Entertainment Law Author(s): Andrew Hennigar & Mike Weber For a variety of reasons, business owners and prospective buyers of businesses will often give instructions to their counsel that they have agreed to back-date a purchase agreement. While seemingly innocuous, back-dating agreements has impacts for tax, regulatory and third party relationship purposes. Perhaps most importantly, it may also cost a buyer real money if the date ownership risk and the dates on which ownership and actual control of the target cannot be effectively reconciled. Generally, a seller gives the buyer a snapshot of the target company’s condition by giving representations and warranties in a purchase agreement. These representations and warranties must be true at closing, when control and ownership of the target company are transferred to the buyer. Sale transactions also customarily include a “working capital” adjustment to ensure that at the closing of the acquisition, the target company has a pre-agreed level of cash and other current assets on hand. By back-dating a purchase agreement, the buyer creates a black hole between the back-dated closing date, and the date a purchase agreement is actually signed and the buyer takes control of the target company. During the “black hole” period, a buyer has no control over the financial state or operations of the target company. However, since the purchase is agreed to have already closed, the buyer bears all the risk of ownership. The target company may incur a significant liability or the seller may strip out all of the target company’s cash immediately prior to buyer taking control. With all of the ownership and control transferred retroactively, the buyer is powerless against such events unless it takes precautionary steps. If signing and closing a transaction in real time is not possible, a better way to achieve the goal of back-dating a purchase agreement is to sign an agreement in real time, and fix an effective date at some point in the past. Using an effective date allows the buyer to craft a purchase agreement that helps to synchronize the retroactive transfer of ownership (as of the effective date) with the actual transfer of control of the target company (as of the signing date). Two ways this is achieved are:
  • requiring that representations and warranties remain true not only as of the effective date, but also as of the date the agreement is actually signed; and
  • including customized representations and warranties regarding absence of certain balance sheet manipulating actions.
Another key to synchronizing ownership and control of a target company is due diligence. When using an effective date, the buyer’s due diligence cannot stop at the effective date, but must be completed through the signing date when the buyer will actually take over operational control of the target company. The more up-to-the-minute information the buyer has the fewer surprises it will encounter when the seller hands over the keys to the target company. Even with the protections noted above, using an effective date is not without risks. A buyer will still need to consider the complications for tax, regulatory and other matters like basic relations with counterparties to key contracts like banks and suppliers, who will not be bound by a fictional effective date in the past vis-à-vis their dealings with the target company. Got questions? Call us at (604) 669-1119. This post is for informational purposes only and does not constitute legal advice or an opinion on any issue. If you are interested in receiving additional details on the topic above or advice about specific circumstances, please contact MEP Business Counsel at 604-669-1119.