On Mergers, Acquisitions and Ducks

On Mergers, Acquisitions and Ducks

Doron Afik, Esq.
April 17, 2009

One of the main specialization of our firm is mergers and acquisitions. A transaction currently conducted by our office is the acquisition of a group of European companies at an amount of about Euro Millions 40. The terms agreed between the parties are that 50.1% of the shares of the sold company will be transferred immediately against  half of the agreed transaction amount and the remainder of the shares - 49.9% - will be sold only in two years. In practice, the agreement between the parties is clear - between the current share transfer and the transfer of the remainder of the shares, there is no exit point. The purchaser is required to purchase in two years the remaining shares at the price agreed. Until such time, the shares to remaind in the hands of the seller will be effectively without rights 'dormant shares' as such are called in the M&A language.

On its face, the terms make sense: The consideration is paid in two installments and the second half of the shares are held as collateral to ensure that the second payment will indeed be made. This was the original agreement between the parties. However, our office advised the parties to modify the structure of the transaction so that all shares will be sold immediately while a pledge agreement will be executed together with the main agreement and such pledge will also will be duly recorded at the relevant register of companies.  Under the pledge agreement half of the shares will be pledged to the seller.  Why?  Mainly because the ducks.

There are two main reasons to change the structure of the transaction. The first is designed to prevent the exposure of the seller to extortion.  For example, a person who sues the seller and imposes a lien on the shares during the two years will have a stronger position against the seller, who will have twenty million reasons to pay the claimant sums that the claimant is not entitled to only to enable the seller to transfer the shares at the end of the two years and not be under breach of agreement. If the shares are not owned by the seller from the first stage and this is in fact recorded in a public registry the seller will be able to show that there is no reason to impose any restriction on the transfer of the shares to the buyer.

The second reason is the duck test: a well-known American proverb says that if looks like a duck, sounds like a duck and walks like a duck, it must be a duck.  Israeli Pledge Law (and similar legislation in other jurisdictions) includes the duck in section 2 thereof: "This law will apply to every transaction which intends to pledge an asset as collateral for a liability, whatever the name given to the transaction."  In other words, as set in numerous Israeli caselaw, including the judgment famous affair of Kiduchey Tzafon, if title is retained but a pledge was not duly recorded, the retention of title will not be in effect for creditors or the liquidator of a party, unless the retention of ownership represents a real commercial or business logic.

As the sole aim of retention of ownership by the seller is to ensure payment of the second part of the consideration for the sale of the shares, there is a real risk of reclassification of the transaction as a pledge. In such case, it is better to call a spade a spade in the first place and structure the transaction in a manner that would represent the real intention of the parties. Involving a mergers and acquisition lawyer in the early stages of the transaction may enable proper construction of the transaction and save a lot of aggravation later.