The Journal of The DuPage County Bar Association

Back Issues > Vol. 19 (2006-07)

Ancillary Documents to a Business Purchase Agreement
By Terence P. Kennedy


Whether you are preparing an asset purchase agreement, a stock purchase agreement, a recapitalization agreement or a merger agreement (each a "Purchase Agreement"), negotiating and drafting the Purchase Agreement is only half the job. You also have to prepare the documents ancillary to the Purchase Agreement. A correct understanding of the function of each of the documents and attention to detail in negotiating the same are critical to your client’s success. This article gives a brief overview of the ancillary documents to a Purchase Agreement.


Purchase Agreements are agreements to do something, i.e., to sell and buy assets or stock or to merge two companies. However, they are not the documents by which such acts are achieved. They will be accompanied by title documents. These are the documents by which title to the property is transferred from the seller to the buyer and by which the buyer becomes the actual owner of such property.

In an asset sale, the assets are transferred from the seller to the buyer by a bill of sale. The bill of sale incorporates the representations of seller about the assets set forth in the Purchase Agreement. If the company is selling registered trademarks and/or patents, separate assignment agreements are used that will be filed with the United States Patent and Trademark Office. In addition, in most asset purchase agreements, the buyer will assume the trade payables and the business contracts of the seller at closing. This is accomplished by entering into an Assignment and Assumption Agreement whereby the seller assigns and the buyer assumes such payables and contracts. This agreement should specifically state that the buyer is only assuming the obligations and liabilities that accrue on or after the closing date. Practitioners should be aware that many contracts require the consent of the other party to the contract before it can be assigned. Failure to obtain such consent would be a default under such contract, possibly resulting in termination. The buyer’s counsel should insist that the seller obtain consents to all material contracts. In addition, a sale of all or substantially all of the assets of a corporation other than in the usual and regular course of business must be approved by the board of directors of the seller and two-thirds of the outstanding shares entitled to vote.1  Shareholders must be given notice of their right to dissent.2  Shareholders who make a demand for payment before the vote is taken and who do not vote for the sale may dissent thereto by following the statutorily ascribed procedure to dissent.3 

In a stock purchase agreement, the stockholders assign their stock to the buyer. This is often achieved by use of an assignment separate from the certificate, also known as a stock power. In a merger agreement, the merger is effected by filing articles of merger with the Secretary of State of Illinois.4  Merger agreements need to be approved by the Seller’s board of directors5  and most merger agreements need to be approved by two-thirds of the outstanding shares entitled to vote in the non-surviving corporation.6  Shareholders who make a demand for payment before the vote is taken and who do not vote for the merger may dissent thereto and receive fair value for their shares.7  The non-surviving corporation must give notice to the shareholders of their right to dissent and any shareholder who desires to avail himself of such right must follow the statutorily ascribed procedure to dissent.8  First drafts of the title documents are usually drafted by the buyer’s counsel.


After the Purchase Agreement and the title documents, the Non-Competition Agreement is probably the most important agreement that will be entered into, from the buyer’s perspective. When buying the business, the buyer has the rightful expectation that the seller will not move across the street or around the corner and set up a competing business; otherwise, the buyer would not have paid a premium over book value for the company as an ongoing business. The agreement that protects this expectation is the Non-Competition Agreement. The Non-Competition Agreement generally includes four covenants. First, the seller agrees not to compete with the buyer. This prohibits a seller from engaging in any activity which is competitive with the business sold to the buyer in a particular, well-defined territory for a particular period of time. Second, the seller agrees not to solicit any of the customers of the business. This prohibits the seller from doing business with the company’s prior customers for a particular period of time, no matter where such customer is located. Often, the seller will also be prohibited from inducing any supplier, licensee, licensor or other business relation from discontinuing or reducing its relationship with the buyer, as it pertains to the purchased business. Third, the seller agrees not to entice away the employees of the sold enterprise for a particular period of time. Finally, the seller agrees to hold as confidential all confidential information pertaining to the sold business for a particular period of time.

Covenants not to compete are easier to enforce in the sale of business context than in the employer/employee context. One Illinois court has held, "[i]f the covenant [not to compete] is ancillary to the sale of a business by the covenantor to the covenantee, then all the covenantee must show is that the restriction is reasonable as to time, geographical area and scope of prohibited business activity. If, however, the covenant is ancillary only to an employment agreement, the covenantee must show additional special circumstances, such as a near-permanent relationship with his employer’s customers and that but for his association with the employer, the former employee would not have had contact with the customers."9  It is a good practice to have the seller acknowledge in the non-competition agreement that the agreements and covenants contained therein are central to the goodwill of the sold business; that the buyer would not have entered into the business purchase but for the covenants and agreements; and that such agreements and covenants are reasonable in geographical and territorial scope and in all other respects. In addition, in the past, practitioners required the seller to acknowledge that a court of law may reduce the scope, duration or area of any term or provision or replace or delete certain words in order to prevent such agreement from being invalid or unenforceable. In a recent case, however, a court declined to amend non-competition provisions in a contract to make it enforceable in the absence of a contractual direction to do so.10  Accordingly, practitioners are advised to require the court in the covenant not to compete to blue-pencil the contract in the event the court finds the covenant to be too broad as to scope, duration or area. Finally, this agreement should provide that the buyer, among its other remedies, may seek injunctive relief against the seller for the breach thereof without the requirements of posting a bond. First drafts of this agreement are usually drafted by the buyer’s counsel.


Although not always the case, at the closing of a Purchase Agreement, the key stockholders and managers of the seller will often enter into an employment agreement or a consulting agreement with the buyer. This is done for two reasons. First, the buyer often wants to keep such people around to continue to run the business or to train the buyer to manage the business. If the buyer is a private equity firm, it will almost certainly require employment agreements for such people because, as a general rule, although the private equity firm will provide management oversight for the recapitalized company, it will not run its day-to-day operations. Second, the buyers will often try to transfer some of the purchase price to the employment agreement. By doing so, the employer/buyer is able to expense the cost of such employment for tax purposes, which permits it to deduct such costs from income during the year such expense is incurred. The same principles apply to a consulting agreement. Typically, a consulting agreement has a shorter duration than an employment agreement (e.g., one to six months). Also, because the consultant is an independent contractor, the employer generally does not provide benefits to the consultant or have to withhold taxes. First drafts of these agreements are usually drafted by the buyer’s counsel.


Escrow agreements are commonly used in Purchase Agreements. An escrow agreement is an agreement whereby the buyer and the seller establish an escrow fund with a third party, typically a bank. A portion of the purchase price is placed in the escrow fund to protect the buyer. Escrow agreements are used for a variety of purposes. The two chief functions of an escrow agreement and the escrow fund is to provide a readily-available fund to pay any of seller’s indemnification obligations or to pay for any purchase price adjustment that may be necessary.

As noted earlier in this article, the Purchase Agreement contains a section wherein the seller is making certain representations and warranties about the business being sold. Another section of the Purchase Agreement covers indemnification. Among other things, this section requires the seller to indemnify the buyer from any damages the buyer might experience as a result of a breach by the seller of the representations and warranties. Generally, the duration of the indemnification obligation depends upon both the representations and warranties being breached and the negotiating leverage of both parties. Typically, breaches of representation about authority to do the transaction, validity of the transaction, enforceability of the transaction, title to the assets and brokers fees can last forever. Breaches of representations about taxes, environmental and employee benefits will last for the relevant statute of limitations. All other breaches of representations (e.g., regarding litigation, condition of the assets or the financial statements) last for an abbreviated period (e.g., 18 months or two years).

However long such representations may be valid, the seller’s promise to indemnify is only as good as its ability to pay. When the sellers receive payment at closing, it is not unusual for them to redeploy the funds immediately or to use such monies to fund trusts for the benefit of others, including children and grandchildren. As a consequence, a buyer is often left with the possibility of suing someone who no longer has enough assets to make good on a claim. To avoid this problem, the buyer generally insists that a portion of the purchase price, typically 10 to 15 percent, be placed in an escrow fund as a source of compensation for such eventualities. The escrow agreement provides the mechanism for releasing such funds to the buyer upon a successful claim for damages against seller. It also provides a mechanism whereby the seller can dispute such a claim, preventing the release of funds. In the event of a dispute, the funds will not be released by the escrow agent until it has received a signed agreement from both the buyer and the seller or a final non-appealable judgment of a court. At the end of a negotiated period, the funds remaining in the escrow fund, reduced by any amounts needed to cover any disputed claims, are released to the seller.

Escrow agreements also are used to provide a source of funds to the seller to pay any purchase price adjustment. The purchase price in many Purchase Agreements is based upon the financial statements of the purchased company at a particular point in time or on the assumption that the purchased company will have net assets or working capital at the time of the closing equal to a certain amount. Within a certain amount of time after the closing, the balance sheet as of the closing date of the purchased company is calculated by the parties. There is usually a procedure specified in the escrow agreement to resolve any differences. If the target amount of net assets or working capital is not met, then the purchase price is adjusted upward or downward, as the case may be. If the purchase price is adjusted upward, the buyer pays the difference to the seller. If the purchase price is adjusted downward, the seller must pay back the difference. Since the buyer is not always confident that the seller will not have disbursed the purchase price by the time of the downward adjustment, the buyer requires the seller to put a certain amount of the purchase price into the escrow fund at the closing. An escrow agreement is signed by the buyer, the seller and the escrow agent. The escrow agent will be concerned about two things. First, it will want to see that its responsibilities are set forth clearly in the escrow agreement. It wants the escrow agreement to be a stand-alone document (i.e., it does not want to have to refer to any other document (e.g., the Purchase Agreement)). Second, the escrow agent will be particularly concerned about the provisions detailing its liabilities. Most escrow agreements provide that the escrow agent will only be liable for its gross negligence or intentional malfeasance. In addition, the escrow agreement permits the escrow agent to submit any dispute between the other parties to a court for resolution. It also details the procedure allowing the escrow agent to resign. Accordingly, it is advisable to get the escrow agent involved in the preparation of the escrow agreement well before its execution. The first draft of the escrow agreement is usually prepared by the buyer’s counsel.


Many buyers and/or the banks providing the acquisition financing will require that a portion of the purchase price be paid in the form of a promissory note to the seller often called seller financing. The value represented by the promissory note often bridges the gap between the appraised value of the assets and the amount the seller believes the business, as an ongoing enterprise, is worth. Many times this can represent 25 to 30 percent of the purchase price. The promissory note also provides the buyer with some comfort in the event of a breach by the seller of some part of the Purchase Agreement. The buyer will provide in the Purchase Agreement that it can offset any payment due under the promissory note against any claim for indemnification it has made. The seller will often require that such offset be put in an escrow fund until the dispute is resolved. The first draft of the promissory note is usually prepared by the buyer’s counsel.


If the seller accepts a promissory note in a transaction, it will be entitled to security for such payment. In many instances, the seller will receive a junior security interest in the assets being purchased pursuant to a security agreement by and between the buyer and the seller that will be accompanied by a UCC-1 filing. The seller sometimes requests a pledge of the stock of the buyer, or some portion thereof, from the principals under a pledge agreement. In the alternative, the seller may request that the principals of the buyer execute a guaranty of the promissory note. Finally, the seller may request a letter of credit from a bank as security. The buyer will often resist giving a guaranty from the principals, since it forces the principals to be primarily liable to the seller for payment of the promissory note and encumbers their credit and future ability to obtain financing. The buyer will also usually resist any request to secure the promissory note with a letter of credit because a letter of credit will reduce the buyer’s amount of available credit on a dollar-to-dollar basis equal to the value of the letter of credit.

Banks will always require that the seller sign a subordination agreement whereby the seller’s security interest in the assets will be subordinate to the bank’s security interest. The subordination agreement will also contain a standstill provision, which prohibits the seller from exercising any remedy pertaining to the promissory note and security agreement for a particular period of time after a default by the buyer. Banks will also often require a standstill agreement with respect to a pledge agreement or a guaranty. The reason for this is simple. If a buyer defaults under the promissory note and the security documents, it is most probably in default under the bank’s loan documents as well. For its part, the bank wants to maintain the status quo for as long as possible after any default by the buyer to give the buyer room to remedy the situation and to position itself to recapture the greatest portion of its loan. The first drafts of security documents typically are drafted by the seller’s counsel. First drafts of subordination agreements and standstill agreements between the seller and the bank typically are drafted by the bank’s counsel.


Many Purchase Agreements require that the seller’s counsel provide a legal opinion to the buyer at closing. If that is the case, and the seller’s counsel is willing to provide the opinion, the seller’s counsel will usually request that the buyer’s counsel provide a reciprocal opinion. Many articles have been written on legal opinions and the conventions regarding the same. Suffice it to say, at a minimum, the parties will request that counsel opine that (1) the client is organized in its state of organization; (2) the client has the power to enter into the Purchase Agreement and the documents ancillary thereto and that all necessary actions have been taken by the client to authorize the execution, delivery and performance of the Purchase Agreement and the documents ancillary thereto; (3) such documents have been duly executed and delivered; (4) such documents constitute the legal, valid and binding obligations of the client and are enforceable against it in accordance with its respective terms; (5) such documents do not violate the client’s organizational documents or any statute or regulation; and (6) the right of the client to enter into the transaction does not require the consent of any court or governmental agency. Opinions often are accompanied by certain assumptions and exceptions which can be heavily negotiated by the respective counsel of buyers and sellers. Unlike the other ancillary documents, the clients do not have any input into the opinions. Practitioners should avoid giving opinions as to factual matters, as opposed to legal matters. A typical example of such an opinion requested from the seller’s counsel is that "counsel has no knowledge of any litigation involving the client, except as disclosed in the schedules to the asset purchase agreement or except for litigation which would not have a material adverse effect on the sold business." This is not a legal opinion, because it does not require any legal analysis. In this case, the buyer’s counsel would be trying to get the seller’s counsel to make a statement of fact (a representation) which is covered by the Purchase Agreement already. The buyer and its counsel should rely on the Purchase Agreement and all due diligence information to verify such a representation. An attempt to get the seller’s counsel to opine as to the statement of facts reflects the buyer’s lack of confidence in the seller’s candor or its due diligence. It is also an attempt to make the seller’s counsel, and more importantly, its insurance carrier, liable for breaches of the seller’s representations. Counsel should scrutinize all opinions. In addition, many firms and their insurance companies require or recommend that opinions be given a fresh review by an attorney in the firm not working on the matter. Such procedures can help reduce any potential liability for the law firm.


The Purchase Agreement is usually accompanied by a real estate transaction. If the seller owns its real estate, it can either sell or lease such real estate to the buyer. If the seller leases its real estate, the seller and the buyer will enter into a lease assignment agreement, which generally will require the consent of the landlord. These commercial transactions follow the general conventions of real estate transactions.


The ancillary documents to a Purchase Agreement are critical to the overall success of a transaction regardless of whether you represent the buyer or the seller. The practitioner must ensure that these documents properly and accurately reflect the deal between the parties, and he or she must give them the time and attention necessary to accomplish this end.

 1 805 Ill. Comp. Stat 5/11.60 (2006).

 2 805 Ill. Comp. Stat. 5/11.70 (2006).

 3 805 Ill. Comp. Stat. 5/11.70 (2006).

 4 805 Ill. Comp. Stat. 5/11.25(b) (2006).

 5 805 Ill. Comp. Stat. 5/11.05 (2006).

 6 805 Ill. Comp. Stat. 5/11.20(a) (2006).

 7 805 Ill. Comp. Stat. 5/11.65(a)(1), (2006)

 8 805 Ill. Comp. Stat. 5/11.70 (2006).

 9 Hamer Holding Group, Inc. v. Elmore, 202 Ill.App.3d 994, 560 N.E.2d 907 (Ill. App. 1 Dist., 1990).

 10 See Grand Vehicle Works Holdings Corp. v. Frey, 2005 U.S. Dist. Lexis 13629 and Pactiv Corp. v. Menasha, 261 F.Supp.2d 1009 (N.D. IL 2003). But see Total Health Physicians, S.C. v. Barrientos (1986), 502 N.E.2d 1240, 151 Ill.App.3d 726 (Ill.App. 5 Dist., 1986), cited in Gillespie v. Carbondale & Marion Eye Ctrs., 622 N.E.2d 1267, 251 Ill.App.3d 625 (Ill.App. 5 Dist., 1993): "It has long been recognized by the courts of Illinois that if the area covered by a restrictive covenant is found to be unreasonable as to area, it may be limited to an area which is reasonable in order to protect the proper interests of the employer and accomplish the purpose of the covenant."

Terence P. Kennedy is a member of Meltzer, Purtill & Stelle LLC with offices in Schaumburg and Chicago, Illinois. His practice consists of acting as general counsel to a number of closely-held businesses and handling mergers and acquisitions, management buyouts, capital formations, loans and other commercial transactions. Mr. Kennedy graduated from Fordham University School of Law in 1984. He was an associate editor of the Urban Law Journal in 1983. He also received a Master of Fine Arts degree from Virginia Commonwealth University in 1978 and a Bachelor of Arts degree from the University of Notre Dame in 1975.

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