WWW.WNJ.COM

Dispositions / Acquisitions

Basic Risk Management Issues

Friday August 21, 2009Presentation to the JapanBusiness Society of Detroit

Andrew H. Thorson, PartnerChair, International Business GroupWarner Norcross & Judd LLP

WWW.WNJ.COM

Introduction

WWW.WNJ.COM

Current Trends in the Market

Assets on the market due to an increased number of distressed suppliers

Forced restructuring (OEMs / Tier 1’s directing suppliers to purchase divisions of other suppliers)

New market entrants (Magna crossing into the OEM business; Chinese acquisition of Hummer, etc.)

WWW.WNJ.COM

Acquisition Opportunities

Benefits of Strategic Acquisitions - Upside Fast track to increase capacity, diversify (products,

customers, markets, etc.), acquire assets (intellectual property, production facilities, etc.) and obtain “turn- key” operations with existing revenues

Risks - Downside If not managed properly, the acquisition itself can

be expensive and extremely time-consuming (internal costs, broker’s fees, consultant fees, etc.)

There can be a significant risk of successor liabilities

• Risks can often be mitigated but rarely eliminated

• Difficult to obtain warranties from distressed sellers

Post-acquisition “integration” costs

WWW.WNJ.COM

LEGEND

T = Target

B = Buyer

H = Holder

TH = Target’s Holders

BH = Buyer’s Holders

= Cash

= Assets

= Stock

= Entity

= Holders

= Holdings

= Transfer

= Merger

WWW.WNJ.COM

SALE OF STOCK

1. T remains intact

2. T becomes a wholly owned subsidiary of B

3. TH cashed out and/or become shareholders of B

BB

T Co.T Co.

THTH

TT

WWW.WNJ.COM

SALE OF STOCK: AFTER CLOSING

BB

TT

THTH

WWW.WNJ.COM

SALE OF ASSETS

1. T remains intact (and holds $ and/or B stock received from B)

2. T’s assets and liabilities transfer to B

3. BH own B and business transferred from T

4. TH continue to own T

BB

THTH

TT

BHBH

WWW.WNJ.COM

SALE OF ASSETS: AFTER CLOSING

BB

THTH

TT

BHBH

WWW.WNJ.COM

DIRECT MERGER

1. T shares converted into $ and/or B shares

2. T merged into B and ceases to exist

3. BH own combined B and T

4. TH cashed out and/or become shareholders of B

BB

BHBH

T Co.T Co.

B Co.B Co.

THTH

TT

WWW.WNJ.COM

DIRECT MERGER: AFTER CLOSING

*Includes T*Includes T

THTH BHBH

B*B*

WWW.WNJ.COM

Managing Acquisition Risks

General differences between Mergers, Stock Purchases and Asset Purchases Mergers: Assets and liabilities of the purchased

company become assets and liabilities of the “surviving company”. All assets of the surviving company are exposed to the liabilities of the purchased company (extinguished company)

Stock sale: Only the ownership changes. Liabilities of the purchased company generally remain with the company. The purchase price paid by the buyer is at risk

Asset purchase: The acquisition agreement lists the assets and liabilities acquired by the buyer. Generally, buyers only assume liabilities specifically identified in the contract as “assumed liabilities” and acquire only those assets identified as “purchased assets”

WWW.WNJ.COM

Managing Acquisition Risks (Cont’d)

Key Mitigation Factors (particularly important when dealing with financially distressed sellers) Buyer’s due diligence: Prior to the purchase,

the buyer should undertake detailed reviews of all aspects of the targeted operations:

• Long-term contracts with customers and suppliers

• If assets include real estate, obtain an environmental audit

• Review past product liability, employee and other third party claims

• Consider negotiating new contracts with substantial customers / suppliers rather than assuming existing contracts

WWW.WNJ.COM

Managing Acquisition Risks (Cont’d)

Security for seller’s indemnification obligations:

• Payment of a portion of the purchase price into an “escrow account”

• Holdback of a portion of the purchase price to be paid only after satisfaction of seller’s post-closing obligations and passing of a reasonable time after closing to enable buyer to confirm that there are no Warranty breaches

• Related party guaranty

Integration Plan: Develop a detailed integration plan to ensure smooth transition of projects, supplier and customer relationships, shipping, key employees, and equipment, etc.

WWW.WNJ.COM

Disposition Opportunities

Benefits of Strategic Dispositions - Upside

Fast track solution to stop financial bleeding, avoid costs of liquidation, secure a successor to continue to perform the company’s long-term obligations and to continue employment of the workforce

Risks – Downside

If not managed properly, the sale can be expensive and time-consuming (internal costs, broker’s fee, consultant fees, etc.)

Subsequent to the sale, sellers typically remain liable to the buyer for indemnification of undisclosed and contingent liabilities and third party claims

• Risks can often be mitigated but rarely eliminated

WWW.WNJ.COM

Managing Disposition Risks

Basic differences between Mergers, Stock Purchases and Asset Purchases Mergers and Stock Sales: The post-closing

liability of the seller to the buyer is generally limited to the seller’s post-closing indemnification obligations agreed in the merger or stock purchase agreement

Asset purchase: • Warranties: Seller has indemnification obligations

to the buyer under the asset purchase agreement

• Excluded Liabilities: Seller retains all liabilities not assumed by the buyer (i.e., employee lawsuits, existing contract breaches, long-term obligations under contracts where seller cannot secure a release of its obligations, environmental liabilities, etc.)

• Cost of Winding-up: In a sale of all operations of seller, the seller will retain the costs of liquidation of all remaining assets and the dissolution of the company

WWW.WNJ.COM

Managing Disposition Risks (Cont’d)

Key Mitigation Factors Seller’s due diligence: As soon as possible, sellers

should:• Instruct financial and legal consultants to perform “seller’s

due diligence”• When problems are not disclosed early in negotiations

regarding price, buyers are often in a better position to demand a price reduction

• When problems are discovered after signing an agreement or after closing, sellers are often exposed to termination, price reductions and even damage claims by the buyer. The buyer and seller’s customers and vendors will often align against the seller and the seller will have a weak bargaining position

Consider requiring buyer to negotiate its own contracts with substantial customers / suppliers rather than relying upon an assumption of existing contracts

• Rationale: suppliers often don’t know their own contracts.Buyer’s will typically not assume existing breaches or undisclosed side agreements, etc., and these could result in significant liabilities to a seller after the closing.Your customer / supplier and the buyer may join forces against you

WWW.WNJ.COM

Managing Disposition Risks (Cont’d)

Security for seller’s indemnification obligations: • Escrow is preferable to a holdback

• Holdbacks are preferable to a parent company guaranty

Before entering into negotiations, know your strategy to defend against price reductions and post-closing claims:

• Perform seller’s due diligence

• “as is” terms are seller’s best defense but result in a lower price

• Beware of the bad “hair cut”: In a down market, the seller’s negotiating power decreases with time. Anticipate requests for price reductions during buyer due diligence based upon the buyer’s claims to have discovered risks and costs unanticipated by the buyer when the price was initially determined. Do seller’s due diligence early, disclose risks / costs early to buyer, consider demanding a “break-up fee” inpreliminary agreements

WWW.WNJ.COM

Managing Disposition Risks (Cont’d)

• Reduce opportunities for post-closing claims: if not “as is” then clarify early in the negotiation process the limitations on the buyer’s rights to claim against the seller. For example, agree upon limited warranty periods and limited claim periods, demand “caps and baskets”, limit the seller’s indemnification obligation at a specific dollar amount and clarify early that the parent company will not provide a guaranty, etc.

• Many sellers and brokers prefer to deal with these issues later in negotiations. The results of putting off these discussions can go either way. Failed deals can be expensive if after much time and money spent on both sides the parties cannot reach an agreement

WWW.WNJ.COM

Joint Venture Use of joint ventures to pursue acquisition opportunities:

Acquisitions can begin with testing the water via a joint venture

Make sure the goals are clearly stated (avoid fundamental misunderstandings of the purpose of the joint venture)

Make sure each party’s obligations are clearly stated (contributions of personnel, funding, intellectual property, etc.)

Build in an “exit strategy”

Exiting a JV or Buying-out a JV Partner:

Risks are similar to that of a buyer or seller in an acquisition

Buyers – obtain indemnification for unknown or contingent liabilities (do not overpay)

Sellers – try to obtain “as is” terms and limit your post-closing liabilities (make a clean break)

WWW.WNJ.COM

Problems with Forced Restructuring

Sellers have little negotiating power as they often face a limited or non-existent market for the subject assets once the customer makes the decision to discontinue the supplier

Sellers have little negotiating power after the sale to resolve pre-sale customer and supplier problems (i.e., recalls, undisclosed obligations to customer or suppliers); buyer and customers / suppliers will use their combined leverage against the seller (i.e., seller becomes everybody’s insurance company)

WWW.WNJ.COM

Problems with Forced Restructuring (Cont’d)

Buyers face dilemmas, such as: 1) pricing and timing issues in determining whether to build their own capacity or acquiring existing capacity, 2) risks of successor liabilities related to the program (e.g., liabilities for condition of the facilities, liabilities relating to human resources, liabilities for past production and assumed obligations, etc.)

Split-offs of a division can be difficult, especially if the division has not been clearly operated on a stand-alone basis with respect to internal accounting and other matters. Issues arise with respect to separating joint-use assets that are necessary for both the sold operations and the retained operations (shipping and other service contracts, IT contracts, equipment, intellectual property, key employees,etc.)