Virtually any time that there are transactions involving cannabis company mergers, cannabis company acquisitions, or cannabis real estate sales, and in many cases involving the sale of assets of a cannabis company, the parties are likely to encounter a concept called “closing” in their purchase agreements. Closing isn’t necessarily unique to purchase and sale situations and can be happen in other types of contracts as well, but for the purposes of this post, I’ll focus on cannabis mergers and acquisitions (M&A), as well as real estate transactions.
“Closing” under a contract is essentially the process where the main purpose of the contract is carried out. In most M&A and real estate transactions, the contract is executed before closing – and in some cases long before it. For example, parties to a company acquisition may sign the papers on June 1, but the actual transfer of shares and the purchase price may not happen until September 1.
You may be asking, “why not just sign the contract on the same day as the asset is purchased?” The answer is that having a future closing gives the parties to the contract time to carry out certain pre-closing conditions. For example, if in a cannabis company acquisition, the local jurisdiction in which the business has a license requires pre-approval of new owners (the buyers), there will be a condition to closing that the parties get that approval before the transfer happens, and both parties will be obligated to work together to get it done. Other common pre-closing conditions include things like:
- The buyer obtaining financing for the purchase price of the transaction
- The seller taking care of any existing liabilities – for example, paying off tax debts or settling litigation
- Getting approval from the landlord if a business is being sold – most commercial leases require the tenant to get the landlord’s consent prior to a change of ownership, so this is something that usually has to happen before closing
- Executing third-party agreements that may be necessary for closing to occur
- Getting necessary internal corporate approvals for the transaction squared away
- Permitting the buyer to undertake due diligence
You may now be asking, “why not just do all this stuff before signing?” There are lots of reasons for this too. Signing a contract locks the parties into a specific course of performance. The sellers usually can’t keep shopping the business or property around and the buyer will generally not feel the need to go looking for other opportunities. Getting pre-closing conditions taken care of can take a lot of work (and money) so the motivation to do that when the deal’s not locked in is usually a big risk that sophisticated business people just won’t take.
Well, you may ask, “if there is a long delay between signing and closing, isn’t the buyer taking a huge risk that the property or business could change during this period?” The answer is yes and no, and depends on how good the purchase agreement is. The buyer will usually insist on all kinds of seller covenants for the pre-closing period and incorporate them into the purchase agreement. Some common ones include:
- Keeping certain amounts or ranges of inventory and working capital so that the sellers don’t just take money or assets out of the business prior to closing – there are often very complicated calculations for both of these concepts which change significantly from deal to deal
- The absence of material adverse changes to the business or property – also often a very specifically defined term
- Seller maintaining any licenses in good standing
- Any representations and warranties made by seller on signing will still be true at closing
Purchase agreements will spell out the circumstances under which either party can terminate the agreement and not close if certain pre-closing conditions are not met to the applicable parties’ satisfaction or certain pre-closing covenants are not carried out.
Given the fact that the transaction may not work out in the long run, it’s no surprise that parties don’t want to exchange much of anything at signing. Many parties will use an escrow company during the pre-closing period to hold certain assets that will be exchanged. For example, the buyer may deposit the purchase price with an escrow company and the seller may deposit title to the property. This further helps the parties feel comfortable that the other side won’t just bail absent the agreement being terminated for valid reasons.
Purchase agreements don’t usually define when exactly closing will occur. Instead, closing is usually contingent on the occurrence of any pre-closing condition and/or waiver of conditions from the party who doesn’t have to perform them (i.e., even though the buyer may have satisfactory diligence results as a closing condition, it can waive that condition if it doesn’t want to do the diligence though that’s a big risk). It’s usually impossible to say when closing conditions will be satisfied and to set a closing date – nobody knows when the regulators will approve a change of ownership, for example. The best parties can usually do is to say that closing will occur at a fixed time after the parties agree that the conditions have been satisfied.
Another option that we see is a “drop-dead date”, which is a date at some point in the future where, if the closing conditions haven’t occurred, the contract is terminated. Parties don’t want to be locked into a deal that drags on and on forever (which unfortunately is common in the cannabis context). A fixed drop-dead date incentivizes the parties to get things done and work towards closing. And in the event that the parties still can’t get things done despite their efforts, they will sometimes agree to extend that date.
Once all the conditions to closing have been met, the parties will close the transaction and perform any obligations that are required to be performed at closing, such as exchanging money or stock certificates. In many cases, certain documents may be executed at closing to acknowledge the completion of the sale. And there are usually some post-closing obligations of each party as well, such as removing prior owners from a state cannabis license in California and tying up other loose ends.
After any post-closing obligations have been taken care of, the parties are usually done with one another. M&A agreements will often limit the time that any representations and warranties in a purchase agreement survive the closing period, meaning that after those expire, the parties will have no further obligations.
We plan on writing more on the intricacies of M&A and real estate transactions, so stay tuned to the Canna Law Blog.