Sales and Mergers of California Businesses – September 2024 Update

With the increasing use of artificial intelligence in many aspects of business operations, both buyers and sellers of AI-enabled applications (or companies using AI applications) should review and address the following issues as part of their due diligence process. Generally, the buyer or seller will need a multi-disciplinary team to do so.

• What AI applications are being used or developed by the target, and how are they being used (e.g., in human resources, marketing, or software development)?
• Are there any intellectual property ownership issues or licensing issues related to the input or output of those AI applications? What restrictions exist with respect to the use of those AI applications?
• Were those AI applications developed by the target itself or acquired from a third party or both?
• Are there any issues regarding those applications concerning privacy or compliance with laws?
• Are there any performance issues or risks associated with those applications? What is the target’s process for identifying, mitigating, and remedying those risks?
• Does the target have an AI usage policy? If so, what is the target’s process for managing compliance with that policy?
• What are the litigation risks? Is the target addressing and mitigating those risks?

See §1.57B.

The employer must, as of February 14, 2024, notify their current employees and former employees hired after January 1, 2022, that their noncompete clause or noncompete agreement is void. See Bus & P C §16600.1(b)(1). If the noncompete agreement is void, then a current or former employer cannot enforce it against the employee, even if the contract was signed and the employment was outside California. Bus & P C §16600.5. See §2.12.

The Tax Cuts and Jobs Act (HR 1) (Pub L 115–97, 131 Stat 2054) (TCJA) is scheduled to sunset on December 31, 2025. Practitioners should remain alert to a potential extension of provisions or new law that that may be enacted to supersede provisions of the TCJA. See §3.1.

The alternative minimum tax (AMT) (see IRC §55) is designed to ensure that higher income taxpayers pay a minimum tax. After the TCJA, the AMT is still in effect for noncorporate taxpayers, but the AMT exemption amount for 2024 is $85,700 for single taxpayers and $133,300 for married couples filing jointly. See §3.3B.

On January 2, 2024, the IRS issued Rev Proc 2024–1 and Rev Proc 2024–3, expanding the IRS’s letter ruling practice for certain corporate transactions. See §3.4.

For taxable years 2020, 2021, and 2022, California suspended the NOL carryover deduction. However, SB 113 decreased the suspension period by 1 year. See §3.47.

The §4(a)(1-1/2) exemption rests on the theory that resales of privately offered securities to an investor to whom the original private sale by the issuer could have been made under §4(a)(2) should not be deemed a distribution and should therefore be exempt from registration. See §4.49.

On December 18, 2023, the Department of Justice (DOJ) and Federal Trade Commission (FTC) issued revised merger guidelines that set out the framework through which the agencies will analyze whether a proposed transaction violates antitrust laws. The guidelines contain proposed market share thresholds above which the agencies contend a transaction is presumptively illegal as well as potential theories of competitive harm for horizontal and vertical combinations. See §5.1.

On June 27, 2023, the DOJ and FTC announced proposed changes to the Hart-Scott-Rodino Premerger Notification and Report Form and associated instructions. These changes would expand the number of documents and the amount of information required to be included with every Hart-Scott-Rodino Premerger Notification and Report Form. See §§5.2, 5.5. The notification requirements under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (15 USC §18a) apply when the parties to a proposed merger or acquisition transaction meet specified “size of person” and “size of transaction” thresholds. Effective March 6, 2024, the reporting threshold for transaction size is $119.5 million. Thus, transactions of $119.5 million or less are not reportable. In addition, however, under the size-of-person test, a transaction of $478 million or less is not reportable unless one party has annual net sales or assets of $239 million or more and the other party has annual net sales or assets of $23.9 million or more. See 89 Fed Reg 7708. See §5.2.

A filing fee must be paid by the acquiring entity to file a premerger notification. The fee depends on the size of the transaction. The fees are as follows for 2024:

HART-SCOTT-RODINO FILING FEES FOR 2024

These amounts are also adjusted annually. See §5.2.

              Many potential customers or acquirers of generative artificial intelligence systems are rightly concerned about the possibility of liability claims by third parties based on copyright infringement or other legal issues discussed in chapter 3A of Internet Law and Practice in California (Cal CEB). Thus, some generative AI vendors are seeking to address the concerns of their business customers by offering protection through contractual indemnification. See, e.g., the indemnity offered by Google Cloud: https://cloud.google.com/blog/products/ai-machine-learning/protecting-customers-with-generative-ai-indemnification. At the same time, many other generative AI vendors are hesitant to provide a broad level of indemnity for their AI systems and have issued terms of service that attempt to shield the vendors from liability, leaving some or all liability risks on their customers. See, e.g., the indemnity limitations described in OpenAI’s terms of service: https://openai.com/policies/service-terms. See generally https://www.wsgr.com/en/insights/will-indemnification-commitments-address-market-demands-in-ai.html. For a review of some of the different types of indemnities offered by generative AI vendors and their limitations, see https://techcrunch.com/2023/10/06/some-gen-ai-vendors-say-theyll-defend-customers-from-ip-lawsuits-others-not-so-much/. It is therefore advisable for any potential customer or acquirer of an AI system to review carefully the terms of any indemnity offered to determine whether and to what extent it is limited and whether it is sufficient. See §8A.26A.

A sample form of electronic signatures has been added to the Counterparts section in the Stock Purchase of Sale Agreement, Asset Purchase and Sale Agreement, and Merger Agreement. The same form may be used in Counterparts sections in other agreements. See §§10.123, 11.126, 12.113.