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This article is written by Ishita Goyal pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from Lawsikho.

Introduction

A business can be sold in two ways, first, by the quick sale and second by an asset sale. As far as the sale of assets is concerned, the buyer usually just gains from buying the rights and obligations selected by him and gets rid of other rights and obligations which may not be needed by the company to generate profit. The asset purchase will recognize the work items that are part of the ownership transfer. However, from the businessman’s point of view, a quick sale is more desirable, as capital gains taxes are paid at a value much less compared to the purchase of assets.

What is the significance of a slump sale?

“Slump sale” is one of the methods of corporate restructuring. The company will sell its business and this is one of the most common forms of business buying in India. Retail is usually done to: 

  • Increase business performance;
  • Improve focus and eliminate negative synergy and facilitate strategic investment; and
  • Benefit from relevant tax and regulatory benefits.

Legal implications of a Business Transfer Agreement

A Business Transfer Agreement in India is subject to the Indian Contract Act, 1872 that covers general contractual principles, for instance, formation and mutual understanding and Sale of Goods Act, 1930 that deals with title to goods and warranties. General principles of contract law, as provided by the common law, therefore, apply to this agreement.

In furtherance to this, depending on the industry within which the business operates, other legal frameworks, specific to that industry, may also apply. For instance, if along with the business, even the tenure of the employees is being transferred, then elements of employment law may apply. Similarly, if there is a patent or trademark relating to the business being transferred then elements of intellectual property law can apply, such as the Trade Marks Act, 1999 or the Copyright Act 1957.

Important provisions that need to be incorporated in an agreement for business transfer

  • Recital clause

This clause provides for the background of the entities entering into the transaction. It is more like an explanatory clause of the agreement and contains the factual matrix of the transaction, highlighting the intent of the entities regarding the transaction, etc. herein the party may choose to describe the nature of the business, place of operation of the business, about the purchaser and the business. 

  • Description of transfer

In the description clause, the nature of the transaction taking place is described in detail. This clause offers particular details relating to the mode of transfer and the liabilities attached to the agreement. It should be ensured that only the necessary and specific assets and liabilities for running the business undertaking are included. Liabilities must be defined meticulously and must only include liabilities that are related to the business being acquired. This clause shall be complemented with additional details of assets and liabilities with the help of annexures or exhibits. An example of this is laid as follow;

“Subject to the provisions of this agreement, the seller shall, irrevocably and unconditionally, sell, assign, and transfer the business to the purchaser on the closing date. Such a transfer shall be inclusive of all the present assets and liabilities of the business. The purchaser shall purchase and acquire the business from the seller free from all encumbrances on a going concern basis with effect from __(Date of transfer)__.”

  • Purchase consideration

This clause describes the nature, amount, currency and mode of payment that will be made to the seller by the purchaser on the transfer of the business. An illustration of the said clause could be;

“The consideration for the transfer of the business of the seller shall amount to 10,00,000/- (Indian Rupees Ten Lakhs only) which shall be paid by way of a bank transfer from the purchaser’s merchant to the seller’s bank through NEFT.”

In furtherance to this, the parties need to furnish their bank details or any such detail that would help in ascertaining the mode of transfer of money. 

  • Representations and warranties of the parties

This clause ensures that every future right and obligation of the seller and purchaser are safeguarded. An example of such a clause can be;

Representation and warranties of the seller;

According to this provision, the seller has complete authorisation and consent from the concerned authorities and performs the obligation agreed for this transaction. Few of the representations made by sellers include:

  1. The books and records maintained and submitted by the seller are complete and correct.
  2. The seller would execute all the documents and other formalities that are necessary for the completion of the business transfer.
  3. The business assets are free from all mortgages, encumbrances, or any other adverse rights. 
  4. The seller holds all documents in which the seller is included as a party.

Representation and warranties of the purchaser;

In the representations made by the purchaser, he shall agree that;

  1. He holds complete authorisation and consent from the appropriate authorities to enter into any agreement related to business transfer and perform obligations for the same.
  2. The execution, delivery and performance of the transaction under the agreement would 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

The condition precedent is also an essential clause in a business transfer agreement because it provides for the conditions or events that need to be accomplished before the agreement is brought into effect and hence, only upon the condition’s precedents being 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 a clause is laid as follows;

Condition precedent;

  1. The seller ensures that no objection under Section 281 of the Income Tax Act 1961 for the sale of undertaking under this agreement is raised. 
  2. The seller ensures that all approvals and permits required by law for the sale and transfer of the business under this agreement have been obtained by him.
  3. The seller assures that there exists no material defect in relation to the business in his knowledge.
  • Indemnification 

This is a statutory provision in which a party agrees to pay a loss to another party.  They can also be used to release the indemnifier or the other party of liability if a breach of contract occurs, or damages/loss of goods are incurred and basically make good of any such loss. 

An indemnity clause protects the interest of the purchaser of the business enterprise and further shall be motivated to be diligent enough to evade any upcoming dispute. The compensation clause in an agreement to sell is incorporated so as to ensure that compensation is received from the seller if any losses or expenses are incurred in the future. 

  • Term and termination of the agreement

This provision lays down the period for which the business transfer agreement would stand valid and legally binding. The conditions in which a termination clause can be invoked by either of the parties and the procedure by which this agreement can be terminated is also enlisted in this provision only. In the said section, the parties may choose to also lay down the penalty for unlawful termination of termination. 

  • Governing law and mode of dispute resolution

This provision in the agreement talks about the law that shall govern and construe in accordance with the laws of India and the courts of whichever state that shall have the exclusive jurisdiction. 

The parties, however, proceeding towards litigation, find ways to settle the disputes that may arise between them during the term of the business transfer agreement. The parties can mutually 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.

Conclusion

For an effective business transfer, it is important to pay extra caution on the drafting of the agreement and enlisting the provisions of the agreement. Furthermore, as far as restructuring the business and its operations and functions is concerned, more and more businesses in these times should opt for slump sale because of its less complex nature and speedy process for business restructuring. Further, it is important to make a watertight agreement leaving no room for any ambiguity so that no legal dispute or conflict may arise due to any situation.


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