California Business Law PRACTITIONER Volume 25 / Number 4 Fall 2010 An Annotated Form of Investment Banking Engagement Letter Louis R. Dienes and Alison M. Pear Louis R. Dienes is a Alison M. Pear is an A great deal has been written about the legal as- member of the Corpo- associate in the Corpo- pects of mergers and acquisitions, ranging from struc- rate Department of rate Department of ture to strategy. Annotated forms of merger and ac- TroyGould PC, Los TroyGould PC, Los quisition agreements, including stock purchase Angeles, where he Angeles. Her practice counsels boards and includes general corpo- agreements, asset purchase agreements, and merger management when en- rate law, mergers and agreements, as well as ancillary agreements, are gaging investment acquisitions, private widely available in legal literature. Surprisingly, one of banks as advisors in equity transactions, the first agreements that the principals in a business mergers, acquisitions, and securities law. She and divestitures; equity received her J.D. de- transaction execute—one that materially affects their and debt financings; gree from the Univer- respective rights—has been neglected: investment and other services. He sity of California, Los banking engagement letters. received his J.D. de- Angeles, in 2006 and An investment banking engagement letter is ordi- gree from Stanford her B.A. from the Uni- narily drafted by the investment banker. The client that University in 1994 and versity of Pennsylvania retains the investment banker should therefore review his A.B. from the Uni- in 2003. versity of California, the letter carefully with its legal counsel. Berkeley, in 1990. —continued on page 109 IN THIS ISSUE An Annotated Form of Investment Banking Engagement Letter.....................................................................107 by Louis R. Dienes and Alison M. Pear Contractual Mechanics: Covenants, Conditions, Representations, Warranties, Guaranties, and Indemnities...........................................................................................................124 by George W. Kuney Legal Ethics and Lawyer Websites, Part I..........................................................................................................133 by Kevin E. Mohr CEB CONTINUING EDUCATION OF THE BAR CALIFORNIA © 2010 by The Regents of the University of California CALIFORNIA BUSINESS LAW PRACTITIONER Fall 2010 Annotated Investment Banking Engagement Letter 109 Because engagement letters often follow consider- derstand what services the investment banking firm able interaction between the client and the invest- is expected to perform. In some circumstances, spe- ment banker, and counsel may work closely with the cific services should be identified as within the investment banker in the transaction, the negotiation scope of the engagement—and within the scope of of the engagement letter requires some delicacy on the expected compensation bargained for in the en- counsel’s part. To best serve the client, counsel must gagement letter. For example, if the client is expect- understand and communicate both parties’ interests. ing a fairness opinion from the investment banking Ideally, the engagement letter will align the interests firm without paying an additional fee, that fact of the client and its investment banker and create the should be clearly established in the engagement let- foundation for a mutually beneficial relationship and ter. Other services that may be provided by the in- a successful transaction. vestment banking firm, which the client may or may not want to be included in the engagement, include services such as the preparation of marketing mate- [E]ngagement letters should be rials, placement agent services, or underwriting ser- sufficiently clear that both the client and vices. In contrast, if the parties believe that addi- the investment banker understand what tional services may be required, but want any addi- services the investment banking firm is tional services to be subject to a separate agreement expected to perform. or an additional fee, the engagement letter should explicitly state that additional services will be sub- ject to a separate agreement to be negotiated in good Investment banking engagement letters set the faith by the parties. If the client does not want to be stage for mergers, acquisitions, and debt or equity bound to enter into an additional agreement, it may financing transactions. The investment banker’s ma- prefer to structure the relationship so that the in- jor objectives will include: (1) defining the type of vestment banking firm has a right of first refusal to transaction for which it is being engaged broadly, so provide additional services, but the client retains the that the client’s liability for payment of the banker’s right to use another service provider if it so wishes. fee is triggered easily; (2) defining the exclusivity of Although the substantial size of investment bank- its services as broadly as possible; (3) limiting the ing fees may encourage clients to define the scope circumstances that allow the client to avoid paying of services to be performed as broadly as possible, its fee; and (4) limiting indemnification liability. such an approach should be tempered with caution. As discussed below, investment banking engage- SCOPE OF SERVICES ments are often exclusive, and the broader the ser- vice definition, the more onerous the exclusivity Engagement letters begin by identifying the ser- limitations may become and the greater the risk that vices that the investment banker will be engaged to the investment banking firm may become entitled to perform. The engagement letter represents an impor- compensation unintended by the client. tant opportunity to ensure that all parties understand the services that are expected, the nature of the EXCLUSIVITY AND TERM transaction that is sought, and the types of transac- tions that will lead to compensation. Typically, the Investment banking engagements are often exclu- engagement letter will make a general identification sive and entitle the investment banking firm to com- of what role the investment banking firm will play, pensation on the occurrence of certain events during such as “financial advisor,” followed by a list of the term of the engagement and for a certain length included services, such as reviewing the client’s fi- of time after the term. nancial condition, soliciting and coordinating poten- Because, as discussed below, the investment tial investors, and identifying and evaluating poten- banking firm’s compensation is largely dependent tial acquisition targets or possible purchasers. The on the occurrence of a transaction and the size of desired services will be directed toward a financing that transaction, exclusivity is important to invest- transaction or a purchase or sale transaction, or both. ment banking firms because it helps assure the firm Because of the advisory nature of investment that its efforts will be rewarded. If an investment banking engagements, it may be difficult to define banking firm spends 6 months reviewing and analyz- with great specificity the services to be provided, ing potential targets for a client, it will not want a but engagement letters should be sufficiently clear concurrently engaged competitor to ultimately re- that both the client and the investment banker un- ceive the desired success fee. To that end, exclusive 110 Annotated Investment Banking Engagement Letter Fall 2010 CALIFORNIA BUSINESS LAW PRACTITIONER engagement letters often provide that if the desired firm will have little need for advance notice of a transaction is accomplished during the term of the termination. The client, however, may need the abil- engagement or, as discussed below, within a “tail” ity to free itself quickly from any exclusivity con- period thereafter, whether or not resulting from the straints and, to the extent permitted, any monthly or investment banking firm’s efforts, the firm is still other periodic fees that may be associated with the entitled to its fees under the engagement letter. If the engagement. The client should also consider negoti- relationship is not exclusive, the engagement letter ating a termination of the tail in the event that the should clearly delineate how the parties will deter- engagement is terminated for cause, in order to mine when the investment banking firm may be enti- avoid an obligation to reward an investment banking tled to compensation versus when another engaged firm that has committed a breach. firm may be entitled to such fees. Although the client should have significant free- Often, the exclusive term of an investment bank’s dom to terminate the engagement, the circumstances engagement will be for a period of time ranging in which the investment banking firm itself should from 6 months to a year and may or may not auto- have power to terminate should be limited, because, matically renew on an ongoing basis thereafter. The as discussed below, the client has likely paid a re- term should be a compromise between how much tainer that would be at significant risk if the invest- time the investment banking firm needs to perform ment banking firm had the power to terminate at any the engagement and how long the client wants to be time. bound to an exclusive relationship with the firm. FEES The engagement letter also usually provides that if a transaction of the type subject to the engagement The element of the engagement letter that usually is consummated within a certain period after