Outside Publication

Considerations in Transition Services Agreements in M&A Transactions, The Legal Intelligencer

March 01, 2016

When a company is sold in an M&A transaction and the seller is expected to continue to provide services to support the post-closing company, the parties to the transaction enter into a transition services agreement (TSA), which governs the provision of such services to the post-closing company. Depending upon the complexity of the transition services arrangement and the criticality of the services being provided, TSAs can range from short, back-office administration services agreements with an agreement to set fees in the future and no formal performance standards, to comprehensive service agreements with a defined scope, service levels, variable fee arrangements, and detailed data security and privacy provisions.

In every M&A transaction that has a transition services component, it is incumbent upon both buyer and seller to arrive at an agreement on certain key considerations prior to the closing of the M&A transaction. These considerations should be negotiated by the parties to the TSA as early in the process as possible, ideally during the due diligence phase. Set forth below are key issues to consider when negotiating and drafting a TSA.

Understand the Scope of the Services

The buyer and seller should agree on a clearly defined strategy for how the post-closing company will operate, both immediately after closing and on a long-term basis. Be prepared to identify the specific services that will be provided, the duration for which such services will be offered, appropriate service standards, and applicable costs and expenses. Addressing these issues early on will allow for cleaner drafting and fewer rounds of negotiation once the TSA has been reduced to writing.

Establish Pricing Mechanisms; Consider Renewals, Extensions

The buyer and seller must agree on clearly articulated, objective pricing terms. Unit pricing, hourly NRE rates, deliverable testing and acceptance procedures, transition time lines, and phased milestones are all useful mechanisms to make pricing terms as objective as possible. It is important for the buyer to have the ability to renew the term of the TSA with agreed-upon pricing increases for the renewal terms.

Define the Performance Requirements

Service levels must be defined in the TSA or the supporting documentation with the right level of detail, allowing the parties to understand exactly how the requested services must be performed, but without giving the seller any contractual "outs." Avoid defaulting to "reasonable," "commercially reasonable," "best commercial efforts," and similar standards of performance that could allow the seller to technically perform in accordance with the TSA, but without actually providing the requested services in a manner that gives the buyer the benefit of its bargain.

Consider the Consequences for Nonperformance

What are the remedies for the buyer if the seller does not adequately perform under the TSA? A seller may have little incentive to perform in accordance with the service levels set in the TSA and its supporting documentation after closing unless there are express liquidated damages that can be recovered by the buyer—standard indemnities may not provide adequate motivation. For maximum enforceability, consider recovery against an escrow for inadequate performance under the TSA (though this may be difficult to negotiate in the context of the larger M&A transaction).

Discuss Services Provided by Third Parties

Often, the seller will need to rely on its own vendors and service providers to provide services to the post-closing company. Determine if the seller has sufficient rights under its existing upstream contracts and licenses to provide the requested services itself, or whether third-party agreements and licenses with the seller's vendors and service providers need to be entered into or amended. Consider the criticality and complexity of the requested services and the costs and timing of entering into or amending third-party agreements (keeping in mind that third parties may have meaningful leverage and little incentive to provide short-term or transitional services).

Identify Third-Party Consents

Third-party consents should be identified as early in the diligence phase as possible, as the related services could require significant time to properly transition. Third-party consent fees may be significant and should be considered as part of the larger economic understanding of the M&A transaction.

Establish Necessary Review and Audit Rights

Understand the buyer's review and audit needs, including whether it needs additional review and audit rights of the seller's own vendors and service providers. While general audit rights are common in TSAs, consider whether specific audit rights for the service recipient, regulatory agencies, or other third parties are necessary for the service recipient to comply with its own policies or any legal/regulatory obligations.

Attend to Data Privacy Concerns

The parties to a TSA need to understand whether there will be personally identifiable, Health Insurance Portability and Accountability Act-related, or other sensitive or confidential information used in connection with the services being performed. If so, consider implementing appropriate safeguards for the buyer and seller and their respective employees and contractors.

Allocate Liability

The allocation of liability will often follow the leverage and allocation of liability in the principal acquisition documents. Careful consideration should be given to whether, and to what extent, the seller is responsible for the failures of its own third-party contractors. It is common for a TSA to include a waiver of indirect damages (i.e., consequential, punitive, diminution in value, etc.) and contain individual and aggregate caps on direct damages. Consider appropriate exclusions to these waivers and caps, such as breaches of confidentiality, gross negligence, willful misconduct, infringement and misappropriation.

Plan for Major Service Continuity Issues

It is common for TSAs to contain arbitration clauses or clauses requiring the parties to bring a lawsuit if there are major service continuity issues; however, a buyer may not want to invest the time and resources needed to comply with these traditional dispute resolution options for anything but the most egregious failures. Consider including escalation clauses that allow for internal representatives of the service provider and service recipient to settle continuity issues amicably. Take into account whether there is any need for enhanced business continuity or disaster recovery plans.

Barbara Melby is a partner in Morgan, Lewis & Bockius' Philadelphia office and leader of the firm's outsourcing and strategic commercial transactions practice. This was co-authored by Jason Rodriguez.

Reprinted with permission from the March 1, 2016 edition of the Legal Intelligencer© 2016 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.