This article is written by Darshee Madhukallya, pursuing Diploma in Law Firm Practice: Research, Drafting, Briefing and Client Management from LawSikho. The article has been edited by Tanmaya Sharma (Associate, LawSikho), Ruchika Mohapatra (Associate, LawSikho) and Arundhati Das (Intern at LawSikho).
This article has been published by Abanti Bose.
Table of Contents
What is an asset purchase agreement?
An Asset Purchase Agreement (APA), also known as an asset sale agreement, is an agreement pertaining to the sale and purchase of the assets of a company. It is not necessary for the buyer to purchase all of the assets of the company in an APA. An Asset Purchase Agreement is essentially a dossier putting forth the terms and conditions for the sale and purchase of assets in a company. Usually, the assets transferred under this agreement include, but are not limited to, contracts, stocks, goodwill, inventory, plant machinery, machinery, equipment, premises, and intellectual property rights.
Who enters into an asset purchase agreement?
An asset purchase agreement is primarily between a seller and an asset purchaser i.e. a buyer. It regulates the transfer of assets. In such an agreement, the buyer wants to maximize their control and the seller seeks to maximize their profit. In such an agreement, the ownership of the particular asset gets transferred from the person selling it to the person buying it. The seller can no longer impose their right on the asset sold. It sets the terms of such a sale and includes provisions such as payment of purchase price, monthly instalments, liens and encumbrances on the assets, condition precedent for the closing, and representations of the parties among others. APA is used in cases where a company prefers to buy specific divisions of any other company or when a court or a tribunal orders the company for repayment of debts through the selling of assets.
What is the importance of an asset purchase agreement?
Buyers often prefer to buy only some assets of a company rather than buying all the shares and thus taking the burden of the liabilities too. An asset purchase allows the buyer to choose which assets it wants to buy and which liabilities to take on. Asset purchase gives the upper hand to the buyers by letting them cherry-pick assets and liabilities they want to obtain, therefore, reducing the risk of hidden liabilities as opposed to a share purchase agreement. There is, thus, a scope of negotiation.
There are certain advantages and disadvantages to entering an asset purchase agreement. In such an agreement, it is upon the discretion of the seller to decide as to which asset to sell and which do not and the discretion of the buyer as to which machinery to buy as seen above. Thus, their mindsets might not match but still, they can negotiate. Also, an APA reduces the extra burden and formality of any complicated acquisition structure to deal with any other laws. However, such an agreement doesn’t prove to be that convenient when it comes to transferring items, as under it, each item must be transferred separately, according to the set rules. Also in cases where there is an involvement of a third party, the process of acquiring/buying delays the transactions and adds extra costs. Furthermore, in some cases, contracts may need to be reviewed and renewed or permits and licenses may not be transferable to the buyer unless they are reapplied for.
What are the differences between asset purchase agreement and share purchase agreement?
There are two main types of definitive purchase agreements, namely: the asset purchase agreement and the share purchase agreement. But there exist several notable differences between the two. As seen from the above explanation, an asset purchase agreement is one where the transfer of assets takes place between the buyer and seller regarding the purchase of a particular asset(s). The buyer merely buys a particular asset assuming the attached liabilities and the seller retains the ownership and possession of his entire entity.
But in the case of a share purchase agreement, the seller transfers the share of the entity to the buyer. Here the liability associated with the asset too gets transferred to the buyer. Unlike an APA, the buyer here becomes the owner of the company and there is no provision of buying some assets as the buyer needs to buy all the shares. It also requires a single documentation process, unlike an asset related transaction that requires different documentation for different assets. The sale must comply primarily with the Companies Act, 2013.
What are the important clauses in an asset purchase agreement?
There are certain important provisions/clauses that should be included in an asset purchase agreement for the sale of machinery or equipment. Some of them are:
- Recital Clause: This is the first and the foremost clause in an asset purchase agreement. It includes the names of the parties to the agreement. In order to know who is involved in the agreement, it is important to specify the parties’ details as well as the nature of the business in the clause. It should also specify the purpose of the agreement, be it for business purposes or for other services.
- Definitions and Interpretations: This clause is inserted in order to specify the terms and terminologies used in the agreement. This prevents any kind of miscommunication or misinterpretation. For instance, the term “Act” can be used to refer to the concerned Act or legislation in the agreement; the term “Court” can be used to refer to the concerned Court; and so on.
- Asset(s) Purchased: Since the agreement is regarding purchasing assets, it is important to define the type(s) of the asset(s) that is/are being talked about in the agreement. It should include each and every detail of the machine/equipment; even the minutest information can help eliminate any future confusion and misinformation. Also failing to include the required information may lead to the creation of a loophole on either side. It must also include those assets that the buyer wants to buy and the seller wants to sell.
- Purchase Price and Allocation: There should be a price clause mentioning the structure in terms of the price of the product, payment method, and liabilities. It should also include payment methods as to whether the payment would be done through instalment, one-time payment, whether payment will be in cash or equity and borrowed funds will be used to fund the purchase price, paid overtime, etc. If the assets fall under the debt category, then too, both the seller and buyer must decide on the payment of such debt.
- Method of Transferring Goods: This is another important clause specifying the method through which the seller would be delivering the goods to the buyer. It should also include any kind of documentation process if involved in the transferring of the concerned goods.
- Closing and Post-Closing Obligation: Before the closing of the agreement, it is important that the seller provide the buyer with all necessary documents. It is the obligation on part of both the seller and buyer to adhere to required terms and conditions to complete the asset purchase. The closing terms should specify what is required to complete the purchase or sale of the business asset, as well as any terms and contingencies. It should include approval matters, third-party consent, the legal status of the other party and deal-specific conditions, etc.
- Warranties and Representations: It is an important clause as it deals with the nature, quality, and condition of the product. The representations must be authentic and up to the mark of the buyer’s expectations. In the case of warranties, it is indemnified on the payment part of the seller. It includes the condition or quality of the product, the fitness of the product, and also the legal status of the parties entering into the agreement. A warranty is a form of indemnity in the case of the asset not meeting the agreed conditions put forward by the buyer. This is a very crucial clause for the buyer, the violation of which can also lead to termination of the agreement or any legal claim. The warranties include, but are not limited to, taxation, intellectual property, ownership, capacity to sell, etc.
- Liens and Encumbrances: This clause specifies the liens and encumbrances if any, which are associated with the asset purchase. It should mention that the asset must not be under the possession of any third party and thus no lien should be associated with it. It should also mention that the seller is the sole owner of the asset. It should clearly specify that no encumbrance, mortgage, or claim exists on the asset.
- Covenants: It includes the obligations on part of either party to fulfil certain terms and conditions and precedents laid down by the other party before entering into the final contract. It includes certain restrictions that must be followed by either party. It should specify all the promises and agreements between the seller and the buyer.
- Indemnification: This is a very important clause to be included in order to take actionable legal claims if the material breach, fraud, or misrepresentation of any conditions by either seller or buyer takes place. It may include the damages that the party violating any conditions should pay to the other party. There should be detailed clarification on Indemnity to avoid further confusion.
- Governance: In an agreement, there are various legislations that might govern the contract. This clause includes everything related to the governance of the agreement like jurisdiction of the parties; the law(s) governing the agreement; the medium to solve any disputes arising, be it arbitration or litigation or other means; the cost of the dispute resolution process; etc.
- Dated Signatures: It is the final stage where the buyer and the seller have to put their signatures on the agreement. This is very important as it ensures that both the parties have agreed to the mentioned clauses and conditions in the said agreement. This also helps in raising any legal claim against either party.
Since every asset purchase agreement differs from the other, the clauses should also be framed as per the asset in the question and the nature of the agreement.
What are the other miscellaneous clauses in an asset purchase agreement?
Apart from the mentioned clauses, there are also certain other clauses that shall be included in an asset purchase agreement. These include rights and responsibilities of the buyer and seller; condition precedent or subsequent for the closing; severability clause; no waiver clause; specific performance clause; terminating clause; assumption of liabilities clause; notices; etc. It shall also include a clause regarding third-party approvals which are required for assets that need approval from a third party, if any, before assigning the asset to the purchaser.
It is important that the above-mentioned clauses be included. It should be a well-drafted asset purchase agreement in order to avoid any loopholes that might work against the buyer or seller after the purchase of the equipment is done. There should not be any grey areas in the agreement. While entering into an agreement for purchasing equipment or machinery it is important that the parties analyze the clauses with due diligence and take proper caution. The agreement must clearly specify the assets that are dealt with in the agreement.
What are the important filings in an asset purchase agreement?
It is also required that a Letter of Intent, containing important information, should be included. When a business is interested in purchasing assets from another it sends out a Letter of Intent notifying the various modalities of the transaction. It includes value exchanged for the asset purchase, buyer’s exclusivity, negotiations, and deal structuring timeline, modification and termination clauses, mention of the restricted activities at the buyer’s and the seller’s end, etc.
Registration holds very significant importance in an asset purchase agreement. Such agreements should be registered and stamped, so that an actionable claim can be made, if needed, in the court of law. But there are circumstances where registration might not have been possible. In such cases, the parties rely on the goodwill associated with the other party and enter into the agreement.
Conclusion
Asset purchase agreement becomes quintessential in ensuring that the parties get maximum value from the sale and purchase of assets. Furthermore, an asset purchase agreement specifies the various intricate modalities of the transaction, thus ensuring that the parties reap the deserved benefits. Given the intricacies involved in an asset purchase agreement, it is advisable to be extra cautious while drafting one and seek professional help to avoid grey areas and loopholes.
References
- https://www.contractscounsel.com/t/us/asset-purchase-agreement
- https://www.solegal.co.uk/insights/share-purchase-or-asset-purchase-whats-difference
- https://www.lexology.com/library/detail.aspx?g=13ea8da2-0c69-47df-abfe-0c900f058d21
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