In addition to the appointment of financial advisors, each of the parties to a Management Buyout will require specialised legal advice on a vast array of legal issues and documentation together with professional assistance and legal protection at each stage of the process. Company law, Competition law, European law and Employment law are just some of the areas which are visited during the course of an MBO. This document aims to highlight the core legal issues that arise at the various stages of the process and sets out how the legal advisor becomes a fundamental part of the transaction.

1.1 Structure

The number of legal teams involved will vary depending on the size of the transaction. In relatively small MBO's, the management's legal team will carry out a great deal of the legal work in conjunction with the vendor's advisors and will normally also advise Newco, (the company which is set up to purchase the target company and provide the senior debt to the lender). Typically, Newco will be a wholly owned subsidiary of Newco 2 which in turn will be owned by the management team and the private equity investor - hence the various and sometimes complex relationships. The private equity investor will appoint its own advisors as will the senior debt provider. However, in the case of smaller buyouts, that roll tends to be mainly of a supervisory nature which involves checking and confirming the work carried out by management's legal team in addition to independently advising their own clients. Larger buyouts will see a more defined division with each party engaging its own independent legal advisor and preparing and negotiating its own documentation.

1.2 Changing the status quo – legal capacity of management to turn owner

It is important for Management to obtain legal advice at an early stage in particular to ascertain the legal position under an existing contract of employment. The moment a member of management takes the first step in the process there may be an instant breach of contract, breach of statutory duty and/or breach of common law duty. Members of management who also fill the position of director within the company and must abide by onerous directors duties to both the company and its shareholders as provided in the Companies Acts. There are also fiduciary duties under common law the most onerous being that a director must act as all times in good faith in what the director considers to be the interest of the company.

Most contracts of service will contain a confidentiality clause and a clause stipulating that all time and attention of the director shall be devoted to his or her employment duties. A legal examination of existing service contracts and terms of employment will devise a structure within which management can take preliminary steps to ascertain the viability of the process without the fear of compromise, claim or dismissal. Advisors for private equity investors must also be aware of this obligation and must have the legal position ascertained as liability could possibly extend to them for illegal use of confidential information. Ultimately, once the decision has been made to proceed with the buyout then approval from the board should be sought for the transaction to proceed to the next level.

1.3 Heads of Terms

It is strongly recommended that this document is prepared under legal supervision. Under normal circumstances, Heads of Terms are expressly stated to be subject to contract and therefore non-binding. However, the High Court in England recently ruled that in a commercial environment, the use of the words "subject to contract" can, in certain circumstances, be insufficient to exclude contractual obligations. Careful planning must be made in order to avoid this disastrous pitfall. Notwithstanding this, the Heads of Terms will usually provide that some clauses do have contractual force, the purpose of which is to provide protection to the parties in the event that the transaction does not complete. Examples include circumstances where an exclusivity period is required (where the seller agrees not to negotiate with others for an agreed period), or, in the absence of a separate confidentiality agreement, confidentiality and nonsolicitation clauses are included.

Your legal advisor will ensure that intended clauses only are expressly contained so as to impose contractual relations. As Heads of Terms will set out the fundamentals of the deal, it is important that the envisaged group structure is set out set out and verified as compliant with the Companies Acts. Further, there will be competition law aspects to be reviewed at this stage together with initial warranty and indemnity protection. Although the Heads of Terms is a preliminary document and detailed negotiations should be postponed until later on, it is important recognise that it does form the basis of the agreement between management and Target and as such, requires careful legal consideration so as to avoid difficulties later on.
If there is a private equity investor on board at this stage, Heads of Terms should also be agreed between this investor and management – usually carried out in the form of what is known as an equity term sheet. Similar principles will apply.

1.4 Exclusivity and Confidentiality Agreements

It is advisable for these issues to be in the form of a separate agreement from the Heads of Terms but signed simultaneously. Time, effort and expense is made in anticipation of a deal being agreed and Management will want a period of time where negotiations and due diligence can be carried out during which the seller agrees that it will not negotiate with third parties for the sale of the business. The Exclusivity Agreement must be accurately drafted to express the true intentions of the parties. Permitted and non permitted activities must be clearly set out as well as the precise period of exclusivity. There should also be a clause aimed at the running of the business throughout the period and a requirement for notification to the buyer in the event of an approach by third parties. A choice of law clause should be inserted as well as an indemnity for costs in the event that the deal does not proceed.

A Confidentiality Agreement must be entered into. Such an agreement will be for the benefit of the seller yielding protection from the unauthorised disclosure of confidential information which is furnished to the buyer and its advisors over the course of the investigation or due diligence operation. The definition of what information is confidential will depend on the industry in question and also on the relative bargaining power of the parties. Rules in relation to how the information is transmitted are drafted as are the procedures for the return or destruction of the information at the request of the seller. This agreement should also contain a non-solicitation clause preventing the buyer from enticing away employees of the Target during the course of due diligence.

1.5 The Investment Agreement between Management

and the private equity investor

While taking into consideration the respective balance of power between the parties, management and investor will effectively be joint owners of Newco. This relationship between the investor and management is separate from the relationship between Newco and the Target and is regulated primarily by the Investment Agreement.

Generally speaking, the Investment Agreement will focus around the business plan that Management has prepared, its reasonableness and its basis for any proposed rate of return. In particular, the investor will require various confirmations, warranties and indemnities from management. It will be argued by the investor that these should be detailed because management should already have intimate knowledge of the business. (Obviously in the case of a Management buyin, an investor will carry out more of its own independent enquiries).

To protect its investment the investor will generally require the right to control Newco and the right to appoint nominee directors and managers should Newco under perform. The agreement will set out the respective investment by management and the exit strategy. Share transfer provisions are also included here and care must be taken to ensure that the relevant clauses dovetail with the articles of Newco, the acquisition agreement and the bank security documentation.

1.6 The Memorandum and Articles of Newco

This is a fundamental document from which the operation of Newco is governed. Share classes are defined, respective rights are allocated, restrictions on share transfers are set out and pre-emption rights and obligations are laid down. Voting rights are allocated according to the shareholding. Share classifications will be set out which will correspond to dividend entitlements, rights to a return of capital and rights of control. Other clauses will include tag along/drag along rights, roulette clauses, and buy back arrangements each tailored to the particular transaction and the intention of the parties. Various collateral documentation and agreements will be required and these documents must be carefully drafted in order to dovetail with the Articles. Such documents can include the investment agreement, supplementary shareholders agreements, disenfranchisement agreements and adherence agreements depending on what is called for in the circumstances.

1.7 Due Diligence

Due Diligence is the process by which a full understanding of the structure of the Target company is achieved. The maxim "caveat emptor" (let the buyer beware), applies in the case of the purchase of a company. On a share purchase, the purchaser buys the company in its entirety which means that all liabilities, as well as the assets, pass with ownership. Warranties and indemnities will be provided as discussed above however these may be difficult to enforce – an extensive examination of the company prior to purchase is the best protection. Accounting and taxation due diligence will be the task of the financial and taxation advisors and, although there is some overlap, these are generally separate and distinct from the legal due diligence. The Investors legal advisor will produce a due diligence questionnaire which will begin the process. Issues for the legal advisor are vast and will include a full examination of the legal structure of Target. At the heart of the Company will be its Memorandum and Articles which form the basis of the company's powers, for example power to trade, power to give security and guarantees, power to borrow, and so on.

All existing borrowings of the company will be examined. The legal title to the company's assets are thoroughly examined, as are intellectual property rights, software ownership, patent and copyright rights and ownership of all intellectual property. Insurance will be examined. Any litigation or claims made against the Target will be examined and assessed and management will be advised accordingly. Existing contracts are examined and their enforceability assessed. Target's pension and taxation history are examined in conjunction with financial advisors. The employment history of the company and key employment contracts are examined to ensure regulatory compliance and compatibility under any proposed new structure. Compliance with the vast area employment law is examined ensuring compliance with Transfer of Undertakings regulations and a huge range of employment statutes including the Redundancy statutes, Health and Safety law, unfair dismissal, Maternity and Parental Leave and Trade Union law. Health and Safety and Environmental issues are examined as is the company's compliance with the Data Protection Acts.

Newco's legal advisors will also examine the Disclosure Letter furnished initially in draft form for approval, by the Target. The Disclosure Letter presents an opportunity for the Target Company to confess any sins which would otherwise give rise to a claim under the warranties contained in the Acquisition agreement. It is prepared under the legal guidance of the Vendor's legal advisors. Certain disclosures will be deemed unacceptable as their effect is to dilute the warranties upon which Newco will be seeking to rely. This is all the more relevant if the private equity investor is seeking for the warranties to be repeated by the management team in the investment agreement. All disclosures made by Target are examined carefully in the light of the independent due diligence. After the legal due diligence process, the purchasers legal advisor will compile a report for the benefit of the Investor and Management as the case may be. This report will contain a full assessment of Target and will assist in negotiations. Depending on the size and structure of the deal this report may be relied on by other parties to the transaction.

1.8 The Acquisition Agreement

This document will set out the Agreement between Newco and the Target Company. The structure of the acquisition agreement will depend on whether the preferred route to acquisition is share or asset purchase. Financial, tax and legal advice must be taken in relation to the merits of either route. The transaction may be subject to Conditions Precedent in which case the completion of the transaction must be postponed until such conditions have been satisfied. These conditions can vary according to the circumstances but common conditions include requisite consents from third parties such as a landlord in the case of the transfer of leasehold property, and regulatory approval, for example under Irish and EU merger control and competition legislation. Your legal advisor will identify these necessary conditions and ensure that same are included in the agreement. The Due Diligence Reports are also delivered at this point as is the Disclosure Letter. In smaller transactions, the signing of the acquisition agreement takes place simultaneously to completion however, in the event that completion is not simultaneous with exchange of contracts, the agreed form documents are settled at contract stage but will not usually executed until completion.

The Acquisition document will be several pages in volume and will be the basis of many hours of negotiation between the legal representatives on either side. It will set out all of the rights and obligations of the parties in respect of the sale and purchase. The Warranties and Indemnities provided by the seller are contained in the body of the acquisition agreement and it is this area which will be the source of most negotiation. Warranty negotiation will focus on the extent, threshold and time limits of each warranty. Joint and several liability will be discussed and there may be a side agreement between the warrantors regarding proportionate liability as the purchaser will usually insist on nothing less than joint and several at first instance. The Tax Deed, as agreed by the finance and taxation teams, is also handed over as is the Disclosure Letter in pre-agreed format. At Completion the Subscription of Shares in the Target takes place and ownership is transferred. After completion the statutory registrations of security asset transfers are carried out as necessary.

1.9 Competition Law and Merger Regulation

The relevant authorities are the Irish Competition Acts and EU Merger Control Regulation. which derive from the basic framework of the EC Treaty. Broadly speaking, the legislation addresses prohibited agreements and dominant positions. Prohibited Agreements are those which have as their object or effect the prevention, restriction or distortion of competition and are prohibited. A Dominant Position can be described as a position in which a firm or group of firms would be in a position to behave to an appreciable extent independently of its competitors and ultimately of its consumers. It should be noted that there is nothing wrong in having a dominant position, it is the abuse of such a position that is illegal.

Merger regulation will apply if the combined turnover of the Undertaking concerned reaches the aggregate turnover threshold (currently €40 million), and other thresholds contained in the regulations Each venture should be examined in its own right and an opinion formed as to whether the rules apply and if so, a notification procedure is applicable. Parties should be aware that both civil and criminal sanctions apply in respect of breach of the Acts and notification requirements. Furthermore, title to shares and assets that have purported to pass under a transaction requiring notification which was not in fact notified, will fail to transfer.

1.10 The Companies Acts

From company structuring to shareholding to directors duties to the provision of security, Company legislation applies in almost every aspect of a Management Buyout. The consequences of acting in breach are serious for a company, its directors and its bankers. Statutory sanctions range from restriction and disqualification orders, to personal and criminal liability. Asset security taken in breach of the Acts can be deemed voidable and under certain circumstances, criminal liability can also extend beyond the officers of the company. It will very often come as a surprise to a company director that he or she is in breach of the increasingly complex provisions. Some of the common sections which arise in the course of an MBO include:-

Section 29 and 31 of the Companies Act 1990 which govern the legal requirements to be met where a director, or his company, acquires substantial assets of a company, the issuing of directors loans and also the provision of security by a company in connection with a loan to a director. The term director includes what are defined as "connected persons" which, in turn include a body corporate or company controlled by that director. These provisions are complex and arise frequently as a result of the lending structure of a buyout. Other provisions include Section 53 of the Companies Act 1990 which imposes an obligation of directors to notify the company of his or her interests in shares or debentures of a company. Section 60 of the Companies Act 1963 which prohibits a company from giving financial assistance for the purchase of its own shares and also Section 194 of the Companies Act 1963 which imposes a duty of directors to disclose any interest in contracts made by the company.

1.11 Finance

Typically, managers will lack the full extent of the recourses required to complete the buyout and invariability will require finance in the form of senior debt and private equity providers. In a classic structure, the senior debt provider provides finance to Newco to allow it to purchase the shares or assets of Target and to provide initial working capital. As Newco will be a newly incorporated entity it is likely to be at the initial stage, a hollow vehicle. Accordingly, security must come from the Target company usually in the form of guarantees, collateral charges and floating debentures. The security becomes more complex in a group structured buyout where guarantees will also be required from each company in that group and these guarantees will be backed up by floating debentures or specific charges over the assets of each guarantor.

Management's legal team will negotiate the Bank facility agreement and security documents with the Bank's Lawyers, ensure compliance with all legal conditions precedent and, in particular, compliance with the security provisions of the Companies Acts. Issues such as the health of the company, it's power to borrow, power to provide security, and title of the company to its material assets will normally be certified to the lender by Management's lawyers backed up by their professional indemnity insurance. If there is more than one senior lender or if a pre-buyout lender remains secured then an inter-lender agreement will regulate respective priorities.

Howard Doyle is a solicitor with T.O. Doyle Solicitors Business & Corporate Clients. He can be contacted on +353 1 4053504.