The Hindu Business Line : Acquiring companies in UK: The legal obstacle course

Drafting a legal agreement for acquiring companies and businesses in the UK can be a painstaking task but there are advantages as it gives little scope for ambiguity if a dispute were to arise at a later date.

The impact of India's economic boom can be seen around the world in the form of overseas acquisitions by Indian corporates. Many of these acquisitions have been made in the UK. Tata's high-profile acquisition of Corus, a listed steel company comes to mind immediately. Most of India Inc's acquisitions have been of unlisted companies, such as Mahindra & Mahindra's acquisition of the Stokes Group Ltd or Wockhardt's acquisition of CP Pharmaceuticals. What are the key legal issues involved in the acquisition of a private company or business in the UK.

Shares or Assets

Just as in India, a UK business can be acquired either by buying the shares of the company that owns the business, or by purchasing the assets and goodwill which make up the business. A share acquisition will give the acquirer control over not only all the assets of the company, but also bring with it all the company's liabilities, including those about which the acquirer may have no knowledge.

If assets are purchased, the acquirer may decide on the specific assets and liabilities that he wishes to acquire. However, an asset purchase will require the separate transfer of each and the documentation is likely to be more complex. Also, it may involve many more consents and approvals from customers and suppliers. An acquisition of shares from an existing shareholder involves a stamp duty of 0.5 per cent. No duty is payable on shares directly issued by a company. The tax issues arising on the sale of shares will be different to those on a disposal of assets; though more of an issue for the seller, they need to be factored in.

Due diligence

This is a process by which the acquirer seeks to gain a complete picture of the target, to decide whether it wants to proceed with the acquisition and, if so, at what price. Due diligence is typically carried out by the acquirer's financial, accounting and legal advisers and the acquirer's own personnel. Environmental consultants, surveyors and actuaries may also be brought in.

Financial assistance

If the assets of the target company are to be used to secure a loan given to the acquirer to fund the acquisition, this would amount to "financial assistance" by the target company for the purpose of the acquisition of its own shares, which is currently prohibited under the UK company law. It is possible to get around this prohibition in the case of private companies through a "whitewash" procedure, which involves approval by a special resolution of the company's shareholders, and the giving of statutory declarations of solvency by the directors, backed up by an auditor's report.

The law in this area is set to change when the relevant parts of the Companies Act, 2006 comes into force in October 2008. Although the new Companies Act contains many more exemptions than the existing legislation, this area will continue to be a minefield for acquirers.

Approvals required

The consent of third parties, such as banks or financial institutions that have lent to the target, may be required if the loan documents restrict disposals of assets or a change in control or shareholding pattern. If the target company operates in a regulated industry, for example if it is a bank, broker or insurer, authorised and regulated by the Financial Services Authority, or if it is a broadcaster or a publisher, it may be necessary to obtain specific approval from the relevant regulator for the proposed acquisition.

Variable consideration

It is common for purchase agreements to provide for a variable price, either by reference to the net assets actually taken over or by a reference to profits in the period before or after completion of the transaction. Thus, the price may be increased or decreased to the extent the net assets, on completion of the transaction, are higher or lower than a pre-determined target. Alternatively, the consideration payable may be the enterprise value of the target business (based on estimated sustainable future annual earnings) plus any cash in the business on completion, less any debt.

The consideration may also be structured to cover any non-cash working capital in the business over and above the normal level of working capital. If working capital at completion is lower than the normal level, there may be a reduction in the price payable. To enable the price to be adjusted, it is common for the purchase agreement to provide for accounts to be drawn up following completion as at the date of completion of the transaction (called completion accounts) and agreed between the parties.

As an alternative to including a completion accounts structure, a "locked box" mechanism may be used. For this, the parties agree on a value for the target based on a balance-sheet, drawn up and settled between the parties as at a date in advance of signing the purchase agreement, with only specific payments being permitted to be made by the target company between the `locked box' balance-sheet date and completion.

If this mechanism is used, the acquirer's solicitors should ensure that the sale and purchase agreement prevents the seller from extracting value from the business after the lock-in date by declaring dividends or making other payments to the seller, other than agreed payments required for the operation of the business in the ordinary course.

Employee issues

The Transfer of Undertakings (Protection of Employment) Regulations, 2006 seek to protect employees employed by a UK business that is sold or transferred. The acquirer of the business will take over all the employees employed in the business, on the same terms and conditions which they enjoyed before the transfer, by operation of law. These regulations impose various obligations on the acquirer and the seller of an undertaking to inform and consult with the employees before the transfer. The acquirer can obtain indemnities from the seller to mitigate the burden placed on the acquirer by these regulations, but it is not possible to contract out of them altogether.

A bulky sale and purchase agreement, which sets out the details of the transaction, is the hallmark of any share or asset purchase transaction governed by English law. In addition to identifying the subject matter of the sale (shares or assets), the agreement will include extensive warranties and indemnities in favour of the buyer as well as provisions for transitional services and restrictive covenants. It is customary for the solicitors acting for the acquirer and the seller to be present and play a major role during the negotiations between the parties.

Warranties and Indemnities

Warranties are contractual statements made by the seller in the sale and purchase agreement and are like assurances from the seller as to the condition of the target business. For example, as to its audited accounts, books and records, or the business since the last balance-sheet date.

In the case of a breach of warranty, the acquirer may bring a claim for damages if the effect of the breach is to reduce the value of the company or the business acquired. An indemnity on the other hand is a promise to reimburse the acquirer in respect of a particular type of liability, should it arise.

It is not necessary to show that the value of the business has diminished as a result of the happening of an event which triggers the indemnity, but merely that the relevant event has occurred.

For example, if a seller warrants that the target company has not violated any environmental law, but after completion of the purchase, the acquirer finds out that the company is facing various pollution charges, the acquirer can recover damages only if it shows that the value of the shares in the company, or the business, has been reduced as a result of the charges. If the seller has given an indemnity, the acquirer can claim indemnity to cover the cost of meeting the pollution charges, even if the value of the business as a whole is unaffected.

Conditions precedent

It is common to enter into a sale and purchase agreement and provide that certain conditions be fulfilled before the actual transfer of assets or shares and payment of consideration. These conditions could be the obtaining of buyer shareholder approval, anti-trust clearances, consent from lenders for assets to be transferred etc. If the conditions are not fulfilled within a specified time, the agreement lapses, unless the time period is mutually extended by the parties.

Drafting a sale and purchase agreement governed by English law can a painstaking task, but the benefit of doing so is that it leaves little room for ambiguity in case a dispute arises at a later date. English judges are familiar with this style of agreements and, if one party to the agreement breaches any of its terms, relief though should be readily available for the aggrieved party.

(The authors are Partner and Solicitor, Reed Smith Richards Butler LLP.)

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