This article has been written by Sai Suvedhya R., pursuing the Certificate Course in Introduction to Legal Drafting: Contracts, Petitions, Opinions & Articles from LawSikho.
Table of Contents
Introduction
Raising funds for a business is said to be one of the toughest deal breaking parts of a business. Businesses require investors to raise capital or funds. The business may require funds to expand further. For these reasons businesses sell their shares to the investors. However, providing these investors with voting rights in a company would be disastrous for the business to prosper. For these reasons, a legal document called a Share Purchase Agreement is used for protecting the interests of the company as well as the investors. A Share Purchase Agreement is a legal contract between a seller and buyer, i.e. a company and an investor respectively.
It acts as a proof of legal buying of shares as well as dictates all the terms and conditions relating to the purchase of a company’s shares. It’s primary reason is to ensure that either parties have agreed upon the terms and conditions of the selling and purchasing of shares as well as provides these investors or share holders some power in the decision making process of a company. The different clauses in the share purchase agreement have a specific importance. The following are the main clauses:
Parties to the Agreement
This clause aids in identifying the parties to an agreement as well as their specific relationship. The parties in a typical share purchase agreement would be the seller and the purchaser. The parties to this agreement may also be shell companies with no financial records at times and to ensure that the claims post the closing of the agreement are made and the promises made in this agreement are kept.
Recital Clauses
The factual background of the transaction should be clearly spelled out in the recitals, with no gaps in identifying and laying out the relationship between the parties, the transaction’s objective, and each party’s role. Recitals establish the context for an agreement and are relevant to its interpretation. Recital clauses, also known as the preamble to an agreement, are traditionally preceded by the word ‘WHEREAS’. They are generally not regarded as an operational or integral part of the share purchase agreement and are not binding on the parties. However, the parties may agree and stipulate expressly that the recitals are an integral part of the share purchase agreement and make them binding on parties thereby.
Definitions and Interpretation
Definitions are necessary in order to provide context and meaning to specific words and phrases used in the agreement. A definition should ideally be limited to the meaning of the term and should not include any covenants that are intended to be included only in the main text. Typically, defined terms are listed alphabetically at the beginning of the share purchase agreement or in a separate annexure to the share purchase agreement. Terms are sometimes defined in the place where they first appear in the share purchase agreement. The most common way to distinguish a defined term from a common word is to capitalise it and treat it as a proper noun. Definitions may be either inclusive or exclusive.
The interpretation clause is used to reduce repetition within an agreement’s body and make it easier to read. It also provides context for specific words used in the agreement. Although much of the interpretation section of a share purchase agreement is standard, it can still contain useful and significant pointers for reading the agreement.
Sale of Shares and Consideration
An exhaustive payment structure must be specified, including the deposit to be paid at the time of execution; the sum payable on closing (pricing formula to be determined on a case-by-case basis); and, if applicable, the sum held in escrow to be set off against indemnities or breaches of representations and warranties, as well as the amount payable if any security is registered against the property.
Nowadays, money is transferred directly through bank accounts, and cheques/demand draughts are the exception rather than the rule. In the case of an escrow fund, the operation dynamics must be clearly defined.
Operative Clause
Even though it has a direct bearing on the sale and purchase of the shares in question, the operative clause in a share purchase agreement is usually the shortest and simplest clause in the agreement. This clause is typically written in such a way that the purchaser receives full ownership of the shares. It is also common for it to state that the shares must be transferred free and clear of all encumbrances. The precise description of the shares being sold and purchased prior to and after the transaction’s closing is frequently listed in a schedule at the end of the agreement, with such a schedule being cross-referenced in the respective clauses.
Conditions Precedent
Meeting of minds, or Consensus ad idem, is critical in any contractual agreement. Agreements for the sale and purchase of a company’s shares are no exception. However, there is typically a time lag between the signing of a share purchase agreement and the completion of the sale and purchase of shares under that agreement. As a result, in such cases, the meeting of minds between the parties to a share purchase agreement may become a contentious issue, because the circumstances that existed at the time of signing may differ from those that exist at the time of Completion.
Conditions Precedent are the conditions that exist prior to the conclusion of the Completion. CP’s differ from transaction to transaction based on the facts and circumstances of each individual case. The conditions precedent clause should be comprehensive, including all necessary authorizations, permissions, and permits, both internal and external, as well as the person responsible for obtaining each of these. A clause granting the acquirer the right to waive any condition is typically included to provide flexibility in the event that certain routine approvals that do not prevent a transaction from closing are not forthcoming or are delayed.
Closing
Closing or Completion under a share purchase agreement may occur concurrently with its signing, or may be postponed to account for the fulfilment of certain conditions, known as Conditions Precedent or CPs. CPs typically include regulatory clearances, board/shareholder approval, third-party consents, and so on. Because of their nature, CPs are mostly discovered during the due diligence process. The Closing Mechanism should specify the time frame, location, and actions (including, but not limited to, document exchange) that will take place during the closing.
Covenants by the Parties
Share purchase agreements typically limit both the buyer and the seller’s ability to engage in certain activities that would jeopardise the rights of the other party under the agreement. For the function they serve, these are referred to as ‘restrictive covenants’ or ‘negative covenants.’ Restrictive covenants can limit a party’s actions both before and after the Closing date.
Representations and Warranties
The corporate status of the company, as well as its good standing in the market, must be clearly stated. The company’s capital structure, including a list of directors and the number of shares owned by the vendor, should be provided. This clause also includes an affirmation of the seller’s title and rights to the company’s shares/property, the status of compliance with the law, any pending or threatened litigation or dispute, information on loans and related agreements, and the fairness of accounts and financial and other information provided by the seller.
Clauses for inclusion in this chapter include the purchaser’s right to contract, purchase, and ability to pay compensation and enter into subsequent agreements. If the purchaser is a corporation, the purchaser’s corporate status must also be highlighted.
Confidentiality
This is especially important when parties have exchanged sensitive information and listed entities are involved in a transaction. It is also customary to state that the terms of the agreement are confidential and cannot be disclosed without both parties’ consent. Confidentiality clauses have time limits ranging from 18 months to two years.
Indemnification
Indemnification clauses are hotly contested, particularly the lower and upper claim threshold limits, time period, subject matter, and the procedure between the parties for dealing with disputes, including tax disputes that affect claims. They also provide the process for reimbursing claims and are frequently the most scrutinised clause in the event of a dispute, so special care must be taken to ensure that the purchaser is adequately covered in the event of issues relating to the company prior to the transaction but arising post-closing. This is also why a purchaser will require a substantive party from the seller’s side to act as a guarantor for indemnification.
Severability
The severability clause states that each clause in the agreement is independent, so that even if a court rules that a specific clause is void, unconstitutional, or fraudulent, the other clauses continue to operate and are enforceable. This clause is particularly important because it states that if one clause is declared unenforceable, the entire share purchase agreement remains in effect. While drafting a share purchase agreement, this clause can be clarified further by stating how the parties can amend the agreement.
Notice
The notice clause is frequently overlooked, but it is critical. Not only should the locations be specified, but so should the manner in which the notice is to be dispatched and whether the parties are willing to accept electronic formats of notices to be dispatched.
Stamp Duty
Stamp duty is the amount paid to the government when certain documents are executed. Stamping, in addition to being a transfer tax, provides the document with evidentiary value. In India, stamp duty is levied according to state laws, so the parties must decide on the jurisdiction for payment of stamp duty and the applicable rate based on their registered office.
Force Majeure
Though force majeure is a standard clause, the parties’ interests can be strengthened by including a phrase about fluctuating market conditions, such as a sudden financial crisis. Though this type of clause is extremely rare in India, we can follow Western practises that followed the inclusion of such a clause following the 2008 financial crisis.
Waiver
A waiver clause typically states that a party’s failure to enforce a contractual right, whether intentionally or unintentionally, does not constitute a waiver of that right by the party. This clause is critical because it ensures that, in the event of a later breach, even if a party had previously overlooked a breach of the share purchase agreement by another party, the latter is unable to use the former’s prior failure to enforce its rights to establish a pattern, intention to waive, or implicit waiver of its rights.
Amendment
The parties to a contract reserve the right to amend it as needed. In general, the amendment clause in a share purchase agreement specifies the terms and method for changing the terms of the agreement. This clause is essential because it usually avoids oral amendments, amendments made without informing the other parties, and so on, ensuring that any variation in the terms of the share purchase agreement is made in accordance with a process defined and agreed upon at the time the agreement is entered into.
Dispute Resolution and Arbitration
Despite being one of the most important clauses in most share purchase agreements, the clause governing dispute resolution between the parties is the most ignored. The survival clause in a share purchase agreement typically provides that the dispute resolution clause survives even if the agreement is alleged to be void or brought into dispute in any way, so we are confident that this clause will survive even if there are conflicting interpretations of the share purchase agreement.
The dispute resolution clause contains extremely important information: first, the type of disputes covered by this clause; second, the method of dispute resolution parties wish to use – mediation, arbitration, or litigation (and their order, if more than one); and third, the venue for adjudicating disputes. A drafter begins his task with the goal of making these three key points as clear as possible. While a drafter may be tempted to select one of several boilerplate clauses at first glance, it is important to give this clause careful consideration.
Arbitration in India has gained a reputation for delays and abuse of process, with courts being used to overturn arbitral awards. The Supreme Court has ruled that if both parties are based in India, it will be a domestic arbitration under the Arbitration and Conciliation Act; if at least one of the parties is an overseas entity, the parties may choose any international forum, such as the ICC or Singapore International Arbitration Center.
Jurisdiction and General Clauses
Indian laws will apply, and the courts in the city of the vendor’s registered office will have jurisdiction. The usual and standard clauses should be included, but special emphasis should be placed on the assignment clauses and the relationship clause, which should state unequivocally that the agreement does not create or contemplate creating any particular type of relationship between the vendor and the purchaser, unless expressly stated otherwise in the agreement. There is no employer-employee or principal-agent relationship created.
Public Announcements
Most successful merger and acquisition transactions have ensured that the announcement of the deal is made at the right time and in the right manner, with the consent of all parties. Furthermore, for publicly traded companies, the share price is sensitive to such announcements, so extreme caution is required. This clause specifies the procedures that must be followed before making an announcement or making a public disclosure. This clause of the share purchase agreement also provides for exceptions to disclosure requirements by regulatory authorities, courts, and so on.
Conclusion
Those clauses described above are template clauses that will vary depending on the structure of the transaction. However, the majority of them appear in an SPA. The drafting of a share purchase agreement is determined by the party that a lawyer represents. Likewise, the number of representations and warranties varies. The agreement’s beauty, however, lies in the transaction that governs it. Every corporate lawyer wishes to draught a share purchase agreement as the crowning document.
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