by drew S. fiNe aNd alexaNder m. Kaye
Purchase of assets. The second method of acquisition, the direct purchase of the actual underlying assets (e.g. the ‘metal’
of the aircraft, ship, rail car, container, etc.) addresses the major downside of the first method. It is possible to structure an asset purchase agreement so that only the desired assets are acquired, thereby significantly limiting the buyer’s exposure to the liabilities that would otherwise be transferred with the purchase of an entire company. Of course, an acquirer who also takes an assignment of the operating leases will by contract law be assuming the obligations and liabilities arising under those leases.
However, despite its seeming conceptual simplicity from a legal point of view, the direct purchase of transportation-related assets is a complicated
transaction in a mechanical sense. The direct transfer often requires complying with government approvals or formal registration with official registries, and may have incremental tax consequences to both sellers and purchasers. As an example, aircraft are often registered in the country where the lessee is located. If a purchaser purchases a portfolio of 100 aircraft on lease to 30 lessees located in 25 countries, then the seller and purchaser may need to make appropriate local filings and registrations in all 25 countries to consummate the purchase. Also, since the underlying leases will also need to be transferred to the purchaser, there may be a need to involve all 30 lessees in the transfer process. Planning for and accommodating these issues requires in-depth knowledge of the nuances of the various laws which may come into play. In addition, it is wise to consult with local counsel in the various jurisdictions where assets reside prior to scheduling a
definitive time and place of closing.
Purchase of SPVs. Many leasing companies put their leased-assets into SPVs for a variety of reasons, including limiting the spread of potential liability and for ease of transfer. Another method of acquisition can be effected through the purchase of all of the outstanding equity interests in each asset-owning SPV. This form of acquisition marries the simplicity of a stock transfer with the benefits of a direct asset purchase. For example, SPVs often have no employees, are party to very few contracts (other than the operating leases) and own no real estate. Therefore, although the liabilities of the SPV are not retained by the seller (but remain with the SPV), it is likely that the liabilities just relate to the assets being purchased, as most of the these asset-owning entities were formed and structured solely for the purpose of holding the relevant assets.
However, care should be taken during due diligence to confirm that the SPV did not take on additional liabilities since formation (and appropriate representations to that effect should be included in the definitive acquisition agreement). For example, an SPV may have guaranteed debt incurred by the seller unrelated to the assets being acquired. Structured correctly, a transaction involving the acquisition of special-purpose entities will grant to the buyer ownership of the assets in a manner which ideally reduces the key concerns raised by the other two methods: the mechanical and timing considerations involved in a direct asset transfer, and the difficulty of ‘leaving liabilities behind’ in a Holdco acquisition.
Diligence
The possibility of any of these transaction
structures yielding the expected trouble-free results depends in large part on the adequacy of the diligence performed prior to and contemporaneous with the drafting of any purchase agreement. Thorough legal and financial due diligence is the foundation of any successful corporate acquisition.
Among other things, a good due diligence investigation will help a savvy buyer: (i) uncover contingent or hidden liabilities;
(ii) better understand the day-to-day operations of the business; (iii) determine the key areas of weakness in the business, as well as the areas having the most
potential for growth opportunities; and (iv) determine whether its proposed purchase price is justified by the financial condition, results of operations and prospects of the business.
In addition, a good diligence investigation will often uncover areas of concern that a buyer may want to address through seller representations (and accompanying indemnification obligations) in the purchase agreement. More importantly, a thorough diligence examination allows a buyer to discuss its concerns with the seller prior to entering into the definitive acquisition agreement.
In the context of leasing company
acquisitions, due diligence encompasses both corporate diligence (of the target company or SPV) and the particularly specialised expertise required for asset and lease diligence.
Depending on the size and value of the assets involved in a particular deal, asset and lease diligence may be a long and exhaustive process or a relatively short one. Deals involving large and expensive assets, such as the acquisition of dozens of aircraft then under lease, may require
physical inspections of each aircraft and the production of highly detailed lease summaries. Whereas the purchase of a large pool of standardised leased office equipment may merit no physical inspection and shorter, less complicated lease summaries, highly sophisticated deals may involve a mix of assets, including assets which have yet to be produced or which may be acquired only upon occurrence of certain conditions (such as the conversion of a passenger jet into a freighter jet). Such deals require customised diligence which matches the sophistication of the deal.
Lease and financing due diligence,
particularly of moveable assets, demands a specific analysis of the terms and covenants which govern the relationship between the lessor and lessee. It is important to understand at the outset of the diligence process that provisions which are fairly routine in other contracts can present a costly, even insurmountable obstacle to the successful completion of a deal, if present in a lease or other financing document. For example, the added expense of negotiating around a change-in-control provision may make a deal prohibitively expensive for both the seller, who must get a waiver of the condition, and the buyer, who may not be able to afford the risk of enforcement if a waiver cannot be obtained. Even where added expense is not an issue, a deal may be delayed while experts assess the risks involved with moving forward with a transaction.
Also, there are many complicated lease structures and provisions which contain traps for the unwary, such as: (i) the right of a lessee to purchase the asset at a bargain purchase price; (ii) the right of a lessee to return the asset in a poor condition; (iii) underinsured assets; (iv) the obligation of
the lessor to make substantial contributions to the maintenance or other costs related to an asset; and (v) lease arrangements where a third party (which may or may not be creditworthy) holds title to the asset.
Also, where the assets to be purchased are located in many countries around the world, it may be desirable to retain local counsel in each jurisdiction who can advise the purchaser of the burdens of repossessing the assets in the particular jurisdiction should the lessee default.
Approvals
In addition to the standard approvals, consents and government filings that must be obtained or addressed in an ordinary acquisition (e.g., permit transfers, HSR antitrust clearance), a leasing company acquisition may require additional approvals and filings depending on the types of assets involved. Moveable assets are often located in multiple jurisdictions;
approvals (including anti-competition clearance) may therefore be required based on the location of the asset, where the asset (such as an aircraft or ship) is registered or flagged, and/or where the SPV which owns the asset is incorporated. Acquirers must also comply with any formal procedures required to transfer title to the assets.
Other terms
A definitive agreement for the acquisition of a leasing company will contain
customary representations and warranties with respect to the company and its
business and operations. However, one notable exception to the ‘rep package’
normally found in a purchase and sale agreement relates to the condition of the assets being sold. In connection with a sale of moveable assets, the assets are
typically sold ‘as is’ ‘where is’ since the assets are typically in the possession of the lessee and the seller has no ability to put the assets in any particular condition.
Accordingly, it is expected that the buyer will perform due diligence on the assets.
Additionally, although the seller may
indemnify the buyer for breaches of general representations, warranties and covenants, it will typically not provide indemnity
protection for losses relating to the condition of these assets.
There are not many covenants unique to the acquisition of leasing companies.
Generally, a purchase agreement will contain covenants: (i) restricting the amendment of current leases; (ii)
prohibiting optional modifications to the assets; and (iii) prohibiting liens on the assets (with exceptions for ‘permitted liens’).
Indemnity clauses generally provide for cross-indemnity, with the seller responsible for risks attributable to the period prior to the sale and the buyer responsible for risks attributable to the period after the sale.
Another key consideration for an acquirer is management. In a highly specialised field such as leasing, an acquirer will need an experienced management team. If the acquirer does not have this expertise, it should condition its obligation to close on the entering into of satisfactory employment arrangements with key members of management.
Closings – scheduling and structuring closings
The closing of any deal implies timing concerns involving both the scheduling of individual availability and coordinating
the distribution of documents and the delivery of the assets (if needed). There are particular concerns with moveable assets, especially transportation assets, which may not be evident to parties who do not regularly conduct business in the field.
These added concerns can impose both a financial and time cost if not anticipated and properly coordinated.
Transfer tax
When selling moveable assets, the location of the asset at the time of the transfer may determine whether a transfer tax needs to be paid. Transfer tax laws vary by jurisdiction. For example, transfer taxes are not consistently and uniformly imposed within the US, let alone internationally.
In any event, tax counsel in the relevant jurisdictions should carefully examine this issue. Generally speaking, the parties can best ensure that the transaction will not trigger a transfer tax that could have otherwise been avoided by either:
(i) waiting to close until the assets are located in a ‘tax-friendly’ jurisdiction; or (ii) structuring a staggered closing so that the transfer of any particular asset only occurs when such asset is located in such a jurisdiction.
Conclusion
When properly structured and conducted, leasing company acquisitions can be exciting and lucrative opportunities, but like all complex deals, such acquisitions can also be an expensive trap for the unwary.
Only investors who recognise the need for industry expertise and have acquired or are willing to acquire that expertise can hope to be rewarded.
Drew S. Fine and Alexander M. Kaye are partners at Milbank, Tweed, Hadley & McCloy LLP.
Merger and acquisition contracts typically feature a material adverse change or material adverse effect (both abbreviated here to MAC) clause, under which a buyer may exit the deal or renegotiate terms if an unforeseen material adverse business or economic change affecting the target company occurs between executing the acquisition agreement and closing the transaction. A MAC clause also provides the seller with a means of qualifying certain representations and warranties so that immaterial breaches are ignored (at least for purposes of closing). MAC provisions are heavily negotiated, with buyers seeking broad MAC clauses for maximum flexibility to exit the transaction. Not surprisingly, sellers prefer narrow MAC clauses to ensure that the transaction closes at the agreed-upon price. Understanding how courts view these MAC clauses, as well as recent trends in their drafting, is essential in negotiating M&A transactions.
MAC clauses in the US
Below are details of a few cases regarding MAC clauses which have been litigated and decided.
In In Re: IBP, Inc. Shareholders Litigation, 789 A.2d. 14 (Del. Ch. 2001), the merger agreement contained a broad MAC clause with no carve-outs. Tyson Foods asserted that IBP, the target, had suffered a material adverse effect because its first quarter 2001 earnings were 64 percent behind those for the first quarter of 2000. However, the
Delaware Court of Chancery did not regard this downturn as affecting IBP on a long-term basis. In the standard set by the court in IBP, a party seeking to invoke a MAC clause and terminating a deal faces the high burden of proving that the events claimed to be a MAC “substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice;
rather the [MAC] should be material when viewed from the longer-term perspective of a reasonable acquirer”. The court determined that IBP had not suffered a MAC, and, as a result, Tyson Foods was forced to complete the purchase.
Frontier Oil Corp. v. Holly Corp,. C.A. No.
20502 (Del. Ch. Apr. 29, 2005), which embraced the standard set forth in IBP as Delaware law, also demonstrated the importance of carefully crafting MAC clauses. The court noted that the phrase
‘would have’ or ‘would reasonably be expected to have’ a MAC, as used in the agreement at issue, created an objective test with a significantly higher threshold than the wording ‘could’ or ‘might’. This standard requires a buyer to examine not only current conditions but also the future, and to produce evidence of a long term downturn.
The MAC clauses at issue in Frontier Oil and IBP were similar in that they both contained a qualifier that a given effect
‘would reasonably be expected to’ have a MAC, requiring the seller to consider