The Gap Between Signing and Closing
In some transactions, signing and closing happen at the same moment. The parties execute the purchase agreement and complete the deal on the same day, and there is no period in between. In many others, particularly where regulatory approvals, third-party consents, or financing have to be arranged, the parties sign first and close later. That gap between signing and closing can last weeks or months, and it is governed by a specific set of provisions that determine what has to happen before the deal actually completes and who bears the risk of what occurs in the meantime.
A signed purchase agreement is often treated as a done deal. When there is a gap before closing, that is not quite accurate. The signature creates a binding commitment to close if a defined set of conditions is satisfied, subject to the parties’ obligations during the interim period and to the possibility that something happens before closing that lets one side walk away. The provisions that govern the gap, the closing conditions, the interim operating covenants, the bring-down of representations, and the material adverse change clause, decide whether the deal that was signed is the deal that closes.
Closing Conditions: What Has to Happen Before Anyone Is Obligated to Close
Closing conditions are the events that must occur before a party is obligated to complete the transaction. If a condition to a party’s obligation is not satisfied, that party is not required to close, and depending on the circumstances may be able to walk away without liability. The conditions are, in effect, the list of things that have to be true or have to have happened for the deal to close.
Common conditions include receipt of required regulatory approvals, such as antitrust clearance, obtaining specified third-party consents, the accuracy of the other party’s representations at closing, the other party’s performance of its covenants, delivery of specified closing documents, and the absence of any material adverse change in the business. Some conditions are mutual, applying to both parties’ obligations. Others run in favor of one party only.
The allocation of conditions is a negotiation. Each condition to a party’s obligation to close is, from the other side’s perspective, a way out of the deal. A buyer wants conditions that protect it against closing a deal that has changed for the worse. A seller wants the conditions limited and objective, so the buyer cannot use a vague or subjective condition as a pretext to walk away from a deal it has simply reconsidered. The tighter and more objective the conditions, the more certain the closing.
Closing certainty is largely a function of how the conditions are drafted. A seller focused on getting the deal done should press for conditions that are specific and measurable rather than open-ended, and should pay particular attention to any condition that turns on the buyer’s judgment or satisfaction. A condition that lets the buyer decline to close if it is not satisfied with something, in its sole discretion, is close to an option to walk away.
Interim Operating Covenants: Running the Business Until Closing
Between signing and closing, the seller still owns and operates the business, but the buyer has agreed to purchase it based on how it looked at signing. The interim operating covenants govern how the seller runs the business during that period, protecting the buyer against changes that would alter what it agreed to buy.
The core covenant is usually an obligation to operate the business in the ordinary course, consistent with past practice, between signing and closing. This keeps the seller from making significant changes to the business the buyer is counting on acquiring in substantially the condition it was in at signing. Layered on top of the ordinary course covenant is typically a list of specific actions the seller cannot take without the buyer’s consent: incurring major new debt, selling significant assets, making large capital expenditures, changing compensation, entering or terminating material contracts, issuing equity, or making acquisitions.
These covenants involve a genuine tension. The seller still owns the business and has to run it, including making real decisions as circumstances change. The buyer does not yet own the business but has a legitimate interest in it not being changed in ways that affect what it is buying. A covenant package that is too restrictive can prevent the seller from responding to ordinary business developments. One that is too loose leaves the buyer exposed to changes it did not anticipate. There are also legal limits on how much control a buyer can exercise over a business it does not yet own, particularly before regulatory approvals are obtained, which is a reason the covenants have to be drafted with care rather than simply maximized in the buyer’s favor.
The consent rights are where much of this gets negotiated. A buyer wants a low threshold and a broad list, so it has visibility and control over significant actions. A seller wants a higher threshold and a narrower list, along with a requirement that the buyer not unreasonably withhold or delay consent, so the business can keep running without the buyer’s sign-off on routine decisions. The specific dollar thresholds and the breadth of the consent list are the terms that determine how much operational freedom the seller retains during the interim period.
The Bring-Down: Testing the Representations Again at Closing
The representations in the purchase agreement are generally made as of signing or another specified date. When there is a gap before closing, the agreement typically requires specified representations to remain accurate at closing, through what is called a bring-down condition. The buyer’s obligation to close is conditioned on the seller’s representations being accurate as of the closing date, not just as of signing.
The bring-down is one of the things that gives the representations continuing significance during the interim period. If something happens between signing and closing that makes a representation untrue, the bring-down condition may not be satisfied, and the buyer may not be obligated to close. This gives the representations ongoing force rather than treating them as a snapshot taken at signing and never revisited.
The standard that applies to the bring-down is heavily negotiated, because a literal requirement that every representation be true in all respects at closing would let the buyer walk away over a trivial inaccuracy. To prevent that, the bring-down is usually qualified by materiality. A common formulation requires that the representations be true in all material respects at closing, or that they be true except where the failure to be true would not have a material adverse effect. Fundamental representations, such as those covering ownership of the business and authority to sell it, are often subject to a stricter bring-down standard than the remaining representations. The choice among these formulations, and how the underlying materiality standard is defined, determines how much room the buyer has to decline to close based on a change in the accuracy of the representations.
The bring-down standard is one of the most important terms governing the interim period, and it interacts with the material adverse change clause discussed below. A seller should understand precisely what standard the representations have to meet at closing, because that standard is one of the main things standing between a signed deal and a completed one.
The Material Adverse Change Clause
The material adverse change clause, sometimes called a material adverse effect clause, is the provision that most directly addresses the risk that the business deteriorates between signing and closing. It typically appears in two places: as a condition to the buyer’s obligation to close, so the buyer is not required to close if a material adverse change has occurred, and as a qualifier woven through the representations and the bring-down.
The clause allocates the risk of adverse developments during the interim period. If the business suffers a serious downturn before closing, the question of whether the buyer can walk away turns on whether the downturn amounts to a material adverse change as the agreement defines it. That definition, and the exceptions to it, are among the most negotiated terms in the entire agreement.
The definition usually starts broad, covering any change or effect that is materially adverse to the business, and is then narrowed by a list of exceptions. Common exceptions carve out changes resulting from general economic or market conditions, industry-wide developments, changes in law or accounting standards, the announcement of the transaction itself, and acts of war, terrorism, or natural disaster. The rationale is that the buyer should bear the risk of general conditions that affect all comparable businesses, while the seller bears the risk of problems specific to the business being sold. Many of these exceptions are themselves qualified by a disproportionate effect proviso, which returns the risk to the seller if a general condition affects this business disproportionately compared to others in the industry.
The cases applying these provisions generally reflect a demanding standard, particularly where the alleged deterioration is temporary rather than durationally significant. That demanding standard means the clause is invoked successfully far less often than it is argued about, but the negotiation over its definition and exceptions still matters, because the allocation of interim risk it represents shapes the parties’ leverage if the business does deteriorate before closing.
For a seller, the goal is a narrow material adverse change definition with broad exceptions, so the buyer cannot escape the deal over developments outside the seller’s control. For a buyer, the goal is a definition broad enough to provide a genuine exit if the business fundamentally changes. Because the standard is demanding and the definition is where the risk is allocated, both sides should treat the material adverse change clause as a core commercial term rather than boilerplate at the back of the agreement.
The Takeaway
These provisions are easy to treat as mechanical, but they decide who bears the risk of everything that can happen between signing and closing, and whether a party that has second thoughts can find a way out. For the seller, they determine how certain the closing is. For the buyer, they determine how much protection it has if the business changes before it takes ownership. A signed purchase agreement with a gap before closing is a commitment to close on defined terms, and the provisions governing the gap are what define those terms.
This post is general information only and does not constitute legal advice. For questions about a particular transaction or agreement, contact Cruxterra Law Group.
