Legal Ease: M&A Due Diligence - How to Be Legally Prepared to Buy or Sell
BY MATT DAUS
Editor’s note: This article addresses the legal parameters of mergers and acquisitions (M&A), but if you are looking for a complement to this piece, such as how to prepare your business to sell or common mistakes to avoid, check out our Q&A with Ken Lucci of DrivingTransactions.com.
The modern form of M&A transactions runs the gamut of highly technical and exotic to routine and vanilla. In the luxury ground transportation industry, we are seeing a similar trend among the complexity of the transactions—from larger portfolio purchases of multiple companies operating in multiple states to a midsize company merging with another of comparable size. Each transaction presents a variety of legal issues to navigate leading up to, and sometimes beyond, the close of the deal. In other words, each acquisition is unique in scale and difficulty, and should be treated that way.
Whether you are the buyer or the seller, careful attention should be given to legal issues and business points, so that you will know where to start when the time comes. Because we are seeing an increase in the pace of M&A transactions in the industry, now is a good time to look inward to your own company to note the various items for corporate compliance and clean-up (i.e., position it to look attractive to a buyer), or to look outward and scope out potential targets to acquire.
M&A is more than just acquiring a competitor or merging because you share a similar company culture, although those factors are obviously important to the new entity you are creating. Whether you’re a buyer or a seller, it’s the technical and legal diligence of the sale that will protect both parties in the process, so it should be taken seriously and handled thoroughly. After all, both parties will be tied to each other until all aspects of the deal are satisfied, which may take years.
The Current M&A Market
Even before the pandemic hit, many operators were looking to retire or simply get out of the business due to the 24/7/365 nature of the industry. Many who started their company in the ’80s have been in business nearing four decades. This also includes family companies that are being passed down to the next generation of leadership.
Now that we’re in recovery, driver shortages have turned the tables on the traditional models that favored the demand side over the supply. Operators who are turning away work due to a lack of chauffeurs may look to monetize their otherwise losing position by selling their book of business and taking an extended payout based on earnings generated by the transferred accounts, or by staying on as a manager or employee of the buyer.
As more operators sit with idle vehicles waiting on chauffeurs to operate them and start farming out overflow work in the meantime, larger operators with the economies of scale to absorb the increased operational costs and/or an expansive network of drivers can look to leverage their resources for strategic acquisitions. My practice is already seeing an increased pace of M&A transactions as we note the above trends in the industry, and we expect the consolidation in the marketplace to continue.
Licensing Requirements and Pitfalls
The first of those issues to navigate in a regulated industry like ours is licensing and regulatory compliance. Ensuring knowledge of the regulations, and confirming compliance with same, is essential to avoiding legal pitfalls that can derail a deal. The buyer will need to understand any authorizations, licenses, and permits that are required for the target company to operate in the jurisdiction, the status of those licenses, and the process for regulatory approval to transfer a license to a new owner—all part of your due diligence. This is especially important if you are purchasing a company outside your area or state.
First consider the types of authorizations and permits that the target company holds, especially if you are considering an acquisition outside your city or state. In New York City, for example, a limousine or black car company will likely have one or more dispatching base licenses that allows it to dispatch vehicles, as well as separate licenses for each vehicle that it owns. In other cities, the same company may only need to obtain permits for the vehicles, but different types of vehicles may likely require different types of permits. For example, in Broward and Miami-Dade counties in Florida, luxury sedans operate under a different type of license than stretch limousines and luxury vans. In addition, for larger vehicles like motorcoaches and any stretch limousines may require registration with the US Department of Transportation, and may possibly trigger interstate operating authority (a motor carrier number).
After the determining the types of licenses and authorities needed to operate the business, the parties will then need to determine whether the licenses may be transferred to a new owner. For example, if the jurisdiction does not cap the number of licenses, the local regulations may not allow transfers. In those jurisdictions, the buyer/new owner will need to separately apply for new permits. In California, the Public Utilities Commission only allows transfers of operating certificates; vehicle permits may not be transferred. In addition, the original owner of the certificate must remain as an active company with the California Secretary of State to initiate and complete the transfer process. If the company is dissolved, then its certificate is revoked and cannot be transferred, making post-closing cooperation a continuing obligation of the seller.
Using New York City as an example, there is currently a cap on all new for-hire vehicle (FHV) licenses, except for wheelchair accessible vehicles. The NYC Administrative Code—the city’s ordinance—prohibits the transfer of FHV licenses, absent the creative workarounds that can be provided by competent counsel such as stock purchase or membership interest transfer in the entity owning the underlying FHV licenses. These transactions present their own unique issue, so it is important to understand the requirements and processes to transfer licenses in each jurisdiction you are seeking to consolidate or operate. Some things to consider:
❱ Does the regulator require a bill of sale or legal document showing the sale of the asset?
❱ Do the M&A documents contemplate any such requirements?
❱ Can the sale be completed before the transfer?
❱ Will vehicles have to come out of service while the transfer is pending?
❱ Are there are other timing concerns? In California, transfers cannot be done if the transferor has fewer than 180 days left on its certificate.
❱ Are the licenses and the operator in good standing?
❱ When is the license up for renewal and what are the regulatory requirements and costs for the renewal?
Local regulations will dictate the requirements for transferring licenses, and each regulator will have its own set of rules and processes. It is important to understand those rules before even starting the transfer process so that the parties have the requisite foundation to proceed with an orderly M&A transaction.
Evaluating the Target and Due Diligence Matters
The next issue to consider is the seller’s compliance with applicable laws and regulations. Non-compliance with statutes and regulations can taint a deal before closing has occurred and can result in unwanted toxic assets. Sellers will want to ensure that their business is free and clear of liens and encumbrances to fetch top dollar, while the buyer will want the seller to cure any deficiencies prior to closing or re-trade the purchase price in the event of serious lapses in compliance or gross violations of law.
For example, New York Business Corporation Law §630 imposes personal liability on corporate shareholders for wages to due to laborers, servants, or employees, and a corporation’s non-compliance with applicable labor laws constitutes a non-waivable liability that can attach to the assets of the seller and may result in purchaser liability in some instances. Additionally, NYC imposes a Business Corporation Tax, and failing to file necessary returns on business activity can result in the docketing of a lien against the corporation’s assets without notice other than regular mailing.
Because these types of “phantom liabilities” are not necessarily of record, a lien may be lurking until buyer makes a proper request for disclosure from the seller. Therefore, an airtight due diligence list is essential to avoiding the derailment of your transaction.
With a strong diligence request list and full disclosure from the seller, the transaction should proceed at a smoother, quicker pace and with fewer last minute corporate clean-up and renegotiation so that the parties can take advantage of the market forces spurring the M&A transaction. The current trend of the chauffeured driven market, as mentioned above, has tailwinds, and appears to be swinging toward consolidation despite rising operational costs and driver shortages. [CD0922]
Disclaimer: The foregoing is provided solely as general information, is not intended as legal advice, and may not be applicable within your jurisdiction or to your specific situation. You are advised to consult with your attorneys for guidance before relying upon any of the information presented herein.
Matt Daus is a partner with the law firm Windels Marx, president of IATR, and a leading authority on ridesharing apps. He can be reached at email@example.com.