A Guide to Acquisition Agreements - Covenants Before Closing
“Covenant” is fancy lawyerspeak for “promise.” So unlike the representations and warranties, these are enforceable promises. Even though the main point of the contract – to transfer the business from seller to buyer – doesn’t happen until closing, the agreement is a binding contract once it’s signed. The “covenants before closing” are the promises that are enforceable immediately after the contract is signed. Typically, these are promises to do things that will help get to closing and not to do things that won’t. For example, if the parties know that they will have to make a federal “Hart-Scott-Rodino” antitrust filing and wait to get antitrust clearance, each party will make promises to carry out its role in that process.
Another purpose of the promises between signing and closing is to deal with the possibility that the situation will change. For example, the seller usually makes promises as to how it will and will not conduct the business in order to maintain the status quo and what it will do (e.g. inform the buyer) if conditions change in ways that contradict its representations or warranties or threaten the transaction.
These covenants also often give the buyer rights to do further diligence investigations. This can be crucial if the parties decided to sign up the deal before the buyer had completed diligence (not a recommended procedure). In the usual situation where the buyer has completed its diligence before signing, this covenant is mainly important to the buyer’s planning for post-closing integration.
In thinking about these promises, the most important consideration is that they be practical. For example, the seller almost always promises not to sell assets between signing and closing. If the business has to securitize its receivables or sell its defaulted receivables on a regular basis, the contract should usually contain an express exception for that to happen without notice to or the permission of the buyer. The covenant will usually make an exception for “transactions in the ordinary course of business” but if there are important transactions that happen regularly, the parties should consider specifying them, to avoid misunderstandings.
A more subtle consideration in drafting these provisions is the powers and incentives they give the parties. For example, a buyer that promises to use its “best efforts” to obtain anti-trust clearance might have to divest significant parts of it existing business if the government demands the divestitures as a condition to clearing the sale. That could give the seller an incentive to side with the government’s silliest positions, even if they entirely undermine the point of the deal for the buyer. By contrast, if the buyer’s promise to help obtain anti-trust clearance specifically states that the promise doesn’t require the buyer to divest any assets, a buyer who didn’t want to close for other reasons could hide behind even the mildest and most reasonable government demands. There are circumstances where each of these alternatives makes sense, but you shouldn’t agree to either one without serious thought.
the businesspeople can usually safely allow the lawyers to take the laboring oar on antitrust or regulatory approval matters unless approval is in real doubt. That’s not true of covenants concerning operation of the business and diligence investigations that might take up the time of seller personnel or otherwise interfere with regular operations. The businesspeople need to understand these covenants well and think through how they will play out in practice.