This article is written by Dewansh Vashishth, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from lawsikho.com.

Introduction

A business is defined under section 2(17) of the Goods and Services Tax Act. When there is a sale of a business from one entity to another, it is called business restructuring, which in itself is a very comprehensive and complicated process. This business restructuring can take place in different modes, like organisation of capital, merger/amalgamation, demerger, takeover/acquisition, slump sale by way of business transfer agreement, etc. the primary objective for business restructuring is to grow and develop in size as well as profits.

A business can be sold in two ways, i.e., either by slump sale or by asset sale. In case of asset sale, a buyer can benefit as he/she purchases only the rights and liabilities cherry picked by him/her and eliminates other rights and liabilities that are not needed for the business to avail profit. An asset purchase will determine as to what items of business will be forming the part of ownership transfer. Purchaser is usually benefitted from an asset sale/purchase. However, from a seller’s perspective, a slump sale through business transfer is more preferable as the taxes on capital gains are paid at low value when compared to that of asset purchase.

For an entire business to be transferred a method of slump sale takes place by way of a business transfer agreement.

Slump sale

In India, the term ‘slump sale’ and ‘business transfer’ is used interchangeably and refers to the transfer of an entire undertaking on a going concern basis at a lump sum consideration by the purchaser. Slump sale can be understood as a selling or transfer of one or more undertakings of a business in consideration for a lump sum amount, wherein the assets and well as the liabilities of such undertaking/s is also transferred to the acquiring entity, without the values being assigned to every particular asset and liability in such a sale/transfer.

Essential elements of slump sale

1. Sale of undertaking – the transfer should essentially be by a manner of sale. Any other manner by which transfer is made, it would not attract the provisions of Section 2(42C) of IT Acts.
2. Going Concern Basis – as per this rule, the business must have the ability to function even after the transfer of business has been made.
3. Assets and Liabilities – there is transfer of undertaking as a whole. If only the assets are subjected to transfer of the business, it cannot be regarded as a slump sale.
4. Lump sum consideration – consideration to be paid as a whole and not for itemized assets. It should be an upfront one-time payment and not made in instalments or any other mode.

Advantages of slump sale

One of the most significant advantages of slump sale, when compared to assets purchase, is its tax implication over the seller. During asset sale, individual values are being assigned to each of the assets and the capital gains that arise from the sale of such assets will be ascertained for each separately. Thus, depending upon the holding period for each of these assets, there are short term or long term capital gains on each of these assets. In case an undertaking has been held for more than 36 months, the profits arising from the business transfer are subjected to long term capital gain and calculated at an interest rate of 20%. In cases where the undertakings are held for less than 36 months, the business transfer is subjected to short term capital gains at an interest rate of 30% for domestic and 40% for foreign companies.

Another reason as to why businesses are restructured by way of slump sale is that restructuring through slump sale attracts only stamp duty on immovable property. By way of slump sale, the performance post-integration is increased; the sale helps in strategic investments; and through slump sale, the entity can avail tax and regulatory advantages that come with the business.

Modes of execution

A business transfer agreement can be of two types –

1. Agreement to sell – it in this the manner in which the business undertaking shall be sold will be provided. There is no immediate transfer of undertaking but this agreement lists out the intention of the parties.
2. Deed of conveyance – through this agreement, there is a sale or transfer of an undertaking and consideration is paid for such transfer. It is also referred to as a sale deed.

Steps to draft a business transfer agreement

In order to give effect to a sale or transfer of business by the method of slump sale, a business transfer agreement is entered into by and between the parties, wherein the entire business undertaking is transferred to the purchaser on a going concern basis, i.e., the business is being transferred in a running condition. A business transfer agreement gives an overview of the type of transaction, terms of sale and details transfer, representations and warranties of the seller and of the purchaser, condition precedents, etc.  A business transfer agreement lists down assets, liabilities, contracts, capitals, taxes, intellectual property and other provisions which are discussed below in detail.

Terms of agreement

Parties to the agreement

This clause entails hive-off of one or more business undertakings from the side of the seller and the liquidation such hived off undertakings in the purchaser. The parties necessarily have to be natural persons and no artificial person can enter into such agreement. Even a non-resident is not allowed to conduct business in India without having a place of business in the country. Therefore, for a non-resident to initiate a slump sale or even asset purchase, it first has to establish an Indian entity and then use this Indian entity to initiate a business transfer. 

Recital clause

This clause provides for the background of the entities entering into the transaction. This clause however, is not operative in nature but an explanatory part of the contract. The clause must contain the factual matrix of the transaction, highlight the intentions of the entities regarding the transaction, etc. An example of such clause can be –

“WHEREAS

1. The Seller is a retailer in the city of Bhopal, Madhya Pradesh.
2. The purchaser is a private company engaged in the business of manufacturing and marketing clothing products and has a pan India presence.
3. The Seller wants to sell the Business by way of slump sale and the Purchase agrees to buy the Business of the Seller.
4. The parties have entered into this Agreement for the transfer of Seller’s Business on a going concern basis on the terms and conditions of this Agreement.” 

Description of transfer

The recital clause is followed by the description clause, wherein the transfer of business is explained. The description clause describes the nature of the transaction. This clause should provide a clear and precise mode of transfer and the liabilities attached therein, with no exposure to ambiguity. It should be ensured that only the necessary and specific assets and liabilities for running the business undertaking are included. Liabilities must be defined precisely and must only include liabilities that are related with business being acquired. This clause shall be supplemented with additional details of Assets and Liabilities, provided in annexures or exhibits. An example of this can be –

“Subject to fulfilment of terms and conditions of this Agreement, on the Closing Date, the Seller shall, irrevocably and unconditionally, sell, assign, and transfer the Business to the Purchaser and shall include the Assets and Liabilities in such transfer. The Purchaser shall purchase and acquire the Business from the Seller free from all encumbrances on a going concern basis with effect from 3rd August 2020.”

Purchase consideration

Once the explanatory clause is established in the contract, the operative clauses of the contract begin. This clause describes the nature, amount, currency for payment and mode of payment that will be made to the Seller by the Purchaser on transfer of the Business. Illustration of such clause can be –

“The consideration for the transfer of Business of the Seller shall be INR 5,00,000/- (Indian Rupees Five Crore only) which shall be paid by way of bank transfer from the Purchaser’s Merchant to the Seller’s Bank through NEFT.”

Representations and warranties of the parties

The purchaser will proceed with the agreement for transfer of undertaking based on the representations and warranties made by the seller during negotiations between the parties. Here the seller promises the purchaser regarding the assets and liabilities of the business. A seller gives undertaking that he is permitted to sell the business and has legitimate approvals as per law to sell the undertaking. The representations and warranties given by the seller in a business transfer agreement will be comparatively broader as compared to that of purchaser. This clause ensures that every future rights and obligations of the purchaser is safeguarded. An example of such clause can be –

Representation and warranties of Seller

1. The seller has complete authorisation and consent from concerned authorities to enter into this Agreement and perform the obligation hereunder agreed for this Transaction.
2. The books and records maintained and submitted by the Seller are complete and correct.
3. The Seller will execute all the documents and other formalities that remain necessary to complete the business transfer transaction.
4. The Business assets are free from all mortgages, encumbrances, or any other adverse rights.
5. The seller is in possession and control of all deeds and documents to which Seller is a party and which is related to this Transaction.

Representation and warranties of purchaser

1. The purchaser has complete authorisation and consent from concerned authorities to enter into this Agreement and perform the obligation hereunder agreed for this Transaction.
2. The execution, delivery and performance of the transaction under this Agreement does not constitute a material default to any material contract by which it or any of its material assets are bound, or an event that would, with or lapse of time or both, constitute such default.”

Condition precedent of the parties

Apart from the representation and warranties clause, the condition precedent is also one of the most essential clauses in a business transfer agreement as it enlists conditions or events that must be completed before the agreement is brought into effect. Once the conditions precedents are satisfied by the purchaser, the rights and obligations of the parties are given effect. This clause ensures that the seller has legitimate rights, approvals and consent to transfer the undertaking. An example for such clause can be –

Condition Precedent –

1. The seller has obtained all approvals and permits required by law for the sale and transfer of the Business under this Agreement.
2. The seller has obtained no objection under Section 281 of the Income Tax Act 1961 for the sale of undertaking under this Agreement.
3. There is no material defect or the Seller is not aware as to any material defect, in relation to the Business.”

Indemnification clause

There are chances that the business undertaking that has been transferred, come with disputes and can be subjected to various liabilities. An indemnity clause safeguards the interest of the purchaser of the business undertaking and further shall be motivated to be diligent enough to avoid any future dispute. Compensation clause in an agreement to sell is intended to seek compensation from the seller if any losses or expenses are incurred in the future. All possible situations must be addressed while drafting the indemnity clause An example for such clause can be –

“Both Party indemnify and hold the other Party harmless from and against any and all direct claims or losses that indemnified person may suffer or incur due to – (1) breach of any warranty of such Party, (2) non-fulfilment of any obligation or duty as mentioned in this Agreement, (3) any non-compliance by such Party with any regulatory requirement.”

Term and termination of the agreement

This specifies the duration for which the business transfer agreement will stand valid, the valid conditions in which the termination clause is invoked by any of the parties and the procedure by which this agreement can be terminated. One such example can be –

Term and Termination –

1. Either Party may terminate this Agreement before the Closing Date.
2. The right to terminate in Clause 11.1 shall be without prejudice to all available rights and remedies available to the Parties hereto under Law including the right to seek, as an alternative to termination, specific performance of obligations under the Agreement or terminate the Agreement and seek damages for the breach either Party for breaches committed during the period prior to such termination.

Governing law and mode of dispute resolution

This clause helps to convey the laws applicable and the jurisdiction to try a potential dispute that may arise. A specimen of this can be –
Governing Law – 

This Agreement shall be governed by and construed in accordance with the laws of India and the courts at New Delhi shall have the exclusive jurisdiction.” 

The parties, before proceeding towards litigation, find ways to amicably resolve the disputes that arise between them during the term of the business transfer agreement. The parties decide the mode of dispute resolution which can either be mediation or arbitration or both, and the place and procedure to be followed for the resolution process. 

The parties negotiate as to where or which courts will hold jurisdiction in case the dispute is escalated.

“Dispute Resolution –

• All or any dispute, controversy, claim or disagreement arising out of or touching upon or in relation to the terms of this Agreement, or its termination, breach, invalidity, including the interpretation and validity thereof, and the respective rights and obligations of the Parties hereof, that cannot be amicably resolved by mutual discussion within 30 (Thirty) calendar days, shall be referred to arbitration as per the provisions of the Arbitration and Conciliation Act, 1996, which shall be final and binding in nature upon the Parties.
• The Parties shall appoint one (sole) arbitrator who would be a retired High Court Judge or a retired Supreme Court Judge. The arbitrator should be appointed mutually within 15 (Fifteen) days from the date of the receipt of the notice of invocation of arbitration by either of the Parties to this Agreement.
• If a mutual consensus cannot be arrived at for the appointment of a sole arbitrator then in such a case the entire matter will be decided by a forum/tribunal of three arbitrators. One arbitrator each will be nominated by the respective Parties and a third arbitrator shall be decided and appointed by the two nominated arbitrators, who shall also be the chairperson of the arbitral tribunal so formed.
• It is expressly stated that the courts of New Delhi, India, shall have the exclusive jurisdiction with respect to matters relating to the arbitration, including the enforcement of awards and injunctive relief.

Conclusion

There are several ways of restructuring of entities, that is, by scheme of arrangement for demerger, mergers, acquisition of shares, however, these processes are complex and require various approvals from NCLT for their further processing and are costly. However, business transfer by way of slump sale is less time consuming, less costly and more simplistic in nature as compared to the above mentioned restructuring mechanisms. Slump sale by way of business transfer agreement involves much less compliances and confusion within the purchaser and the seller for transferring of undertakings or businesses.

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