications (whether in writing or orally) that occurred before signing the contract.  The email that you were so happy to receive is of no value! Most contracts have entire agreement provisions. Therefore, make sure that any agreement you have with another party ends up in the contract.

So, has our three part series on the top 10 commercial contract terms to negotiate taught you anything?

Because we are lawyers and write too much (you should not have expected anything else from us), we could not finish our list of top ten commercial contract terms to negotiate in Part I.  So, we are back with more.

#4 – Indemnification

After the business terms, the indemnification provisions in your contract may be the most important provisions in your contract.  When you agree to indemnify the other party, you are telling that party that you will reimburse him or her for money coming out of his or her pocket because of something that you or another party has done or failed to do.

Although indemnification provisions can be drafted in many ways, they are generally very broad and cover any “losses” that are in any way connected to your contract.  The indemnification provisions typically also include a requirement that you defend any claim that may result in your obligation to reimburse the other party.  Your goal is to:

  • limit the amount of your liability (commonly by stating that you will never need to pay the other party more than a percentage of fees received from that party);
  • limit the type of liability (by stating that you will not need to reimburse the other party for any indirect, consequential, incidental, punitive and special damages, including lost profits, lost revenues, diminution in value, etc.);
  • limit the other party’s time to ask for reimbursement (commonly by requiring that they ask within a set period of time); and
  • give yourself the right to defend against and settle a claim of a third party (rather than letting the other party choose how it wants to defend a claim or for how much it settles a claim, for which you will be reimbursing the party).

#5 – Failure to Live Up to Contract

All the most favorable provisions to you in a contract will do you no good if you cannot do anything about the other party’s failure to live up to the terms of the contract.  You want to leave yourself with options if the other party does not live up to expectations.  Of course, you may not actually use any of those options if the relationship with the other party goes bad but it is still beneficial to have options because it gives you leverage out of court to reach an agreement with the other party.  If it turns out that the other party’s actions did harm you significantly, then you will be happy to be able to do something about it.

You want to keep an eye out for anything that will limit the amount of money you can recover from the other party.  Similarly, you would want to ensure that you are not only prohibited from collecting money from the other party in a manner not specified in the contract, which may be referred to as the “sole remedy” or “exclusive remedy,” or waive your rights to certain types of payments to which you may be entitled, which may be referred to as a waiver of “consequential damages,” “special damages” or “incidental damages.” If the other party breaches a confidentiality provision, then you want to have the right to get a court to force the other party to stop sharing confidential information rather than being limited to the unsatisfactory rights in the contract.

#6 – Termination

Consider what society would be like if you could get married but could not get divorced and begin having screaming matches with your spouse multiple times a day.  It would be equally disastrous (alright, maybe a little less than equally disastrous) for a party not to give himself or herself an out when a contractual relationship worsens.  So, say hello to the termination provision.

The termination provisions in a contract will set out the circumstances when you or the other party has the right to end the relationship.  Your primary concern is making sure that the other party cannot end the relationship at any time, for any reason, and to make sure that you have that right if you expect to have it.

After you have overcome your primary concern, you should keep an eye out or negotiate for other common termination triggers:

  • a breach of the contract (though you may want to limit it to material breaches and consider a parties right to fix the breach);
  • insolvency; and
  • failure to achieve targeted milestones.

Regardless of your right to terminate the agreement, the relationship you have, including any future dealings you expect to have, with the other party should drive whether those termination provisions are ever put to use.

Nobody likes paying legal fees to have contracts reviewed, and we get it. For that reason, we figure our best option is to get you focused on contract terms that really matter when you get into DIY contract negotiations. Let’s talk about the ten terms in commercial contracts that you should negotiate. That way, when you choose not to hire us, you hopefully never need to hire our litigation colleagues.

#1 – Business Terms

Everyone loves a good checklist. Take out your mental or written checklist of business points you want in the contract. Walk through the contract and make sure that all of those points are included. More importantly, you will want to make sure that you have captured all of the business points you want in your contract – how much you will be paid, how you will be paid, when you will be paid, when you need to deliver products or provide services, how those products will be delivered or the services will be provided, what needs to happen before either party needs to act, what happens if a party does not act as required, etc.

Keep in mind that as you negotiate or choose to accept legal terms in the contract, you may need to budge on some business terms to get your way on important legal terms. Figure out which business terms and legal terms are important to you and stick to your guns, then give in on the others if necessary to get the contract signed.

#2 – IP Protection

We all love gold. If we had bricks of gold, then we would protect them. We would likely put them in a vault. If we needed to show the vault to someone, then we would want to investigate the person, put procedures in place to ensure that no gold is taken out of the vault without our permission and figure out what to do about it if any gold was removed. IP, to many companies, is gold. It just happens to be invisible gold. You should treat your IP as you would physical gold. So, whenever you have a business relationship that will give another party a glimpse at your IP, try to understand that other party’s history and make sure you have a contract that protects your IP as well as (or better than) a vault protects gold.

Your contract, at a minimum, needs to make clear that you will at all times own the IP, put procedures in place for making sure any new IP becomes your IP, prohibit sharing your IP with a third party and make sure there are no limits on your right to recover harm done to you if your IP is stolen.

#3 – Representations and Warranties

Representations and warranties are statements and assurances that you make regarding events or facts. Representations and warranties are important because they tie to indemnification and termination rights. For example, if a contract represents and warrants that you have the best product in the world (which, by the way, we have no doubt that you do) and it turns out that another product is better, then the party making the representation and warranty has breached the agreement.

It is common to think that because both parties know a representation or warranty is not entirely accurate it is okay for it to be inaccurate. It is also common that the party making the representation or warranty thinks everyone understands it to mean one thing regardless of the meaning of the words. Both of those thoughts are wrong. The words are the only things that can be counted on if an argument ever arises and any unwritten understandings at the time of the agreement go out the window. Make sure the representations and warranties say only what is completely accurate. If they are not completely accurate, then change them to make them completely accurate.