M&A Vocabulary - Experts explain: Closing conditions

Sequence of a M&A transaction

The sequence of a M&A transaction can usually be divided into several phases, regardless of whether a share or an asset deal is being negotiated. It usually starts with items such as valuation of the target, due diligence, setting the price or determining the mechanism for calculating the final purchase price, ancillary agreements such as exclusivity or non-disclosure agreements. A share (or asset) purchase agreement is then negotiated and signed. The negotiated purchase agreement essentially contains the obligation to transfer ownership of the object of purchase in return for payment of the purchase price, as well as the conditions under which this is to take place. In simple transactions, the signing, i.e. entering into the contractual obligation to transfer ownership or to pay, and the closing, i.e. the payment itself, as well as the transfer of ownership of the object of purchase  can take place on one day.

Purpose of the Closing Conditions

In other and more complex transactions, the ultimate completion and viability of the transaction depends on external and internal factors, some of which the parties themselves can influence and some of which they cannot. The following items can be mentioned as examples:

• Antitrust or other necessary regulatory approvals;
• Replacement, renegotiation or confirmation of bank financings;
• Waiver of rights of pre-emption of minority shareholders;
• Practical preparation of integration measures with regard to the target company.

This requires separating the signing and the closing by a certain time interval to give the parties time to fulfil the outstanding conditions. Likewise, it can happen that certain steps can only be performed after the purchase agreement has been signed or that a party is only willing to take certain steps if the parties are bound by the contractual obligation to carry out the transaction.

Fulfilment or non-fulfilment

A (pre-) closing condition is therefore a requirement of the purchase agreement that must be fulfilled by one party for the closing to take place. If it is not fulfilled, the other party is usually not obliged to fulfil its obligations related to 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 are not jeopardised. A risk-averse buyer, on the other hand, will insist on as many and detailed closing conditions as possible in order to minimise legal, commercial or operational uncertainties around the transaction. 

Clearly defined closing conditions should clearly regulate the process of fulfilment, e.g. they should specify how the fulfilment of a condition should be documented. It is also common to grant the party that does not have to fulfil the closing condition the right to waive the fulfilment of the closing condition by the other party if the parties' interests have changed in the meantime or a risk has been minimised otherwise. It is also common in the context of such a waiver to transform a pre-closing condition into a post-closing condition, i.e. to postpone the time of fulfilment until after the closing.

Common issues

Just like in all other contracts, it is crucial to clearly specify the rights and obligations of the parties. 

This includes in particular the scenario in which a closing condition is eventually not fulfilled, the transaction is cancelled, and the purchase agreement must be reversed:

• Which party has the right of termination?
• What are the legal consequences of the termination?
• What happens with the already incurred costs and expenses?
• Is the party which could not fulfil a closing condition obliged to pay any compensation?
• What practical steps must be taken to reverse the agreement and who must take those steps?
• What happens if one party has hindered the other party in bad faith from fulfilling a closing condition?

In summary, it can be said that clearly formulated closing conditions are an indispensable tool for structuring the process flow of a transaction and distributing the risk between the parties. Poorly drafted closing conditions may lead to an unnecessary cancellation of a transaction and – still worse – to expensive and time-consuming unwinding of signed purchase agreements.