Put: Antonio Mazzucco and José Henrique Torres
This article aims to detail the clauses and conditions commonly found in contracts for the purchase and sale of shares or company quotas. It is not the purpose of this article to detail each of these clauses and conditions, but merely to provide a general overview for professionals who deal with this on a daily basis and do not have legal training.
The Share Purchase and Sale Agreements (we will refer to them by the acronym “SPA” or Share Purchase Agreement) are entered into between a buyer and seller(s) of equity interests in a target company. Under an SPA, the seller agrees to sell and the buyer agrees to purchase a specified number of shares or units at a specified price and subject to other agreed terms and conditions. The purpose of an SPA is to formalize a mutual written agreement on these terms and conditions.
When a buyer acquires all or a significant portion of the shares of a target company, it must take into account that the company has assets and liabilities and that the liabilities may affect the buyer's assessment of value. The SPA may or may not contain clauses that reduce the buyer's exposure to these liabilities, the value of which the seller would be obliged to indemnify. In any case, an M&A transaction is always preceded by a due diligence (“DD”), which can be more or less extensive. The due diligence Its purpose is not only to identify potential liabilities and contingencies, but also to obtain important information about the seller (especially its liquidity and ability to dispose of its assets) and about the company that is the object of the acquisition, such as its real asset base (fixed assets, contracts, finances, human resources and customers, among others).
Preliminary Considerations
Preliminary Considerations, although not essential, are an important element of the SPA, or indeed of any other contract. This is particularly true after the enactment of the Civil Code of 2002, according to which “legal transactions must be interpreted in good faith” (art. 113). These clauses explain the reasons of each party and usually indicate the events that preceded the contract. Since contracts are usually concluded while there is a good understanding between the parties, it is common for due importance not to be given to these clauses, which may be important when interpreting the contract in a possible arbitration or judicial proceeding.
Definitions
In a SPA, specific meanings should be given to specific words. This makes the contract precise, especially as to the meaning of words commonly used in certain industries or contexts or in specific sectors. While certain words or phrases may be defined in the body of a contract, any words or phrases that have critical, ambiguous meanings or require lengthy definitions or explanations should be included in the definitions section. This is particularly useful in the case of frequently used words, phrases or concepts. Each defined term should be initially enclosed in quotation marks to make it clear that it is a defined term, in bold (so that it can be easily found) and the first letter of each defined word should be capitalized so that it is clear throughout the contract that when the word is capitalized it is in fact a defined term and, as such, will be interpreted in accordance with the definition. If, for example, “Party” is a defined term referring to a Party to the contract, it will avoid confusion when the word “party” in all lowercase letters is used to refer to any party that is not a Party to the contract.
Subject of the Contract: Sale and Purchase of Shareholding
As an essential element of any SPA, the subject matter of the agreement specifies the quantity, type and class of shares or quotas to be acquired. It must also specify whether the shares or quotas are free and clear, which will be explored in more detail in the Representations and Warranties clause.
Price, Payment Method and Escrow Account
This section must specify the purchase price of the shares or quotas and the form of payment, the currency of payment, the place of payment, whether in cash or in installments, whether conditional upon certain events, whether in cash, conversion of credits, assumption of debts/liabilities, exchange of assets, movable property, movable property, or other forms of payment.
In most M&A transactions, the purchase price is usually determined in relation to the financial statements closest to the closing date, and the contract should provide that the price will be adjusted based on accounting indicators at the closing date. Purchase price adjustments are usually due to the company's own operations, especially changes in working capital or debt. In this regard, the buyer and seller should agree on a valuation method and adopt accounting formulas in order to have a clear picture of the company at the closing date. The value of the transaction may vary, up or down, depending on the company's results between the signing date and the closing date.
As previously mentioned, payment of the price must occur at the time of transfer of the acquired equity interest. However, it is common for part of the price to be used as collateral against contingencies identified in the due diligence. This guarantee may take the form of a price retention or an escrow account, also known as escrow account. While retention is beneficial to the buyer, it creates uncertainty for the seller as to the actual receipt due to the buyer's liquidity. Hence, the seller often opts to open a escrow account, notwithstanding the costs arising therefrom. Having eliminated the contingencies or liabilities that justified the retention or opening of the escrow account, the retained or deposited portion must be released to the seller. The SPA must contain very clear stipulations regarding the entire procedure.
In general, a escrow account is a current account opened in the name of the seller and the buyer, the movement of which depends on joint authorization and an investment policy previously agreed upon between the bank, seller and buyer. The bank, as depositary, must faithfully follow the rules for maintenance and release of funds, which are stipulated in a specific contract that will be signed together with the SPA. In other words, the institution of the escrow account is the subject of a separate contract which specifies the terms and conditions under which the escrow agent must manage and release the funds in escrow to the seller or buyer. An escrow contract should be drafted carefully and specifically to capture the key elements that determine whether funds are to be paid or withheld in respect of its subject matter.
Pricing is often one of the most complex issues in M&A negotiations due to the different perceptions of value of the seller and the buyer. One way to overcome this difference in perceptions is by using the pricing mechanism. earn-out.
Earn-Out
The clause of andarn-out consists of linking part of the price to the company's future results. This type of adjustment is a creative solution to reconcile any difference in the seller's and buyer's price perception and allow the buyer to capture the synergies and part of the value that may be created with the buyer's entry. This is because the company's pricing (valuation) is always based on future results and, as such, is uncertain. These results may be financial (e.g., achieving future sales targets) or non-financial (e.g., key target customers are retained after the transaction). The earn-out, therefore, links part of the price to future results and, as such, is an instrument widely used to resolve disagreements about the company's value and price.
The clauses of earn-out must be carefully drafted, especially with regard to the time frame and the financial and accounting criteria for determining the results within that same time frame. It must also ensure that the seller is retained in the company as well as the maintenance of other conditions that may be necessary for achieving the results.
Ideally, the exercise of the put and call option related to a stock option clause earn-out must be the subject of a shareholders' agreement, as this type of instrument involves specific execution of the right of Put and of Call, that is, options to sell and buy shares or quotas.
Closing
The so-called Closing (or closing, in English) consists of the delivery of shares or quotas against payment of the price, in full or in part. Closing represents the moment in which the shares or quotas, and the obligations arising from their ownership, are transferred to the buyer.
In this regard, it must also be specified in the SPA whether the purchase and sale closing will take place at the time of signing the SPA or whether there will be an interval between signing and closing (deferred closing).
This is necessary to the extent that the closing of the transaction depends on CADE or any other regulatory agencies that must approve the change in control of the company. Or even in the event of the need for other events and approvals to occur.
Therefore, deferred closures are common and may be necessary for a variety of reasons that invariably require a certain amount of time to complete.
Conditions precedent
Conditions precedent, or closing conditions, are stipulations agreed upon by the parties that must be satisfied, or waived, as a condition to the completion of the acquisition. Conditions precedent are typically assigned to a specific party, but some may be mutually enforceable. They may also be contingent upon third parties, such as approval for the transfer of control by a regulatory agency or even a lender. Failure to satisfy a closing condition typically gives the counterparty the right to walk away from the transaction, terminating the purchase and sale agreement without liability. This protects the parties from not receiving what they bargained for. In the case of a deferred closing, the conditions must occur after the SPA is executed.
Pre-Closing Commitments
Deferring the closing brings even more complexity to the contract as it will be necessary to regulate the business conditions from the moment of signing until the moment of closing – which is done by the commitment clauses (called covenants, in English). The purpose of these clauses is to limit the company from entering into contracts outside its normal course of business, as the parties may agree.
Pre-closing clauses generally limit what the seller can do before closing. Typically, the seller’s commitments are more onerous than those of the buyer since the seller retains control of the company until closing. As do-or-not-do obligations, pre-closing agreements are common in transactions with deferred closings to protect and preserve the value of the business between the execution of the SPA and the closing. However, in transactions subject to prior approval by CADE, care must be taken to ensure that the commitments assumed by the seller do not constitute excessive interference or integration of activities prior to the approval of the transaction by that authority (this is the so-called gun jumping).
Material Adverse Effect (MAC)
Also as a consequence of a deferred closing, the purpose of MAC clauses is to create protection for the buyer against adverse changes that are not due to acts of the parties, but of third parties. These clauses have the consequence of releasing the buyer from the obligation to complete the purchase and sale if adverse changes occur to the company as a consequence of acts attributable to third parties, such as pandemics, cataclysms or other unforeseeable factors, as may be negotiated between the parties.
Representations and warranties
In M&A transactions, so-called representations and warranties (or representations and warranties, in English) are given by each party to the other with the purpose of confirming the existence of the essential conditions for the validity and effectiveness of the legal transaction. However, they can also refer to the conditions of the company itself whose shares or quotas are the subject of the contract. In the latter case, the seller's representations and warranties will certainly be more extensive and detailed than those of the buyer insofar as they relate to the company, its business, assets and liabilities. Representations and warranties allocate risks between the parties and form the basis for a legal claim in the event of misrepresentation or breach. They can be complex or rudimentary and may cover one or more aspects of the company. The stipulation of representations and warranties relating to the company is neither necessary nor essential to the transaction. In their absence, the company is deemed to have been disposed of as is (which in English is called The Is, that is, “in the condition in which it is found”). In this case, the seller does not provide any guarantee as to the condition of the company and the buyer assumes all assets and liabilities, whether or not identified in the due diligence.
Termination/Rescission Rights and Severance Pay
Deferred closing SPAs are contracts whose performance is extended over time until the Conditions Precedent are met. As such, these are contracts that stipulate obligations for both parties that must be fulfilled between the date of execution and the date of Closing. Failure to comply with any of these obligations should give the injured party the right—but not the obligation—to terminate the contract and seek damages from the defaulting party. In SPAs that contain representations and warranties regarding the company, a breach of these clauses gives the buyer the right to terminate the contract and seek damages. As such, these clauses should be negotiated in detail and usually include concepts of materiality and seller knowledge to prevent a breach from being established.
Once the closing has occurred, the obligation to indemnify will remain for the period agreed between the parties. Both the period of the obligation to indemnify and the maximum amount of compensation may be negotiated between the parties.
Auxiliary Contracts
Supporting documents and agreements typically consist of a series of documents listed in a schedule attached to the SPA that the parties must deliver to each other at or prior to closing. They may relate to conditions precedent or to transactions or agreements that are to take effect after the closing of the transaction. Examples include shareholders’ agreements, service agreements, intellectual property rights licensing agreements and real estate lease agreements. One or more of these documents may be required to govern relationships that will continue after the closing of the purchase and sale of shares or units.
Post-Closing Commitments
Unlike the Conditions Precedent and in the same way as the aforementioned Supporting Documents, these clauses regulate obligations that will also have effect after Closing. A typical example is the non-competition and non-solicitation commitment.
Confidentiality
Confidentiality clauses after the closing of the contract are intended to protect the buyer from the risk of the seller disclosing to third parties or even using confidential information in their favor or in favor of third parties. In other words, they protect the value of the deal itself. While in the preliminary stages of negotiations the seller must be concerned with the confidentiality of information, this equation is reversed after the closing. In addition, it is very common for strategic information to be made available only after the signing of the contract or even at the time of closing. Therefore, this clause may regulate this situation.
Miscellaneous Provisions
In addition to the clauses referred to in this article, any other clauses may be added to the contract to the extent necessary to document the agreements and covenants entered into between the parties. In any event, under the heading Miscellaneous Provisions, clauses are normally inserted to regulate such matters as communications between the parties for any matters arising from the contract, survival of the other contractual provisions if any of them is considered null and void, rules for assignment of the contract, language that shall prevail if the contract is signed in more than one language, and responsibilities for costs and expenses incurred by each of the parties in carrying out the transaction.
Applicable Law, Jurisdiction and Dispute Resolution Method
The issue of applicable law and jurisdiction becomes even more important in the case of contracts entered into between parties in different jurisdictions, including due to the provisions of the Law of Introduction to the Rules of Brazilian Law (Law 12,376/2010).
As for the dispute resolution method, arbitration has become increasingly common in SPAs, mainly due to its confidentiality and faster decision-making. However, contracts usually reserve the right of each party to appeal to the Judiciary to obtain urgent decisions in order to preserve their rights.