PROTECTING A BUYER'S INTERESTS IN A SHARE TRANSFER TRANSACTION A typical share transfer transaction involves a buyer and seller whereby a seller sells an agreed number of shares to a buyer for a specified price. A share purchase transaction will generally involve an extensive due diligence exercise carried out on the target company (and its subsidiaries) from the outset to inform the buyer...
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PROTECTING A BUYER'S INTERESTS IN A SHARE TRANSFER TRANSACTION
A typical share transfer transaction involves a buyer and seller whereby a seller sells an agreed number of shares to a buyer for a specified price. A share purchase transaction will generally involve an extensive due diligence exercise carried out on the target company (and its subsidiaries) from the outset to inform the buyer of any potential liabilities it may be exposed to when acquiring the target and to dictate the tone of subsequent negotiations of a definitive Sale and Purchase Agreement (commonly referred to as an "SPA") which sets out the mutually agreed terms and conditions by which the share transaction will be governed.
In English law, the principal of "caveat emptor" (let the buyer beware) implies that there is a duty on the buyer to make independent inquiries when acquiring shares in a company and that the risks associated with a purchase are generally absorbed by the buyer. Therefore, it is important that a buyer seeks additional protection by adopting some of the measures addressed in this article.
Conducting legal due diligence is imperative in understanding and assessing the target company's strengths and weaknesses. It aims to identify and clarify key information on the seller and the target company's intellectual property, corporate and financial records, legal claims, contracts, its asset base, among others. It is used to investigate a company's position and dictates the scope of the warranties and indemnities in an SPA. It also enables the buyer to negotiate any price adjustments or potentially withdraw from the transaction entirely.
Representations and Warranties:
The most significant way to ensure a buyer's interests are adequately protected and any risk mitigated is through the incorporation of representations and warranties in the SPA. A representation is an assertion as to a fact being true on the date the representation is made. It is given to induce another party to enter into a contract or take some other action. A warranty is a promise of indemnity if the assertion is false. Warranties aim to allocate risk and liability between the seller and the buyer. Specifically, they encourage the seller to make disclosures against the warranties and allow the buyer to elicit information about the target company (or any target group) through disclosure that will enable them to decide whether to proceed with a transaction. The representations and warranties allocate risk between the parties and serve as the foundation for an indemnification claim in case of a breach or inaccuracy. A breach or inaccuracy of a representation or warranty can also provide the other party with a right to terminate or refuse to close the transaction. A seller's representations and warranties are usually more extensive as there is more material information to disclose about the company's business, assets, and liabilities. Incorporating representations and warranties and ensuring that they are repeated at key milestones in the SPA is beneficial to the buyer as it minimizes risks and provides for a remedy in the event that the seller breaches the agreement.
A Material Adverse Change ("MAC") clause aims to protect the buyer in the event that a situation occurs that adversely affects the target company and results in its affairs being materially different to what the buyer was promised. This clause is especially relevant today as we navigate through the COVID-19 pandemic. This clause can equip the buyer with the right to terminate the agreement before completion of a share transfer.
Representations and warranties allocate risk between the parties and serve as the foundation for an indemnification claim in case of a breach or inaccuracy. A breach or inaccuracy of a representation or warranty can also provide the other party with a right to terminate or refuse to close the transaction.
An escrow account is an arrangement whereby a neutral third party holds funds or assets in relation to the share transaction until completion. Escrow accounts are used to mitigate any concerns the buyer has with regards to the seller's ability to transfer ownership of the company to the buyer and may assist in securing a partial retention of the purchase price in the event of a warranty or indemnity claim.
A condition precedent is a condition of a contract which must be fulfilled for either the contract to be valid or certain contractual obligations to come into effect. This is a useful tool for a buyer to incorporate into an SPA to make sure it has a "get-out" in the event that its due diligence exercise raises material concerns or certain aspects of the transaction that are important to the buyer fail to be satisfactorily fulfilled, among other conditions that can be included.
Conduct of business clause:
This clause is particularly useful as it aims to regulate the conduct of the target company's business during entry of the parties in to the SPA and until completion. It gives the buyer an ability to terminate the contract and claim damages in the event that the target carries out certain actions that are prohibited by the buyer under the agreement and that could negatively impact the value of the business.
Restrictive covenants and protection of goodwill:
these clauses set out restrictions on the parties' actions that are defined by three key parameters namely, (i) the type of business; (ii) time/duration and (iii) geography. In the context of share sale transactions, restrictive covenants aim to limit the seller's actions during the term of the agreement and for a certain period thereafter in order to prevent the seller from damaging the business of the target by way of setting up a competing business, for example, or enticing away its customers and suppliers. It is important to ensure that these clauses are reasonable and relate directly to the business of the target. Ensure that a "severability" clause is included in the SPA in the event that any aspect of a clause, including a restrictive covenants and protection of goodwill clause, is held to be unenforceable, so that the rest of the agreement remains unaffected and the unenforceable provision can be amended to the extent necessary to ensure its enforceability.
When representing a buyer in an M&A transaction it is important to ensure that in addition to carrying out extensive due diligence exercises, adequate contractual protection measures are put in place. The above points are a few key examples among a number of measures that can be implemented to help reduce your client's risk and exposure in a proposed M&A deal. It is also important to ensure that when drafting, the terms included are reasonable, drafted clearly and are capable of being enforced in the relevant jurisdiction.
Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.