S&C Critical Insights - Common Issues in Divestitures - YouTube

Hi, I'm Matthew Goodman, a partner in S&C's M&A Group and I'm joined by two of my colleagues:

Annie Ostrager, a litigation partner who is co-head of our Labor & Employment practice,

and a member of our Criminal Defense & Investigations Group; and Jeannette Bander, a partner in

the firm's Executive Compensation Group.

We will discuss considerations unique to divestitures today.

I will discuss overarching transactional process and substantive points.

Jeannette will then discuss common employee compensation matters arising in these transactions.

And Annie will address employment and privilege issues which could present a risk of litigation.

Divestiture transactions often come up because they are mandated by one or more regulatory

agencies in order to facilitate the closing of a pending deal, or where a seller is simply

interested in selling off a non-core business to shore up its balance sheet, or a buyer

is interested in acquiring a specific asset.

Mandated divestitures often come up because of antitrust issues, but more and more national

security interests are coming into play, and that trend started even before the pandemic,

which only intensified the concerns.

Carve-out transactions are often complicated enough, but the added pressure of multi-level

negotiations-and an existing deal hanging in the balance while the clock is ticking-makes

regulatory mandated divestiture deals that much more challenging.

I'll focus on regulatory mandated divestitures, but many of the issues we discuss here are

also applicable in other divestiture scenarios as well.

With that in mind, I want to go over a handful of key process and substantive related points

which, like most things we do, are intertwined.

From a process perspective, divestitures are usually curveballs thrown by one or more regulatory

agencies, and therefore nimbleness, efficiency, and coordination are all necessary.

The acquirer in the pending transaction is going to have to go from focusing on closing

the pending transaction to determining the scope of the business or assets to be divested,

a business that does not own or operate, and whether the business or assets in question

can be cleanly separated, or whether supply, transition services or other ongoing obligations

are needed.

This requires lots of coordination with the target company and its advisors and the team

in charge of integration planning on the pending acquisition.

You don't want to find out a few weeks after closing that you don't own something that

was critical to the closing integration of the initial transaction.

Some might say main transaction, both the initial transaction divestiture must be treated

as headliners in order to ensure a successful result.

Running a sales process to identify a capable and willing buyer for the business or assets

is also extremely important.

Ensuring the divestiture transaction and buyer are both suitable to the regulatory agency

that mandated the divestiture is high on the priority list.

Understanding that the acquirer, now seller, likely has little leverage with respect to

the divestiture buyers and will have to take the best terms available.

Lots of thought and care must go into how the sale process is managed and how the transaction

and buyer are presented to the regulatory agency.

One, the agency needs to be comfortable with both.

Two, the presented buyer and spurn sales process participants as well as other third parties,

for example customers, suppliers, etc., if not managed carefully, are often incentivized

to rock the boat.

Rethinking integration planning for the pending acquisition, i.e., what does it mean for synergies,

long-term strategic plans, capital structure, human capital and other business and operational

considerations to pull the divested business or assets out of the picture.

Another important step in the process is revisiting the financing for the initial transaction

and how any debt for the financing may be impacted.

From the substantive perspective, as noted previously, the divestiture buyer is going

to have a lot leverage and therefore, as seller, now, you need to be very flexible on almost

all deal points.

For example, deal certainty is always important, but it is of the utmost importance in a divestiture

transaction.

You cannot be in a situation where the initial transaction is ready to close but gets hung

up because a divestiture sale has hit a snag with a closing connection.

Flexibility with the regulatory agency regarding the terms of the divestiture agreements and

the divestiture buyer.

If the relevant regulatory agencies do not believe the version of the deal or the buyer

presented are satisfactory, you'll want flexibility to change the deal terms with the buyer easily

and without distraction.

There are certainly other issues to grapple with in divestiture deals such as indemnities,

economic terms, and others, but they are not ones that are challenging because of the divestiture

context.

I want to turn it over to Jeannette and Annie to discuss some of the thorniest issues that

really should be on everyone's checklist of issues to consider in a divestiture deal.

Thank you, Matt.

I will discuss an overview of key compensation issues to consider in connection with a divestiture.

A gating issue to any transaction requires agreeing on the scope of employees to transfer

with the business.

A strategic buyer often is most focused on the employees critical to the core business

being acquired.

A private equity buyer, for example, will often also need the back office support functions

like accounting, finance, and payroll which may be employees that work not just for the

business being acquired, but other business lines of the seller.

In order to determine the business's day-one readiness, it is critical to nail down an

agreed transferred employee population and identify any transitional services that may

be needed after closing in order to fill any gaps.

Once this population and the transaction structure is known, the parties will need to consider

how employees will transfer.

In a stock transaction, in which employees are employed by the entity or entities being

transferred, employees should generally transfer by operation of law.

If any employees are not at the transferred entity, though, the parties will need to consider

whether employees can be transferred before closing, or whether the buyer will need to

make offers of employment.

In asset transactions, the buyer will need to make offers of employment to each business

employee.

Asset transactions tend to present thornier issues.

For example, these transactions are more likely to trigger union or Works Council rights,

like a right to consult or bargain in a transaction.

Additionally, benefits under severance and other plans may be triggered by a termination

of employment in connection with the sale of a business, even where the buyer provides

an offer of employment on comparable terms to the employees' existing terms of employment.

For this reason, careful attention will need to be paid in diligence in order to determine

whether compensation can be unintentionally triggered as a result of the structure of

the deal.

The structure of the transaction also will need to be considered in determining the treatment

of employee arrangements and liabilities.

In some circumstances, the seller maintains separate employee plans for the divested business.

More commonly, however, business employees participate in plans established for the broader

employee population.

A private equity buyer, for example, may prefer that plans, to the extent of the business

employees, transfer with the business because establishing all new plans can be costly and

time-consuming in a situation where the parties are trying to time the closing of the divestiture

with the closing of the initial transaction.

A strategic buyer with established plans may prefer to leave plans with the seller.

Plans that provide retirement benefits, particularly defined-benefit pension plans, will need careful

consideration as well.

The buyer should consider engaging pension experts to determine any funding or liability

risks in the event that the buyer is asked to assume pension liabilities, particularly

given recent market volatility and funding delays permitted by the CARES Act.

In the event of pensions sponsored outside of the United States, the buyer should also

consider engaging local experts.

In the U.K., for example, the pension regulator can have broad powers to require funding or

other actions in order to ensure that pension benefits are protected in the event of a deal.

Other employee arrangements that are often the subject of negotiation include annual

and long-term incentive arrangements.

Change-in-control provisions in these awards may not be triggered in a divestiture which

could result in employees, particularly those who accept offers of employment in an asset

transaction context, forfeiting awards.

As a result, the buyer may ask the seller to vest all or a portion of awards, and the

seller may ask if the buyer agreed to replace forfeited opportunities to reduce employee

retention risks.

I'll now turn it over to Annie to discuss a few employment and litigation considerations.

Thanks, Jeannette.

All of those employee and compensation considerations intersect with the issues I'll touch on, which,

if not handled properly, could result in litigation or undermine a party's position in litigation

arising out of a divestiture.

First, it's important to conduct thorough due diligence on the HR structure and employees

of both the parent and the sub being divested early in the process.

Doing so will provide much-needed clarity on who owns HR's various contracts, plans,

programs and systems, and what HR processes will need to be changed or added for both

the parent and the sub after the divestiture.

It will also confirm the legal entity employing any employees who do work for the parent and

the sub to be divested, and identify any critical talent employed by the entity being divested

that should remain employed by the parent.

The businesses can then identify any employees who should transition from one company to

the other, implement a plan as to which employees will work for the parent and the divested

sub after the closing, and identify any job or role that they can see will exist in both

entities after closing and get a head start on filling them.

It will also be important to assess whether the transaction will trigger any payments

or issues arising out of employment agreements, such as severance payments or the vesting

of or termination of any equity awards.

For employers with unionized workforces, careful review of any collective bargaining agreements

is key at the beginning of the proposed transaction.

CPAs may provide unions with transaction-related rights, such as to be informed by a specified

date about the proposed transaction, or to be consulted regarding the transaction itself.

They may also provide employees with certain rights before being transferred to another

entity.

In terms of communicating with employees, before the transaction is announced, there

are certainly good reasons for keeping the proposed transaction on a need-to-know basis.

However, after the transaction has been announced but before closing there may also be good

reasons to have open dialogue with employees of both companies, particularly those who

will be affected by the transaction.

Employees, especially those who do work for both the parent and the sub to be divested,

may be concerned about the transaction's impact on their jobs, compensations and futures.

Additionally, employees often look for new employment when the future of their roles

or the company in question is at issue, so the need to retain certain employees along

with whether to offer incentives to do so should be considered.

Open communication about the company's plans is important, but it is also important not

to make any promises or commitments which are not settled, as those statements could

then result in litigation risk if plans change.

Finally, in considering the attorney-client privilege that may be shared by the companies

prior to the divestiture, it's generally accepted that a parent and a subsidiary may be represented

by the same counsel and that communications with counsel are protected by the attorney-client

privilege.

The parent they want to ensure it retains complete and unilateral control over attorney-client

privileged information or communications if previously shared with the subsidiary before

the divestiture, at least with respect to the sale or merger transaction itself, and

possibly as to other sensitive matters that may arise.

A number of courts have concluded that, because a parent and a sub are two different entities,

a lawyer who represents both assumes a joint representation, and neither client can unilaterally

waive the privilege, but neither joint client may assert the privilege in a dispute between

themselves.

So, a former parent corporation may be required to produce privileged documents for guarding

a divestiture to its former sub in a later litigation about the transaction if the entities

were jointly represented by the same counsel on the transaction.

Privilege issues become even more complex when the divestiture is mandated based on

regulatory concerns with a pending merger or acquisition.

For example, if Buyer A is purchasing Seller A, and Buyer A is selling a portion of Seller

A to Buyer B in order to get antitrust clearance on its purchase of Seller A, information shared

by Seller A with Buyer A may not be protected.

Given the lack of clarity and uniformity in the law and risks for subsequent litigation,

the parties in a divestiture may seek separate counsel for purposes of the transaction and

may wish to include in the sale or merger agreement specific terms governing the control

of the attorney-client privileged information, both related to the transaction itself and

related to business operations communicated prior to the transaction.

Thank you for listening.

For more information about our practice, please visit us on the web at www.SullCrom.com.

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