A condition precedent (CP) prior to closing is a condition that must be satisfied by a party to a transaction, failing which the other party is not bound to close the transaction. In the context of buying or selling a company, it is usually the vendor of a business who must satisfy certain CPs before the investor is obliged to close; but there may also be conditions precedent that an investor must satisfy before the vendor is obliged to close.

On rare occasions, it is possible to close a transaction immediately upon signature of a Sale and Purchase Agreement (SPA); more often, however, there is a delay of a few weeks to a few months from the signature of the SPA to closing, primarily due to the need for parties to the transaction to satisfy CPs.

While it is impossible to provide an exhaustive catalog of all the types of CP that a vendor may need to satisfy, a sample of some of the more common CPs offered by a vendor could be:

(a)Obtaining consent of banks: Usually there is a clause in any bank loan agreement or similar financing facility that a change in ownership in and/or control of a company requires written consent of the bank(s). Vendors are usually reluctant to approach banks (and indeed banks are often reluctant to consider such cases) until there is a signed SPA.

(b)Client approvals: There are times when contracts with key clients also contain change of control provisions.

(c)Approvals from other selling shareholders: Sometimes other shareholders of the company being sold have pre-emption rights, which are best dealt with during this period.

(d)Obtaining approval of Competition Office: If Competition Office approval is required, most Competition Offices in Central Europe or in any other EU country are not prepared to consider an application until an SPA has been signed by all parties.

(e)Restructuring: At times, certain restructuring events must be carried out prior to closing, such as the creation of a holding company, or the transfer of a subsidiary or real estate that is not included in the transaction.

(f)Curing defects to title: Should the Vendor not have clear title to real estate or other assets, this can be made into a CP.

(g)Regulatory approvals: The transfer of ownership of a telecommunications or utility company, for example, often requires approval of the ministry regulating the industry.

CPs might also be used to provide the vendor with time to fix problems that emerged during due diligence (for example, if the company's environmental or other permits were not in order). It is better for a vendor to fix problems prior to or during due diligence, because failure to do so will either lead to postponement of signature of the SPA, or give the investor a possible exit from the transaction in the form of a CP.

Very often no CPs are provided by an investor to the vendor. To the extent that there are such CPs, these are usually "light." For example, the investor may need to take the signed SPA before his board, supervisory board, or investment committee for approval, and this may form the basis for a CP.

The time between signature of SPA and closing may also be used for the investor to meet with the management of the company being acquired, possibly negotiating and signing new employment agreements with management. For vendors it is important to note that during the period between the signing of the SPA and closing the target company must be managed in the ordinary course of business Any material transactions outside the scope of the ordinary business require the approval of the investor.

Although the SPA is almost always a legally binding agreement, my advice is not to count chickens before they hatch. There is many a slip between cup and lip.

There may be bona fide business reasons for CPs not being capable of being satisfied (eg. the bank does not approve transfer to the new owners).

Nor should the binding nature of the agreement be treated lightly - a party who does not use best efforts to close the transaction or who exercises bad faith will quite probably find himself or herself in litigation or arbitration, and probably on the losing end. Hence all parties are well advised to try very hard to satisfy the CPs.

At or prior to closing, the lawyers from all sides will go through all CPs as set out in the SPA and ensure that these have been satisfied. The CPs become part of the checklist required for closing. Indeed, if all CPs have been satisfied, both sides are usually legally bound to close.

When negotiating the purchase or sale of a company, the investor or purchaser will often insist on what is known as a Material Adverse Change (MAC) clause.

This article deals with three issues related to the MAC clause: 1) what is it? 2) When should it be sought by an investor or granted by a seller? 3) What happens if it is exercised by the purchaser?

1)What is it?
A MAC clause is a clause typically requested by the purchaser of a business to be inserted into a Sale and Purchase Agreement (SPA). It states that if the condition of the business being purchased materially deteriorates between the time of signing the SPA and the closing, the investor can call off the closing.

2)When should it be sought by an investor or granted by a seller?
For an investor, the longer the time to closing, or the more volatile the industry of the selling company, the more important a MAC clause may be. The MAC clause helps the purchaser to ensure that he obtains at closing what he signed up for in the SPA. Often, it is accompanied by a final due diligence immediately prior to the closing, or at least the right to obtain certain data in the period between the signing of the SPA and closing.

A seller should only grant a MAC clause if he or she is either very confident that there will be no deterioration in the business in that time, or if he or she is willing to bear the risk of such a deterioration annulling the transaction.

Such a clause essentially means that the risk arising from a deterioration in the business is transferred from the investor (who typically bears such risk after signing a binding SPA) to the seller.

3)What happens if it is exercised by the purchaser?
If the purchaser exercises the MAC clause (typically by providing written notice to the seller or the seller's legal council), the seller basically has two choices. He or she may either accept the purchaser's position (in which case there may even be a return of deposit required), or the seller may choose to litigate. The SPA would normally give guidance as to the jurisdiction whose laws will apply, and as to whether the appropriate remedy might be litigation in the court system or arbitration at a body such as the London Court of International Arbitration. Pursuing a legal remedy is not for the faint hearted, and may be extremely expensive.

On the positive side, at least in Anglo-Saxon case law, there is a considerable body of case law on what constitutes a MAC, meaning that a MAC clause is not something that a purchaser or investor can just arbitrarily exercise. There will likely be considerable expert testimony on both sides, as to whether there truly was adverse change, and, if so, whether such adverse change was truly material.

In the event that the court or arbitration panel decides that there was no MAC, there may be either an award of specific performance (ie. the investor must belatedly complete the purchase of the business), or there may be an award in damages. Because litigation or arbitration typically takes years, and any business typically changes considerably in the course of several years, courts and arbitration panels may lean more towards awarding damages rather than specific performance.

Ultimately, a MAC clause is a reflection of the negotiating strength of the parties in a transaction; an investor can only gain by it but for the vendor it can bring nothing but trouble.