This article has been written by Prathamesh More, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho. It has been edited by Ruchika Mohapatra (Associate, LawSikho).
Business transactions in today’s times are complicated and involve high stakes for all parties involved, especially when it involves an investment of large sums of money. Any prudent investor, before committing a significant amount of money whether into an ongoing project or purchase of another business, will do his homework on the fundamentals of that particular place of investment, the return on investment and the risks involved. For example, banks require collateral security from the loanee as a condition for sanctioning a loan, and they keep track of payments received at regular intervals to ensure that there is no default. Similarly investors also need a safety mechanism to ensure that their investment bears results. To ensure that, both parties negotiate the conditions and obligations that will govern the investment process to secure their interests. We will be discussing those conditions in detail in this article.
What is the condition precedent?
A Condition Precedent (CP) can be defined as a condition which is supposed to be fulfilled or satisfied to create a right, obligation or contractual relationship between two parties. It is a condition that creates a situation or takes place prior to or before a party has to perform a duty in the contractual relationship.
What is the condition subsequent?
A Condition Subsequent (CS) can be defined as a condition which is supposed to be fulfilled or satisfied to excuse a party from the contractual relationship which means creation of an obligation or termination of the contract between the parties due a future uncertain fact or event that may or may not occur.
It is quite clear that, both conditions CP as well as CS, when satisfied; either gives rise to a right, obligation, or contractual relationship or terminates the same.
The core of this article is the Investment Agreement. An investment agreement is an agreement that deals with the share subscription by the investing parties or investors in return for the investment consideration. It binds all the participating investors, even any separate funding parties that have invested in the company.
An investment agreement is a contract between a company and its shareholders and an investor dealing with a proposed investment in the company. The investing party can be an existing shareholder of the company or all the shareholders of the company but it might be impractical for all the minority shareholders to be a party if they are in huge numbers.
Why is investment agreement important?
When a company wants to accept a new investment, there can be various challenges and risks that are supposed to come with new funds. To manage these issues, the company finds a way to monitor such risks and maintain good contractual relations with the investor. This usually plays a vital role for the start-up companies and companies that are going through initial investments to provide clarification to all the parties on what the investor is entitled to now as well as in the future.
Hence, Investment Agreement helps the company to create a legally binding agreement that lays down the risk and rights and obligations of each party, including provisions to clarify on what all the parties know to do if things do not go as expected which might create a breach or violation of the investment agreement and provision related to dispute resolution and termination of the agreement.
If an investor is receiving minority shareholding, it is advisable for the investor to use the investment agreement to ensure the rights and protections set out in the agreement are consistent with the law of the land. In the end, the investor is willing to have a legally binding contract which can help him/her to have an adequate say in the company’s decisions for the sake of justification of his/her investment.
How condition precedent and condition subsequent play a role in investment agreements?
First of all, in investment agreement under the Purchase and Sale of Shares clause it is mentioned that the payments are to be “tranched”, i.e., a portion of the amount or segment of funds which are supposed to be paid according to certain conditions. Usually, these conditions are mentioned in the investment agreement, to make sure the monetary claims required for the development of the company at various stages are satisfied. In simple language, the company will want funds to be coming in at various stages of its development which need to be planned precisely to avoid any kind of violation.
So, the term “tranche” can be interpreted as Condition Precedent and Condition Subsequent because tranche indirectly means milestones or in simple language a certain condition which shall be fulfilled or satisfied. An investment agreement requires two types of tranches “Initial tranche” and “Subsequent tranche” much like Condition Precedent (Initial Tranche) and Condition Subsequent (Subsequent Tranche). This term exists because the investors will be paying money in parts or portions only if the conditions are fulfilled, so in short, a tranche can be said to be a payment paid only after fulfillment of the conditions. Now, let us understand the aforementioned terms in detail.
The investors will want certain conditions to be fulfilled before the initial tranche of the investment i.e., initial investment in the company. The conditions required to be fulfilled are as follows:
- Due diligence of the company;
- A convincing business plan and accounts management;
- Tax clearances (if any);
- Formation of requisite authorities (Board and Shareholder) to issue new shares to the investors and adoption of new articles of association;
- Issuance of shares or options to the founders and key management people;
- Assignment of all the intellectual property rights owned by the founders to the company; and
- Appropriate insurance for the investors as well as company employees.
Initial tranche completion mechanics
The measures required to be taken for the completion of the initial tranche of the investment are as follows:
- Investment Agreement approval and disclosure letter if required;
- Issuance of Subscription Shares and certificates pertaining to the investment to the investors;
- The Board of Directors shall have Investor Director(s);
- Investors are obligated to pay the subscription monies to the company’s official bank account;
- If the founders are willing to become executive directors of the company, then there shall be approval and execution of service agreements; and
- Adoption of a share option plan.
The investment agreement shall mention that proceeds of the investment (initial or subsequent tranches) shall be used for fulfilling the agreed conditions and business plan or budget.
For each subsequent tranche of investment there exists a certain completion condition or conditions which might include the following:
- Initial investment or initial tranche occurring shall be completed;
- No adverse changes materially;
- Achievement of the agreed condition pertaining to the tranche in question;
- Ensuring that there is no material breach of the investment agreement, articles of association or executive director’s service agreement;
- Retaining the employment of the company founders and certain important employees; and
- Ensuring that the company hasn’t faced any kind of insolvency event.
Subsequent tranche completion mechanics
The measures taken for the completion of the subsequent tranches of the investment:
- Issuance of new shares and certificates pertaining to the investment by the investors; and
- Investors are obligated to pay the subscription monies to the company’s official bank account.
Difference between condition precedent and condition subsequent
From the above-mentioned information we get an idea that condition precedent and condition subsequent according to the perspective of an investment agreement can be stated as tranches which shall be paid on completion or fulfillment of certain conditions (precedent and subsequent). If there is any fault in fulfillment of such conditions, it might lead to termination of the whole investment agreement, like a condition subsequent clause does for instance, if an investor does not pay the subsequent tranche the investment agreement shall collapse. The actual difference between condition precedent and condition subsequent is as follows:
|No.||Condition Precedent||Condition Subsequent|
|1.||A condition precedent is one the fulfillment of which completes an inchoate title.||A condition subsequent is one of the fulfillments which extinguishes a title already completed.|
|2.||A condition precedent always comes before the creation of an interest.||A condition subsequent always follows the vesting of an interest which is already complete.|
|3.||In the case of Condition precedent, the vesting of the estate is postponed till the performance of the condition precedent.||In the case of condition subsequent, vesting is complete and not postponed.|
|4.||In the case of condition precedent, an interest once vested can never be divested by reason of non-fulfillment of the condition.||In the case of condition subsequent, interest even though vested, is liable to be divested by reason of the non-fulfillment of the condition.|
|5.||In the case of condition precedent, an estate is not in the grantee until the condition precedent is performed.||In the case of subsequent, the estate immediately vests in the grantee and remains in him till the condition is broken.|
|6.||In the case of condition precedent, transfer will be void if the condition precedent is impossible to perform, or immoral or opposed to public policy.||In the case subsequent, the transfer becomes absolute and the condition will be ignored if that condition is impossible of performance or immoral or against public policy.|
|7.||In the case of condition precedent, the condition precedent must be valid in law.||In the case of subsequent, it need not be so, and the invalidity of the conditions can be ignored.|
|8.||In the case of condition precedent, the doctrine of cy press applies and the condition precedent is fulfilled if it is subsequently complied with.||The doctrine of cy press does not apply.|
It is quite clear that condition precedent and condition subsequent are certain conditions that are to be fulfilled for happening or non-happening for an uncertain future event. In investment agreements, these conditions play a vital role in the functioning of the company and its financial stability as each condition is targeted towards tranches to keep the monies coming in for further development of the company. The tranches also allow the investors to waive off the conditions that are agreed to be fulfilled for the purpose of investment in the company.
- Relevance of conditions precedent and subsequent & implications of non-compliance. (IPleaders).
- How to write an investment agreement [Harper James Solicitors]
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