This acquisition note has been prepared for French businessmen and their French legal counsels who are already familiar with French acquisitions and desire to become acquainted with some of the differences when the target company is a company in the United States.
There are two basic ways to acquire a business in the United States. One way, if the business is a corporation, is to purchase at least a sufficient number of outstanding shares to acquire working control of the business. The other way is to purchase enumerated assets of the business. The form of acquisition has significant tax ramifications, certain of which are discussed at the end of this document.
In a French or American stock acquisition, the problems are generally similar:
- are the assets really worth the negotiated price?
- are there undisclosed or unknown liabilities (tax, potential litigation, environmental, etc)?
- how will indemnities be assured, if the representations and warranties are incorrect?
- can key employees be retained?
- will cost effective non-compete protection be available?
- if there are minority shareholders, should they be offered the same sale opportunity as that to be
- offered to the controlling shareholder?
Audited Financial Statements and Due Diligence
Many closely held American companies will not have audited financial statements and, even if they do exist, they may only provide an approximate understanding of the liabilities. Accordingly, a potential buyer will normally wish to cause the target to sign a letter of intent whereby it agrees not to “shop” the deal to others for a period as long as 6 months while the buyer:
- conducts its legal and accounting due diligence and
- seeks to negotiate the price and other terms and conditions of the sale, once significant progress on the due diligence has been achieved.
Contingent Legal Liabilities
Even if the target company has no pending litigation, the hidden or unidentified danger of litigation could be greater than the net worth of the target company. For example, “excessive” jury verdicts in millions of dollars for punitive or consequential damages are not unknown in the fields of:
- alleged age, race or sex discrimination suffered by management and non-management employees,
- personal injuries resulting from allegedly defective products, even if the injury is suffered in the future, and
- commercial damages resulting from allegedly defective products or services.
(See Les contentieux commerciaux avec les américains : comment éviter d’être attaqué aux Etats-Unis.)
The buyer will need to:
- understand the scope of the target’s existing liability insurance coverage,
- determine which disclosed claims are adequately covered by insurance,
- obtain contractual representations, warranties from the selling shareholder(s) that such contingent liabilities do not exist or, in the aggregate, they will not exceed a certain amount.
Then, a portion of the purchase price should be placed in escrow for an appropriate period of time and/or the buyer needs to obtains personal or bank guarantees. (As an alternative, as the United States tax code permits capital gains treatment on installment payments, installment payments over several years are often used as a form of escrow.)
(Naturally, such contractual representations and warranties are much broader, but the European purchaser needs to recognize the unusual litigation risks not generally encountered in other countries.)
As the selling shareholder(s) would expect to obtain such protection, if the roles were reversed, such protection is negotiable and achievable.
Employees in the United States are far more mobile than employees in France. Thus, key employees need to be identified and possibly offered “golden handcuffs” prior to the signing of a stock purchase agreement. On the other hand, most States provide that employees are “employees-at-will” who can be discharged on short notice without severance benefits, at least so long as the discharge is not challenged as hidden age, race or sex discrimination.
Unless the Certificate of Incorporation. the By-Laws or a preexisting shareholders agreement of the target specifically provide otherwise, control of the company is generally conferred on the holder of 51% of the stock, as the concept of a “minorité de blocage” does not generally exist.
However, as under French law, a majority shareholder has a duty not to self-deal at the expense of the minority shareholders. If the potential buyer is not willing to offer the existing minority shareholders the same per share purchase price as that offered to the selling shareholder, the fact pattern must be examined with care with American counsel so as to avoid litigation.
Due to the difficulty of quantifying contingent liabilities, unless there are important tax loss carry-forwards or franchise or liability insurance transfer benefits to a stock acquisition, the preferred form of acquisition in the United States is generally an asset acquisition. Among the benefits are:
- 100% control of the new company,
- non-assumption of many (but not) all liabilities of the seller. (In certain states, the purchaser in a bulk transfer of assets may be held liable for personal injuries resulting from defective products previously manufactured by the seller, even if the injury is suffered in the future!),
- purchase obtains a step-up in the tax basis of the assets.
On the issue of non-assumption of liabilities, American buyers are familiar with the Bulk Sales Act (Article 6 of the Uniform Commercial Code) which requires the buyer of substantially all of the assets of certain types of businesses to notify creditors of the proposed sale, if the buyer wishes to avoid becoming liable for certain liabilities of the seller of the assets.
However, it is not uncommon for the buyer to agree to waive its rights under the Bulk Sales Act, as the seller and the buyer both fear that such notices will generate litigation or destabilize key suppliers. It behooves the French buyer to only agree to such waiver, if the indemnity rights and post-closing guarantees are adequate.
If the potential off-balance sheet contingent liabilities are potentially larger than the escrow and solid identity undertakings, the buyer of assets may also wish to create a new company to hold the acquired assets in a new shell company, thereby seeking to protect the assets of the parent company in France. If such strategy is deemed appropriate, it will be important that the new American subsidiary be operated in an arm-length basis so as to minimize the danger of creditors seeking to pierce the corporate veil (a complex issue in itself). In addition, a separate United States subsidiary is generally advisable to simplify and significantly reduce the accounting costs of the Federal and State tax returns.
From the respective points of view of the seller in United States and the buyer, stock and asset acquisitions will have different tax consequences. It is therefore important that the French buyer understand this issue before trying to negotiate a purchase price and even before the negotiation of a letter of intent.
For example, when stock of a corporation is purchased, the assets of the business, for tax reporting purposes, will retain the value at which they historically have been carried on the books of the business (“book value”). If the assets are serviceable but more than a few years old, book value will probably be considerably less that the real value of the assets. This will limit the ability to get future tax deductions for depreciation and could result in taxable income if and when the assets are sold for fair market value.
When assets of a business are purchased, the purchase price for the assets as set forth in the acquisition agreement will be used as the initial book value of the assets. This will enable the purchaser to value the assets on its books at what often is a higher amount than the seller’s book value. The purchaser can then take better advantage of depreciation rules to decrease income tax obligations and realize less taxable income upon a sale of the assets are sold.
The negotiations and the agreements
United States stock or asset purchase agreements are complex and no prudent buyer will even commence negotiations unless and until it has a local legal and accounting advice to help formulate the negotiating strategy. Any European contemplating his first acquisition in the United States should also consider reading a leading book on the subject: Anatomy of a Merger – Strategies and Techniques for Negotiating Corporate Acquisition by James C. Freund (Law Journal Seminars-Press, New York, New York).
|Michael G. Wolfson
Member of the Bar of the State of New York
| Jonathon Wise Polier
Member of the Bars of New York State and Paris