The perfect Share Purchase Agreement
By Barnik Ghosh
Share Purchase Agreements (SPA) come in different colors and shapes - long, short, detailed, complicated, conditional, two or multi-party. One common thread is the need to make SPAs balanced and most importantly, enforceable. While keeping in mind the fundamentals of the transaction, a lawyer needs to prioritise the business aspects while ensuring that the legal points are not relegated to footnotes. Over the years, thousands of SPAs that have been “executed”, but the perfect completely error free agreement eludes us all, despite the hundreds of years of collective experience in this field. Some of the essential features of a classic textbook document are discussed below for a better understanding of the topics that need to be covered while drafting an SPA.
The parties to the agreement
Parties to the agreement generally comprise the seller and the acquirer, though at times, these parties are mere shell holding companies or incorporated just for the SPA with no financial history or stability. In such cases, it is important for substantive entities of the principals to be added as covenanters/guarantors to ensure that claims post the closing are paid and promises made in the agreement are kept.
The factual background of the transaction should be clearly spelt out in the recitals with no lacunae in identifying and laying down the relationship between the parties, the objective of the transaction and the role of each of the parties.
Definitions and Interpretation
Definitions are important to provide a context and meaning to certain words and phrases as used in the agreement. If a word is defined in the text of the agreement, the clause referencing needs to be done diligently in the definitions section for ease of reference. Ideally, a definition should be limited to the meaning of the term and should not contain any covenants that are meant for inclusion only in the main text.
Consideration and sale of shares
An exhaustive structure of payment needs to be spelt out including the deposit to be given at the time of execution; the sum that is payable on closing (pricing formula to be determined on a case to case basis) and if applicable, the sum held in escrow to be set off against indemnities or breaches of representations and warranties and the amount payable in case any security is registered against the company.
In current times, consideration is transferred directly through bank accounts and cheques/ demand drafts are the exception not the rule. In case of an escrow fund, the dynamics of the operations need to be clearly set out. If the payments are to be done in tranches, the details of the trigger for the payments should be spelt out in the document to pre-empt differences on interpretation at a later date.
The conditions precedent clause should be exhaustive providing for all authorizations, permissions and permits which are necessary, both internal and external and the person responsible for obtaining each of these should also be stated. Normally a clause on the right of the acquirer to waive any condition is also included to provide flexibility in case certain routine approvals that do not impact a transaction from closing are not forthcoming or are delayed. The conditions precedent clause should also provide for fulfilling all the representations, warranties, obligations, execution of agreements and covenants under the agreement.
The Closing Mechanism should establish the time frame, place as well as the actions (including but not limited to exchange of documents) in which the closing shall take place. It is prudent to include a closing memorandum listing the actions that are to take place on closing day including the board resolutions to be passed. A particular line clearly stating that the closing should take place on satisfaction of condition precedents is also wise.
Ideally, there should not be any conditions subsequent in a share purchase agreement, but this becomes necessary though rare. There are some permits and obligations which are always residuary in the conditions subsequent. However, protection should be afforded to the purchaser in case any of the conditions subsequent are breached.
Covenants by the parties
Covenants may be negative or positive and provide a level of comfort to each of the parties on their past and proposed actions regarding the SPA. Covenants are also required by the purchaser from the seller regarding management of the company between signing and closing. Acts that are permissible during this period will normally require the consent of the acquirer though the company is still technically managed by the seller in the interim.
Vendor’s Representations and Warranties
The corporate status of the company and the good standing in the market needs to be clearly spelt out. The capital structure of the company including the list of directors and the number of shares owned by the vendor should be provided. In addition, this clause contains an affirmation regarding the title and rights of the seller on the shares/property of the company, status of compliance with law, any pending or threatened litigation or dispute, information on loans and related agreements and fairness of accounts and financial and other information provided by the seller. It is a good practice to state that the vendor has the unhindered right to sell and transfer title to the shares to the purchaser there are no restrictions imposed by any other agreement or contrary court orders.
Purchaser’s Representations and Warranties
The purchaser’s right to contract, purchase and ability to pay the compensation and enter into subsequent agreements are clauses for inclusion in this chapter. In case, the purchaser is a company, the corporate status of the purchaser also needs to be highlighted.
Obligations pre and post closing
This is primarily a repeat of the representations and warranties clause but is incorporated in the share purchase agreement to protect the interests of the parties. Some of the warranties fall away at closing, while others like right and ownership of shares will continue well past the closing.
This is particularly important when parties have exchanged confidential information and/or when listed entities are involved in a transaction. It is also standard to state that the terms of the agreement are confidential and cannot be revealed without the consent of both parties. Confidentiality clauses are limited in time ranging between 18 months and two years.
Indemnification clauses are hotly negotiated, particularly the lower and upper threshold limit on claims, time period, subject matter and the procedure inter se the parties for dealing with disputes including tax disputes that have an impact on claims. They also provide the process for reimbursement of claims and often the most scrutinized clause in case of disputes, hence particular attention has to be paid to ensure that the purchaser is adequately covered in case of issues relating to the company prior to the transaction but which emerge post closing. This is also the reason why a purchaser will demand a substantive party from the seller’s side as the guarantor for indemnification.
The notice clause is generally overlooked but this is extremely important. Not only should the locations be specified, but the manner in which the notice is to be dispatched and whether the parties are ready for electronic formats of notices to be dispatched needs to be keyed in.
Though force majeure is a standard clause, the interests of the parties can be strengthened by putting in a phrase regarding fluctuating market conditions including that of a sudden financial crisis. Though this type of clause is extremely rare in India, we can adopt the western practices which follow the inclusion of such a clause post the financial crisis of 2008.
Dispute Resolution and Arbitration
Arbitration in India has gained notoriety for delays and abuse of process by resorting to courts to set aside arbitral awards. The Supreme Court has ruled that if both parties are based in India, it will be a domestic arbitration under the Arbitration and Conciliation Act, if at least one of the parties is an overseas entity, the parties may choose any international forum like ICC or Singapore International Arbitration Center for quick resolution, keeping in mind the notified countries for enforcement of arbitration awards in India. The clause must contain in addition to the procedural law, the seat of arbitration, the number of arbitrators, language (English), the disputes that will be referred to arbitration after an initial attempt to resolve amongst themselves. Poorly and hastily drafted clauses will cause a lot of pain to affected parties when this clause is sought to be enforced.
Jurisdiction & General Clauses
Indian laws will be applicable and the courts in the city of the registered office of the vendor will have the jurisdiction. The usual and standard clauses should be provided but special emphasis should be provided to the assignment clauses and the relationship clause which will set out clearly that the agreement does not create or envisage creating any particular form of relationship between the vendor and the purchaser except as otherwise categorically provided in the agreement. No employer employee or principal agent relationship is deemed to be created.
The drafting of a share purchase agreement depends on the party a lawyer is representing. Similarly, the number of representations and warranties also change. But the beauty of the agreement lies in the transaction which governs the agreement. A share purchase agreement is the crown agreement which every corporate lawyer wishes to draft. This article sets the tone for drafting an SPA.
[The author is an Associate, Corporate Practice, Lakshmikumaran & Sridharan, Kolkata]