In the period between the execution of definitive documentation for an acquisition and the intended closing, it is important to be aware of the “ordinary course” covenant often included in purchase agreements. The ordinary course covenant, sometimes called the “conduct of business” covenant, helps protect the buyer against the risk that the seller might take actions that could reduce the business’s value in the so-called post-signing period. Such a covenant typically specifies that the seller is to operate the business “in the ordinary course and consistent with past practices.” 

In addition, there are usually a number of negotiated actions known as interim operating covenants that the seller cannot take, at least without the buyer’s approval, including material increases in executive salaries and payment of dividends. These can run counter to the seller’s desires, who usually seeks maximum flexibility to react to changing circumstances. Covenants should be drafted with the rest of the M&A agreement in mind. For example, if any actions such as those that are necessary to close the transaction would trip the ordinary course provisions, they should be specified and acknowledged. 

In some cases, there may just be a covenant that the target company uses its best efforts to conduct business in a manner consistent with past practices and not include interim operating covenants. In the event of a claimed breach, a covenant written in this manner will typically fall back on industry custom and practice to determine whether the seller acted appropriately.

Remember that, in the event of a breach of the ordinary course or interim operating covenants, the buyer usually often has the ability to terminate the purchase agreement. 

The ordinary course covenant and interim operating covenants are intended to protect the buyer in an M&A agreement from the risk that the target company management takes actions that may reduce value between the signing and closing of a transaction. These covenants are important and should be carefully and clearly negotiated and drafted. 

Jonathan F. Foster
Founder  – Current Capital Partners LLC