UK M&A Transactions: Key Considerations for US Buyers

Despite a general slowdown in global mergers and acquisitions activity in recent years, certain U.S. buyers have continued to target U.K. businesses and assets for acquisition, fueled by an abundance of available capital, an international expansion strategy and a stronger U.S. dollar against the British pound. Interest in the U.K. M&A market has been further supported by its perceived safety in a global macro environment that appears increasingly challenging, with rampant inflation, rising interest rates, geopolitical unrest and supply chain disruptions leading certain U.S. buyers to focus on opportunities for transatlantic acquisitions.

In this note, we highlight certain key considerations for a U.S. buyer interested in pursuing an M&A transaction in the U.K. Although the core principles of dealmaking are similar in the two jurisdictions, there are differences between U.S. and U.K. M&A practice, which are useful to understand to achieve a successful closing.  

Regulatory Considerations

Any necessary regulatory clearances and filings must be considered at an early stage in the transaction process and as a key part of the due diligence exercise. Regulatory filings can significantly impact the timing and conditionality in a transaction, particularly in a cross-border transaction that involves an overseas buyer. Issues of potential concern include competition, employees and national security, amongst others. Similar to the Committee on Foreign Investment in the U.S., which requires notification where a non-U.S. buyer obtains control of a U.S. business in certain conditions, the U.K. has the National Security and Investment Act 2021. The NSI Act applies to certain types of transactions in 17 proscribed sectors. A deal in one of the proscribed sectors is subject to mandatory or, sometimes, voluntary notification to the U.K. government, and a requirement to obtain government clearance before closing. The NSI Act gives the U.K. government the ability to prohibit a transaction or to condition its consent on the imposition of certain undertakings by a buyer in respect of the target business. If the NSI Act is relevant to a transaction, it is crucial to factor the timetable for NSI Act clearance into the overall deal timeline. 

Purchase Price Adjustments: Working Capital Adjustments, Locked Box

One difference often encountered in U.K. M&A practice is the approach to fixing the purchase price of a deal. In general, M&A transactions typically include one of two mechanisms for determining and adjusting the final purchase price paid by the buyer: a debt-free, cash free deal with a working capital adjustment or a “locked box” approach.

U.S. M&A transactions typically favor a debt-free, cash-free deal with a working capital adjustment as the mechanism to determine the ultimate purchase price of the target company. Under this structure, the closing purchase price is determined based on estimates at closing of cash, debt and working capital (typically, in the case of the working capital, against a target figure representing a 12-month normalized amount). Post-closing, there is a true up for the actual amounts of cash, debt and working capital, based on a set of post-closing accounts, prepared to reflect the actual situation at closing. An adjustment to the purchase price is then made to reflect any differences between the actual and the estimated figures. Sometimes, the parties will escrow a portion of the purchase price as security for any post-closing adjustments.   

In the U.K., while the working capital adjustment mechanism remains prevalent, private M&A deals with institutional sellers often adopt a “locked box” approach, which is less common in U.S. M&A transactions. The key difference with this approach is that there is no post-closing price adjustment. Instead, a target company’s purchase price is set by reference to financial statements made up at an agreed date pre-closing (the “locked box date”). The purchase price is then determined on cash-free/debt-free basis by (1) adding cash and (2) deducting debt (as highlighted in the financial statements) from the purchase price agreed at the outset of the transaction. Under this approach, the economic risk associated with a target company shifts to the buyer from the locked box date, as the price is effectively fixed at the equity value in advance of closing and there is no post-closing adjustment.

To ensure that no value or benefit ‘leaks’ out of the target in the period between the locked box date and closing (“leakage”), the acquisition agreement will typically restrict the seller from receiving any leakage, except certain permitted amounts (“permitted leakage”) to cover legitimate payments the seller is entitled to receive. What constitutes permitted leakage can be a heavily negotiated provision in the acquisition agreement. The leakage restrictions will usually be backed up by a protection for the buyer in the form of an indemnity for any leakage, pursuant to which the seller must pay the buyer on a pound-for-pound basis. In the lock box structure, fixing the price at an early stage without a post-closing adjustment increases the importance of buyers conducting very thorough due diligence on the target at the outset. This may be more challenging in a cross-border context and may lead to U.S. buyers seeking to avoid the lock box structure as a result.

Due Diligence and Risk Allocation

As part of an M&A deal in either the UK or United States, the buyer will undertake a fact-finding due diligence exercise prior to entering into an acquisition agreement, obtaining in-depth knowledge of the target company. The findings revealed during that process will reverberate throughout key provisions of the acquisition agreement, as the parties allocate the identified risks among themselves by the scope of their respective warranties and representations, qualifications to them via general or specific disclosures as well as knowledge qualifiers, and the extent of indemnities provided in the event a warranty or representation is breached. Although the diligence process is similar in both the United States and the UK, there are some key differences in the way the process is reflected in the agreements in the two jurisdictions. Certain of these are highlighted below.     

Warranties vs. Representations

Both U.S. and U.K. M&A acquisition agreements typically require the seller to provide the buyer with a set of warranties in respect of the target company that can be used by the buyer as a basis for a potential claim if the warranties later transpire to be untrue — putting the buyer back in the position it would have been had the warranties been true (subject to certain legal limits on recovery, based on foreseeability and remoteness of loss). The purpose of the warranties is to underpin the basic value assumptions on which the purchase price is based and to allocate liability for unknown risks. In both the U.S. and the UK, the remedy available to a buyer for breach of warranty is a contractual claim for damages. 

In the U.S., the terms “representation” and “warranties” are generally used interchangeably, without particular distinction as to their meaning. In the U.K., however, the terms “warranties” and “representations” are not used interchangeably, as the term “representations” has a specific legal meaning under English law. Importantly, in the U.K., the term “representations” can give rise to tortious (i.e., noncontractual) claims and a right of rescission which sellers in the U.K. are typically not willing to give.

Disclosures

In both the U.S. and the U.K., warranties and representations given by a seller are usually qualified by disclosures. There is a difference, however, in the way that the jurisdictions allow those disclosures to be made. The U.S. approach to disclosure is based on specific disclosures in a schedule to the purchase agreement, with specific cross-references to relevant individual representations and warranties in the purchase agreement. Matters disclosed on the disclosure schedule are usually deemed to be disclosed for the purposes of other representations and warranties to the extent the relevance of such disclosure to the representation or warranty is either “readily” or “reasonably” apparent. It is unusual in the U.S. to have a general disclosure against all warranties.

By contrast, in the U.K., the disclosure process typically allows a seller to qualify the warranties via general disclosures (such as matters of public record, e.g., Companies House filings), the contents of a data room (as to which, see below) and specific disclosures in a disclosure letter. The breadth of this scope is mitigated somewhat by requiring that any disclosure made by a seller meet a pre-agreed standard of fairness — if a disclosure does not meet this standard, it will not be held to be effective. It is more common for disclosures to qualify all warranties in a U.K. transaction.

Buyer’s Knowledge

In the U.S., a buyer’s awareness of a fact or circumstance may limit its ability to demonstrate “reasonable reliance” on the representation or warranty. As a result, some buyers seek to include a pro-sandbagging clause in the purchase agreement. This type of clause is intended to allow a buyer to bring claim even if there is evidence that it had pre-closing knowledge of the existence of the breach. Sellers will sometimes try to include an anti-sandbagging clause, intended to prevent a buyer from bring a claim for matters of which it has pre-closing knowledge. Because it is not uncommon for voluminous diligence materials provided to buyers in connection with an acquisition, buyers will strongly resist anti-sandbagging clauses as any of such disclosures could be deemed to have provided knowledge of a breach of a representation or warranty that it did not fully appreciate, recognize or understand at the time of disclosure.

There are several caveats here. Firstly, many acquisitions in the U.S. use representation and warranty insurance which customarily defines knowledge as actual knowledge which is helpful to buyers in this regard. Secondly, some of this is jurisdictionally dependent as Delaware and New York are primarily known as “pro-sandbagging jurisdictions” as there is a strong inclination to rely on the terms in the contract, while Texas and California are generally regarded as more “anti-sandbagging” as the breach of representation and warranty is looked at as more of a tort and the knowledge of falsity would result in the inability of a buyer to claim reliance on a false representation and warranty.

In the U.K., the position is more fluid, and anti-sandbagging clauses relating to buyer’s knowledge are commonly negotiated. As an example, sellers will usually seek to limit any claims for breach of warranties if the matter is known to the buyer, subject to it being fairly disclosed as discussed above. Conversely, a buyer will seek to define the scope of its awareness and limit it to specified key members of its deal team. In the U.K., case law suggests that if a buyer possesses actual or imputed knowledge of certain facts, it may, subject to the terms of the purchase agreement, still be able to bring a claim for breach of warranty, however it is likely that the amount of damages received will be reduced.

Indemnities for Breach of Warranty

A U.S. buyer should be aware of how the approach to indemnities for breach of warranty differs in the U.S. and the U.K. In the U.S., it is common for representations and warranties to be provided on an indemnity basis — that is, a contractual promise to pay in the event of loss arising from a breach, which is not generally subject to a duty to mitigate losses. In the U.K., the approach is narrower: The remedy for breach of warranty is typically contractual damages, which require proof of breach of contract, loss arising from that breach, and are subject to a duty to mitigate loss; indemnities are typically reserved for specific risks identified as part of due diligence. In the U.S., indemnities are also used for specific risks identified as part of due diligence.

Restrictive Covenants

Both U.S. and U.K. deals will typically have restrictive covenants in the purchase agreement to protect the target business and restrict the seller’s actions after the sale to protect the buyer’s interest. In the U.S., the duration of restrictive covenants such as noncompetition, nonsolicitation, and no-hire covenants is often longer than that seen in the U.K. and advice will be needed in each situation as to what may be enforceable in the circumstances. In this instance, the analysis can again be jurisdictionally dependent. Although in all jurisdictions reasonable noncompetes in connection with the sale of a business for majority owners are generally enforced, recent decisions in Delaware have indicated a willingness to limit noncompetes. In Texas, such noncompetes that are reasonable are usually enforced, but practitioners should keep in mind the increased scrutiny of noncompetes both at the federal and state levels.

Concluding Thoughts

The U.K. market remains an attractive jurisdiction for investment and M&A activity, and there is significant overlap in U.S. and U.K. M&A practices. The jurisdictions are similar but not the same, and it is in the areas of difference where money or advantage may be gained on a deal. A careful understanding of those differences — and the way they play out in the purchase agreement — is, therefore, critical to deal success.

Oliver Williams and Omar Malek also contributed to this article.