The United Kingdom and United States are two of the world's largest markets for private company mergers and acquisitions. Similar legal principles in each market mean that substantially the same protections can be negotiated for a given transaction in each market but there are marked differences in practice which can be relevant to considering which law is suitable to govern an international transaction and what may be acceptable to a UK or US party participating in an international transaction.
The key difference in market practice relates to risk allocation. Under the UK market paradigm economic risk is considered to pass from a seller to a buyer at the time of executing a share purchase agreement ("SPA") whereas, under the US market paradigm economic risk is considered to pass upon completing the acquisition of a target company. This difference is reflected in the degree of deal certainty, the approach to pricing mechanisms and the scope for post-acquisition liability under an SPA seen in the UK and US markets.
In the UK market, company acquisitions customarily proceed on a "certain funds" basis whereby a buyer must be able to demonstrate the availability of acquisition finance with very limited scope for lenders to refuse to fund on completion of the acquisition. While a number of mechanisms are adopted in the US market to provide assurance as to the ability of a buyer to be in a position to fund the acquisition of a company at completion, the obligation to complete is often subject to greater conditionality than is encountered in the UK market.
Reflecting the risk shifting paradigm in the US market, company share acquisitions are customarily subject to a wider range of conditions than in the UK market. US sellers will typically at least agree to conditions that:
- the seller warranties are true at completion of the acquisition of the target company;
- the seller has (materially) complied with its contractual covenants;
- the target company has not suffered a material adverse change to its business; and
- all mandatory competition and other regulatory authority approvals triggered by the transaction have been obtained.
By comparison, consistent with economic risk passing upon entering into an SPA, UK sellers will often only accept conditions required by law or regulation. Material adverse change conditions are commonly proposed by buyers in the UK market but are not accepted by sellers to the same extent as in the US market. The accuracy of a wide selection of warranties as a condition to completion of the acquisition of a target company is very uncommon in the UK market and a condition that the seller must have complied with its contractual conditions is anathema to most UK sellers.
In the UK market, it is common (although by no means universally the case) that parties will agree to a fixed price specified at the time of entering into an SPA (referred to as a "locked box") which is only adjusted in respect of any impermissible leakages from the locked box.
By comparison, it is customary in the US market for accounts to be drawn up as at completion in accordance with negotiated policies and procedures based upon which the price paid at completion will be adjusted to reflect the true price of the target company. This completion account procedure provides opportunity and incentive for price-negotiation between the parties after completion which can prove to be expensive and time consuming.
Parties to acquisitions in the UK and US markets commonly negotiate a wide range of warranties but the scope of post-acquisition liability can differ in a significant respect. Private equity sellers in the UK market, for example, regularly succeed in not having to give warranties in respect of the target company's business. This is not necessarily a consequence of the risk paradigm underpinning market practice in the UK and US but does require buyers in the UK market to focus on due diligence and has resulted in the development of a market for warranty and indemnity insurance as a means for buyers to protect themselves.
Consistent with the economic risk shifting paradigm, SPAs in the UK market customarily contain more extensive pre-completion operating covenants than in the US market. By subjecting a seller to a wider range of contractual obligations, with the prospect of a claim for damages in the event a seller fails to comply, the buyer seeks to preserve the negotiated value of the target business until it is legally transferred at completion.
One notable difference in the approach to post-acquisition liability is that recovery for a breach of warranty is ordinarily on an "indemnified basis" in the US market. Arguably this arises as a consequence of ensuring that a victorious party in a dispute in the US market is able to recover the associated attorneys' fees rather than due to any economic risk shifting paradigm. However, the issue can cause some initial confusion for US buyers participating in transactions in the UK market where an "indemnification" provision customarily included in a US SPA does not arise and UK sellers asked to give warranties on an "indemnified basis" will commonly retort that a buyer ought be required to "prove their loss".
This difference in UK and US market practice with respect to indemnification often, however, may not prove to be substantial. Subject to the scope of the definition of "loss" included in a US SPA, buyers in the UK and US markets will be compensated for a loss in the profitability of the company as a consequence of the breach of warranty. However, as a result of recovery for breach of warranty in a US SPA being on an indemnified basis, a buyer may also recover for a balance sheet shortfall that does not impact the profitability of the target business and so would not be considered to result in a diminution in the value of a target company. Consequently, in circumstances where a buyer wants post-acquisition recourse in respect of particular warranted assets, US market practice is generally regarded as being more "buyer friendly". While there is nothing to preclude a buyer in the UK market with a strong negotiating position securing specific protection in respect of particular warranted assets on an indemnified basis, such an approach is not often encountered.
The differences in market practice cause the UK market to be regarded as generally being more "seller friendly" and so, where there is a choice of governing law, potentially more suitable for an auction process. US buyers faced with such an approach may benefit from adapting their expectations accordingly.
Simon J Little is a Counsel in the London M&A group of Shearman & Sterling (London) LLP where he advises clients on public and private mergers and acquisitions, particularly cross-border transactions, joint ventures and general corporate matters. He is admitted as a solicitor in England and Wales and as an attorney in the State of New York.
The views expressed in this article comprise a general discussion of the relevant issues, should not be regarded as legal advice and are those of the author alone and not of Shearman & Sterling (London) LLP.