Legal issues for the Managers in a MBO
1. Structure
The usual format that is adopted in structuring an MBO is that a new company is formed (commonly known as "Newco") to purchase the shares of the Target Company. On completion, the equity investors and the managers become shareholders. At the same time, some of the managers will also become directors and in all probability will be joined on the Board by a representative of the equity investors as a non-executive director. Newco will, after receiving the necessary cash injection, proceed to purchase the shares of the Target Company.
2. Confidentiality
Managers may well be employed by and/or be directors of the Target Company that is to be used as the vehicle for the buyout. As such, they will bound by terms of their service contracts as well as, in the case of a director, owing significant fiduciary duties. Investors backing the transaction will need to see confidential information and managers would be well advised to obtain the prior consent of the Seller to avoid the risk of being dismissed for breach of contract. This will generally be dealt with by way of a confidentiality agreement between all the parties involved.
3. Documentation
There will be a number of legal documents depending on the complexity of the deal and the financial structure. In addition to the Share Purchase Agreement, there will often be facility letters, loan agreements, personal guarantees and security documents emanating from any banks involved; director's employment contracts for the managers and probably a subscription and shareholders agreement with equity investors and the managers.
A subscription and shareholders agreement will cover such matters as:
- the composition of the Board
- undertakings as to future funding
- provisions for realising the investmenta veto over certain events such as acquisitions or sales of subsidiaries or assets.
Certain key provisions would be included in new Articles of Association which would also cover:
- the rights of the various classes of Shares
- dividend rights
- issues of new shares
- transfers of shares
- provisions for Board and General Meetings
- powers and duties of directors.
The terms of any banking documents involved will be based on the bank's standard terms and it is unlikely that anything other than the key commercial terms will be the subject of negotiation.
4. Warranties
In addition to the probably limited set of warranties that Newco will look to take from the Seller, one of the most important aspects amongst the mass of documentation that will confront the managers is the warranties they will be required to give. Any investor providing the finance involved in a management buyout is going to be looking to the managers to provide certain comforts. Generally, managers will be required to give the warranties and they will, no doubt, argue that they are risking potential bankruptcy despite the fact that their contribution to the overall investment may be relatively small. From the institution's point of view, however, the warranty process severs to the focus the minds of the managers on the issues in hand although one of the key tasks of the managers' solicitors will be to negotiate suitable limitations on the warranties. The managers' solicitors will also need to be involved if warranty insurance cover is taken out by the managers.
5. Company law considerations
The financial structure of the buyout will need to comply law. For example, "financial assistance" considerations under the Companies Act 1985, together with demanding provisions under the Financial Services and Markets Act 2000 relating to misleading statements and practices, can often arise. The ultimate sanctions of criminal liability hang over the heads of the managers if the correct "hoops" are not jumped through or procedures not followed.
6. Due Diligence
The legal due diligence (or checking) procedure is monotonous and time consuming but nevertheless vital. The depth to which each area needs to be covered will depend on the nature of the target company's business but generally will include such matters as the ownership of shares and assets, material contracts, litigation, taxation, environmental aspects and regulatory requirements. Although vigilance is important in this verification process, the ability of the managers' professional advisers to concentrate on the relevant issues rather than wasting time (and consequently legal cost) on the worthless minutiae is to be valued.
7. Restrictive covenants
The legal position relating to restrictive covenants is uncertain with the Courts unwilling to enforce covenants that they believe go beyond what is reasonable to protect the goodwill of the business. Nevertheless, any investor, which includes the managers themselves, who has injected substantial amounts of money into the Newco, will not want any of the managers involved to leave Newco after a relatively short period and go into competition elsewhere.
Contact
Tony Forster Head of Company Commercial
Martino Burgess Associate
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This article summarises the law on issues which we believe may be of interest to your business. It is not a comprehensive review of the subjects and accordingly is published without responsibility for loss occasioned to any person(s) acting or refraining from action as a result of information published. This document is provided for information only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.