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This Guide provides an overview of the differences in the legal process when buying or selling a private company in the UK1, when compared with US2 practice. It covers some commonly asked questions and areas of interest to lawyers representing both sellers and buyers, including how these deals are structured, the process and the key differences to consider in looking at typical negotiation points as compared with US transactions.
Below is an introductory summary:
The buyer’s first draft of an English share purchase agreement (‘SPA’) is generally regarded as being more ‘seller friendly’ than a US-style SPA. This reflects current market practice that negotiations will normally be streamlined to specific points and that the boilerplate and other minor clauses will not undergo dramatic changes.
By contrast, first draft US-style SPAs are often more heavily weighted in favour of the buyer in the expectation that most provisions will be heavily negotiated.
In addition, English SPAs tend to be drafted in ‘plain English’ (ie avoiding legalese, long sentences etc) whereas US-style SPAs are usually longer and contain more detailed legal drafting/legalese.
US SPAs often use the terms ‘representations’ and ‘warranties’ conjunctively. In English law, the two concepts are very different with representations providing the potential remedy of rescission and a potential tortious claim for damages.
Given this, prudent sellers will resist the inclusion of representations and also likely express that contractual damages will be the buyer’s only remedy for breach of contract.
Under US law, a breach of a party’s ‘representations and warranties’ does not, generally speaking, give right to a rescission or tort claim, but rather only a claim for indemnification, or breach of contract.
In the US, there is generally no distinction between protection by warranty or indemnity, as indemnification is usually the main legal remedy for breaches of representations/warranties under the acquisition agreement. In the UK there is a marked distinction between the two concepts.
A breach of warranty claim in the UK is similar to a US claim for indemnity in that the burden to prove the breach occurred rests with the party alleging the breach. The alleging party also has an obligation to ensure that it took reasonable steps to mitigate those damages.
In UK law, however, the claimant not only has to prove that actual loss was suffered, but also that the loss caused a diminution in value of the company or business acquired.
Indemnities are often given by sellers in a UK transaction but typically against specific risks/liabilities only (for example, an unresolved piece of litigation discovered during due diligence), rather than as a general basis for recovery under the warranties.
That said, it is customary for pre-completion tax risk to be the subject of a specific tax covenant (ie a promise to pay any unpaid tax given by the sellers to the buyer).
Furthermore, in certain sectors one often finds additional core risks covered by way of indemnity. For example, in the technology sector, the intellectual property warranties, or at least the infringement warranties, may be given on an indemnity basis. Similarly, in the industrial/chemicals sector, environmental warranties may be given on an indemnity basis.
A UK lawyer in a strong negotiating position may seek to get an indemnity basis of recovery for breach of the warranties. This allows the claimant the right to be reimbursed in respect of a particular type of liability should it arise and seeks to provide £1 for £1 compensation for a specific loss. For the reasons set out above, this will be very strongly resisted by the sellers.
MAC clauses typically grant the buyer a right to refuse to complete the transaction if an event occurs between signing and closing that has an effect on the target company that is materially adverse. There are two types:
These clauses also tend to include carve-outs for changes in the law, general economic industry-wide changes and other associated risks.
MAC clauses are heavily negotiated in the UK, but are not so common so as to be deemed a feature of every transaction. To the extent that they do appear in UK SPAs, MAC clauses are generally narrow in definition (although a buyer will seek to widen this), and limited to specific events.
In US acquisition agreements, MAC clauses, and the heavily-negotiated carve-outs to MAC clauses, are a common component.
In the US, it is common practice to require warranties and representations to be repeated at closing, and frequently the accuracy of warranties/representations at closing is a condition to closing. The seller is often required to deliver certificates for this purpose.
The repetition of warranties at closing is also common in the UK. Where warranties are repeated, a seller will seek to limit these to matters within its control and may seek to make further disclosure (although this is often negotiated and resisted by a buyer).
The US legal terminology of ‘closing’ is more commonly known as ‘completion’ in English legal terminology. They do, however, have the same meaning.
In the UK parties generally try and avoid having a split signing and completion to avoid the uncertainties that this limbo period can create. However, in some circumstances this is not possible. Common conditions precedent to completion would be anti-trust or sector specific regulatory clearances and a change of control approval in respect of a material customer contract.
There are major differences between the approach to disclosure against warranties in the US and the UK.
In the UK, it is market practice to provide general disclosures (in addition to specific disclosures) in a separate Disclosure Letter rather than in schedules to the main agreement. The Disclosure Letter is a negotiated document, the final agreed form of which is delivered to the buyer at exchange of contracts.
General disclosures in UK transactions tend to ‘deem’ disclosure of certain information which qualify all warranties, and may cover all (or some) documents/matters disclosed in a data room or in response to due diligence requests provided to the buyer.
However, a buyer who concedes to a general disclosure of a data room (in whole or in part) or of due diligence responses will often require the seller to warranty the accuracy of such information.
It is also common for general disclosures to deem disclosure of all information that is available from certain publicly available sources or searches (such as filings at Companies House or the Land Registry) even if the buyer does not actually receive this information or carry out the relevant searches.
Please note, however, that general disclosure of all information available from intellectual property registry searches can be regarded by buyers as unreasonable.
The Disclosure Letter is usually accompanied by a ‘disclosure bundle’. This is a large collection of documents that are expressly mentioned in the Disclosure Letter (although they do not have to be), and the entire contents of the bundle are often treated as disclosed against all warranties.
Sometimes this can extend to all the documents in the data room. Most US buyers view due diligence as a process for their benefit only and are often surprised that UK sellers ask for the contents of the data room to qualify the warranties they are giving.
The practice in the UK is therefore more ‘pro-seller’ than in the US. However, there is a caveat to this – the ‘fair disclosure’ principle. This principle provides that a disclosure is unlikely to be effective unless it contains sufficient information to enable a reasonable buyer to make a reasonably informed assessment of how this information impacts on the particular warranties provided in the transaction.
Pointing the buyer in the right direction to a source of information that may enable the buyer to reach certain conclusions may not necessarily be sufficient to constitute ‘fair disclosure’.
A buyer under a UK SPA will typically seek to insert a provision in the SPA or the disclosure letter to the effect that disclosures only qualify the warranties if they are ‘fair’, ‘complete’, ‘clear’, ‘specific’, ‘full’ or a combination of all of these.
A further difference to the US approach is that specific indemnities are generally not qualified by the information provided in the seller’s Disclosure Letter.
General disclosures are rarely accepted in the US and a buyer will often seek to ensure that specific disclosures do not provide disclosure in relation to all warranties unless specifically cross-referenced.
Sometimes the buyer will accept that the disclosure can be extended to other representations to which the disclosure 'would reasonably be deemed to apply’.
In UK transactions it is relatively standard to include a provision in the construction section of the Disclosure Letter to state that any disclosure is deemed to qualify any warranty to which that disclosure may be applicable, regardless of whether it is expressly cross-referenced.
However, to ensure that a disclosure is considered 'fair' a prudent seller will always seek to cross- reference disclosures to all relevant warranties.
In addition, any general disclosure, whether actually received by the buyer or ‘deemed’ to be disclosed, may qualify a warranty, even though it might not have been brought to the specific attention of the buyer.
There is, however, a statutory duty under the Financial Services Act 2012 pursuant to which it is an offence to make false or misleading statements or create a false or misleading impression with the intention of inducing someone to enter into a contract or a transaction.
So-called knowledge saving (or, in US parlance, ‘anti-sandbagging’) provisions, such as those preventing a buyer from bringing a claim where it has actual knowledge of a breach of warranty, can generally be relied on in the UK.
However, whether in the absence of such a clause, actual knowledge is a general bar against a warranty claim is uncertain, and it is generally felt that even if a claim was successfully brought, a court may well penalise the buyer on the measure of damages.
Accordingly, if the matter of which the buyer has knowledge is important, it is probably best for the buyer to seek a specific indemnity on the matter (a claim under which is less likely to be limited by reference to any related disclosure). Anti-sandbagging often sits uncomfortably with US buyers as this seems to penalise them for carrying out proper due diligence.
The legal effect of an express ‘reverse knowledge saving’ or (‘sandbagging’) provision, to allow a buyer to bring a claim even where it has knowledge of facts or circumstances giving rise to a breach, is unclear as a matter of English law.
Whilst there is case law to suggest that a court will seek to give effect to such a clause if this was what the parties clearly intended, there is a distinct risk that the court may only award nominal damages, particularly if it detects unfair play. This should be of particular note to US buyers for whom reliance on a formulation which states that a buyer's claim would not be prejudiced by any investigation by the buyer or its agents is commonplace.
Given the current uncertainty of the law, a buyer would be well advised to seek specific indemnity cover or a reduction to the purchase price rather than rely on a knowledge saving provision where it did, in fact, have actual knowledge of a breach of warranty.
In UK market practice, warranty periods tend to be longer and caps for warranty claims tend to be higher than in the US. It is fairly standard for a maximum cap to be equal to the amount received on the sale. US caps are instead typically based on a percentage value of the transaction (usually 15% to 50% of the consideration).
Both jurisdictions, however, tend to carve-out ‘fundamental’ warranties (such as title and capacity) and exclude fraud by the seller.
In terms of limitation periods, the tax warranties are usually given for 7 years and the general business warranties for anything from 12 months to 3 years. Certain core sector warranties may be given for a longer period but this is a matter for negotiation and varies from deal to deal.
For a buyer in the UK to bring a claim, the claim must generally exceed a certain threshold/’basket’. Once this has been achieved (either by a single or an aggregate claim), the buyer will either recover the total aggregate amount (a ‘tipping basket’) or alternatively the amount above the threshold only (a ‘deductible basket’).
It is also common in the UK to negotiate a ‘de minimis’ (or ‘mini basket’) ie a qualifying amount per claim below which a claim will not count towards the basket/threshold. A similar approach is used in US market practice, although the use of deductible baskets is perhaps more frequent.
Restrictive covenants in the UK tend to be much shorter than in the US. The maximum duration that a non-compete will be considered reasonable is likely to be 3 years (although for an asset sale without the sale of goodwill a non-compete up to a 2 year period would be enforceable) whereas in the US a non-compete for sellers can be enforced for up to 7-10 years, depending on the jurisdiction (with the notable exception of California, where ‘non-competes’ are much more strictly limited).
Completion accounts have traditionally been the default mechanism of choice in the UK and are usually considered buyer friendly.
However, in recent years, the use of a locked box structure has become more widespread. The key distinction between the two is the date at which economic risk transfers.
Under a completion accounts mechanism, the consideration paid by the buyer is usually based on the estimated net asset value of the target as at completion, with such purchase price subject to a post-completion adjustment depending on the actual net asset value determined by reference to accounts to the completion date prepared in the month or so after completion. This is the standard in the US as well.
By contrast, there is no post-completion adjustment in a locked box structure, other than in respect of claims for contractually-defined ‘leakage’, since the purchase price is calculated shortly before signing the SPA using a recent historical set of accounts of the target.
The parties must agree what constitutes leakage (transfer of value from the target to seller, such as dividends) and permitted leakage in order to preserve the value of the business between the locked box accounts date and completion, with the seller providing the buyer with an indemnity for any leakage between these dates.
The seller will be keen to ensure that the representations and warranties contained in the SPA are the sum total of the ones it will be giving. As such entire agreement clauses are common in the UK to ensure that any pre-contractual statements are excluded from the agreement.
An entire agreement clause will normally have the following elements:
Often the entire agreement clause will state that it is not intended to exclude liability for fraudulent misrepresentation. This wording is intended to prevent the courts from finding that the restriction of liability for misrepresentation is unreasonable.
Some recent UK cases have shown that it is important to get the drafting of these clauses correct to ensure that they operate as intended.
In the US, states vary on whether pre-contractual statements can found a claim where the SPA contains an entire agreement clause and a non-reliance statement.
We understand, for example, that New York courts favour the parties' freedom of contract, and are loath to allow a pre-contractual misrepresentation claim where the parties have agreed to a contract which contains an entire agreement clause and a non-reliance statement.
Other states, however, have taken a different view favouring the position of the buyer.
In the US there is generally a more relaxed attitude to signings than in the UK. It is common practice for pre-signed signature pages to be distributed in advance of signature pages being ‘released’ and documents being finalised.
Signings in the UK take a more formal approach in comparison and lawyers are required to follow relevant procedures for compliance. Backdating is strictly prohibited as it is treated as fraud in England (although it is possible to agree an ‘effective date’ upon which economic risk is agreed, as between buyer and seller, to have passed).
Virtual signings are common in the UK but it should be noted that there are recommended Law Society guidelines that English lawyers should follow (particularly in respect of deeds).
It is not uncommon for English law SPAs to be executed as ‘deeds’. A deed is a special legal instrument that has a 12 year limitation period (instead of 6 years for ordinary contracts) and does not require any form of consideration in order to be legally binding. Execution in this form is not recognised under law and practice in the US.
US-style SPAs are subject to implied covenants of good faith and fair dealing. There is no equivalent in English law and practice in M&A transactions, although recent court decisions imply that an enforceable right may be created if there is an express obligation to negotiate in good faith.
In addition, when exercising their discretion under such rights, a party must act honestly and not act unreasonably. This said, enforcement of the covenant of good faith and fair dealing in the US is generally speaking on the wane.
It is common practice in a UK transaction for the parties’ solicitors to act as escrow agents and to operate a retention account on behalf of the parties.
The account is managed jointly by the solicitors and a formal Escrow Letter setting out the terms in which the solicitors have agreed to act will usually be signed by each party and their respective legal representative.
Some of the larger UK law firms have internal policies which prevent them from accepting a joint escrow agent appointment, but most UK firms do still accept such instructions.
Joint solicitors’ accounts remain uncommon in the US and a separate third party (an escrow agent) is usually instructed to hold the retained funds on behalf of the parties to the transaction.
Purchase price retentions vary from deal to deal but in the UK typically range from 5% to 20% depending on the bargaining position of the parties and whether the deal involves a private individual or a corporate seller.
Whilst the essentials of a UK and US transaction are broadly similar there are important distinctions that a corporate lawyer should be aware of. Knowledge of these differences and being empathetic to the other side's customary way of doing deals can give a lawyer an advantage in securing a smooth transaction process and getting the best deal for his client.
This article was written by Mark Howard and Hamish Perry.
For more information please contact Mark on +44 (0)20 7203 8902 or firstname.lastname@example.org, or contact Hamish on +44 (0)20 7203 5392 or email@example.com