Key Terms in a Definitive Purchase Agreement

When you’ve come to a final agreement to sell your healthcare company, you and the buyer will negotiate a definitive purchase agreement to close the deal. This document is the official and final contract that says you are transferring ownership to the buyers. The definitive agreement lists the agreed terms, conditions, and responsibilities of the buyer and seller after the sale. While the buyer’s and seller’s lawyers typically will be in charge of drafting and negotiating the document, it’s still important to know the key terms so you understand what you’re agreeing to and can provide clear feedback and guidance to your attorney as the negotiations progress.

Representations and warranties

Representations and warranties are assertions of facts that you make to the buyer about your healthcare business. Representations deal with the current status of your business while warranties are promises about future performance. For example, a representation could be the current revenues of your business while a warranty could be that there won’t be a pending lawsuit against the company shortly after you sell for something that happened on your watch.

Representations and warranties survival period

Your promises under representations and warranties don’t last forever. Most definitive purchase agreements have a representations and warranties survival period of between 12 to 18 months.  During the window, the buyer can make a claim that one of your business assertions was incorrect and it caused them a loss. The claims generally come from unknown liabilities or lawsuits that the seller did not know about at the time of the signing of the purchase agreement.  If a claim is valid, you would possibly need to pay the buyer an indemnity to make up for the loss.

Indemnity cap and escrow

Of course, there are some reps and warranties that are impossible to know for sure.  For instance, maybe you unintentionally underpaid a tax bill or an employee makes claim against the company for an issue that occurred during the period you owned the business.  The purchase agreement will provide for a process for you to protest or address the claims; however, if you are ultimately responsible for the liability, the buyer expects you to indemnify them for the claim and pay what is owed.

Your purchase agreement should also put a cap on the amount you need to pay for indemnities. This is the maximum amount you would need to pay to settle indemnity claims against your representations and warranties.

To prepare for possible claims, most agreements require the seller to fund an indemnity escrow account from the purchase price, sometimes referred to as the holdback. This typically ranges from 5% to 25% of the purchase price. The agreement will also list how long the money needs to stay in escrow before it will be returned to you, typically between 12 to 18 months.

Indemnity cap and basket

Besides a cap, your agreement can also have an indemnity basket. This is a minimum amount of damages the buyer would need to face from an incorrect assertion before they could file an indemnity claim against you. For example, if your basket was set at $100,000, they couldn’t make a claim unless they had over $100,000 in damages. The intent of the basket is to avoid small claims like an unexpected bill that did not get paid or recorded prior to closing.

There are two ways to set up an indemnity basket. 1) Under a first-dollar threshold, you would need to pay all the damages once they exceed the basket limit.  2) Under a deductible basket system, you only pay the amount of damages over the basket limit. For example, if a client has $105,000 in damages and your basket was set at $100,000, you would pay them the full $105,000 under the first-dollar system but only $5,000 under the deductible system.

Carve-outs

Carve-outs provide exceptions to the general indemnity terms of your agreement to provide additional protection to the buyer for certain items. Carve-outs for the reps and warranties survival period specify certain items that you will be liable for longer than the listed survival period. This can be items like unpaid taxes, unpaid employee benefits, intellectual property claims, and Medicare fraud or  liabilities. Typically, carve-outs are reserved for significant items that are either detrimental to the business or the seller should have known about the issues.

By understanding these key terms in a definitive purchase agreement, you can provide better feedback and guidance to your attorney as they negotiate conditions and risks associated with closing the deal.