The Anatomy of a Deal Newsletter March 22, 2019
Each month, Eric Duffee looks at a different piece of The Anatomy of a Deal – a series of easy-to-digest articles that break down complicated aspects of business transactions – helping you better understand terms + processes that can shape the direction of your business.
What is it?
Earlier, we talked about caps and baskets. But those aren’t the only limitations on the Buyer’s right to obtain reimbursement from the Seller for pre-closing losses. While there are several other important possible limitations, we focus here on the survival period, which limits the amount of time the Buyer has to make a claim for breach of the Seller’s representations and warranties after the closing. Here’s some sample language:
“Subject to the limitations and other provisions of this Agreement, the representations and warranties contained herein shall survive the Closing and shall remain in full force and effect until the date that is [NUMBER] months from the Closing Date; provided, that the Fundamental Representations shall survive for the full period of all applicable statutes of limitations (giving effect to any waiver, mitigation or extension thereof) plus 60 days. All covenants and agreements of the parties contained herein shall survive the Closing indefinitely or for the period explicitly specified therein. Notwithstanding the foregoing, any claims asserted in good faith with reasonable specificity (to the extent known at such time) and in writing by notice from the non-breaching party to the breaching party prior to the expiration date of the applicable survival period shall not thereafter be barred by the expiration of the relevant representation or warranty and such claims shall survive until finally resolved.”
What does it really mean?
The survival period imposes an artificial limitation on how long the Buyer has to make claims for breaches of the representations and warranties after the closing. Said another way, without the survival limitation, the Buyer generally would have had a much longer period of time in which to make claims for breaches of the representations and warranties.
Survival periods generally range from 12 to 24 months after the closing. A recent American Bar Association study found that 83% of transactions included a general survival period of 18 months or less. The general idea is to give the Buyer at least one full audit cycle after the closing to uncover any potential issues. Eighteen months should generally be enough time for the Buyer to conduct that audit.
However, as you might expect, there are some important caveats:
- The survival periods only apply to the representations and warranties. Just like caps and baskets, survival periods only apply to the representations and warranties. So, they don’t protect the Seller from violations of covenants – though some covenants, like non-competes, include their own survival periods – or unassumed liabilities in an asset sale.
- They don’t apply to all representations and warranties. Also like caps and baskets, there are generally some “fundamental” representations that have longer survival periods. However, the universe of fundamental representations may be different for survival purposes than for purposes of the caps and baskets. And the length of the extended survival period may run from a few years, to the applicable statute of limitations, to “indefinite” survival – though Delaware courts have ruled that a contract cannot extend the survival period beyond the applicable statute of limitations anyway.
- Careful drafting is required to make sure they serve the intended purpose. Courts have been confused in the past about how these survival periods work. A properly-constructed survival provision should require the Buyer to make the claim for breach during the applicable survival period. A poorly-constructed survival provision might instead be interpreted as setting the period during with the Buyer has to uncover potential breaches after the closing, but the Buyer then has additional time thereafter in which to assert its claim.
- The survival period doesn’t protect the Seller after a claim is asserted. Once the Buyer asserts a good faith claim before the expiration of the survival period, the Buyer’s claim will remain valid and enforceable until final resolution of that claim. Said another way, the survival period only sets a deadline for the Buyer to assert its claim; once asserted, there’s no limitation on how long it might take for the claim to be ultimately resolved.
- Survival periods should generally match the duration of any escrows or holdbacks. If any funds are placed in escrow or held back by the Buyer to provide a source of payment in the event of a post-closing indemnification claim, the survival period for the non-fundamental representations generally matches the duration of the escrow or holdback.
- The survival periods don’t apply to liabilities uncovered prior to closing. As with caps and baskets, the survival periods don’t protect the seller from liabilities or issues discovered prior to closing. Instead, the survival periods are only intended to address those liabilities or issues that are unknown at the time of closing.
Why Should I Care?
Buyer: It’s unfortunately not uncommon for pre-closing issues to arise after the closing occurs. Even if the Buyer completes an exhaustive due diligence investigation, the Buyer needs to make sure it has adequate time after closing in order to uncover and assert claims against the Seller. Depending on the nature of the business, the Buyer may also want to insist on a longer survival period for certain types of representations and warranties. For example, a Buyer acquiring a technology company may require the Seller to agree to a longer survival period with respect to the intellectual property of the target company. Furthermore, as a practical matter, the Buyer needs to remain cognizant of the survival period’s expiration date so that it can identify and assert those claims prior to the expiration of the survival period.
Seller: The survival period is a very important limitation for the Seller that is sometimes overlooked in terms of its importance. The Seller can’t truly feel safe until the survival period expires. As with caps and baskets, it’s important for the Seller to negotiate the survival period – and any exceptions – in the letter of intent.
Next Month: Potential Deal-Killers
Read last month’s piece: Earnouts: Seller and Buyer Beware