In Part – II of the Series on Share Purchase Agreements (SPA), we shall look at the grey areas involved in a SPA, problems generally borne out of SPAs and the clauses which the seller must negotiate before entering into a SPA.
1. Warranty: A problem with Share Purchase Agreements
The onus to conduct due diligence about the seller and his business is on the buyer. However, despite such due diligence and after strict scrutiny, the buyer still demands warranty from seller. This poses a dilemma for the sellers at the negotiation table.
2. Auction Sales
When the seller is a private equity firm, there are chances the seller would auction inviting competitive bids from several interested parties.
3. Cross Border Deals and Transactions
If any difficulty arises in case of transactions dealing in international and cross border businesses, jurisdictional differences arise at the drafting as well as the dispute resolution stage.
4. Failure to Protect Against Competition from the Seller
The terms of the stock (common or preferred), liquidation preferences, dividend rights, redemption rights, voting and board rights, restrictions on transferability (if any) and registration rights are quite fluctuating and traded on competitive basis. Often times, SPAs are inadequate in protecting the buyer from competition from the seller in future.
MAJOR ISSUES IN A SHARE PURCHASE AGREEMENT
1. The SPA comprises of intricate and complex legal provisions and as a result the execution of such agreements may give rise to several legal complications.
2. The Buyer acquires all the assets and assumes all liabilities, rights and obligations of the seller. Though the Seller has to track various modalities, the Buyer has to conduct complete due diligence to find previous disputes or liabilities, if any, is associated with the seller and his enterprise.
IMPORTANT CLAUSES TO BE NEGOTIATED BY THE SELLER
1. Representation and Warranties by Seller
Representations and Warranties are facts disclosed by the seller to the buyer, stating that such facts are completely true. These statements made by the sellers in the representations and warranties clause usually deal with various aspects of the company like shares being sold, price of the shares, any pending disputes, financial and tax liability, etc.
Warranties in detail include title, all taxation related warranties, compliances to be followed, employment warranties, labour warranties, books maintained by the seller, the business practices of the company, the assets, all financial matters, all contractual matters, intellectual property matters, environment related issues, insurance related warranties, borrowings, power of the lawyers, insolvency related matters and various licenses and consents that have been duly obtained.
The sellers shall ensure the provision of a Disclosure Letter detailing the non-compliances regarding the business and Warranties related to the company affairs.
SPA contains an indemnity clause incorporated in it solely for the purpose of managing risks, i.e., making good the losses that may arise in the course of the transaction. The Indemnity Clause is the most scrutinized clause in an SPA and plays an indispensable role in the event of any dispute which may arise between the seller and the buyer under the SPA. An Indemnity Clause typically states that one party agrees to ‘indemnify’ the other party.
The clause mentions terms such as “jointly and severally liable”, when there are other individuals who may also be involved. In such cases, the sellers shall negotiate thoroughly as well.
3. Limitation of Liability
The buyers in an SPA have the right to claim indemnification. The sellers have to ensure that indemnity claim is warranted. The burden of caution to ensure that the buyer does not claim indemnification for any losses incurred apart from the SPA is on largely on the seller.
4. Insurance Benefit
If the Seller has to release the indemnification granted for the Buyer, the Seller might require the Buyer to purchase and carry liability insurance to cover potential obligations if any such obligations arise. In that scenario, there are several financial and legal implications that the insurance companies are required to deal with.
The SPA is a formal document setting out the rights, obligations and liabilities of the Parties, ensuring proper recourse to the aggrieved Party in case of any dispute. It serves as a basis for contract structuring as well as an extension of both Parties’ investment with the growth of the enterprise. Because it covers all parts of the transaction, the SPA gives both Parties a way to protect their interests prior to transferring the shares.
The SPA clearly distinguishes between voting and non-voting shares, expressing the highest priority in ensuring that the transferee receives the best possible service because they represent value.
Additionally, it gives Parties a chance to defend their interests before the shares are transferred. It includes every facet of the transaction, and it is critical for both Parties to thoroughly review and comprehend each clause in the contract before concluding the same. A SPA can also help a company increase its revenue with its fundamental advantage of eliminating any potential misunderstanding and simplifying the transaction.
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