In El Makdessi v Cavendish Square Holdings BV and another  EWCA Civ 1539, the Court of Appeal in the UK held that clauses in a share purchase agreement providing that, if the seller breaches restrictive covenants, the buyer's obligation to pay deferred consideration would cease and the buyer would be entitled to acquire the remainder of the seller's shares at price based on net asset value (and excluding goodwill), were unenforceable penalties. The case suggests that a careful approach will be required where a buyer of shares wants to link payment of deferred consideration to the seller's compliance with non-compete or similar covenants following completion of the transaction.
The attached checklist highlights the main legal risks that a buyer should consider when buying another business or enterprise. Legal advice should always be sought. This checklist does not explore the legal issues behind the list and is intended to outline the process and identify key points to watch out for.
Buying a business: Your legal checklist
This checklist highlights the main legal risks to consider when buying another business or enterprise. A buyer should always take legal advice at the outset of any acquisition.
Structuring the acquisition
A buyer can buy either the shares of the company that owns the target business or simply buy the assets which make up that business:
- Share purchase. The buyer buys the whole company (including liabilities that it may not know about).
- Asset (or business) purchase. The buyer chooses the assets that it wants to buy. This will provide more flexibility, but it can be complicated to identify and transfer specific assets.
Tax and accounting issues
Check how any goodwill on the acquisition is likely to be treated for tax and accounting purposes. Asset deals are typically less tax efficient for sellers than share deals, which can affect the price the buyer pays.
If a buyer buys a business as a going concern (even via an asset purchase), it must take on its employees on their existing contract terms.
The buyer may have to take over the target company's existing pension arrangements or offer prescribed pension arrangements to transferring employees.
Intellectual property rights
A brand, trade mark or patent may be the most valuable asset of the target business. Take legal advice to check that the target business:
- Owns the rights.
- Has adequately protected the rights.
- In the case of asset sale, can transfer the rights to the buyer.
The buyer could face huge liabilities (possibly including criminal liability) if it buys contaminated land or a company that caused or allowed contamination.
If the target business is part of a larger corporate group, it may share assets (such as computer systems, property and insurance policies) with other group members. Consider whether these arrangements can be unravelled without incurring prohibitive costs or disruption to the target business. An agreement can be drafted to deal with how the assets are divided and shared after the completion of the sale.
Consider whether the buyer wants to incentivise or tie in key staff or management on special terms.
Consents and third party approvals
- The acquisition may need the approval of third parties (for example, industry regulators) or require approval from competition authorities. Consider when to approach them and whether the transaction is likely to get their consent.
- If the buyer is acquiring all the shares in the target company, check that no important contracts can be terminated on a change of control.
- The transaction may require approval from either the buyer's or the seller's shareholders.
Early stage negotiations: key points to remember
- Make sure that the person the buyer is negotiating with has the authority to talk to the buyer and has the power to provide the information the buyer requires.
- If the seller or the target company is a competitor, the buyer must take legal advice before starting any discussions or exchanging information. Sharing business sensitive information is risky as it could lead to a breach of competition law, and potentially a large fine for the buyer.
- Avoid making a legal commitment by mistake. A binding deal can be made without anything in writing (even through a conversation). When talking or writing, make sure the seller is aware that nothing is legally binding until the formal acquisition agreement has been signed (for example, mark correspondence "subject to contract").
Process and documents
Acquisitions can be complex, involve a lot of people and take a long time to complete. Make sure the buyer compiles a detailed plan with key deadlines and responsibilities.
Acquisitions are highly business sensitive. Sign a confidentiality agreement (also called a non-disclosure agreement) at an early stage. This will generally require both parties to keep the deal secret until it is formally announced and protect any information exchanged by the parties. A buyer should take legal advice before signing a confidentiality agreement to ensure that its position is adequately protected and its obligations under the agreement are reasonable.
Heads of terms
Heads of terms are usually signed at an early stage of a deal before detailed due diligence. They may also be known as:
- Heads of agreement.
- Memorandum of understanding.
- Letter of intent.
- Term sheet.
They set out the key terms of the deal and are generally not legally binding. However, legal obligations can be created inadvertently and a strong "moral commitment" can be created that could weaken the buyer's negotiating position later on. The buyer will normally prepare this document. A buyer should always take legal advice before signing this document.
An exclusivity agreement (also known as a lock-out or no-shop agreement) gives the buyer a period of exclusivity in which to negotiate the transaction by preventing the seller from actively seeking or negotiating with other prospective buyers during the specified period. An exclusivity commitment can be dealt with in a separate agreement or as part of the heads of terms for the transaction.
The purpose of due diligence is to investigate the assets and liabilities of the target business. A buyer must take legal advice to ensure it gets the legal protections that it requires. If the buyer becomes aware of any significant problems in the due diligence process, it can:
- Abort the deal.
- Negotiate a price reduction.
- Seek specific protections in the acquisition agreement.
The acquisition agreement sets out the agreed terms governing the transaction and the mechanics of the deal (for example, the parties involved, the amount to be paid, the timing of the completion and any consents or approvals required before completion). It will typically contain a number of provisions designed to protect the buyer, including:
- Warranties. These are contractual promises given by the seller about different aspects of the target business (for example, that it owns all the assets and there are no disputes with third parties). If they are untrue, the buyer can sue for damages.
- Indemnities. These require the seller to compensate the buyer (on a pound for pound basis) for specific liabilities if they arise (for example, potential tax or environmental liabilities).
- Restrictive covenants. These can prevent the seller from competing with the target business or poaching key customers or employees for a period following completion. They will only be enforceable if they are reasonable in scope, duration and geography.
The disclosure letter is an important document that must be read in conjunction with the warranties in the acquisition agreement. A buyer cannot make a warranty claim for anything disclosed in this letter, although it may want to negotiate alternative protection for disclosed issues (such as a price reduction or an indemnity to cover the issue). If the buyer knew about a problem before signing the acquisition agreement, it may be unable to make a warranty claim for that issue even if it is not disclosed in the disclosure letter.
Seller limitations on claims
The seller will try and limit the claims that can be made under warranties and indemnities (for example, by limiting the time within which the claim can be brought and the amount that can be claimed).
Signing and completion
Signing of the acquisition agreement and completion of the transaction are often simultaneous, but a gap between them may be necessary if there are completion conditions to be fulfilled. For example:
- Informing and consulting with any transferring employees.
- Getting approval from the competition authorities.
- Obtaining shareholder consent to the transaction.
If there is an interval between signing and completion, additional issues will need to be addressed in the acquisition agreement, including:
- How the target business will be operated between signing and completion.
- The period for satisfying the completion conditions, each party's responsibility for ensuring the conditions are met and what will happen if any of the conditions are not fulfilled.
- Who bears the risk of any breach of the seller's warranties or other adverse event that occurs in relation to the target business in the interval between signing and completion.
After the acquisition
- Prepare a detailed integration plan for the acquired business after completion. Poor integration planning is often cited as the most common reason for acquisitions to fail.
- Carry out the post-completion filings with Companies Registration Office, update the company books (if necessary) and pay any stamp duty due.
- A buyer should take legal advice immediately if it thinks it has a possible claim for compensation from the seller. The acquisition agreement will invariably include strict time limits for bringing warranty claims which are often drafted to expire once the buyer has completed its first audit of the target business (although the time limit will usually be longer for tax claims).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.