Business Vantage Point Blog

In a merger or acquisition involving a carve-out deal where the seller is selling a division of a larger business and/or a subsidiary integrated with the seller’s overall business enterprise, a transition services agreement (TSA) is often critical to consummating the transaction. A TSA allows the buyer to avoid disruptions with its new customer base, vendors, employees and other important aspects of continuing the business after the closing of the transaction. At the same time, the seller should be aware of the complexities and risk allocation touchpoints associated with negotiating and entering into a TSA with the buyer with respect to certain assets and resources that are shared by both the retained business and the business that is being sold.

Operational Services

When negotiating a TSA, the parties need to be very clear on various aspects of the scope of the agreement. Imprecise terms can lead to adverse impacts on both the seller and the buyer. First and foremost, the parties should pay careful attention to the schedule of services that will be provided during the transition period. Often the services to be provided will require subleasing or sublicensing of assets such as real estate or software being used by the business. The fundamental questions listed below need to be expressly addressed in the TSA to determine the scope of the arrangement:

• Is the seller able to provide the services under existing agreements with third parties or will providing such services create a risk that the seller is in breach of a critical contract needed for its own ongoing operations?
• How much will the seller charge the buyer for the services to be provided?
• Will the seller simply pass through its actual direct costs, or will there be an allocation of overhead charges or a profit margin added to the services fee?
• Are specific details on costs, fees, reimbursements and timing of payments clearly documented?
• Have expectations for invoicing, audit rights and dispute resolution been addressed?
• How long will each service need to be provided?
   

When negotiating the schedule of services, the term during which each service will be provided and whether a party has the right to terminate the provision of the services early in certain circumstances should be clear. For example, if a service requires the availability of certain employees, the seller may not be able to guarantee the continued employment of employees with the necessary skill sets or that these employees will have sufficient availability to continue to allocate time to the buyer’s business needs. Thought should be given as to whether there are limits on the number of hours to be devoted by the seller’s employees to transition services as, in most cases, these continuing employees have ongoing responsibilities with respect to the seller’s retained business.

Can the buyer terminate a service early if it no longer requires the service from the seller? A lack of clarity as to these matters could put the seller in a position of providing buyer services for an extended period, or the provision of services could interfere with the availability of adequate resources for the seller’s own business. From the buyer’s standpoint, if it cannot terminate early, it may end up paying for services it no longer needs. However, if early termination is allowed, the parties should also consider notice periods for termination so that each party has adequate advance warning to adapt to the impending termination.

Risk Allocation

In addition to operational aspects, the parties will need to carefully negotiate certain risk allocation features of the TSA. For example, the buyer in a TSA often requests that the seller provide a service that is not expressly permissible under the underlying service agreement with a vendor (i.e., continue its human resources and payroll services under the seller’s existing plans for the benefit of its employees) so that the buyer can ensure a seamless transition until the buyer is able to migrate the services to its own vendor. The seller, in trying to get a deal done, may not be thinking about the overall impact such a request may have on its business and needs to protect its overall business from a situation where it is in breach of its contract with the vendor as a result of permitting the buyer to utilize these services.

In this case, the seller may want to request that the buyer provide an indemnity to the seller in the event the seller is damaged due to providing these services, arguably in violation of the underlying terms and conditions of the vendor contract. At a minimum, the seller needs to disclaim all liability and responsibility to the buyer for being able to provide these services, and, if this relationship were to disrupt the seller’s other business aspects, then an ability to terminate such services under the TSA.

Employee Relationships

Another important tension point relates to the employees of the seller providing services under the TSA to the buyer. The parties should clearly identify in the TSA that each retained employee who is providing services under the TSA is an employee of the seller, and not the buyer, and that the seller has the sole authority, responsibility and obligation to give directions to the employees, set their compensation and handle the overall day-to-day responsibilities over such employees. It should also be clear if any of these employees will at some point transition to employment or consulting arrangements directly with the buyer. The more unclear, the more likely an outside third party may view the employer-employee relationship as a co-employment relationship, which could introduce some complexities for both parties.

Performance Criteria

Finally, another point of negotiation is the standard of care or performance criteria for the services to be provided. The buyer may ask for the seller to perform the services in accordance with industry standards or best practices or some other standard that could create liability for the seller in what the seller usually views as an accommodation arrangement to assist the buyer for a transitional period. The seller generally has a contrary view, which is that the services are being provided as is, where is or at the same levels and standards as provided by the seller to its own business immediately prior to the closing. The seller will want no liability associated with providing these services other than for gross negligence or willful misconduct. This position is both to limit liability as well as to encourage the buyer to transition as quickly as possible to remove the burden from the seller of continuing to provide these services for any lengthy period.

Discuss TSA Terms Early

Each carve-out M&A transaction requiring a TSA will involve very deal and business-specific issue relating to the level of integration of the carve-out business and the retained business as well as the nature of the buyer and its ability to timely replace the shared assets and services. This may depend on whether the buyer has an ongoing business that can quickly absorb and integrate the acquired assets or business or is trying to stand up the acquired business as a standalone entity. There may be other issues that relate to regulatory or other requirements that may drive the nature, scope and timing of the TSA. Even though the TSA is often viewed as an accommodation by the seller to the buyer, it can be critical to the success of the deal. Both the business and legal teams negotiating the deal should discuss the issues surrounding the transition as early as possible in the transaction to be able to work out all the necessary details to facilitate a smooth closing and post-closing period.