M&A Vocabulary – Understanding Experts: “Closing Conditions”

M&A Transaction Process

The process of an M&A transaction can typically be divided into several phases, regardless of whether a share or asset deal is being negotiated. At the outset, topics such as target valuation, due diligence, determination of the price or mechanism for establishing the final purchase price, and ancillary agreements such as exclusivity or confidentiality agreements are usually addressed. A Share (or Asset) Purchase Agreement is then negotiated and signed (signing). The negotiated purchase agreement essentially contains the obligation to transfer the object of purchase in exchange for payment of the purchase price, as well as the conditions under which this is to occur. In straightforward transactions, the signing—i.e., entering into the contractual obligation to transfer or pay—and the subsequent phase, namely the payment itself and the transfer of ownership of the object of purchase (closing), can take place on the same day.

Purpose of Closing Conditions

In other and more complex transactions, the ultimate success and feasibility of the transaction is determined by external and internal factors, some of which the parties can influence themselves and some of which they cannot. The following processes can be cited as examples:

• Antitrust or other necessary regulatory approvals;
• Repayment, renegotiation, or confirmation of bank financing;
• Waiver of preemptive rights by existing minority shareholders;
• Practical preparation of integration measures with regard to the target company.

This then leads to a time gap between signing and closing being necessary to give the parties time to complete the outstanding requirements. It may also be the case that certain processes can only be initiated after the purchase agreement has been signed, or that a party is only willing to take the appropriate steps once the contractual obligation to complete the transaction exists.

Fulfillment or Non-Fulfillment

A (pre-)closing condition is therefore a requirement of the purchase agreement that must be fulfilled by one party for the closing to occur. If it is not fulfilled, the other party is usually not obligated to fulfill its obligations as part of the closing.

Normally, it is in the seller’s interest to define as few closing conditions as possible so that the completion of the transaction and thus the payment of the purchase price is not jeopardized. A risk-averse buyer, on the other hand, will insist on as many and as detailed closing conditions as possible in order to minimize legal, commercial, or operational uncertainties surrounding the transaction.

Clearly defined closing conditions should clearly regulate the fulfillment process, for example by specifying how the occurrence of fulfillment is to be documented. It is also common to grant the party that does not have to fulfill the closing condition the right to declare a waiver if the interests have changed in the meantime or a risk has been minimized in another way. It is also common, as part of a waiver, to convert a pre-closing condition into a post-closing condition, i.e., to postpone the time of fulfillment to the period after closing.

Common Issues

As with all contracts, the clear definition of the rights and obligations of the parties is of paramount importance.

This includes in particular the treatment of the scenario in which a closing condition has definitively not been fulfilled and the transaction must be terminated and the purchase agreement unwound:

• Which party has the right to terminate?
• What are the legal consequences of termination?
• What happens to costs and expenses already incurred?
• Does the party that was unable to fulfill a closing condition become liable for damages?
• What practical steps are required to unwind the transaction and who must take them?
• What happens if one party has acted in bad faith to prevent the other from fulfilling a closing condition?

In summary, it can be stated that properly formulated closing conditions are an indispensable tool in structuring the process of a transaction and also the allocation of risk between the parties. Poorly conceived closing conditions can lead to the unnecessary termination of a transaction and—worse—to an expensive and time-consuming unwinding.

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