Drafting Exclusivity Agreement in an acquisition transaction

Typically in an acquisition transaction, at the inception of the deal (which in practice happen before or during the same time of signing the term sheet), the parties to the acquisition (both buyers and sellers) (Parties) insists on signing an exclusivity agreement (Exclusivity Agreement).  The reasons for signing Exclusivity Agreement are:

•  the buyer wants to buy some time (some specified dated for e.g. from 1^st September, 2011 to 30 September, 2011) from the seller by undertaking a preliminary due-diligence over the target company (Target) to evaluate its interest in the Target;

• while undertaking such preliminary due-diligence, the buyer may dig some price sensitive information, which the seller would not like its opponents or markets to know.

Salient provisions in an Exclusivity Agreement

As a matter of practice, Exclusivity Agreement is not drafted in a form of standard contract/ deed, but as a letter which is at the end signed by both the Parties.  Among other things, some of the salient provisions of an Exclusivity Agreement are as follows:

• the buyer takes a promise from the seller that, the buyer and its affiliates will not during the exclusivity period solicit or enter into any acquisition proposal with other potential buyer;
• terms exclusivity fees paid to the sellers are mentioned;
• signing of exclusivity agreement under any circumstance should not construed as share purchase agreement;
• the exclusivity agreement should be kept confidential unless required by law; and
• the exclusivity agreement is not binding upon the Parties.

Exclusivity Agreement under Indian context

Generally, an Exclusivity Agreement is signed at the signing of term-sheet/ starting of negotiation and as regards the exclusivity period the practice varies.  It could be just prior to making the public announcement (in case of listed company) or could be a week/ month duration. 

But while, undertaking the preliminary due-diligence, the buyer may (and in practice almost every transaction) come across some price sensitive information- as generally while conducting due-diligence, the buyer have full excess to the accounts/documents etc of the Target.  Often, the ever eager seller is happy to disclose the secret information of the Target to the buyer.  At present there is no ‘chinese-wall’ policy etc prescribed under the law for knowing-what information may be disclosed to the buyer and what should not be disclosed.  This may give rise to possible case of insider trading, but this may be defended by inserting a ‘chinese-wall’ clause in the Exclusivity Agreement or any other such document, additional insider trading charges are very difficult to prove in the court of law.

Enforceability of Exclusivity Agreement

Exclusivity Agreement is not a binding document, once the exclusivity period ends none of the parties have any claim over the other, but during the exclusivity period if any breach is committed then that breach may be rectified under the contract laws.  In a recent transaction (acquisition of Wachovia by Wells Fargo), Citigroup Inc. had entered into an Exclusivity Agreement with Wachovia to acquire certain number of its shares, however during the Exclusivity Agreement period, Wachovia was tacitly negotiating with Wells Fargo and in the end Wells Fargo acquired Wachovia, much to the embarrassment of Citigroup.  Citigroup had no alternative but to file a law-suit for damages for $ 6 billion- it did that only to be compensated by Wells Fargo to the amount of $100 million.  So, in practice it can be reasonable concluded that an Exclusivity Agreement is difficult to enforce; only claim which a party has is under the provisions of breach of contract clause.  As a transactional lawyer, (depending on who is being represented), it is required to insert a clear and precise language for the breach of terms of Exclusivity Agreement and if possible (depending upon the negotiation), a right to first refusal clause as to the purchase of shares (if you are acting for buyer) may be inserted in the Exclusivity Agreement.

ROFR clause extends BCCI and Nike’s legal relationship

A news piece (reported in the Business Standard dated 27 April, 2011), captured my attention about the importance of ‘first right to refusal’ clause (called as ROFR in businesso-legal lingua franca) in a legal agreement.

The news piece reported –“Nike, the official apparel sponsors for the Indian National Cricket Team since December, 2005 has extended its contract for a period of five years with the Board of Control for Cricket in India (BCCI)”; “Nike had the first right of refusal in this case. The BCCI did not go into the market to see if others were interested”.

The scope of this note is limited to (a) the meaning and scope of ROFR clause and (b) how a ROFR clause is typically drafted by transactional lawyers.

ROFR clause

A “right of first refusal” is simply a fancy name for a small bundle of contract terms. In the simplest terms, a right of first refusal is a privilege to preempt a contract’s execution by matching the price and terms of a third party’s acceptable offer. Such rights have enjoyed a long history of generally consistent treatment in the common law.

Generally, the right of first refusal is granted as one element of a larger transaction-for example the right of first refusal is generally incidental clause to the full-fledged sports-sponsorship agreement, share purchase agreement etc. It is conceivable, however, that parties might contract solely for the grant of the right of first refusal.

Wordings of ROFR clause

Generally, a ROFR clause as worded as follows:

 Right of First Refusal

(a)        If at any time, either party (Intending Party)  proposes to Transfer all or some of the Shares to any Third Party, then the Other party as “Vesting Party” shall have a right of first refusal (the First Refusal Right) with respect to such Transfer as provided in this Clause [__].

(b)        If either party receive a bona fide, firm and irrevocable offer to acquire Shares and the Intending Party proposes to accept such offer, then such Intending Party shall send a written notice (the Offer Notice) to the Vesting Party, which notice shall state the following:

(i)        the name and address and beneficial ownership of the proposed Purchaser (the ROFR  Offer Purchaser),

(ii)        the number of Shares that the Intending Party  hold in the Company and those which are proposed to be Transferred (the ROFR Offered Shares),

(iii)       the amount of the proposed consideration   offered by the ROFR Offer Purchaser (ROFR Offer Price),

(iv)       a representation that the ROFR Offer Price set out in the Offer Notice represents the entire consideration receivable by the Intending Party  for or in connection with the proposed offer.

(v)        All other terms and conditions of the Proposed Offer.

(c)        The Vesting Party shall have the right to exercise this option within a period of [__] days (ROFR Offer Period) from the Offer Notice exercisable by it through the delivery of a notice (ROFR Acceptance Notice), to purchase for cash, in the aggregate the ROFR Offered Shares at a purchase price equal to the ROFR Offer Price and upon the other terms and conditions set forth in the Offer Notice.

(d)        The failure of the Vesting Party to give a ROFR Acceptance Notice within the ROFR Offer Period in accordance with the provisions of this Clause [__] shall be deemed to be a waiver of such Vesting Party’s First Refusal Right.

(e)        In the event the Vesting Party do not exercise their First Refusal Right under Clause [__], the Intending Party may Transfer all of the ROFR Offered Shares to the ROFR Offer Purchaser identified in the Offer Notice on the terms and conditions set forth  therein.

(f)        The final closing of any purchase of ROFR Offered Shares by the Vesting Party shall be held at the registered office of the Company before the expiry of the [__] months period after the giving of the ROFR Acceptance Notice under Clause [__] or at such other time and place as the parties to the transaction may agree. At such closing, the Intending Party and/or shall deliver certificates representing the ROFR Offered Shares, accompanied by duly executed instruments of Transfer. Save as otherwise agreed, such ROFR Offered Shares shall be free and clear of any Encumbrance, and the Intending Party shall so represent and warrant and shall further represent and warrant that it is the beneficial and recorded owner of such ROFR Offered Shares. The Vesting Party purchasing ROFR Offered Shares shall deliver at such closing (or on such later date or dates as may be provided in the Offer Notice with respect to payment of consideration by the ROFR Offer Purchaser) payment in full of the ROFR Offer Price in accordance with the terms set forth in the Offer Notice and any requisite transfer taxes.

The above mentioned wording essentially captures the essence of a ROFR clause.  This clause may be re-drafted/ tweaked according to the subject matter of the contract (e.g. a sports contract, Share Purchase Agreement, Investment agreement, Real-estate transactions, Assignment agreement etc.) and negotiations between the parties to the contract.

BCCI-Nike deal

In this deal, Nike had the ROFR rights vested in it according to the sponsorship agreement.  However, as per the press statement of a Nike official- BCCI did not go into the market to see if others were interested, that means, Nike did not even exercised the its ROFR right vested by virtue of the sponsorship agreement between BCCI and Nike.  This may be a potential ‘anti-trust’/ competition law dispute, as prima facie it appears that BCCI and Nike have colluded and the sponsorship agreement between then is a ‘tying agreement’, which is per se anti-competitive.  However, that’s not the scope of this note- it’s for Nike’s competitors to take note of.

Some observations

• Some ROFR clauses contain a pre-set ROFR price, (or a formula by which the ROFR price will be set) when and if the owner decides to sell. Transactional lawyers need to negotiate and draft such agreements very carefully. The price (or the formula the parties adopt to set the price) at the time they enter into their agreement may unreasonably undervalue the subject matter (for e.g. property, playing ability of a sportsman etc.) at such time in the future when the ROFR is triggered by the then owner’s decision to sell. 
• Needless to say, that, the ROFR clause should be there in writing.
• Transactional lawyers, while drafting a ROFR clause, must also ensure that (a) there is a mention of ROFR exercise period and (b) the period is not too long and at the same time should be reasonable for the ROFR vesting party to take decisions.  Otherwise this may face wrath of the courts ultimately leading to nullification if ROFR clause.