Introduction
When two businesses combine, it has called a merger & acquisition (M&A). In a merger, the two companies are form a new entity. In an acquisition, one company purchases and absorbs the other into its operations. The ultimate goal of a merger & acquisition is to create a more efficient and effective entity than the two previous companies. The new entity delivers financial benefits for the owners of the original companies, as well as the owners of the newly merged entity. Depending on the deal, some shareholders may cash out their stocks, while others will keep their shares and profit from higher dividends as the new company grows.
Why do Companies Engage in M&A Transactions?
There are several reasons for the companies’ tendency towards M&A transactions. The most important reasons are as follows:
- Enhancing capacity
- Acquiring a platform company
- Leveraging existing possessions, and
- Acquiring a business position
Different Types and Methods of Acquisition
Horizontal Acquisition
A horizontal acquisition is when one company acquires another in the same business. This could involve competitors or not, depending on whether both companies sell to the same customer base. The advantages of a horizontal acquisition include the potential to increase a company’s customer base market share and help expand its reach into new markets. The best example is Procter & Gamble’s 2005 acquisition of Gillette.
Vertical Acquisition
A vertical acquisition occurs when one company purchases another in a different supply chain position. The acquirer can be either higher or lower on the chain. Acquiring companies vertically can generate new revenue and reduce costs by simplifying operations, like the 2002 transaction between eBay and PayPal.
Conglomerate Acquisition
A conglomerate acquisition is when a company acquires another company in an unrelated industry or engages in irrelevant activities. For example, a real estate company may acquire an insurance company. Diversification is the main reason for conglomerate acquisitions, as it helps provide stability for a company by having multiple products or services. For instance, Amazon, Alphabet, Meta (formerly Facebook), Procter & Gamble, Unilever, Diageo, Johnson & Johnson, and Warner Media.
Congeneric Acquisition
A congeneric acquisition is when a company acquires another company that sells different products or services to the same customers, such as Amazon and Whole Foods, eBay and PayPal, and Disney and Pixar. This acquisition helps a company increase its market share and expand its product lines.
Overcoming Challenges During M&A Transactions
Force majeure issues have had a variety of effects on transactions. Specifically, the transaction conditions, such as the price, representations, and warranties, may have been questioned.
Each situation is unique and may vary depending on the target, buyer, financing, and sector involved. For example, the recent crisis (COVID-19) has emphasized a significant challenge in M&A transactions: managing risk and uncertainty. This challenge was particularly critical when a considerable time gap existed between the deal’s signing and closing.
Contractual Mechanisms
Currently, there are various contractual mechanisms designed to address this issue. These mechanisms include Material Adverse Change (MAC), hardship clauses, representations and warranties, and even adjusting the sale price.
Material Adverse Change (MAC) Clause
The term “Material Adverse Change” (MAC) is a legal mechanism that helps minimize the risks and uncertainties for buyers and sellers between when the Merger Agreement is signed and when the deal is completed.
MAC clauses have the specific purpose of outlining the conditions that would allow a transaction to be terminated if an event occurs that significantly impacts the situation of the target company. This clause benefits the acquirers by allowing them to exit the transaction based on the conditions negotiated with the target.
To avoid legal disputes regarding the clause’s application, it’s advisable to be as precise as possible when drafting it. During the pandemic, the use of this clause was likely to increase, and practitioners may refer directly to the epidemic (or health risk) in their clauses in the future. This clause is beneficial as a precedent between the transaction’s signing and closing.
Hardship Clause
In future M&A transactions, it may be beneficial to prioritize hardship clauses. This type of clause enables the possibility of initiating new negotiations if an economic or technological event significantly disrupts the balance of services outlined in the contract. Unlike the MAC clause, the hardship clause only allows for renegotiation of the contract terms, and the parties must negotiate the resulting consequences.
Many national legal frameworks have provisions for hardship clauses like Art. 1195 of the French Civil Code and Art. 3531 of the Polish Civil Code. The drafter must determine whether it applies only to the seller, who usually bears the cost-related risks of the products, or to the buyer, who may have a vested interest in maintaining a good relationship with the seller.
It is essential to include a comprehensive list of all events that would activate the clause and formally document all scenarios to limit the judge’s discretion, whether the case is heard in state or arbitration courts.
Difference between Force Majeure and Hardship
The hardship clause is occasionally utilized in connection with force majeure, as they have similar characteristics, and both address situations where circumstances have changed. But there is still a difference.
“Force majeure” is an unpredictable event that prevents a party from fulfilling their contractual obligations or completing them on time. In such cases, non-performance or delay is excused. “Hardship” pertains to a change in economic conditions that does not prevent either party from fulfilling their contractual obligations but makes it much less profitable or even costly for one party, causing them to lose money due to the contract.
Representations and Warranties
Negotiating the seller’s representations and warranties for the buyer’s benefit can be challenging. These agreements are established at signing but reiterated on the closing day. If there is a significant amount of time between signing and closing, there is a risk that they cannot be verified on the closing date.
This is especially true if a guarantee was provided regarding the company’s management during the current financial year. In the future, consider updating these guarantees during exceptional circumstances.
Adjusting the Sale Price
Buyers will increasingly seek a price that can be adjusted based on objective criteria rather than a fixed price. Earn-out clauses may become more prevalent without locked box mechanisms providing a predetermined fixed price at signing. Legal practitioners will be presented with an opportunity to address new issues and secure the divergent interests of the parties in light of the current crisis.
Iran’s legal system pertaining to Merger and Acquisition
For the first time, the discussion of the merger of commercial companies was raised in 1350 in the Law of Cooperative Companies and Cooperative Unions. Of course, in Article 95 of this law, without providing a comprehensive definition and preventing the merger of cooperative companies, the legislator has provided the following provision:
According to the provisions of this chapter, any cooperative company or any cooperative union can be merged with any other company or cooperative union, provided that they are of the same type and have similar goals and operations.
Although comprehensive and complete definitions of merger have not been stated in Iran’s laws and regulations, but by considering legal theories and legal definitions, the nature of merger can be explained because the principles of merger of commercial companies in the field of commercial law can be realized. In fact, referring to the category of “legal personality” which has a special place in the integration process, it can be said that Article 588 of the Commercial Law emphasizes that a legal person is recognized as having rights and duties, with the exception of those rights and assignments that are specific to real persons.
This is why it has been said that the merger of several joint-stock companies with each other is an accepted subject of most laws because the merger of several companies strengthens the companies’ finances and has many benefits in terms of economy and concentration of affairs. Merger of companies with each other is done by establishing a single company from several companies or by liquidating one or more companies and transferring their affairs to another company.
One of the topics that has been included in Iranian legal literature for some time is the issue of company acquisition. This issue has been introduced to facilitate the transfer of state companies subject to transfer in implementing Article 44 of the Constitution. In Iranian law, first of all, in this regard, the legal bill on the management and acquisition of shares of companies and consulting engineering companies and institutions is significant, which is stipulated in Article 2 as follows: All shares and assets of companies and institutions included in paragraph “A” and fifty-one the percentage of shares and assets of companies and institutions included in paragraph “B” will be acquired by the government after the following actions are taken. Regardless of this legal provision, Article 47 of the Law on the Implementation of General Policies of Article 44 of the Constitution is dedicated to the acquisition, which stipulates:
“No real or legal person should acquire the capital or shares of other companies or enterprises in a way that causes disruption of competition in one or more markets.”
Therefore, discussing mergers and acquisitions in the field of corporate law is crucial due to recent commercial developments. It is assumed that companies seeking mergers and acquisitions have legal personality and comply with commercial regulations. Thus, the independence of the legal personality of commercial companies is essential, which ensures that the companies’ assets, including debts, claims, property, and rights, are separate from their partners and shareholders.
Karimi & Associates Law Firm
