Friday, 30 October 2015

SPA Series Part 9: How to Negotiate M&A Deals in Finland - Escrow Arrangements, Set-Off and Other Similar Tricks

It is once again time to continue our blog posts, and this time we have chosen a topic that surely interests most of those involved in M&A deals, namely escrow arrangements.

As many of you know, escrow agreements aim to secure buyer's right to monetary compensation in case of claims and to provide protection for the due fulfilment of the seller's post-closing obligations. Typically, this protection is needed after the seller has already received his or her compensation, as without an escrow or similar arrangement the seller could comfortably lay back and say "if they (the buyer) want their money, let them sue me, and let the buyer work for his or her money”. 

Before going into more detail on escrow agreements, let us take a bit wider view on the matter and see what possibilities a buyer has in this regard already in the SPA that does not refer to an escrow arrangement. In any case this issue has been discussed in all our deals at TRUST and included in one form or another in the documentation.

As it often happens in real life, the buyer might predict already in the negotiation phase that there could be problems in the future requiring him or her to present a claim for monetary compensation to the seller. Here the question naturally is: how could the buyer consider these? 

Obviously, one possibility is that the parties agree on some deferred payments on top of the initial cash component, where the initial cash component would be payable upon closing and the deferred payments later on, in which case the buyer would merely set-off his or her claims against such deferred payment. However, as is well known, set-off is not always available as it requires, among others, mutual claims and that both amounts (the payment of the purchase price and claim) have fallen due, which is not always the case. For instance, there might be a situation where a part of the deferred payments should be paid within the near future but at the same time the buyer sees that there are several potential claims resulting in liability for the seller, which are not yet due. To avoid the problem, it might be advisable for a prudent lawyer representing the buyer to try to expand the scope of set-off a bit in the SPA, e.g., as follows: 

"If at the time any deferred cash price or earn-out purchase price is or will be due to be paid to any of the sellers, any claim or receivable by the buyer against any of the sellers under this agreement (such claim a "Counter-Claim") may be set off by the buyer or withheld by the buyer until the Counter-Claim becomes due and payable in respect of such Counter-Claim. The sellers hereby waive all their rights to receive such deferred cash price or earn out purchase price up to the amount of the withheld amount (until settled) and, in case of set-off, up to the actual set-off amount. Any withheld sum under this Section shall not carry interest..."

Here, the buyer expands the scope of set-off by adding a right to withhold, enabling the buyer to wait until the preconditions for the set-off are present.

As regards traditional escrow arrangements, where a portion of the purchase price is delivered to a third party stakeholder, it usually comes down to the question of what would be the correct amount transferred to an escrow amount. Typically, the buyer, in whose interest the arrangement is usually made in the first place, wishes to have an as large an amount as possible in the escrow and for as long time as possible, while the view of the seller is quite the opposite.

Unfortunately, it is however often the case that there is no guidelines for determining the amount, unless there are elements in the case that support a certain level, such as identified risks and their possible monetary outcome if realized. In the absence of such specifics, one could always use figures that reflect the market practice, if available. As regards the term of the escrow, one could present a few general rules that are often accepted: 1) it is never longer than indemnification period; and 2)  one seldom sees periods significantly less than one year. Finally, an additional point to consider is whether the escrow amount covers all claims or only the representations and warranties in the SPA, but that is another matter subject to negotiations, and depends on the position and power of the parties in the negotiations.

To provide some guidance, let us briefly summarize the structure and content of a typical escrow agreement. 

Firstly, the background section could be, for example, as follows:

"The parties entered into a share purchase agreement on _________2015 (the "SPA") by which the seller has agreed to sell and the buyer has agreed to purchase shares in _______________.
Pursuant to the SPA it has been agreed that the escrow amount (USD 15,000,000) will be paid at closing into the escrow account with the escrow agent.

The escrow amount shall be held as collateral for partial satisfaction of the seller's obligations and potential claims against the seller and it shall be paid out by the escrow agent in accordance with the terms of this escrow agreement and the SPA.

This escrow agreement sets forth the terms on which the escrow agent will hold and administer the funds to be held in escrow pursuant to the SPA."

After background or the "WHEREAS" clauses, the agreement usually states that an interest-bearing escrow account shall be opened. Here one should pay attention to the fact that recently the applicable interest rates have been negative, and there have been interesting discussions whether one should actually pay something to banks, but typically banks have waived these negative interests. Who is entitled to interest is also of course relevant. A point which is evidently in the sellers interest as without the escrow, the money would "work for them", but also something that the buyer's typically do not present automatically in their first drafts. 

The technical release of the escrow funds is typically determined on the basis of the separate escrow agreement. In this regard, it is worth noting that it is definitely in the buyer's interest that the funds are released only upon joint instruction by both parties, thereby excluding the possibility of the funds being released automatically, e.g., on the basis of a certain time period having lapsed (regardless of, e.g., pending claims). However, there seems to be a trend that in any case banks are more and more reluctant to accept automatic releases and nowadays mutual release is often required. There might be variations between the banks, but this has been our experience from the past deals and this development naturally negatively affects the Sellers. 

When determining the time for releasing the escrow funds, it is typically in the buyer's interest to accept the release only after the audited annual accounts following closing have been prepared, and the time limits for presenting claims have lapsed (we will return to these time limits in our future postings, so we encourage you to stay tuned!).
In order to provide additional protection, the escrow account may also be subject to a pledge. A pledge may be recommended e.g. in in distressed deals where there might be financial difficulties lurking behind the corner, and a pledge would secure the release. Also, especially if mutual release applies, a pledge in the escrow account (tilipantti in Finnish) might prove to be handy depending naturally under what conditions such pledge may be realized.

To give you some more practical tips, the beginning of the pledge section might look, for example, like this:

"Effective as of the date of the closing, the seller as a continuing security for any claims and indemnities under the SPA hereby unconditionally and irrevocably pledges to the purchaser, as a first ranking security, all of its rights and interests in the escrow account, including the escrow amount.
At any time upon or after the issuance of an arbitration decision or any other binding and final judgment referred to in section X to the benefit of the buyer, the buyer may to the fullest extent permitted by applicable laws enforce all of its rights hereunder as well as any other rights which a pledgee may have under applicable laws, and for this purpose dispose of the escrow account, including the escrow amount (or any part thereof), in any manner at its discretion. The pledge created hereunder and all obligations of the seller in relation thereto shall continue in full force from the date of the closing until the closing of the escrow account..."

Hopefully this gives to you a good background on the matter and helps you navigate through tricky post-closing claims you might have in your pocket.

Splendid Autumn for everybody and I hope to see as many of you as possible in our house warming party on 12th November (remember to register from here!). See you soon!



Sunday, 18 October 2015

Liability of the Board of Directors in a Company Facing Economic Difficulties

TRUST's Parties' getting Closer 12 November 2015
Splendid autumn for everyone! At Trust, everything is going well and our house-warming parties are getting closer. If you have not received an invitation, do not panic, just check all your mail bozes and if you still do not find it, send me an e-mail ( and I will send to you an invitation. We have awesome artist playing like Anssi Kela,  Italian wines and good food - you do not want to miss this! 
To our real topic, as we have been advising some Boards lately in companies facing economic difficulties, I thought that I share a few words about this governance topic from director's liability point of few if it could also help others. Naturally this topic is requires further attention to details depending on the particular case, but at least this gives to you an overview of the different options. At the same time I must say that while my M&A blog has been on hold, but we have actually written a few additional posts so I will also publish those shortly.
If a company is going through economical difficulties, it has, in practice, three options: 1) to file for restructuring 2) to file for bankruptcy or 3) to continue its business operations. If the company has lost its equity, the company must notify this to the trade register without undue delay, and the management of the company has an emphasized duty of care. Failure to file the notification has not been deemed a very significant matter in the court praxis regarding directors’ liability, but it is more important what actions the board takes, if the company is in economic difficulties and whether such actions lead to an increased debt burden or weaken the position of the creditors. Consequently, the management is under an obligation to take active measures to correct the situation or to improve the financial position of the company. If they fail to do so, they should generally file for insolvency proceedings. This is important, as continuing the business without corrective actions may lead to personal liability of the members of the Board of Directors of the company as well as that of its other management (including the CEO). Therefore, the management of a distressed company should be extremely alert in the event of loss of equity and other financial difficulties.
The purpose of this memorandum is to outline, at the general level, these possible liabilities under the Finnish law, and the different options a company not having adequate financing or capital could have, without providing an overall understanding of the matter or going too much into detail.
Liability of the Board
According to Section 23 of Chapter 20 of Limited Liability Companies Act (the “Act”), if the Board of Directors of a company notices that the company has negative equity, the Board shall at once make a register notification to the trade register on the loss of share capital. The purpose of such notification is to bring the economic situation of the company to the attention of the company’s debtors. If the Board neglects the notification, this might lead to the personal liability of the company’s Board of Directors and management under Section 1 of Chapter 22 of the Act, if a debtor or another contracting party suffering credit loss can show that it would not have given credit to the company had it known of the loss of equity. The referred Chapter stipulates the following:
“Liability of the management
(1) A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall be liable in damages for the loss that he or she, in violation of the duty of care referred to in chapter 1, section 8, has in office deliberately or negligently caused to the company.
(2) A Member of the Board of Directors, a Member of the Supervisory Board and the Managing Director shall likewise be liable in damages for the loss that he or she, in violation of other provisions of this Act or the Articles of Association, has in office deliberately or negligently caused to the company, a shareholder or a third party.
(3) If the loss has been caused by a violation of this Act other than a violation merely of the principles referred to in chapter 1, or if the loss has been caused by a breach of the provisions of the Articles of Association, it shall be deemed to have been caused negligently, in so far as the person liable does not prove that he or she has acted with due care. The same provision applies to loss that has been caused by an act to the benefit of a related party, as referred to in chapter 8, section 6(2).”
Furthermore, in order to prevent inappropriate and damaging business and to maintain confidence in the business, among others, a person involved in the management of a company (for example as a member of its board) may be imposed a ban on business operations under the Finnish Act on Ban on Business Operations. This requires that the person in question has essentially failed in performing his statutory obligations related to the business, or if he is found guilty of criminal procedure that cannot be considered minor. It is also required that his activities as a whole are regarded as detrimental to the creditors, contractors, public finance, or sound and effective economic competition. The ban prevents its subject from, e.g., engaging in business activities for which the Accounting Act provides for an accounting obligation, being a partner of a general partner or a limited partnership's general partner or a member of the board of a company, as well as establishing a limited liability company, or otherwise to acting in a comparable business operations position. The duration of the ban varies between 3 to 7 years.
If a company’s financial difficulties turn into permanent insolvency, then the company should file for bankruptcy. Some pressure to make the appropriate filings is created by the fact that continuing to run the business of an insolvent company may be deemed as debtor’s dishonesty under Section 1 of Chapter 39 of the Criminal Code, in relation to which the punishment varies between a fine and 2 years of imprisonment. Therefore, it is not recommended to wait that a creditor files for the bankruptcy of the debtor company – at least not for a very long time. The decision on filing for bankruptcy is made by the Board of Directors with simple majority.
Also, according to Section 12 of Chapter 4 of the Credit Data Act, which is applied to registers to which credit data companies enter credit data, which they then provide to others (usually against payment), the credit data registers are entitled to enter information regarding a person’s participation in companies, as well as these companies’ payment default situation, bankruptcy, and similar economic situations. The entry regarding bankruptcy may be in the register for a period of five years. Furthermore, as stipulated in Section 27 of Chapter 6 of the same act, this information may, subject to the fulfillment of specified requirements, be used in the credit rating of a company in which that person is involved. It is our estimation, however, that these requirements would not be fulfilled in the case at hand with the assumption that the company has been up and running for several years and its accounting has been made and filed appropriately. On another note, it is possible that this information be used also in other relations, such as when establishing a new company, or when applying for a personal loan, etc. as the information is publicly available to any interested party.
Restructuring of Enterprises
To the extent the company is in a position to be rehabilitated and it fulfills the requirements under the Restructuring of Enterprises Act, the company could, instead of bankruptcy, file for restructuring. This could be recommended if the debtor company’s business is profitable, but it has so much debt that it cannot pay them in the agreed schedule. The restructuring proceedings creates costs, and thus is not recommended if the company is for example very small.
A member of the Board of Directors of a company going through economical difficulties should pay special attention to the company making the appropriate filings an taking the necessary actions in accordance with the above and also otherwise actively act with due care in fulfilling his or her obligations as outlined above. Continuing the business without corrective actions and/or otherwise not acting as required by the law may lead to personal liability of the members of the Board of Directors of the company as well as that of its other management (including the CEO). Next we continue with M&A themes, but hopefully we meet in our parties so see you there!