Home » Five Methods to Ensure Seamless Covenant Compliance in Mergers and Acquisitions

Five Methods to Ensure Seamless Covenant Compliance in Mergers and Acquisitions

by Andrew Jonathan

M&A, or Mergers and Acquisitions, is an umbrella term denoting an amalgamation of two businesses. Buyers trying to achieve strategic goals get an excellent method for organic growth through a merger and acquisition. On the other hand, sellers get an opportunity to cash out or share their risk and rewards with the newly formed company. However, merging two businesses successfully requires careful thought and planning, one of which is ensuring covenant compliance.

Here, we share five best practices to ensure seamless compliance with covenants while going through a merger or acquisition.

  1. Know the Entity

The first step when entering an M&A deal is to know which entities it involves. Besides the constituents, identify the targets and subsidiaries for general and triangular mergers. Research to understand what they are, their locations and their industries. This includes information like whether they have permission to do business in the target states or countries. Knowing the involved entities and their relationships helps guide the covenant compliance process.

  1. Ensure Good Standing

After knowing the entities and constituents, the next strategy is to ensure they have a good standing. That means the entity must comply with state requirements, such as paying applicable taxes and filing annual reports. Ensuring good standing also means checking if the constituents, subsidiaries, and related entities are legally allowed to conduct business during the deal and at the location of its execution.

If any party does not have a good standing, it might not be the best deal breaker. See if taking some steps can resolve the issues and what will be the required time frame to move forward.

  1. Search UCC Filings

The UCC (Uniform Commercial Code), which first appeared in 1952, is a Uniform Act aiming to harmonize sales laws and other commercial transactions across the US. All 50 states, territories, and the District of Columbia have adopted it. 

Knowing which UCC financial statements are on file for the acquiring and the target entities is crucial. Confirming the validity and correct order of the statements is also essential. If the target is the creditor, ensure securing its interest successfully. However, if the target is the debtor, ensure that the creditor’s interest is not valid anymore.

After completing the research, consider whether the target still looks as lucrative as it appeared. The buyer or seller will need to recalculate if the public records do not accurately reflect their position and status. That might affect the party’s position, increase the merger’s cost for closing, or both.

  1. Ensure Compliance with the Business License

Ensuring covenant compliance with the business license is a crucial but complex part of the M&A procedure. Most entities need different business licenses to comply with the safety and tax mandates. Some require multiple signoffs to ensure compliance with local departments, federal agencies, and other bodies. It might be a prevalent case if the entities work in regulated industries, such as pharmaceutical licenses, for working at the federal, county, state, or city level. For such industries, also look for anti-trust concerns and their impact on compliance as related to licensing.

  1. Address AML Issues

Since many companies operate at a global level, they need to address concerns related to money laundering. Looking beyond the country’s borders while researching the locations of subsidiaries, constitutes, and entities are essential. That might require checking the SDN (Specially Designated Nationals and Blocked Persons). Reviewing the LEI (Legal Entity Identifier) for financial institutions will be beneficial. No one wants to find a surprise at the last minute that the target distributes products to an entity that violates covenants for clients or businesses.

These are some steps to ensure covenant compliance and avoid any related problems, such as using delayed dates while filing and obtaining documents’ pre-clearance before sending them for filing. Some are necessary before completing the deal, such as ensuring good standing for each constituent. Others are possible only after the deal is complete, such as filing to declare the acquirer as the company’s new owner and its assets. However, ensuring that each party takes the proper steps at the correct time is a crucial part of the process. Taking these steps will significantly affect statutory transactions like mergers and acquisitions. Document rejections and filing office backlogs might delay the effective dates and indicate non-compliance. So, beware and take the above steps to ensure covenant compliance in an M&A.

Read Also: Keys to an Effective Covenant Analysis

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