The structure of the deal – what documents are needed?

Whether the transaction is to be structured as a share sale or an asset sale, similar documents will be required.

At the beginning of every transaction most lawyers prepare a checklist listing the documents that will be required in order to complete the transaction. On a sale by private treaty (a bilateral process) where there is only one buyer and one seller, the parties will agree between them who will be responsible for drafting each document. In practice the buyer’s lawyers often carry out most of the drafting but this can vary depending on the circumstances.

The principal documents on a sale by private treaty are as follows.

Confidentiality agreement

Before negotiations begin and certainly before the prospective buyer is given any sensitive information about the seller or target, the seller will ask the buyer to enter into a confidentiality agreement (also known as a non-disclosure agreement or ‘NDA’) pursuant to which, in consideration for providing the buyer with information regarding target and/or the seller, the buyer agrees to (and agrees to procure that its advisers will) keep such information secret. The obligations in the confidentiality agreement will usually continue indefinitely and will survive even if the transaction subsequently does not complete (although, where a private equity house is involved in a transaction, confidentiality agreements may be seen which are subject to a time limit, for example of two or three years. There are a number of other variations to the acquisition process and documents where private equity houses are involved).

The buyer will usually also ask for mutual confidentiality undertakings from the seller in so far as the seller obtains any confidential information relating to the buyer during the course of the negotiations.

Heads of agreement/Heads of terms

Heads of agreement are often used to set out the parties’ basic understanding of the key commercial terms and structure of the deal. They are merely an expression of the intention of the parties to act as a road map for the full form contract and, generally speaking, are not legally binding.

However, as heads of agreement can take a long time to negotiate (and only carry moral force), it is not uncommon for the parties to proceed straight to a full-form binding contract.

Where heads of agreement are used they often contain clauses relating to confidentiality (if a separate confidentiality agreement has not been entered into) and exclusivity/lock-out. If this is the case, it is crucial that these provisions (and any other provisions that the parties intend to be legally binding) are expressly stated to be legally binding.

Exclusivity relates to undertakings given by the seller pursuant to which it agrees not to solicit offers for target from any other source provided that completion takes place by a certain date. A buyer will usually insist on some form of exclusivity undertaking in order to ensure that it is not in a position where it will be in competition with another buyer and wasting legal/accountancy costs.

Due diligence

A buyer is always going to be subject to the maxim of caveat emptor – buyer beware. This means that it is the buyer’s responsibility to ensure that it obtains detailed information relating to the company or business that it is going to purchase prior to completion.

The buyer obtains the information that it needs by going through a process of due diligence. This will involve sending a due diligence questionnaire covering issues such as details of target’s property, main contracts, tax issues etc to the seller for its responses and/or it will involve the buyer reviewing a data room which will include relevant documentation relating to the target company.

The lawyers will carry out the legal due diligence and the accountants will conduct the financial, accounting and tax due diligence. The focus of the due diligence will depend on the nature of the target company.

On completion of due diligence, the buyer’s lawyers and accountants will produce due diligence reports in which they will highlight areas of concern and advise further action, such as a reduction in the purchase price and/or contractual protection for the buyer such as warranties and/or indemnities which should be included in the acquisition agreement.

The due diligence process is extremely important for the buyer (especially on a share sale due to the acquisition of all the liabilities, including hidden liabilities) and therefore the buyer should conduct a thorough investigation of the target company.

Acquisition agreement

Either during or after completion of the due diligence process the buyer’s lawyers will produce the first draft of the acquisition agreement for negotiation by the parties.

The main provisions in the acquisition agreement (whether structured as an asset sale or a share sale) will relate to the following areas:

1. Consideration – how much is the buyer going to pay for the target company / business? What form is the consideration going to take e.g. cash or shares in buyer, and when is it going to be paid? On a business sale, how is the consideration apportioned between the assets acquired?
2. Warranties – we have already mentioned warranties in relation to the results of due diligence investigations. Warranties are statements of fact which the seller makes in relation to specific aspects of target – the seller warrants that the statements are true and if they are subsequently found to be untrue by the buyer, the buyer will have a contractual claim against the seller for breach of warranty (subject to the usual requirements of loss, mitigation and foreseeability). Common areas on which warranties are given are accounts, employees, intellectual property, real estate, contracts and trading arrangements, disputes and taxation. The emphasis of the warranties will vary depending on the type of company being acquired. The seller’s liability for breach of warranty claims is usually limited by the vendor protection provisions and the contents of the disclosure letter.
3. Indemnities – again, we have mentioned indemnities in relation to the results of due diligence investigations. Indemnities are promises made by the seller to reimburse the buyer for any loss it suffers in connection with contingent liabilities. For example, on a share sale, if there is a customer of the target company who has threatened to bring legal proceedings against it, the buyer may ask that the seller indemnifies the buyer for the costs involved in defending any action brought as well as any resultant damages.
4. Vendor/seller protection provisions – vendor protection provisions are included in the acquisition agreement in order to limit the seller’s liability for breach of warranty claims. The provisions usually contain a time limit as well as an upper limit on any claim for damages that can be brought by the buyer (‘de maximus’) – usually, at most, the consideration paid by the buyer – and a lower level below which claims cannot be brought (‘de minimis’). The vendor protection provisions usually also contain a detailed procedure that must be followed by the buyer in order to bring a claim (including time limits for notification of claims).
5. Arrangements for completion – completion may occur at the same time as exchange of contracts (referred to as simultaneous exchange and completion). However, where a condition precedent needs to be satisfied (for example where consent to the transaction is required from shareholders, regulatory authorities or third party suppliers or customers) then exchange and completion will need to be separated with a time gap in between the two – this is referred to as split exchange and completion.

   The acquisition agreement will detail what issues need to be dealt with at completion, such as completion board meetings of the buyer and seller and the target company (as appropriate) and the agreements that need to be executed – this section can act as a good checklist for lawyers attending completion meetings of what needs to happen.

   Where there is a split exchange and completion, most of the practical steps to effect completion will take place at exchange (board meetings, signing most documents etc) and completion will usually be very quick (often done on the telephone) to confirm that everything that should have happened between exchange and completion has indeed happened and to transfer funds.

The key agreement in a share sale is called a Share Purchase Agreement (SPA). This agreement documents the sale of the shares of the target company to the buyer and confirms the consideration and other key provisions set out above.

Disclosure letter

It has already been stated that the seller’s liability for breach of warranty claims is usually limited by the contents of the disclosure letter. The disclosure letter is a letter written by the seller addressed to the buyer in which the seller sets out the details of any matters which make the statements of fact given in the form of the warranties untrue i.e. the disclosures qualify the warranties and as a result will limit the seller’s liability.

There are effectively two types of disclosure that can be found in a disclosure letter. These are:

1. general disclosures; and
2. specific disclosures.

General disclosures are disclosures which are usually found at the beginning of the disclosure letter (often referred to as the ‘front-end’ of the disclosure letter). General disclosures usually relate to searches of public registers that the buyer should do prior to completion such as searches of the Register of Companies and the Land Registry. The seller will usually seek to ensure that anything that the buyer could have found out by conducting such searches is deemed to have been disclosed. The buyer may seek to resist such general disclosures or may seek to make them as narrow as possible.

Specific disclosures are the disclosures usually found in the latter part of the disclosure letter (usually referred to as the ‘back-end’ of the disclosure letter). The specific disclosures are those that relate to the specific warranties given.

A large proportion of the time spent drafting and negotiating the acquisition agreement will be spent negotiating and drafting the warranties and the disclosure letter.

Other completion documents

There are also various other ancillary documents that may have to be
executed at completion or perhaps exchange (in the case of split exchange
and completion) as follows:

1. service agreements – for the directors/managers of target;
2. tax deed – comprising an indemnity from the seller to the buyer in relation to tax issues (only relevant on a share sale);
3. intellectual property licences/assignments – dealing with the transfer of important intellectual property rights such as trade marks;
4. novation/assignment agreements – for the transfer of third party contracts (only relevant on asset sales when contracts may be transferred from seller to buyer);
5. completion board minutes – for target, buyer and seller (as appropriate);
6. statutory forms (e.g. to notify Companies House of a change to target’s registered office, auditors or directors); and
7. transitional services agreement – if target was being provided with key operational services (e.g. HR/accounting/IT etc) by a parent or sister company prior to completion, the buyer may need those services to continue for a short period after completion. This is to ensure there are no problems with the continuity of trading after completion and to allow target to find an alternative supply of such services.

Who is liable under the warranties where there is more than one warrantor?

The parties giving the warranties are often referred to as the warrantors. You know already that there can be more than one seller which means that there can also be more than one warrantor. The buyer of the target company will usually insist, where there is more than one seller, that all sellers give the warranties on a joint and several basis.

Who does the buyer sue?

All the buyer is concerned about is that it will recover damages from somewhere. This is why the buyer will usually insist on joint and several liability so that it can sue (and recover against) any or all of the sellers and leave them to sort out the apportionment between themselves. A seller’s liability can take the form of any of the following:

1. Joint and several – Here, each seller assumes the obligation collectively (on behalf of all those bound) and individually (for himself). The buyer may then sue any one or more of the sellers for the whole or part of the loss.
2. Several – This is where each seller is liable for an agreed specified proportion of the potential damages. Here, the buyer must bring proceedings against individual sellers for their share.
3. Joint – The position is, in many respects, the same as if the parties were liable jointly and severally. However, the death of a party who is jointly liable will release his estate from liability. This has obvious disadvantages, both for the surviving sellers and for the buyer.

Joint liability also carries another disadvantage for the buyer – in order to bring proceedings against joint parties, the buyer must (subject to certain exceptions) issue proceedings against all of them.

‘Splitting the bill’

Civil Liability (Contribution) Act 1978

The Civil Liability (Contribution) Act 1978 entitles a joint warrantor who is found liable to pay damages for a breach of warranty, to seek a contribution from the others liable for the same damage. The court will evaluate the amount each of the parties should pay to the sued seller based on what the court considers just and equitable having regard to each party’s responsibility for the damage in question.

Express ‘Contribution Agreement’

Often the sellers will not want to leave it to the courts to decide the amount they should each contribute if the buyer is successful in a damages claim. So it is reasonably common for the sellers to agree between them a ‘Contribution Agreement’ to which they may refer should a successful warranty claim be made. They may agree, for example, that a minority shareholder, who does not have much involvement in the running of the company, will have a low cap set on any contribution (s)he may have to pay. Note that the existence of a Contribution Agreement does not affect the buyer’s right to choose who to pursue for a claim.