Sleeper Clauses

Joseph W. Bartlett, Founder of VC

For our Encyclopedia of Venture Capital subscribers, we will shortly be introducing a number of interesting additional features, and we well preview some of these features in future Buzz of the Week columns.

For example, one of the new features isolates and identifies clauses in private equity and public equity financing documents which involve representations and/or obligations for which the parties making or undertaking the same may not understand all the legal and practical ramifications. To put this feature in context, it is helpful if we could all agree that there is no such thing as "boilerplate". By that statement I mean that every promise or representation in documents memorializing an investment or M&A transaction can, in the right circumstances, have considerable impact.

In my view, the paradigm piece of evidence for this proposition is the choice of law cum jurisdictional provisions in the agreement between Arthur Andersen and Andersen Consulting, the agreement which governed the resolution of any disputes in case the partners of Andersen Consulting elected (as indeed they did) to separate from the parent accounting firm. The principal issue being negotiated between the parties, an Andersen Consulting (now Accenture) spin-off, was the price to be paid to the accounting firm for the value it was losing, a price expected to be (based on comparable transactions) in the several billions of dollars. Whoever drafted the dispute resolution clause, however, elected an arbitration provision which specified that the arbitrator, with plenary authority to decide disputes, would be a professional from a country in which neither Arthur Andersen nor Andersen Consulting did business, apparently the idea being that this would insure a neutral arbitrator. Of course, Arthur Andersen and/or Andersen Consulting did business in almost every jurisdiction on the face of the planet. The result of this clause was that the arbitrator so selected was a lawyer from Colombia, where the endemic guerrilla warfare apparently had driven both firms out of the country. Without defaming the arbitrator, he delivered what appears to be an eccentric decision (based on comparable transactions) pursuant to which the Arthur Andersen partnership took in effect nothing but reimbursement for cash and accounts receivable accompanying the departing Accenture partners. One could even argue that this slip of the pen is the cause of the Enron debacle, as Arthur Andersen scrambled to rebuild its revenue base after suffering a totally unexpected body blow to its balance sheet and cash position. I do not have to argue this last point to its successful conclusion to illustrate the proposition that obscure clauses, erroneously known as "boilerplate," can have extraordinary results. And, the new feature will highlight examples of this type ... (i) promises and representations which are novel, sometimes sleepers, and the unexpected impact they can have plus (ii) elegant solutions to problems not ordinarily anticipated ... provisions, in short, worth engaging the attention of professionals in this business.

As a concrete illustration, let me dust off an example which I come across from time to time. I often find myself in the course of negotiations in the minority of one expressing concern about the issue this provisions entails.

The problem arises routinely in the course of a financing or M&A transaction in which the financial statements of one or more of the parties are being represented as accurate and complete. It is a routine item of business to provide that, at the closing of, say, the Series A investment, the chief financial officer, and perhaps the chief executive officer, sign an "Officers' Certificate" which certifies the financials. In most transactions, that certificate is routinely executed and exchanged at the closing . a ho-hum item on the closing agenda. I find that practice curious. Thus, in any number of such transactions, the question arises whether certain individuals involved in a private stock issuance should expressly stand behind the representations and warranties, with his or her personal assets at risk. This item is hotly negotiated and arouses intense emotions, as one might imagine. My concern is that the founder may win the point (refusing to expose his or her personal assets to the investors and arguing that buy side due diligence should be sufficient) only to lose it by signing the type of officer's certificate I have described . and to lose it unwittingly, by routinely executing a certificate deemed to be "boilerplate."

Some practitioners take the view that the officer's certificate necessarily implies that the officer is signing only in his or her official capacity and not personally, and the certificate is merely a way of "bringing down" the representations from the date the securities purchase agreement was signed to the closing date. I, however, rarely find that thought expressly stated in the certificate itself, which necessarily implies that a trier of fact (if a dispute arose) could go either way in the absence of a controlling precedent (and I am not familiar with any controlling precedent). Accordingly, when representing the issuer, I routinely add language to the officer's certificate which states clearly that no personal liability attaches to the certifying party.

I have been accused of various sins in the course of that discussion, including the contention that I am overly anal. However, if you analyze the point for the moment and cannot cite any language or controlling precedent which would give the signing officer comfort, I raise this issue as a classic trap for the unwary... and one, incidentally, which is easily fixed.