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Essentials of drafting a business transfer agreement

April 18, 2021
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This article is written by Muskaan Aggarwal who is pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.

Introduction

Business restructuring and starting from the very start can be a very complicated and gruesome process to deal with in terms of financial, organizational, and technological changes that are expected out of such a change. Normally, such business restructuring is conducted through mergers, demergers, takeovers, compromise, amalgamation, alliance, slump sale, etc. Business Transfer Agreement deals with restructuring through slump sale where assets and liabilities of a company are transferred, sold, leased, or assigned to another in return for a lump sum consideration amount. Such restructuring helps in earning ownership over a business, helps in the growth of an existing business, earns better profits, etc. 

However, it is important to know how to understand the concept along with the process. This article aims to analyse business transfer agreements and how should they be entered, to have a profitable outcome, and successful business transfer.

Business transfer agreements

“Business Transfer”, or sometimes referred to as “Slump Sale” in the Indian context, refers to a transfer and sale of an entire business enterprise for a lump-sum consideration. While Section 2(17) of the Goods and Services Tax Act, 2017 defines ‘business’, ‘Slump Sale’ is purely a tax concept which has been defined under Section 2(42C) of the Income Tax Act, 1961 (“Act”). 

According to the definition provided under Section 2(42C) of the Act, the essential requirements of a business transfer agreement are:

Transfer by way of Sale

The Act makes it clear that only transfer by Sale is recognised as a slump sale, and no other mode of transfer shall be recognised as a slump sale. An interesting debate has existed around this concept for years, which is whether the payment of monetary consideration is essential to constitute slump sale under the Act. It is important to note that even though it has been resolved that a transfer without any consideration shall not come under the ambit of slump sale, ambiguity still exists on whether the type of consideration shall have any effect on slump sale and its validity. Despite numerous efforts, the question of whether the payment of consideration amounts to sale or simply exchange of assets still requires a proper resolution.

The term ‘Sale’, even though has not been defined under the Act, but the interpretation is often drawn from the Sales of Goods Act, 1930, which defines sale as a transfer contract of property in goods, by the buyer to the seller for a specified price. The concept further states that monetary consideration is an essential feature of ‘sale’. Further, the Supreme Court has confirmed the view that asset transfer as consideration (in replacement of monetary consideration) amounts to exchange and not a sale. 

However, opposing views have also been taken by courts, and the concept is still unclear on the actual rule to be applied in the distinction between exchange and sale. At present, in order to avoid any conflicts, it is advisable to include monetary consideration with the agreement, to bring the agreement within the ambit of ‘slump sale’ and Section 50B of the Act which relates to the calculation of capital gains. 

Transfer of an undertaking

The term ‘undertaking’ has been defined under Explanation 1 of Section 2(19AA) of the Income Tax Act, 1961. The subject-matter to be transferred as agreed by the Parties through the contract must meet the requirements of the Act. The undertaking of the transferred assets should include information about the impartial business activity, including the information related to the assets and liabilities of the business involved. Moreover, it should possess the ability to continue the business by generating independent revenues, without any external support. 

It is important to note that within a slump-sale transaction, all assets and liabilities essential for the successful running of the business must be transferred, and there is no option to offer a selective transfer of assets and liabilities of the business. The business might exclude the assets and liabilities that are shared by multiple seller divisions, however, as long as appropriate substitutes are provided, and even if they are not, as long as they do not act as an essential part of running the business, the transfer shall still be valid. 

Courts have held that transfer of shares does not act as a transfer of undertaking, and in turn a slump-sale, under the ambit of Section 50B of the Act. 

Transfer as a going concern

Another requirement of slump sale is that the undertaking to transfer must be transferred as a ‘going concern’, and there should be no break between the operations of the undertaking to transfer. The transfer of undertaking from the buyer to the seller, should not hinder the working of the business in any manner, and therefore, the buyer must ensure that the seller already has the essential licenses and infrastructure for the successful running of the business, along with the fulfilment of slump sale. 

Lump-sum consideration

The transferred undertaking should not attribute individual figures to different assets and liabilities attached to the business. Rather, there must exist a lump-sum consideration, as the buyer is buying the business in its entirety, and not individual assets related to the business. 

It is important to note that for the payment of stamp duty and other relevant taxes, there might be a requirement for the individual determination of various assets and liabilities, however, these should not be recognized as the value assigned to such assets and liabilities. The general principle behind stamp duty is that the amount payable must be determined on the basis of the instruments involved in the transaction and not the entire transaction. Therefore, to understand Stamp Duty, specified in the Indian Stamp Act, 1899, it gets important to understand the instruments and subject matter of the transaction. 

Significance of business transfer agreement

The Business Transfer Agreement acts as an essential document for the completion of business transactions in an efficient manner and helps improve the performance and standing of the business post-integration or any change in the business. Moreover, it helps in streamlining the operations of the business, and provides directions for strategic investments, along with helping in the advantages gained through tax and regulations by the government. 

The Business Transfer Agreement can be formed in the following manners:

Agreement to sell

This acts as a written document that indicates the intentions of the Parties to enter into a transfer undertaking. However, this does not act as the final undertaking, and the parties need to execute a separate agreement, in order to enter into an actual transfer undertaking with each other. 

Deed of conveyance 

This is where the parties actually enter into a transfer undertaking, wherein the sale of the business along with the payment of consideration is concluded by both the parties to the agreement. 

Important content in a business transfer agreement

To execute a business transfer agreement or a slump sale, the agreement is entered into by and between the parties, and the business is transferred in a running condition between the parties, as the transaction should not act as a hurdle in the operation of the existing business. The Agreement lists down the assets and liabilities of the business, along with details related to rights, obligations, confidentiality, etc., of the agreement. Some content that needs to mandatorily be present in a business transfer agreement are as follows:

  1. Schedule of Assets – This clause includes all the assets attached to the business for which the agreement is being entered into by the Parties.
  2. Schedule of Liabilities – This clause includes all the liabilities attached to the business for which the agreement is being entered into by the Parties.
  3. Detail of creditor(s) – Creditor(s) is the person that entered into the agreement with the aim to transfer or make changes to his/her existing business. Therefore, the person enters into an agreement with the other party to give the other party rights over his/her business.
  4. List of Contracts – Considering that the rights to the business are being transferred, it is important to provide a list of the existing contracts that the business is bound to and provide details related to the obligations of the business.
  5. List of employees – There must be a list of employees currently working in the business, who are the people responsible for the efficient functioning of the business.
  6. Lump-sum consideration – This acts as the most important clause on behalf of the Creditor, wherein, the consideration involved in the making of the contract is specified, through mutual discussion and negotiations of the parties to the contract.
  7. Detail of intellectual property – Any specific work or trademark related to the company, which has been licensed to the company and the company owns the copyright to it, must be mentioned in the agreement. 
  8. Name of Parties (along with their details) – Again one of the most important parts of the agreement, wherein the names of the contracting parties and their details are mentioned in the truest sense.
  9. Pending suits and cases – the Agreement must include details about any existing suit or cases present on the business, along with the necessary details and documents related to the same. Transparency acts for the benefit of the parties if the company rights are accompanied by company secrets as well.
  10. Any other clause as deemed fit by the Parties – Considering that different companies have different ways of functioning, there might be situations where special clauses need to be added, which are specific to the business. Therefore, any detail of the business which acts as an essential part of the business must be included in the Agreement. 

Conclusion

Even though there exist multiple ways of restructuring the business and its operations and functions, slump sale is a less complex and time-efficient process for business restructuring. Less confusion and chaos are caused through this method between the contracting parties; however, it is important to take into account the legal mechanisms involved in the process. As long as the parties are entering into an agreement with the intention of restructuring the entire business, and not specific assets, the slump sale acts as a beneficial tool for them. 


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