A share purchase agreement (“SPA”) is typically entered into by and between a buyer and seller(s) of a target company’s shares, whereby the seller(s) agree to sell a specific number of shares to the buyer for a specified price.^[1] Share Purchase agreements are used in a wide range of commercial transactions, including acquisitions, private equity investments, and corporate restructuring.

An SPA lays out the rights and obligations of each party concerning all matters relevant to the sale, including:

a. What consideration would be paid for the company?

b. What representations the Seller must make about the company;

c. What recourse does the buyer have if the representations turn out to be inaccurate?

d. how and whether the transaction can be terminated prior to closing, and each of the other issues critical to a business transfer.^[2]

The SPA is therefore primarily a tool for allocating risk. The buyer would want to hold the seller accountable for any post-closing claim or liability that arises as a result of a misrepresentation or material omission by the seller. The seller, on the other hand, wants to bring as much finality to the transaction as possible.^[3]

Commercial urgency frequently influences deal structuring. Companies may prioritize speed of execution in order to quickly raise funds, while buyers may aim to pre-empt competitors or accelerate integration strategies. Where this is the case, parties may proceed with the deal despite red flags identified during the due diligence stage. The irregularities and risks identified by the transactional due diligence will either be addressed in the SPA or taken into consideration when establishing the purchase price^[4]. Therefore, the SPA is a primary instrument for allocating and mitigating residual risk.

This article highlights key risks commonly associated with SPAs and the clauses that provide protection or commercial comfort to parties.

The risks addressed by an SPA fall into three general categories as follows:

a. risks that a proposed deal will not be completed as planned – completion risks;

b. risks that a buyer will misvalue the target company and its businesses – misevaluation risk;

c. risks that the value of the target will shift between the time the deal contract is signed and the completion of the deal – value-shift risk.^[5]

Completion risk can arise from antitrust or other regulatory issues. To address this issue, the SPA would typically contain Conditions Precedent to Close (CPs). This clause provides conditions that must be fulfilled before the transaction is deemed completed or closed. It entails critical milestones that must be achieved before final share issuance. Examples of such milestones include board and shareholders’ approvals, regulatory approvals or notices, rectification of compliance deficiencies identified during due diligence, filings or registration requirements, third-party consents, and even completion of due diligence^[6]. The more complicated or unlikely the condition is to occur, the greater the risk assumed by the party expecting to receive performance^[7]

Failure to satisfy the CPs stated in the SPA can result in a termination of the agreement by the buyer, free from liability. CPs are therefore crucial for minimizing risks between signing and when the parties close the transaction.

To address the core risks of misvaluation and value shifts, transaction lawyers have developed a number of contract provisions. Some of these provisions are discussed below.

Representations and Warranties (R&Ws): This provision requires the target to provide true information to the buyer of a specified nature, often evidently related to value. R&Ws are assurances or statements of truth made by a party that create grounds for enforcement by the other party in the event of breach.

Some examples include representations that the target is not materially indebted beyond disclosed liabilities, that its financial statements present a true and fair view of its financial position, that there is no pending or threatened litigation, and that the seller has good title to the shares with all requisite corporate and regulatory approvals obtained for transfer. It generally solidifies and reaffirms the seller’s key disclosures from earlier stages of the transaction.

R&Ws should be extensive and cover both specific and general matters. Some of the warranties may entail a future financial burden for the seller. Where the liability is unascertainable in quantum but reasonably foreseeable in occurrence, then consideration should be given to a guarantee from a third party.

On their own, representations that are untrue provide a buyer with specified remedies in contract, tort, and in extreme circumstances, criminal enforcement. ^[8]

It is common for the Seller to limit the effect of warranties in the SPA. This can be achieved either by limiting the period of liability or by limiting the warranties in the terms of the disclosure letter. The object of the disclosure letter is to exclude matters set out in the disclosure letter from the warranties. Particular care should be taken to ensure that the terms of the disclosure letter are not so wide as to exclude the value of the warranties altogether.

Indemnity: to more carefully delineate a buyer’s remedies in the event of a breach of R&Ws, an SPA will typically include specific indemnification obligations, linked in large part to the target’s R&Ws, in which specific procedures are laid out for a buyer to collect a damage award if the R&Ws are not true.

Thus, the indemnity clause is closely tied to the R&Ws and the parties’ obligations stipulated in the SPA. It protects against breach of any obligation undertaken by the Parties as well as losses, claims that may be as a result of such breach. It is often coupled with a duty to defend and hold the indemnified party harmless.^[9]

Specificity on the coverage of the indemnity clause is important for both parties. The buyer would seek a wide provision covering all foreseeable risks, while the seller usually seeks to limit the scope of indemnity. A well-drafted indemnification provision allows parties to customize their risk allocation by:

a. Shifting the burden of loss.

b. Compensating an indemnified party for risks it did not assume;

c. expenses that may not be recoverable under common law, like legal fees, and

d. Shifting the cost of defending third-party claims.^[10]

In contracts that do not include such indemnification provisions, the target’s representations typically “die” at completion of the deal – that is, there is an explicit term in the contract that provides that the representations do not “survive,” and serve only as remedies should the target breach prior to deal completion. Thus, while representations on their own provide some risk-shifting prior to deal completion, it is the combination of representations with explicit indemnification clauses that is typically the principal way in which both misvaluation and value-shifting risks are allocated from target to buyer through a deal contract.

Holdback and Escrow Clause: This is a provision in an SPA whereby a portion of the purchase price is retained by the buyer and not paid to the seller immediately at closing. The said portion is withheld for a specified period after closing. It is usually kept to cover potential post-closing adjustments, indemnity claims, unforeseen liabilities, or breaches of representations and warranties.^[11]

An escrow clause, on the other hand, is used where part of the purchase price is held in an escrow or retention account as security for the seller’s potential liability for warranty and indemnity claims under the share purchase agreement. It includes the escrow agents’ administrative duties, fees, limitations on liability, and procedures for handling indemnification claims, ensuring funds are available to cover potential liabilities. It also outlines the conditions for releasing funds, which may include the requirement for a joint written release notice.^[12] Most sellers prefer for the funds to be held in an escrow account. However, depending on the bargaining power between the parties, as well as the nature and size of the purchaser, the seller may be willing to accept a holdback^[13].

Further, the ability to enforce warranties is vital. If the seller is a company, it is possible that when the time comes to enforce the warranties, the company will have been wound up, leaving the warranties with no value^[14]. Therefore, where there is a significant residual liability, it is far safer to make provisions for the deposit of monies to cover this potential liability in the form of holdbacks. It also addresses difficulties buyers may have in enforcing RAWs if there is a dispute or if the target-owners are judgment-proof (e.g., have fewer assets than their liabilities or have fled the relevant jurisdiction, or are too difficult to locate).^[15]

A related means to accomplish a similar goal is for a set of target-owners to accept debt consideration as all or part of the purchase price from the buyer, sometimes referred to as seller financing.^[16]

Protective clauses in an SPA are primarily designed to shield the buyer from non-disclosure and to allocate risk for known and unknown future liabilities. However, these clauses are not a complete substitute for thorough due diligence.

While it may be tempting to minimize the due diligence process in order to reduce transaction costs, over-reliance on the SPA as a risk-management tool is a dangerous strategy. Contractual protections are supplemental and are most effective when informed by a comprehensive understanding of the target’s legal, financial, and operational position.

Experienced transaction lawyers play a critical role in risk allocation. By carefully assessing the commercial realities of the deal, they are able to structure and draft protective mechanisms that meaningfully mitigate exposure and reflect an appropriate balance of risk between the parties.

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^[1] https://www.hilldickinson.com/our-view/articles/anatomy-of-a-share-purchase-agreement/

^[2] Andrew J. Sherman and Milledge A. Hart: ‘Mergers and Acquisitions from A to Z. (2nd ed. Amacom 2006) 174.

^[3] Ibid at 177

^[4] Börzsönyi, Blanka “Intellectual Property-Related Risk Allocation Provisions in Share Sale and Purchase Agreements” Annales Universitatis Scientiarum Budapestinensis de Rolando Eötvös Nominatae: Sectio Iuridica, 2020, Vol. 59, p.97-https://www.ajk.elte.hu/dstore/document/164752/ELTE_AJK_Annales_2020%2005%20Borzsonyi.pdf

^[5] Coates, John C., Allocating Risk Through Contract: Evidence from M&A and Policy Implications (August 22, 2012) Pg. 9. Available at SSRN: https://ssrn.com/abstract=2133343 or http://dx.doi.org/10.2139/ssrn.2133343

^[6] DECODING SHAREHOLDER AGREEMENTS: WHY EVERY FOUNDER NEEDS TO UNDERSTAND SHA, SSA, AND SPA

VOL. 4 ISSUE 4 Journal of Legal Research and Juridical Sciences ISSN (O): 2583-0066.

^[7] Thomson Reuters Practical Law Commercial, “Using Contractual Risk Allocation Provisions to Minimize

Risk and Maximize Reward”. https://uk.practicallaw.thomsonreuters.com/w-008-1168?transitionType=Default&contextData=(sc.Default)

^[8] ibid

^[9] ibid

^[10] ibid

^[11] https://www.equirus.com/glossary/holdback

^[12] Thomson Reuters Practical Law, “Escrow Agreement” by Practical Law Corporate & Securities. https://uk.practicallaw.thomsonreuters.com/1-386-3603?transitionType=Default&contextData=(sc.Default)

^[13] Thomson Reuters Practical Law Commercial, Glossary – Holdback. Resource ID 3-578-5150. https://uk.practicallaw.thomsonreuters.com/3-578-5150?transitionType=Default&contextData=(sc.Default)&firstPage=true

^[14] (Maxim, Trevor. “Property issues and warranties in share purchase agreements.” Journal of

Retail & Leisure Property​ Henry Stewart Publications 1479- 1110 Journal of Retail and  Leisure Property VOL. 4 No.3 PP 229- 235 @ 233-235.

^[15] ibid

^[16] ibid

Written by Michael Isokpehi for The Trusted Advisors

Email us: info@trustedadvisorslaw.com

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