I am often retained to represent dentists in a dental practice purchase or sale transaction. It is not unusual for a “letter of intent” or a “term sheet” to be signed by a buyer and seller before they retain a lawyer to represent them. Letters of intent or term sheets are usually non-binding, other than provisions related to confidentiality and the exclusivity period, which are binding. They tend to focus on deal structure and purchase price, and are designed to align the parties on essential terms of the transaction prior to negotiating a formal agreement. Not surprisingly, navigating the purchase or sale of a dental practice is complex and involves critical decisions and unique considerations that are not well understood or are often overlooked by the parties. Since a formal agreement creates binding and enforceable obligations, it is important that a buyer and seller understand each party’s obligations at the outset and that these obligations are appropriately addressed in the agreement. In this article, I provide a brief overview of the agreement structure to draw your attention to key issues and less-understood provisions, and to highlight the purpose they serve.
Representations and warranties
One of the most important aspects of the purchase agreement is the seller’s statements regarding the dental practice. These statements are referred to as “representations and warranties.” It is usual and customary for a seller to provide extensive representations and warranties regarding the condition, status and key aspects of the dental practice. For example, a seller’s representations and warranties would often cover areas such as ownership of shares/assets, financial statements, lease obligations, compliance with laws, IPAC and tax matters. A buyer will want assurances from a seller that there are no “surprises” after closing.
Conversely, a seller will want to limit the scope of such statements by qualifying them to avoid creating any misleading or inaccurate expectations, which may result in liability to the seller. Negotiating these statements is an extremely important aspect of the buying and selling process. It allows a buyer, along with the buyer conducting due diligence investigations, to learn more about the dental practice before buying and thereby properly allocate risk between the parties. By clearly defining the nature and scope of representations and warranties, the parties can each mitigate their risks and ensure a smoother transition following closing.
Pre-closing covenants
In a transaction that requires an interim period between signing the agreement and closing the transaction, the buyer will want to ensure that there are no material changes to the operation, the assets, and the financial position of the dental practice during this period. Pre-closing covenants are promises or obligations made by a seller to do something, or not do something, during the period between the signing of the agreement and the closing. An agreement should contain a sufficient number of promises to ensure that no significant changes are made to the practice until closing. Promises that restrict a seller’s activities, also referred to as negative covenants, are designed to prevent a seller from making material changes to the practice without first obtaining a buyer’s consent. An example of a negative covenant is not to increase the compensation paid to employees and associates of the practice. Promises that obligate a seller to take certain actions prior to closing are also known as positive covenants. An example of a positive covenant is to operate the practice in the normal and usual course of business, consistent with past practice.
Conditions
An agreement will often contain one or more conditions that must be satisfied to legally require the other party to close. Conditions are usually for the buyer’s benefit and should be drafted in clear and precise language. For example, care should be taken to ensure that a condition will not be deemed satisfied, fulfilled or otherwise waived unless the buyer gives written notice of such intention. Watch out for conditions that are deemed to have been satisfied and/or waived unless written notice to the contrary is given.
Conditions should also stipulate that they are to be satisfied at the sole discretion of the buyer and not by an objective standard. For example, with respect to financing, it is not sufficient to say that the agreement is conditional on the buyer obtaining financing. This can and sometimes does lead to the seller arranging for the financing on terms that a buyer may not be prepared to accept but is forced to do so because of a poorly worded condition. This can be rectified by wording such as the agreement is conditional on the buyer obtaining finance on terms satisfactory to the buyer in its sole discretion. Careful attention is required when drafting and wording conditions to avoid unintended consequences.
Restrictive covenants
A lot has been written on this topic in the last few years. I could dedicate an entire book chapter to this issue alone. For the purposes of this article, it is important that a buyer understands they will need to place restrictions on a seller’s ability to compete and solicit patients and employees of the dental practice to protect their investment. A buyer will need to ensure that any restrictions placed are necessary to protect their legitimate business interests without overreaching in scope and duration, which may render them unenforceable.
In determining what is reasonable and legally enforceable many factors must be considered, including the location of the practice, the nature of the practice, the seller’s age, continued desire to work, other practice locations that may be owned by the seller, the geographic scope and the duration of the restrictions. In the case of a seller who owns and operates another dental practice or intends to continue working after the sale, geographic restrictions alone may not be sufficient to protect a buyer’s legitimate interests in the practice. Consideration should be given to including not only non-solicitation covenants but also a clause entitling a buyer to a pre-determined amount of money as damages for each patient of the practice that, after closing, becomes a patient of the selling dentist. Such clauses tend to have a substantial deterrent effect and will decrease patient attrition that results from a seller’s potential improper competition.
Indemnification
Indemnification provisions are designed to protect a buyer from any matter for which indemnification has been obtained. It is common for a seller to provide indemnification to a buyer for any breach of a representation, warranty or covenant of the seller. By way of example, a buyer should ensure that they are indemnified for any tax matters arising from the dental practice for any period prior to closing. Usually, claims for a breach of representations and warranties are limited in time for one to two years, unless such representations and warranties are considered fundamental representation and warranties, such as the seller ownership of the dental practice and practice assets. These usually survive without limitation of time beyond an ultimate limitation of 15 years. Claims relating to taxes or other covenants usually have specific survival periods, which are negotiated.
Disclosure schedules
Representations and warranties often refer to a disclosure schedule, which contains certain specific information or exceptions that may relate to such representation and warranty. A seller will want to make sure that all disclosures, such as financial statements and business records, are complete and accurate to avoid any potential claims of concealment or non-disclosure.
This article addresses common terms of an agreement. However, it is not intended to be exhaustive in nature and does not replace the need to obtain well-qualified professional legal advice. It provides the reader with some basic general knowledge and awareness of some of the issues which can and should be addressed in an agreement from the outset. Consult with your professional legal advisors early in the process. It usually leads to far greater satisfaction with the outcome.
Written by Louis Laskovski
* Please note that the information in this article is not intended as legal advice, but rather as a general overview on the subject. If you are seeking legal advice, please consult with a lawyer.
