Corporations and Cross Border Transactions

1. CorporationsandCross Border Transactions Visiting Prof. John W. Reboul September 2009

2. Course Overview • Introductions • American Corporations • Cross Border Transactions • International Mergers and Acquisitions • International Component Supply Agreements • International Distribution Agreements • International Joint Ventures • Manufacturing • Natural Resources

3. Introductions • Who is Visiting Professor Reboul? • Class Introductions • Questions

4. Who is Professor Reboul? Education • 1964, Doctorat de l’Université, Faculté de Droit et des Sciences Économiques • 1963, LL.B., Harvard Law School • 1959, A.B., Harvard College Practice He co-founded Reboul MacMurray with John MacMurray in 1973 and is a corporate lawyer with extensive experience in international corporate, finance and securities, joint ventures/strategic alliances, and private equity law. He joined Ropes & Gray in 2003 when Reboul MacMurray Hewitt & Maynard combined with Ropes & Gray.

5. Who is Professor Reboul? (cont’d.) Professional Experience He has advised clients on multinational transactions centered in Europe (France, Germany and The Netherlands) and Asia (Japan, Korea, Malaysia and Thailand).He represented Mitsubishi Motors Corporation for many years, including in its alliance with Volvo Car Corporation to develop and produce a car to be assembled at the Netherlands Car B.V. (NedCar) plant.  He has worked on cross-border joint ventures, acquisitions, distribution arrangements and other agreements involving many countries in Europe and in Japan.

6. Who is Professor Reboul? (cont’d.) Professional Experience (cont’d) • He represented a South African private equity fund borrowing from Overseas Private Investment Corporation. • He represented the Democratic Republic of the Congo in the renegotiation of certain mining contracts entered into with international mining companies.

7. Class Introductions • To give me an idea of your backgrounds and interests, I would appreciate it if several of you would stand up and inform me of your: • Name • Program in which you are enrolled and year in program • Home city • Why are you taking this class?

8. Questions • This is an open class, as such questions and comments are both encouraged and welcome. • I will ask questions about some of the situations described. There are frequently no “right” or “wrong” answers and the purpose of the questions is to encourage discussion of the issues raised. • You may ask questions in any way related to the subject matters being presented but suggest that questions about current events and politics be raised after the class. • Raise your hand if you do not understand anything discussed or if you cannot hear me or if I speak too fast.

9. Characteristics of a Corporation • General • Created by law • Can exist indefinitely • Legal • Can sue or be sued • Can own property • Shareholders not personally liable for actions of corporation, except to prevent abuses

10. How does a Corporation compare to other legal business relationships? Note: There are also limited partnerships (where the general partners run the business and are responsible for the partnership’s debts and the limited partners are primarily investors) and limited liability companies combining some or all of the characteristics of a limited partnership.

11. Taxation Concepts Partnership Partners Partners pay income tax, proportionately, on 100% of the profits $$$ 100% Profits $ Pass Through Taxation (money only taxed once) Corporation Corporation pays Expenses and taxes Net profits distributed to Shareholders as Individuals, who pay income tax $$$ $$$ Net Profits Corporate Taxation (money taxed twice)

12. HOW TO CREATE A CORPORATION

13. Where to Form the Corporation • Multi-state corporations • Most are formed in Delaware • Over 50% of U.S. publicly traded corporations • Over 60% of Fortune 500 companies • Certainty of results if litigation • Management-friendly • Offices/operations in only one state • Delaware or state where corporation will be physically located • Formation extremely simple by signing a Certificate of Incorporation and causing it to be filed with the Secretary of State or other official in the state in which the corporation will be incorporated.

14. General Characteristics of Delaware Corporation • Share capital. Delaware does not impose minimum or maximum limits on share capital. • Non-cash consideration. A corporation's shares can be issued for non-cash consideration. • Rights attaching to shares. The rights, powers and preferences of shares must be set out in a corporation's certificate of incorporation. • Foreign shareholders. Delaware does not impose restrictions on foreign shareholders. • Management structure. Unless the certificate of incorporation provides otherwise, a Delaware corporation is managed by, or under the direction of, its board of directors. There are no co-determination rules or citizenship requirements for management.

15. Certificate of Incorporation NAME AND ADDRESSES • Name must not be the same as another corporation incorporated in the same state • Must include word “corporation”, “corp”, incorporated” or similar • Must include address of each incorporator CAPITAL STRUCTURE (STOCK) MUST INCLUDE : • Number of authorized shares • Number of classes of stock • Information on par value, rights, preferences or limitations of each class • Information on any series (structures) of preferred stock. CORPORATE PURPOSE: • Must include corporate purpose, but purpose can be very general • For example: “The purpose of this corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware”

16. Governance Governance • State Law • Certificate of Incorporation • By-Laws • Not filed with the state • Outsiders to corporation not bound by By-Laws • Incorporator adopts initial By-Laws • Shareholders and Board of Directors (if so provided) can adopt By-Laws

17. Management Structure • Management Structure • A Board of Directors elected by the shareholders manages the corporation. Officers appointed by the Board take care of day-to-day operations • Board of Directors • Acts by Board of Directors • Meeting; or • No meeting with unanimous written consent • Meeting may be held outside state of incorporation • Conference call acceptable, if directors can hear all participating directors simultaneously

18. Management Structure (cont’d.) • Notice • Regular meetings are specified in the By-Laws, no notice • Special meetings require notice with method set in By-Laws • If Director not given notice, any action taken at meeting is void, unless director waved notice by: • Attending the meeting without objection; or • Writing and signing a waiver of notice at anytime • Quorum Requirements • Must have quorum at meeting (generally majority of all director seats) • Can lose quorum if director leaves meeting before voting • At meeting, only need majority present to pass resolutions

19. Duties of Board • Directors of corporations owe a fiduciary to the corporation and can be held liable for breach of this fiduciary duty. Directors can also be liable for the unlawful payment of dividends or unlawful share purchase or redemption. • Liability can arise for breaches of the duty of loyalty (this deals, for example, with conflicts of interest). • Breach of duty of care: • Failure to discharge duties in good faith and with that degree of diligence, care and skill that an ordinarily prudent person would exercise under similar circumstances.

20. Officers Officers are generally named by the Board of Directors and are the persons who run a Corporation. Generally, officers include: • President • Secretary • Treasurer but, may include: • Chairman • Vice Presidents, and many other titles

21. Mergers & Consolidations • The Board of Directors of each corporation must generally adopt plan of merger or consolidation • Each corporation must generally have shareholder approval • No shareholder approval in “short form” merger: B owns 90% of each class of stock of A • Deliver certificate of merger of consolidation to Dept. of State for filing • Right of Appraisal for shareholder of Corporation that disappears • includes dissenting shareholder in short form merger • Surviving corporation succeeds to all rights and liabilities of the constituents “successor liability” A + C B Consolidation B A Merger

22. Transfer of Substantially All Assets/Share Exchange • Fundamental change for selling corporation only • Each corporation's Board of Directors must authorize deal and • Approval by selling corporation’s shareholders • Buying corporation generally does not vote • Department of State for filing • Only if share exchange • Does not apply to asset transfer • Selling corporation shareholders may have right of appraisal • Only successor liability if: • Deal provides otherwise; • Purchasing company is mere continuation of the seller; or • Deal was entered fraudulently to escape such obligations

23. Dissolution • Voluntary: By vote of board and shareholders or by all shareholders without board vote. • Involuntary: Judicial • Board Resolution or resolution of majority of shareholder entitled to vote • Insufficient assets to discharge liabilities or • Dissolution beneficial to shareholder • Under Delaware law, in the case of a corporation having only 2 stockholders owning 50% of the stock engaged in a joint venture and such stockholders are unable to agree on discontinuing the joint venture either one may petition the Court of Chancery to dissolve the corporation.

24. Dissolution (cont’d.) • Dissolution does not end corporation’s existence. Requires winding up: • Gather all assets • Convert to cash • Pay creditors • Distribute remainder to shareholders • Shareholders are never paid before creditors.

25. Cross Border Transactions • This is a very broad topic and can involve almost any business arrangement involving parties in different countries. My lectures will address the following categories of transactions: Cross Border Mergers and Acquisitions • Includes situations in which a company (Company A) in one country buys a company (Company B) in another country or combines with Company B • Also includes Company A buying an interest in Company B of less than 100% • The acquisition of an interest of less than 50% is frequently part of a larger relationship, for example, a joint venture

26. Cross Border Transactions (continued) Cross Border Supply Agreements • A product made in one country is a component in a final product made in another country • For example, an engine made in Japan may be incorporated in an automobile finally assembled in the United States Cross Border Distribution Agreements • A product manufactured in one country by Company A is distributed in another country by Company B • For example, many automobiles are distributed by unrelated distributors in countries other than the country in which they were made

27. Cross Border Transactions (continued) Joint Ventures • A very broad term which may include one or more of the following: the acquisition of an interest by Company A in Company B, a component made by Company A being included in a final product made by Company B or a product made by Company A being distributed by Company B in another country • A characteristic of Joint Ventures is that Company A and Company B are carrying out some business together over a period of time • We will examine two types of joint ventures • Manufacturing joint ventures, and • Natural resource join ventures These lectures will focus on the issues arising in connection with the categories of transactions listed above but note that, in the case of any joint venture, the laws of each country touched by a cross border transaction must be considered • A manufacturing joint venture located in say The Netherlands between a Japanese and a German company will involve the laws of The Netherlands, Japan, Germany, the European Union and maybe other countries, for example England if English law is chosen to govern the interpretation of the joint venture agreement and Singapore law if arbitration is to take place in Singapore.

28. INTERNATIONAL MERGERS AND ACQUISITIONS

29. International Mergers and Acquisitions In the first part of this course, we looked on some of the provisions of U.S. Corporate Law which apply to mergers and acquisitions. In the following discussion, we will consider some of the agreements that are typically involved and some of the issues that need to be addressed. One point to be noted is that a merger or acquisition is a transaction which results in one company acquiring another company or a combination of two or more companies and that distinguishes such transaction from the International Component Supply Agreement, International Distribution Agreement and International Joint Venture in which companies maintain their separate existence and agree to work together for specific purposes. TYPICAL AGREEMENTS • Typical Agreements at Signing: • Stock Purchase Agreement or Merger Agreement • Debt Commitment Letter(s) • Types Additional Agreements by Closing • Stockholders Agreement • Employment Agreements • Stock Incentive Plan and Awards • Management Agreement

30. Business Issues • Identify assets and liabilities to be transferred • Set payment terms • Allocate risks (known and unknown) between the buyer and seller(s) • Obligate parties to take specific steps to get the deal closed • Establish degree to which parties are bound (e.g., closing conditions) • Establish rights in the event that assumptions are not correct (e.g., right to terminate; breakup fee; indemnification) • Establish terms of any continuing relationships (e.g., component supply, IP licensing, transition services)

31. Basic Perspectives of Sellers and Buyers • Sellers want: • Best price • Quick closing • Minimal risk of non-consummation • Minimal continuing obligations • Buyers want: • Exclusive opportunity to analyze the business • Substantive and procedural opportunities to reset the price or exit the deal if Buyer’s assumptions are wrong • Time and process to obtain financing • Minimal exposure if Buyer doesn’t close • Where feasible, indemnification if Buyer’s assumptions are wrong

32. Transaction Structure • Types of transfers: • Stock sale • Asset sale • Merger • Recapitalization • Types of consideration: • Cash • Stock • Debt • Contingent payments and earnouts

33. Tax consequences differ depending on: • Type of transfer • Type of consideration • Jurisdictions in which Buyer, Seller and Target are located • Local law issues: • Limitations on financing • Diligence risks • Limitations on allocation of risks and responsibilities by contract • Procedural issues • Sometimes counterintuitive • Examples of legal issues: • US • State corporate law limits breakup fees that may be paid – generally 2 ½ to 3 % in Delaware • Shareholder merger approval thresholds vary by state • Majority of outstanding shares in Delaware • 2/3 in Texas

34. Germany • Criminal penalties for financial assistance and failure to timely declare insolvency • German statue ensures good title--title warranties unnecessary • German state limits purchaser recovery if purchaser knew of the breach of warranty – explicit language needed to remove limit • Difficult to enforce employee non-competes • Real estate taxes due on stock transfers • UK • Financial assistance limitations on financing • Limits on warranty claims and proof of damages vs. indemnity • Post-closing pension liabilities • Limitation on break-up fees (e.g. 1%)

35. Purchase Price Adjustments • Picking the right measure • Net assets • Net working capital • Other • Picking the right target • Historical • Projected • Average • Mechanics • Closing vs. most recent month-end • International Financial Reporting Standards (“IFRS”) vs. “Company Accounting” • Consistency with IFRS vs. consistency with baseline • Locking certain variables (such as how to calculate reserves and whether to permit reversal of reserves) • Treatment of cash, foreign cash, debt and debt-like liabilities • Preparing calculation vs. objecting to calculation • Preventing manipulation through the operation of the business

36. Representations and Warranties • Overview • These are the Seller’s promises to the Buyer as to what the Buyer will receive when the transaction is completed. • Provide basis for closing condition (bring down) • Provide basis for indemnification (allocation of risks) • Materiality and knowledge • Essential although not always included • Key Representations Often Negotiated • Accuracy of securities law filings • Financials (IFRS) • Undisclosed liabilities (going beyond IFRS) • No material adverse change (“MAC”) • Intellectual property • Noncontravention; material contracts • Compliance with law • Customers and suppliers • Transactions with affiliates • Sufficiency of assets

37. Material Adverse Change • Possible Inclusions • Forward looking element • Prospects • Language that aggregates problems • Adverse effect on timely performance of agreement • Possible Exclusions • Changes in the economy • Changes in political conditions • Changes in industry • Changes in IFRS or interpretations thereof • Changes in law or regulation • Acts of war or terrorism • Natural disasters • Suspension of trading in securities • Changes in market price or trading volume of target securities • Failure to meet projections • Fluctuations in sales or earnings consistent with past practice • Changes in analyst recommendations • Changes in ratings of target securities announcement or performance of deal • Identity of buyer • Litigation related to the deal

38. Covenants • Promises as to the pre-closing conduct of business • Preserving business • Restricting new long-term commitments • Restricting equity issuances • Avoiding manipulation of purchase price adjustments • No shop/Go shop • Limit seller's ability to solicit or facilitate alternatives • Procedural protections to preserve first mover advantage • Approvals and Consents • Allocation of responsibility for obtaining approvals and consents • Shareholder approval • Antitrust and regulatory approval • Third party consents • Providing for failure to obtain consents • Confidentiality and non-competition (pre-and post-closing) • Post-closing matters • Transition services • Cooperation re tax returns and tax audits • Employee matters

39. Closing Conditions • Updating representations • Absence of material adverse change (MAC”) • Absence of injunction • Approvals and Consents • Stockholder approvals • Regulatory approvals • Key agreements • Transition services • Leases, licenses, etc.

40. Termination Arrangements • By material consent • By buyer or target if not closed by a “drop dead date” • By buyer or target if target shareholders reject deal

41. Post-Closing Remedies • Anyone to sue? • Public company • Private company or subsidiary • Types of remedies • Fraud • Claims under securities laws • Contractual indemnification

42. Indemnification • General indemnity for breaches of representations, warranties and covenants • Thresholds, baskets, caps • Length of survival by category • Exceptions to limitations • Special indemnities • Taxes, environment, employee benefits • Known or partially known problems • Making the indemnity work • Solvent seller • Holdback, escrow and set-off mechanics • Providing for seller representative • Suing estates

43. Schedules • Effects of listing items on disclosure schedules • E.g., representation will say no litigation, no employment agreements, no tax claims, etc. except as listed in a particular schedule. • Disclosure • Allocation of risk • Updates to schedules between signing and closing • Buyer’s remedies • Pre-signing occurrences • Post-signing occurrences

44. INTERNATIONAL COMPONENT SUPPLY AGREEMENTS

45. Manufacturers of products from computers to automobiles are dependent on components made in countries other than their own and the component supply agreements governing such sales are essential for both the manufacturer of the component (the “Component Manufacturer”) and the manufacturer of the finished product (the “Product Manufacturer”). What will be addressed in this part of the course is the relationship between independent contractants.

46. The vast majority of sales are transactions between independent parties and are covered under simple purchase orders. • The U.N. Convention on Contracts for the International Sale of Goods (CISG) provides that, in the absence of an express provision specifying that it is not to apply, the CISG is deemed to be incorporated into (and supplant) any otherwise applicable domestic law(s) with respect to a transaction in goods between different contracting states. • As of July 1, 2008 ratified by 71 countries including Hungary • Brazil, India and UK only major trading countries that have not ratified • Battle of the forms • A purchaser may send a purchase order with detailed terms printed on the reverse specifying the purchaser’s responsibility and electing the law of the purchaser’s country • The seller may return a form also with printed conditions which may specify a different law and may specify arbitration in the seller’s country. • Different results under CISG and the Uniform Commercial Code (UCC) in effect in 49 states of the United States • CISG a rejection and counter offer • UCC tries to avoid battle by saying that any acceptance conditioned on offeror consenting to additional terms

47. We will look especially at two of the relationships indicated on The Supply Chain diagram below, which are the contractual arrangements between the Component Manufacturer and the Product Manufacturer and between the Product Manufacturer and the Distributors: Sales Reps/Agents Raw Materials PRODUCT MANUFACTURER (PLANT, INVENTORY, SHIPPING) Retailers and Dealers Component Manufacturer Distributors including Wholesalers Technology And IP

48. Definition of the component • Does is currently exist? • Is it being developed? • What will be the specification of the components to be sold? • output, e.g., horsepower for an engine • fuel efficiency • performance • Evaluation testing to determine • whether technical objectives are attained • whether new regulations are complied with • Is the price fixed or is there a procedure for price adjustments? Purchase Obligations • Maximum and Minimum quantities • Protections for Component Manufacturer against obligation to furnish quantities which it cannot produce or which would require unplanned investment to increase capacity

49. Protections for Component Manufacturer for Product Manufacturer’s failure to purchase an agreed minimum • Need to agree on amount of investment relating to a particular program • How much capacity already exists • Calculation may be subject to difficult negotiations • Reimbursement for unamortized investment • Liquidated damages • can protect the Component Manufacturer’s Profit • fixed amount or a percentage of the price; may be reimbursable based on future excess purchases • Limitations of liability • Direct vs consequential • Liability caps (e.g., US $x)

50. Prices • Most favored nation clause • Adjustments for: • Changes in components • Voluntary changes • Changes to update components or to meet regulatory requirements • Calculation of price adjustments • Currency • What currency does Component Manufacturer usually want? • What currency does Product Manufacturer usually want? • Currency fluctuations and whether risk is to be shared • E.g., no adjustment if the exchange rate is between 85 yen = US$1 and 105 yen = US $1 and 50/50 sharing outside that band • Inflation formulas may be crafted for particular components, e.g., respective weighting for steel prices and wage rates