Serial article regarding M&A on NNA (vol.103)

Continuing from the previous articles, this article looks at cases where actual events identified as a result of due diligence to be a problem.

Contractual Matters

It is neither practical nor necessary to review all of contracts. It is common to focus on crucial ones, such as contracts with customers, suppliers, vendors, etc., which has top 10 transactions; lease agreements which are especially needed for managing factories, offices, or warehouses; continuous supply agreements for a certain period; master transaction agreements that are premises of individual agreements. In DD, lawyers prepare a sheet for each type of contract on a spreadsheet, list the names of clients on the vertical axis and the items to be reviewed on the horizontal axis, and complete the sheet with necessary information while conducting the review. It would be fine if all the items that need to be reviewed are covered from the beginning, but sometimes the items to be reviewed added in the process afterwards. In such cases, lawyers need to review all the contracts for those items again from the beginning.

In contractual matters, especially the change-of-control clauses, which we have discussed in previous articles, can be a problem in M&A. This means, if there are any crucial changes in the ownership of one party, the other party is granted the right or status of terminating the contract and forfeiting of benefit of time. This is commonly stated in loan agreements with financial institutions, and master transaction agreements with major clients, etc. For example, if a parent company, a Japanese head office, guarantees its overseas affiliated company’s borrowings from financial facilities, you must pay attention because its contact of guarantee always contains the change-of-control clause in it. If a buyer of that overseas affiliated company is existing customer of that financial institution, or a listed company with high creditworthiness, replacement of the contract of guarantee with the buyer would be permitted (the buyer becomes the guarantor of that loan instead.). However, if the buyer is an unlisted company or a local company, there is a high possibility that a replacement of the contract of guarantee is rejected by financial facilities. In that case, the buyer must repay the loan immediately. In this way, since the buyer will be responsible for the repayment of the loan, it is important for them to plan financing arrangements of the acquisition on the assumption that they may repay the loan.

In addition, you need to pay attention to master transaction agreement as well. If it has the change-of-control clause, the other party of the contract can terminate it unconditionally with the change of the ownership. Hence there is a risk for the buyer that the expected transactions will be extinguished after the M&A. Therefore, as a buyer, it is desirable to develop a future business plan and conduct a valuation of the target company on the assumption that there is a high possibility that a contract, especially with a competitor, will be terminated.

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