Paul Chases continues his series of articles on corporate real estate transactions by considering specific aspects of the sale and purchase agreement
Last week’s article (“In good company”, 28 February, p99) outlined the principal documents involved in a corporate real estate transaction. This article takes the fundamental sale and purchase agreement (SPA) and considers five key aspects: conditionality, exchange and completion splits, rescission, buyer protections and seller protections.
SPA conditionality
Conditions may have to be satisfied before a corporate real estate transaction can complete, for example, the grant of planning permission or the practical completion of a property development. If so, it is preferable to wait until such conditions are fulfilled before signing the SPA so that completion can take place immediately after exchange of the SPA.
In reality this will be impractical on complicated and higher value corporate real estate transactions, particularly if outgoing and incoming bank debt is involved. The parties will usually therefore enter into a binding SPA (at exchange), which sets out the conditions that must be satisfied or waived before the SPA (and related corporate real estate transaction) can complete.
Split between exchange and completion
On any corporate real estate transaction involving a split between exchange and completion there is an inevitable tension between the interests of seller and the buyer. The seller wants to ensure that, at exchange, the buyer is contractually committed to, and will in due course, complete; the buyer wants to retain the right to walk away from the deal and rescind the SPA prior to completion in certain circumstances.
Several practical matters should be within the contemplation of the seller and the buyer when considering a potential split between exchange and completion of the SPA. This includes whether shareholder (or equivalent) approval may be required by either the seller or the buyer. Approval may be needed if the transaction is either a class 1 or a related party transaction for the purposes of the UKLA’s Listing Rules. EU merger control clearance may also be required.
Attention needs to be drawn to the warranties given by the seller to the buyer at exchange regarding the target group and its property and whether they should be repeated at completion. If so, it needs to be considered whether the seller should be entitled to disclose against such repeated warranties at completion.
The buyer should be entitled to rescind the agreement between exchange and completion if a force majeure event impacts on the value of the assets (of the target group) being acquired; or the seller breaches any restrictive conduct provisions relating to the target group.
Finally, the circumstances in which the deposit paid by the buyer to the seller at exchange should either be returned to, or forfeited by, the buyer if the SPA does not complete.
Rescission
Whether the buyer is able to successfully
negotiate a rescission right between exchange and completion of the SPA will, in part, be determined by which party’s interests give rise to the requirement for a split between exchange and completion.
For example, if for legal or regulatory reasons the seller is required to obtain shareholder approval for the corporate real estate transaction after exchange but before completion, it may be more difficult for the seller to argue that during such period the buyer should face the potential risks, such as breach of warranty by the seller, a force majeure event or the seller’s breach of any restrictive conduct provisions. In such circumstances it would not be unreasonable for the buyer to require a rescission right.
However, if the reason for the split between exchange and completion is down to the time required for the buyer to procure its acquisition debt finance from a third-party bank, it is less likely that the buyer will be able to negotiate a rescission right for anything other than a material breach by the seller of any restrictive conduct provisions.
Buyer protections
Buyer protections are fundamentally important because the buyer is not afforded any statutory or common law protection on acquisition; caveat emptor applies. On completion of a corporate real estate acquisition, the buyer purchases the target group thereby inheriting all related obligations, liabilities and continuing commitments. Consequently, a buyer will want to negotiate a robust package of warranties and appropriate indemnities to be given by the seller.
Warranties
Warranties are contractual statements of fact about the target group’s assets, liabilities and state of affairs. Their typical coverage is set out in the test box and they serve three principal purposes.
First, they provide the buyer with contractual protection. If a statement about the target group is untrue the buyer can sue the seller for breach of warranty and may recover damages determined in accordance with contract law.
Secondly, they allocate risk between the buyer and seller. If the relevant subject matter is covered by a warranty that turns out to be untrue then such breach puts the seller at risk of liability to the buyer. However, if no such warranty is given then the buyer has no breach of warranty claim against the seller and runs the risk of being saddled with the liability.
Thirdly, they flush out information. When the buyer requests a particular warranty the seller’s liability for breach will be limited to the extent that any matter is “fairly disclosed” by the seller. Such disclosure enables the buyer to consider its position pre-exchange and, if necessary, walk away, adjust the purchase price or seek an indemnity in respect of any specific liabilities.
An SPA will not usually include long-form property warranties because the buyer’s property enquiries will be answered by the seller in the form of representations (as is conventional on a property acquisition involving the transfer of title to the property). The SPA will, however, contain a handful of warranties regarding the relevant property being sold. These warrant the truth and accuracy of the replies to enquiries, that the property is owned by the target group and that the target group does not own any other property.
Some buyers will attempt to provide expressly in the SPA that the warranties given by the seller are also representations, which can be achieved by stating that the seller “warrants and represents” the position expressed in the warranties. This approach increases the range of potential remedies available to a buyer as it provides the basis of a tortious claim (under the Misrepresentation Act 1967) that could procure a more advantageous level of damages for the buyer and the statutory right of rescission.
A well-advised seller will usually resist this tactic, requiring any representation language be removed from the SPA (in respect of target group warranties) and include a detailed entire agreement clause that specifically limits the buyer’s remedy to a contractual claim for damages.
Indemnities
An indemnity is a promise by the seller to repay to the buyer, on a pound-for-pound basis, specified liabilities as and when they arise. If the buyer’s due diligence unearths a particular risk or liability that the buyer is not willing to assume (for example, potential litigation or a tax investigation regarding the target group), and the liability is not easily identifiable or quantifiable, the buyer may request a specific indemnity from the seller in respect of that potential liability. This will thereby shift the economic exposure from buyer to seller.
Indemnities v warranties
The burden of proving loss and the quantum of damages for a breach of warranty claim sits with the buyer. The buyer therefore has to establish (on the balance of probabilities) that the warranty was untrue and breached, the breach directly or indirectly caused loss, and the loss is not too remote and was in the reasonable contemplation of the parties.
Remoteness can make a breach of warranty claim difficult in practice, particularly where there is a claim for loss of profit. A court may conclude that the loss, or the extent of the loss, did not follow naturally from the breach of warranty and was not in the reasonable contemplation of the seller and the buyer at the time of entry into the SPA.
By comparison, when claiming for loss arising under an indemnity, the buyer will need to establish the fact of the loss and the quantum, but will not need to demonstrate that the loss was caused by the person who gave the indemnity. From a buyer’s perspective, this makes an indemnity a valuable alternative to a warranty where specific risks or liabilities are identified as part of the due diligence exercise.
Seller protections
There is no “one size fits all” package of limitations on the seller’s liability under the SPA as each transaction will be shaped by the specific commercial dynamics of that particular deal. However, in practice the parties are likely to agree something along the following lines.
Certain warranties, such as fundamental warranties relating to title or a seller’s capacity to contract, will be capped at the overall consideration for the deal. Subject to the type of parties involved and the commercial or competitive pressures of the deal, there will be a different cap on liability for other warranty breaches. For a corporate real estate transaction this will likely be capped somewhere in the range of 15% to 30% of the overall consideration. The general warranties will likely have a duration of 18 months to two years while tax warranties will have a life span of four to six years. There will also be minimum thresholds that have to be reached before a claim can be made to stamp out vexatious claims brought by the buyer.
The seller will be permitted to fairly disclose any matter that is inconsistent with the warranties. The buyer must ensure that such disclosure is sufficiently detailed so that a view can be taken on liabilities the buyer may inherit.
Coverage of warranties
CPRE transaction warranties relating to a target group will usually cover, among other things:
- Establishment and incorporation of the target group
- Good title to the relevant shares, units or partner interests being transferred
- Compliance with law and regulation
- Accounts and liabilities
- Employees, pensions and benefits
- Tax
- Insolvency
- Litigation, disputes or investigations
- Intellectual property rights
The final article in this series – on corporate real estate joint ventures – will appear in next week’s EG
Paul Chases is a senior associate and head of corporate real estate at Herbert Smith Freehills LLP
