This article is written by Gaurav Kumar, from Surendranath law College (University of Calcutta). In this article, the important clauses in the Stock Purchase Agreement are discussed.
Table of Contents
Introduction
The term “Stock”(or equity) refers to the shares that represent the ownership of the stockholder in a corporation or company. This entitles the owner of the stock to hold a fraction or a part of the corporation’s or company’s assets and profits equal to the stock they hold. The stock is owned in the form of shares. The stock is sold and purchased by the stockholders or company, in case they are in need of money. The Stock Purchase Agreement (also known as a Share Purchase Agreement) refers to the legal contract between the buyer and the seller of the share. The Stock Purchase Agreement (hereinafter known as SPA) refers to an agreement on which the buyer and seller agree while selling or buying the shares of any company or organization. The parties entering into such an agreement are referred to as vendors and purchasers.
The specific number of the shares along with the per value share is listed in the contract. The main purpose of the SPA is to protect the interest of the seller and the purchaser. A letter of intent (LOI) is created before the SPA is finalized. The letter of intent must include the same term and conditions as the agreement. The buyer must have due diligence over that agreement. The sell and purchase section, as well as the warranties and representations section, should be checked properly so that it doesn’t contain any statement which is found to be untrue. If any differences are found, the buyer should negotiate before the agreement is completed. In this article, we will briefly analyze the important clauses of the SPA.
Important clauses pertaining to the Stock Purchase Agreement
The important clauses pertaining to the Stock Purchase Agreement is provided below:
Parties to the agreement
In the first article of the SPA, the definitions pertaining to the agreement are provided. Parties to the agreement are known as seller and acquirer. Many of the times the parties to the agreement are just shell holding companies having no financial history or stability and they are just incorporated for SPA. In such a case, the entries of the principals are made as guarantors so that claims post-closing deal is made and the promises as made in the agreement are fulfilled.
In a plain vanilla agreement, there are generally two parties; one is a seller and the other is the acquirer. In such an agreement, the targeted company shall either acquire from being a fully owned subsidiary company of one party, i.e seller to being a fully owned subsidiary company of another party, i.e the buyer. The buyer before going into the agreement needs to check whether the registered holder is a beneficiary in the target company or it holds shares in other forms such as trusts or nominees. In case the seller is a trustee, it will have to check whether it holds the power under the trust instrument to enter into the agreement and perform the obligations.
There may exist a situation where there will be multiple sellers in the SPA, which means the three are more than one stockholder in the target company. In such circumstances, each of the stockholders has to undergo an agreement in order to sell the shares of that target company where they hold the shares. For convenience, the parties in an agreement may appoint an agent for the buyers and sellers for having a streamlined conversation between the buyers and the sellers.
If the SPA confers the rights on parties other than the buyer, seller, or guarantor they have also to undergo the agreement being added themselves as parties according to the specific circumstances.
Recitals
Under this section, the factual details of the transaction along with the relationship between the parties. It should be kept in mind that no errors are made in the recitals. Every minute detail of the objective of the transactions and all the other documents related to the transactions and the role of both parties should be mentioned in the recitals.
Generally in a SPA, the recitals are merely a describing part being a non-functionary one. However, the parties in the agreement may stipulate the recital to be an important part of the agreement being binding on the parties. Generally, the recitals in the agreement try to depict what happened in the agreement and what next the parties are trying to achieve through the agreement.
The recitals play an important role in interpreting the SPA, so the parties in the agreement must ensure that the information provided here is not misleading. However, the recitals never prove to be contradictory to the clauses provided under the SPA.
Definitions and interpretations
The definition clause provides the meaning of each important term and concept that are used in the SPA. The terms and concepts used more than once ensure that they would render a similar meaning every time. The terms find their place usually first in the separate section at the starting of the SPA or in a separate annexure to the SPA. Many of the times the terms are defined at a place where they are used first. The difference between the terms used first, and the common term is the terms first defined are used in a capital letter.
The interpretation clause is used in an agreement to reduce the repetition in the agreement and it is easier to read. The interpretation section is used to provide the representation, liability, warranty, or undertaking arising out in an agreement where there exists more than one seller or warrantors on the part on them and where they are deemed to show themselves as “jointly or separately”. In case the target companies are having their subsidiaries, the warranty shall apply to each of the companies which are part of the target group. It means that the warranties shall apply separately for every subsidiary which is part of the target companies.
Operative clause
The operative clause in the SPA refers to the sale and purchase section of the agreement. The structure of the clause defines the “sale and purchase” of the shares and ensures that all shares are transferred to the buyer free from all encumbrances. The description of shares being sold pre and post-closing of the transaction is mentioned in a schedule at the end of the agreement. It also specifies any waiver rights of the vendor. Further, it also states that any rights attached to the shares shall transfer to the buyer after the transaction is completed.
The operative clause is one of the most standard clauses which slightly varies with the change in jurisdiction. The parties to the agreement should be extra cautious while negotiating the clause and they must understand the full meaning of the transfer of all shares without incumbrances or the attached covenants if any. Later on, the case of light lacuna found may lead to the party’s extra expenses of litigation.
Conditions precedent
Any contractual relationship is regulated by the basic principle of “Consensus ad idem”. It means that the meeting of the mind is an intrinsic and important factor for the completion of a contract. Generally, alike other agreements the SPA should also be signed and completed at the same time. However, practically it doesn’t happen and there is a time lag between the signing of the SPA and closure of the purchase and sale of the shares. Various factors are responsible for this time lag as requiring due diligence of the buyer, tracking regulatory consents, and the buyer being able to manage the adequate funds for payment, and so on. At times, there are chances of contention as the meeting of minds prior to signing may differ at the time of closing off the deal.
So, to avoid such circumstances where there can be a difference of minds prior to and post-closure the parties are brought in a similar state where they can close the transaction. For such purposes, the parties have to fulfil certain conditions. Such conditions lead to the completion of the transaction and so they are known as “Conditions Precedent (CP).” Depending on the transactions, circumstances the conditions precedent will differ. When the SPA contains the conditions precedent clause the parties are bound to comply with the completion fulfilled by a long step date. If the conditions precedent is not complied with by the longstop date, the parties shall have the option of either waving or negotiating the SPA. In case it doesn’t happen and the parties fail the SPA will come to collapse. There are various situations where the CP is snuggled up:
- Existing shareholder’s approval: The private company restricts its transferability of shares through different restrictions such as the pre-emptive right of existing shareholders, right to the first refusal, right to first offer attached to the share. So, as the Conditions precedent clause, the rights of transferability of shares are obtained from the stakeholders of the company.
- Regulatory Clearances: Regulatory clearances are sought before the completion of the contract. The regulatory bodies differ according to the nature of the transactions and the parties. For example: If the transactions meet the requirements as stated in the Competition Act, 2002, prior approval is required from the Competition Commission of India.
- Due Diligence: It refers to an investigation, an audit performed to check the financial information before entering into the transactions offered by another party. So, the parties in the transaction must disclose all the financial facts which may affect the decision of another party. Hence, in case the due diligence is not completed, the buyers enter a Conditions precedent clause of due diligence which makes the buyer enable to make the transaction upon satisfaction.
- Third-party consent: The licenses of the target company are obtained by the government company and their contract by the key suppliers and lenders. When there is a change in control of the target company the prior approval from the governmental institutions is required to obtain. So, if the transaction is expected to result in a change of control of the target company the Conditions precedent clause needs to be inserted in the SPA so that approval is obtained before the closing of the deal.
- The correctness of representatives and warranties: The representatives and the warranties provided by the seller during the deal of the share are done twice once while signing and after the completion. So, the Conditions precedent is inserted so that the representatives and warranties remain the same from the signing stage to the completion stage.
The completion of the clauses of Conditions precedent is confirmed by delivering the written certificate by the parties to each other. The provision of negotiations should also be included in the conditions precedent in case of violation.
Closing
This section comprises the provisions which need to be taken care of while the completion or closure occurs. The closing or completion may take earlier with the signings or deferred to be taken while the conditions precedent are fulfilled. The conditions precedent are identified during the due diligence process and it includes the regulatory authorities clearances, board/stakeholders approval, and third party consent. The closing process, time place, and obligation of both parties are also included in the SPA.
Conditions subsequent
Generally, in the conditions subsequent there should not exist any conditions that exist after the closure of the SPA. However, in rare conditions, it becomes necessary to have the Conditions subsequent. It provides the purchaser protection in case any of the conditions subsequent is breached.
Covenant by the Parties
The covenant is the clause that is contained in a SPA from the date it is signed to the date it is closed. The covenants can be either positive or negative and it is used to protect the purchaser from doing certain acts that the seller can do between the period of signing to the closing of the agreement (vice-versa). A covenant can be a positive one i.e promise to do something and the negative one i.e refrain, someone, from doing something. Restrictive covenants restrict the parties from doing action before and after the closing date.
The use of the restrictive covenants is binding on the part of the seller. However, its use concerning the activities of the buyer is relatively uncommon. The restrictive covenants work as a risk-allocating device and it is meant to de-stimulate the parties against the breach of such covenants. The breacher party shall pay monetary compensation to the opposite party in case of a breach of the covenant.
Vendor’s representation and warranties
Representation is the statement made by the vendor stating the affairs of the companies including the capital structure and the board of directors. The stock holding by the vendor must also be disclosed, This clause also deals with the affirmation on the rights of the shares of the company, status of compliance with laws, any pending disputes or litigation, information on loan and related documents, fairness in accounts and financial status as stated by the seller. The representation and warranties are informational in nature which provides the buyer with insights into the seller’s business prior to entering into the contract.
Basically, the representations and the warranties provide a clear image of the target company at the time of signing off and completion of the agreement.
The representatives and warranties include:
- Title of shares without any encumbrances.
- Accuracy of financial statement and account.
- Applicable law while entering into the contract.
- Status of any pending litigation on the target company.
Representations and warranties are induced in the SPAt as they provide statutory protection to the buyer. In case there is a breach of the warranty clause it amounts to misrepresentation and leads to the award of the damages.
Purchaser’s representation and warranties
It is a repeating clause where the representation and warranties come from the side of the purchaser. The clauses contained in this chapter are the purchaser’s right to contract, purchase, ability to pay compensation and enter into a subsequent agreement. In this case, the purchaser is a company/organization its corporate status must be mentioned.
Confidentiality
The inclusion of a confidentiality clause in the SPA is to prevent a party in the agreement from disclosing the facts without the consent of the third party to the said agreement unless the statutory provision requirement. In highly sensitive cases the leakage of confidentiality may be a ground for the termination of the SPA. The inclusion of the confidentiality clause gives great importance to the agreement where the deal is done with a public company.
However, for the purpose of maintaining extra-security, the parties may undergo a separate confidentiality agreement i.e non-disclosure agreement where undertakings are signed by the parties to explore a better deal. The main purpose is to prevent important data from leakage.
There are two aspects that need to be kept in mind while drafting the negotiation clause:
- One is the confidentiality of the scope of the information and the other one is the various exceptions under the statute that may be invoked by the recipient.
- The seller’s obligation in the confidentiality clause under the SPA is also applicable to the trade secrets and other confidentiality details. In the case of a seller being a corporate group, the buyer must ensure that obligation must apply to all the groups of companies as well. In case the seller is having a parent company there must be ensured that it must join the confidentiality agreement with the status of a party.
- In case a situation arises where third-party consent is required prior to the closure of the deal, the buyer must ensure that such parties also become a part of the confidentiality agreement to ensure complete confidentiality.
- In case of breach of confidentiality, the monetary compensation or the injunction for non-disclosure is not adequate to provide the compensation, so if the damages occurred is irreparable it may lead to termination of the SPA.
Indemnification
Warranties and indemnities both are similar target words having different legal meanings. Both are used to protect the buyer from any kind of loss. The indemnity under Section 124 of the Indian Contract Act, 1872 refers to a “promise made by the promiser to save the other party from the loss caused by himself or another party” whereas the warranty refers to the state of business affairs of the company as stated by the seller to the buyer.
The indemnity provides the buyer with an opportunity to recover the loss that happened in an indemnified event whereas the breach of warranty forms claims in damages. There is a need for this clause in the SPA where the specific indemnity clause will allow the defaulted party to indemnify the other in case of a breach of warranty. The protection provided under the indemnification is more stringent and is easier for the defaulted party to establish the claim under the court than to obtain the damages by proving a case of breach of the warranty.
Indemnities are adopted by the buyer to obtain the claim due to the prior notice of the loss that happened to the buyer, as in the case of warranty the prior knowledge of the circumstance is a defence against the breach of the warranty. Unresolved litigation, taxation, environmental risk, doubtful debts, and the five most common subjects are covered under the indemnity clauses.
In case of commencement of the liability of the indemnifier, there is a conflict in the common law position and what the Indian Courts have ruled. The Common law states that the indemnity is payable to the indemnity-holder once he has suffered from the actual loss. However, the position of Gujarat High Court in the New India Assurance Company Ltd, Vs The Star Trading Corporation of India Ltd and anr is different. The Gujarat High Court has held that in case the liability is absolute as the indemnity holder has incurred a liability of protecting against any loss, the indemnifier can call him as under his liability to protect him against this loss.
In case of uncertainty of commencing liability, the buyer can obtain security against the liability. Such security may include obtaining a bank guarantee from the seller or his parent company or opening an escrow account. The drafting of the indemnity clause in the SPA would require further detailing, if there are multiple sellers in the deals then whether the buyer would like to have the sellers jointly liable or separately liable. From the buyer’s point of view, it is required that he must know the ratio of losses incurred.
Notice
This provision in the SPA is important as it determines the notice requirement for the rights and obligations which may be triggered upon after the service of the notice. It also describes the mode by which the notice is sent whether it is email or by the post, notice period, the acceptance and deem acceptance of the notice, consequences of failure to send the notice. One needs to be extra careful while drafting the notice clause in the SPA and mention whether the notice is mandatory or permissive. The language of the notice period is very important in international transactions and it must be mentioned in a separate schedule of the SPA.
Force majeure
The primary aim of putting this clause in the SPA is to protect the parties in case of unforeseen situations, market crises, or any similar situation that arises. However, this type of practice is still uncommon in the Indian Markets so, if there is a need for the inclusion of such a clause in the SPA one can adopt its position from the common law of western practices.
Severability
The severability clause as provided under the SPA provides that each clause is independent in itself and in case the court declares any clause to be void or unconstitutional the particular clause stays inoperative without affecting any other clause. This clause has significance as it provides that merely unenforceability of one clause does not mean that the whole agreement will cease to be operative.
While drafting one must be extra cautious while preparing the SPA putting clarification on the amendment of clause if any of the clauses is declared unconstitutional by the Court. The intent of such a clause is to provide smooth operation of the SPA and if any of the clauses become in-operative.
Amendment
The parties in the agreement reserve the right to amend the agreement whenever the need arises. The amendment clause provides the terms and ways of modification in the agreement. Provision of this clause is essential as it restricts the oral amendment or amendment without taking the permission of the parties, according to the process defined upon entering at a stage of the agreement.
Dispute resolution and arbitration
The dispute resolution clause in a SPA is one of the most important clauses as it provides resolution between the parties. The survival clause as under the SPA states that despite the agreement being void or due to arising of conflict the cloud has appeared, the dispute resolution clause always survives. Looking at the dispute resolution clause, that provides communication, clarity, and convenience protecting the parties to undergo a long litigation or negotiation process and resolve amicably through the dispute resolution mechanism in case the conflicting interpretation of the SPAt appears.
The dispute resolution clause contains a list of important things. One the types of disputes that will be subject to this clause, the second is the method of dispute resolution the parties are interested to adopt, arbitration, mediation, or litigation, and the appropriate forum for the purpose of deciding such disputes. While drafting the dispute resolution clause these three vital points should be given consideration.
All kinds of disputes arising out of the agreement must be governed by this clause. The parties in the agreement have the option to choose the type of method they want to adopt for the disposal of disputes. However, the traditional method of litigation may be prolonged and expensive. The next available option of mediation may prove painless as it involves a third neutral party without going to court or arbitrator.
However, most of the parties opt to go with arbitration as these days it is one of the most popular available methods for the purpose of resolving issues. Adopting arbitration and mediation have benefits over the litigation as it has total confidentiality and provides the engagement of industry experts of respective fields which will lead to proper guidance in the dispute resolution mechanism.
Each party must be careful while choosing the seat of arbitration and country. The clause of the arbitration must be inserted after knowing the convenience of each of the parties after the negotiations.
Jurisdiction and general clauses
The jurisdiction of the geographical area where the deal is closed will apply and the laws of India shall apply. The courts in the city where the vendor is having his office registered in the city. The usual and standard clause will be applicable but the emphasis shall be given on the assignment clause and relationship clause which will set out that the agreement does not envisage any particular kind of relationship as particularly provided by the agreement. No kind of principal-agent relationship or employer-employee relationship shall be formed.
Conclusion
The clauses provided in the SPA change from case to case. However, here, almost every important clause is provided in the article. The drafting of the SPA depends on the lawyer who is drafting the agreement. A SPA is one of the most important and crown agreements that a corporate lawyer usually wishes to draft. The inclusion of the clauses in an agreement lies in the type of transaction that has occurred.
References
- https://www.upcounsel.com/stock-purchase-agreements
- https://www.lakshmisri.com/insights/articles/the-perfect-share-purchase-agreement/
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