Some SPA Issues

Defining the Company in Sale

The definition of the company in sale is critical. The share purchase agreement must define the shares in sale. Generally, there is a definition of the shares with reference to which the agreement takes effect. It may refer to a schedule setting out the precise shareholding concerned, the holders and the relevant shares.

Where a group of companies are sold, they must be clearly named and defined. Generally, the companies concerned will be listed in the schedule. The company may be sold on the basis that it comprises the shares in a holding company and subsidiary companies. The seller or holding company may not have a 100 percent shareholding in each company. The relevant shareholding and the nature of the interest in each company must be specified.

Accounts

A buyer will generally have agreed in principle to purchase the target company on the basis of audited accounts and financial statements.   It is almost invariably warranted that the accounts give a “true and fair view” of the company. This is the formulation which auditors must sign off on under the Companies Act legislation.   Sellers would not usually give a warranty beyond this.

A provision might be made in accounts, for example in relation to a possible liability which may be acceptable in accordance with accounting practice.  Warranties are not generally expected to promise, in absolute terms, the accuracy of the provision.  There are other items in accounts which are not appropriate to an absolute warranty because this is inconsistent with the manner in which accounting treatment works.

Warranties will typically deal with post audit management accounts covering the period since the latest financial accounts.   The same level of warranties will not be appropriate as financial accounts.  Management accounts by themselves have a different function and would not be audited.

Warranties would usually be required in relation to the business since the accounts date. It would be usual to confirm that there have been no new significant contracts, disposals or adverse changes.  The seller would not be expected to warrant the future profits or position of the company.

The Reference Accounts

The agreement will usually commence with extensive definitions in order to give precision to the meaning of particular terms used.

The keys accounts on the basis of which the company is sold should be defined. They may be the most recent financial accounts which have been laid before the members and audited. They are critical in showing the value of the company in terms of its trading performance and its assets.

The statutory financial accounts will only show the position as on the last accounting date, which may be some considerable time earlier.  The statutory financial accounts reflect the status and position of the company as on that date. The precise financial position usually changes on an ongoing basis as the company trades, make sales, purchases, incurs expenses and enters transactions etc.

Management accounts prepared in a manner consistent with the statutory financial accounts will commonly bring the financial position up to a more recent date. The position on the completion date may require adjustment after completion in order to reflect the precise financial position as on that date

Warranties

The general principle at contract law is that the buyer must beware.  The value of a company may be undermined by risks incurred or created by the past decisions of the controller or which are known to the sellers.  For this reason, it is highly desirable both that “due diligence” investigations are made and that warranties and indemnities are given by the sellers promising and confirming the truth of a wide range of key matters which affect the value of the company.

Warrantors

The warrantors are the parties who give the warranties. Where there is a single shareholder, such as where the target company is part of a group of companies, there will normally be a single warrantor.

The position may be complicated where there is a number of sellers. Each would ideally wish to limit his liability. A buyer would usually want the obligation to be joint and several so that each person can be pursued for the whole liability, with that person having the right to seek a contribution from the other sellers  In this case, the sellers might agree between themselves the terms on which they will share potential liability.

The warranties may be given by all of the sellers,  some of the sellers or the principal sellers only. There may be minority shareholders who have no knowledge of the company and for whom it is not appropriate that they give warranties in relation to matters unknown to them.

Institutional shareholders are unlikely to give extensive warranties as they have not been usually actively involved in the business. They will usually give warranties in relation to their title to their own shares.   If they give further warranties,  they are likely to limit their liability, at most to the sale proceeds received by them.

Warranties and Disclosure

The warranties deal with a wide range of compliance matters which a buyer would deem desirable or necessary.  If the due diligence process or disclosure discloses a very serious matter, the purchaser may simply accept it and  “walks” from the deal or negotiates some kind of indemnity or specific comfort.

As part of the legal due diligence (the investigation) process, a disclosure letter will be prepared by the sellers setting out certain limitations of or deviations from the warranties.  This is a useful mechanism for allowing the buyer to determine whether the deviations from the assumed position are serious enough to justify a price reduction or the abandonment of the transaction.

There may be provisions in relation to the warranties in general terms, which seek to limit their effect to matters within the knowledge of the warrantors. Where warranties are agreed to be in terms of the warrantor’s state of knowledge, the buyer will want to confirm (even if it is already implied) that they have made due and careful enquiry in relation to all of the relevant matters. It would be unacceptable to the buyers if the warrantors could benefit from their willful blindness.

In order to reverse the buyer beware “default” position, there may be a warranty that all necessary information that ought to be provided in order to provide a proper assessment of the target company, has in fact been given. There is another similar warranty to the effect that the seller knows nothing which would affect the buyer’s decision to acquire the target group.   The seller will often seek to reject clauses of this nature,  as too wide.

Limitation of Liability on Warranties I

A seller will usually seek to limit the extent of its liability on warranties.  The general principle is that a breach of a warranty makes a seller liable to compensate the purchaser for the direct loss suffered.  This would usually be measured in terms of a loss in value of the shareholding.

Most SPAs exclude small claims and also provide an overall threshold of loss which must be suffered before a claim can be made.  There will usually be a limit on both smaller claims and a maximum cap. A “de minimis”  limit is usually provided which means that claims below a certain amount, either in total or in aggregate, may not be bought.

Once a threshold is crossed, the full amount is recoverable not just the excess.  Sellers will usually put an overall limit as to total price received. This may not be acceptable under all circumstances.

Limitation of Liability on Warranties II

Liability on warranties lasts six years under the Statute of Limitations.  However, it is usual for the sale agreement to reduce this period to two to three years other than in the case of tax warranties which are usually “live” for to six years.  The notion behind limiting warranties for two to three years is that after one or two years of accounts and audits,  most significant problems would “flush out”.

There is usually a cap on the total liability which is often the amount of the price paid. Where there are multiple sellers, a seller may seek to limit liability to a particular proportion.

Thet sellers may seek to limit liability to matters within their knowledge or the knowledge of certain individuals.The seller may want to qualify or limit his warranties to the basis of his actual state of knowledge. It is preferable from the buyer’s perspective that these limitations are not provided as it would lead to considerable issues of proving another’s state of knowledge.  If they are accepted, the seller should be required to have made proper and careful enquiries and to be deemed to know what he would have so learned.

Limitation of Liability on Warranties III

Non-controlling shareholders, who have not been involved in managing the company, may succeed in negotiating that their warranties are limited to having good title to their shares. Commonly,  such shareholders are not expected to give warranties, or at least extensive warranties in relation to the operational affairs of the company itself.

Warrantors may also seek to put limits in relation to the following:-

• preventing double recovery by requiring recovery from a third party such as insurers;
• provisions in accounts for the liability concerned to be credited to the seller;
• disregard  post completion caused or exacerbated by the buyer’s actions;
• limit to matters arising while the seller was the owner of the company;
• liabilities arising from changes in law.

A seller will seek to have the conduct of certain claims which may later arise so as to ensure the buyer does not unnecessarily settle the claim in a manner adverse to the seller’s interest.

Other Warranty Issues

The general rule is that contracts are enforceable and made for the benefit of the parties only. A third party may not recover for his loss thereunder.  Accordingly, the buyer may require the right to assign the benefit of the warranties to another party if the shares are subsequently sold by the buyer within a certain period.

As warranties depend on the solvency and availability within the jurisdiction of the seller, buyers may seek security to meet claims.  The seller may leave the country or may dispose of assets.  If the seller is a corporate group it may be wound up.

There are a number of options such as

• obtaining a bank guarantee or a guarantee from a  parent company;
• lodgement of part of the purchase price in a joint account for a certain period;
• retention of part of the purchase price until the warranty period has expired;
• set-off whereby the buyer could allow set off of deferred payments against option claims.

It is possible in principle to obtain warranty and indemnity insurance from certain specialist insurers.  Cover will be limited to specified amounts and is usually funded by a single premium paid at the conception of the policy. The premium will depend on the level of risk to the insurer.

Indemnities

An indemnity is a promise to reimburse the buyer in relation to a particular liability if it arises.  Reimbursement is usually on a Euro for Euro basis and does not depend on actual loss. Indemnities are not subject to the common law obligation to mitigate (minimise) loss that would apply in the case of a breach of warranty.

Indemnities are usually given in relation to tax. They will usually indemnify the buyer against all tax liabilities of the target company that are not provided for in the last accounts or do not arise by way of normal trading since that date.

Indemnities are also given for specific problems which are known or arise in the course of due diligence.  For example, there may be potential environmental issues, unresolved litigation or other potential risks.  Indemnities would often be given in relation to doubtful debts, loan repayments, product liabilities, specific litigation etc.

There would generally be both tax warranties and indemnities. The indemnity will generally be a stronger basis for recovery than the tax warranties.

In the case of asset purchases, tax warranties would be much more limited and relate in principle to matters such as ongoing VAT

Assets I

The treatment of property and asset ownership varies from sale to sale. If there are one or relatively few properties, the buyer’s solicitor may investigate title, in which event relatively few warranties will be given.  In effect, the warranties will be constituted by the answers to the standard property enquiries.

If there are a significant number of properties, then the seller’s solicitor may provide a certificate of title dealing with properties with which he may be familiar.  If this is the case, it will reduce the number of property warranties required. Alternatively, if there is neither investigation of title nor a certificate of title, a significant number of property warranties will be given over a range of matters from title, planning, building control and compliance in respect of a whole range of issues which prospectively affect the value of the property.

The need for environmental warranties will depend on the circumstances.  Environmental liability is potentially significant. There is a contaminated land regime under which owners of contaminated land can be made liable for the cost of clean up of past contamination. An indemnity may be given to deal with specific environmental issues or possible remediation requirements, where the land is particularly risky e.g. oil depot.

Assets II

A buyer will want assurance that there is title to the other business assets.  For example, plant and equipment could be subject to hire purchase, conditional sale or lease agreements. It may also require confirmation of the state of repair and conditions of the machinery concerned.

It is commonly warranted that the assets are properly insured in accordance with normal business practice, that there are no outstanding claims and there is no reason known why insurance would be avoided.

Intellectual property is particularly important in certain companies. Patents, trademarks and equivalent rights which are not registered can be a very valuable company asset. Warranties will be required in relation to their status.

Most business will require licences in relation to the use of software, which may have been purchased or licensed from a third party. Information technology has gained in importance and the seller will be required to disclose details of IT systems, terms and conditions of maintenance etc.

Key Commercial Contracts

Customer contracts including facility agreements, supply agreements, distribution agreements and agreements with key customers may require consent or be terminable in the event of a change of control on the company. These agreements should be identified and described.

The term of key commercial contracts may vital to the value of the target company’s business. The provisions in which the agreement can be terminated must be considered. There may be existing circumstances which are such as entitle the other party to terminate the agreement.

The change of control is commonly a ground for termination. In this case, a consent may be necessary to the termination.

The termination clauses in the commercial contracts may be critical. In many cases, an initial agreement will have been entered and the original term will have expired. In these cases, the agreement may continue but on the basis that it can be terminated by reasonable notice.

The buyer may require that the agreement be formally executed for a specific term prior to completion of the purchase.

Restrictive Covenants

A buyer of a company will usually be concerned to ensure that the seller and person connected with him or it, will not establish a competing business which diminishes the value of the newly acquired company.  In the absence of a provision in the agreement, the Courts will imply certain restrictions but these would not usually be regarded as sufficient.

The common law implied restrictions are limited and may be uncertain to apply to the circumstances. It is usual to insert detailed restrictions on both the seller and persons connected with the seller.  These restrictions prohibit them from in any way soliciting existing customers, suppliers or employees or competing with the target company for a period.

The restriction must be reasonably related to a legitimate interest, in this case, the protection of the target company’s goodwill, in order to be valid.  Restrictions that are deemed to be wider than necessary to protect this interest are potentially invalid under common law.  Generally, under Competition law practice a two to three-year non-compete clause is reasonable, where knowhow or goodwill has been purchased, depending on the nature of the business. In some cases longer or shorter restrictions may be reasonable and permissible.

It is vital to ensure that the limitations in relation to the restricted activities the extent of the geographic area and duration are reasonable so as to protect the buyer but at the same time,  do not unduly restrain the seller beyond what is necessary.

Agreed Ancillary Documents

Applicable Legislation

Connected Persons

Termination of Contract

In accordance with contract principles generally, a contract may be terminated in the event of a fundamental breach by one party. The innocent party is usually discharged from further obligations and may obtain compensation for his loss, including expectation loss. In contrast in the case of a breach of a term which is not fundamental and is not designated as such, there is a right to claim for damages only.

Parties are free to designate the effect of breach of a particular term. In most cases, the question of termination of the share purchase agreement does not arise as the breach occurs after completion. It is impractical in most such cases to unwind the agreement, and the warranties give rise to a right to damages only.

If the share purchase agreement has not been completed, there may be outstanding conditions precedent or subsequent. The effect of breach of those conditions may be specifically provided for such as to entitle the innocent party not to proceed or to terminate the agreement.  In this case, the agreement may simply terminate without any mutual liability or further obligations.