acquisitions workshop 3
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. What would you like to do?
Who are normally the parties to the sale and purchase agreement?
Which of the parties gives warranties and to whom?
The buyer and the seller.
If more than one seller, details set out in a schedule to the agreement
Normally all of the sellers give warranties to the buyers. If some do not (e.g. trustee shareholder or private equity seller) then parties may be described as sellers, warrantors and buyers.
Parties may also include guarantors of the seller's or buyer's obligations
Is a sale and purchase agreement dated? If so, when and why?
On execution. To create a binding obligation to buy/sell.
What are the "operative provisions" of a sale and purchase contract? What do they cover?
They set out the basis on which the buyer agrees to buy and the seller agrees to sell.
They cover e.g. price and payment terms, contractual reassurances
Name one definition in the definitions section which could prove contraversial in a sale and purchase agreement?
Definition of statutory provisions
- Buyer: wants it to cover subsequent amendments.
- Seller: this is dangerous for the seller due to potential liability under warranties - it creates retrospective effect.
In acquisitions is there a long gap between exchange and completion
Usually no. Usually completion is simultaneous with exchange of contracts.
If there is a gap then a number of conditions precedent will be necessary
What does the agreement to purchase in the sale and purchase agreement set out?
Sets out exactly what is being bought and sold by reference to a schedule.
Will also provide that the parties agree to buy/sell.
Buyer will want a provision that he is not obliged to buy and of the shares/assets unless it can purchase them all
What will the consideration part of the sale and purchase agreement contain?
Agreed price, form it will take and timing of payment.
Price may be fixed or allow for adjustments following completion accounts/earn out provision
- Multiple sellers: amount payable to each
- Asset sale: amount payable for each asset - apportionment influenced by taxation
Why are completion accounts used?
What form do they take?
To make sure that the figures on which the valuation of the target was based have not altered significantly.
Sometimes the parties may agree that the purchase price will be adjusted due to these accounts.
They can be a full set of accounts (balance sheet and profit and loss account) or just balance sheet/profit and loss account or a valuation of a specific asset.
Who draws up the completion accounts
This is a matter for negotiation between the parties.
Sometimes the buyer may prefer the greater opportunity of financial scrutiny by doing it itself
What does the price clause in a sale and purchase agreement normally provide for?
How is an adjustment to the purchase price usually made?
What must the lawyers be careful about?
- A maximum amount of the purchase price to be paid on completion
- A further adjustment (re)payment to be made once completion accounts have been prepared.
- This is usually made for cash on a pound-for-pound basis
Lawyers must be careful to specifically reflect the parties wishes and that it guards against double recovery e..g for breach of warranty and reduction in net assets reducing completion accounts. Buyer should not benefit from action for breach of warranty AND a lower purchase price.
Will an agreed mechanism for drawing up completion accounts be included in a sale and purchase agreement?
Yes. Usually in a schedule, this must be drafted carefully
Name another thing about the completion accounts which should be put into the sale and purchase agreement
The accounting policies to be used when drawing them up.
It is also necessary to document the method by which these policies will be applied and guidance on how terms should be applied.
- -Slow-moving stock: sliding scale for valuation
- -Net realisable value: define
- - Debtors: parties should agree to apply a specific schedule of timings to identify bad debt
Are all areas for disagreement.
Also consider the need for restrictive covenants to prevent either of the parties trying to improve the accounts by making unnecessary changes
What is a "locked box" transaction? When is it most commonly used? Which party will want one of these?
This is where there is a fixed price before the sale and purchase agreement is signed.
It is most commonly used in share acquisitions?
Seller will want this. This is riskier for the buyer - this means that post-completion they have rely solely on warranty claims
Name two provisions a buyer will want in a locked box transaction
- - That the accounts have been prepared with all reasonable care
- - a provision against "leakage" - where seller extracts value from the target between the date of the agreed accounts and the completion date. the seller will normally undertake to repay leakage on a pound for pound basis
What is an earn out provision?
When are they suitable?
Why are the used?
Where at least part of the consideration is determined by reference to future profitability of the target for a specified period after completion.
Usually most suitable if the seller continues to manage the target company post-completion.
They are used so that the seller does no overpay for a target which fails to perform as expected and motivates the sellers/managers who stay on post-acquisition (esp. if it is employee orientated)
What will the earn out provision say about accounts?
that they will be prepared for the relevant periods by the buyer's accountants.
- Adjustment to purchase price will be based on:
- - Certain level of profitability or
- - Multiple of the profits achieved
What is a problem with earn-out provisions?
Name one way this can be dealt with
The seller may try to maximise profits during the earn-out period whereas the buyer may want to think about long-term gains at the expense of short term profit.
Define the objectives of the company during the earn out provision
What is deferred consideration?
Whre some of the purchase price is paid after completion, e.g. payments may be made by instalment (usually the seller will demand interest and security) or where payment is delayed due to waiting for completion accounts or retention by the buyer in case of a warranty claim.
How is deferred consideration treated for tax purposes?
What is the case where consideration cannot be ascertained at completion?
The seller will normally have to pay tax as at the date of sale on the whole amount of consideration, even if some has not yet been paid if the consideration is certain (capable of being ascertained).
If it cannot be ascertained because it is dependent on a future event (e.g. earn-out arrangement based on future profitability) then tax will be charged on the disposal of two separate assets (Marren (Inspector of Taxes) v Ingles)
- Disposal 1: Consideration actually received + valuable chose in action (the right to receive a further payment - this will be given a value by HMRC)
- Disposal 2: When e.g. earn-out payment is actually received (the dispoal of the right to further payment). if this exceeds the amount it was valued at by HMRC then a CGT/Corp. tax charge is payable. A loss is an allowable loss for capital relief purposes.
For deferred consideration.
What happens where the amount of consideration has not yet been determined but is ascertainable at completion? E.g. when waiting for completion accounts
HMRC will "wait and see". Stamp duty will be charged once the consideration has been finally determined.
the buyer should submit stock transfer forms for stamping within 30 days of completion and make a payment on account of stamp duty to avoid penalties and reduce interest charges (which run from 30 days post-completion even if consideration is not yet ascertained)
When consideration is deferred, name 4 ways in which the seller can take security
- 1. Charge over assets transferred to the buyer
- 2. Guarantee from shareholders/parent co./directors of buyer's obligation to repay
- 3. Title remains with seller for specified assets until full price is paid
- 4. Buyer puts a specified sum in a joint deposit account on completion (not appropriate if seller is giving buyer time to finance the acquisition)
What is the most common form of consideration for an acquisition?
- - Buyer must make sure borrowing is in place
- Sometimes by shares in the buyer:
- Buyer: does not need to borrow/dispose assets to fund acquisition
- Seller: may be able to roll over capital gain and defer capital tax until the disposal of the securities
When will a seller accept consideration in the form of shares?
What must be specified in the sale and purchase agreement if the sale is for shares?
Name one other provision the buyer might want to add and why
When they are readinle marketable (i.e. not for a private company)
How the shares rank and the seller's right to a dividend in relation to a period in which completion falls.
The buyer might want to stop the seller selling all the shares it receives because of the adverse effect on its share price. it could add a restriction as to percentage/specified time for disposal.
What can be done if a buyer wants to pay with shares but a seller is only interested in receiving cash? How does this work?
Vendor placing can be used.
The acquiring company issues shares to the seller but arranges (via a financial advisor) for the shares t be sold on immediately to institutional investors.
In addition to shares or cash, what is another way the buyer may pay the seller?
What will the terms of these be?
Why might the seller be happy with this?
Through loan notes.
Seller can demand payment of all or part at 6-monthly intervals after a certain period from completion (e.g. 12 months)
Receiving staggered payments with interests may appeal to the seller as roll-over relief from capital tax is available on the same basis as for shares under a security exchange
When will loan notes be an acceptable form of payment?
If the creditworthiness of the buyer can be assured. I.e. the buyer is a substantial company
How should a sale and purchase agreement be executed?
As it is a contract is can be signed by the parties.
The buyer may prefer it to be executed as a deed to avoid any question as to whether appropriate consideration has been given.
Remember to check the parties' capacity to enter into such agreements.
What is the difference between a warranty and an indemnity?
A warranty is: an undertaking by the seller that a particular state of affairs exists. On a breach of warranty the buyer must establish its loss under normal contractual principles
An indemnity: is a promise to reimburse the buyer in respect of a designated type of liablity which may arise in the future.
How do buyers seek protection from tax liablity?
On what type of acquisition is this most important?
What will each cover?
Which type is best?
Through warranties and indemnities.
Most important on a share sale.
- Warranties: compliance with VAT/PAYE etc
- Indemnities: specific tax charges which may arise over and above those provided for in the accounts
Buyer may prefer indemnity as no need to prove link between unexpected tax liablity and share value. Warranties may be more appropriate - sellers should argue for this.
If there is more than one warrantor, what type of liablity will the buyer insist they accept? What does this mean? What can the seller do about this?
Joint and several
The buyer can sue any one of them for the full amount.
Note that the one who gets sued is entitled to recover a contribution from the others under s.1 civil liabilities act 1978 according to "what is just and equitable having regard to their responsibility for the particular damage" (s.2). Sellers can agree in advance how liability will be apportioned - usually in a ratio of the amount they paid.
When may taking a warranty from each seller be undesriable/inappropriate
On a share sale with lots of sellers. Also, trustee shareholders may be unwilling to give warranties.
- Small shareholders: joint and several liablity is a big risk
- Trustee shareholders: you may be able to limit their liability to the net capital value of the trust and obliging the trustees to require any beneficiary receiving capital from the trust to give appropriate warranties to the buyer.
If warranties aren't going to be given then the price offered should be lowered.
Will the buyer allow seller shareholders to sue directors if the shareholders get sued for breach of warranty due to information provided by the directors
Not if the directors are still employed by the buyer.
Usually, this will be achieved by the selling shareholders waiving any right to bring a claim against the management/target in these circumstances.
Can warranties and indemnities be assigned to a new buyer?
Not usually - they usually need the consent of the warrantor to be assigned.
Buyer may try to negotiate with the seller.
buyer should try to structure the sale and purchase agreement to include the Contracts (R o TP) Act 1999 - so that 3rd party has right to enforce contract terms. Seller should resist this - esp. if the seller is an individual.
Name 2 ways a buyer can get security for breach by the seller
- 1. Guarantees. Either from parent company or shareholders as appropriate
- 2. Retentions from the purchase rpice
Why would a buyer want to place post-completion restrictions on the seller?
The seller has a lot of knowledge about the business and could do it a lot of harm.
- If there are no express restraints:
- - Very little protection
- - No implied covenant not to set up business in competition (Trego v Hunt)
- - Only undertakings are not to disclose confidential information, not to represent itself as the successor of the business or carry on as the same business, not to solicit customers of the business
The buyer should seek to restrict some activities of the seller but will not be permitted to go too far and stick to things that are reasonably necessary.
Are covenants in restraint of trade valid at common law?
No. they are prima facie void at common law.
However - the court will not strike down a restrictive covenant that is reasonable to protect a legitimate interest of the buyer.
Consider: duration of restraint (1-5yrs), geographical area (must be closely related to area in which target does business), activities (only activities which are the same as the target's will be valid).
When will a breach of warranty give rise to a successful claim in damages?
- If the buyer can show that:
- - The warranty was breached
- - The effect of the breach was the reduce the value of the business
Normal contractual rules and remedies apply e.g. causation, mitigation etc.
Are indemnities subject to the obligation on the aggrieved party to mitigate its loss?
Maybe (this is still better than for a warranty where you definitely have to mitigate)
Court of Appeal: No duty to mitigate, debt due under a contract not a claim for breach of contract (Royscott Commercial v Ismail)
House of Lords: Contract of indemnity gives rise to a claim for unliquidated damages (The Fanti and Padre Island) therefore claimant does have to mitigate
If a buyer has actual awareness of relevant facts and circumstances at the time of entering a contract, does this give an arguable defence against the buyer's claim for breach of warranty
Yes - Eurocopy.
Confirmed in Infiniteland Ltd - the buyer cannot rely on the relevant saving provision if it had actual knowledge of the matter on which it seeks to claim.
This does not mean the claim would necessarily fail
Name 6 areas where indemnities are common
- 1. Tax
- 2. Unresolved litigation
- 3. Environmental risks
- 4. Doubtful book debts
- 5. Repayment of loans by target
- 6. Product liablity claims in relation to products sold before completion
Will the seller accept warranties to be given on an indemnity basis
No. Seller should resist this and only give indemnities for specified risks
When drafting the warranties, what should you consider?
The nature of the target business and the key assets and rights in the business.
You need to tailor warranties to the transaction
Can the seller's limit liablity by their awareness
Best for the seller to do this explicitly by saying "so far as the seller is aware". Buyer will want to make sure it is added "after making due and careful inquiry"/had it made due and careful enquiry od directors etc (if seller is a corporate entity) - if this is not added the courts will imply that the seller had made only such investigation as could reasonable be expected (William Sindall plc v Cambridgeshire CC)
Name 7 ways, other than by an awareness clause, that the seller can limit liability for a warranty claim
- 1. Disclosure
- 2. Time limit - usually 2-3 yrs is agreed or 6yrs for a tax warranty (buyer may want to try to extend to 20 for fraud/gross negligence). If no agreement it will be 6yrs (or 12 as a deed).
- 3. Financial limit
- 4. Prevention of double recovery (e.g. go to insurer first)
- 5. Disregard of post-completion acts/limiting liablity to matters arising during seller's ownership
- 6. Disregard of changes in legislation
- 7. Conduct of claims
Should the buyer accept the indemnities being included in the overall limit on claims
The whole point of indemnities is to get reimbursed on a pound for pound basis
Who will the seller normally permit assignment to? Will they permit assignment to other third parties? How much can be recovered by an assignee?
- -To one of the buyer's group companies
- - Not usually
- -No more than the assignor could have done had the assignment never taken place (Dawson v Great Northern and City Railway)
What is an alternative to assignment?
Contract (R o TP) Act
Are all warranty statements representations?
Whether or not a warranty is also a representation will depend on whether the statement is so important that the buyer has relied upon it in making its decision whether or not to proceed with the purchase.
E.g. shares are not subject to restrictions, accounts reflect a true and fair view of the company
Name two situations where recission is not possible
- 1. Undue lapse of time
- 2. No longer possible to put parties in pre-contractual position
What would you like to do?
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