In business transactions, Share Purchase Agreements (SPAs) are essential for smooth company ownership transfers. However, without a specialist corporate lawyer, even minor mistakes can jeopardise the entire deal. Oversights in crafting precise payment terms or missing layers of protection can unravel a transaction in no time.
This article explores a situation where Threadneedle was brought in by the buyer 12 months after the acquisition to help fix a deal gone wrong. By initially working with an inexperienced advisor there was a huge fallout for the buyer (and for the original buy-side legal advisor) due to numerous avoidable errors.
Ignoring Red Flags in the Due Diligence Process
Diligence and disclosure may seem dull, but overlooking details can be costly. In the SPA's disclosure letter, the seller mentioned an HMRC investigation regarding the target’s auto-enrolment pension. However, the buyer's lawyer failed to probe further, simply relying on the tax covenant to cover any potential tax liabilities. This demonstrates a misunderstanding of the diligence and disclosure process, where the primary aim is to flush out and gain a clear understanding of key risks.
Proper diligence and a review of the underlying correspondence from HMRC would have revealed the target was actually being investigated for tax fraud. The buyer later confirmed they would have abandoned the deal altogether had they known this.
Limitations of Liability Incorrectly Applied to Tax Covenant Claims
To an M&A lawyer, this next error was mind-blowing. Typically, under a tax covenant, the seller is responsible for the target's pre-completion tax liabilities without any minimum claim value. However, in this SPA (involving a £4 million business sale), instead of setting a £1m cap on tax indemnity claims (an intention evidenced by email chains), a £1m threshold was mistakenly added by the buyer’s lawyer (and not corrected by the sell-side).
This meant that the buyer could only bring a tax indemnity claim if it exceeded £1m in value, i.e., the buyer would have to swallow up to £1m of pre-completion tax liabilities. This became problematic a year later when the buyer had grounds to make a claim due to HMRC’s tax fraud investigation.
Set-off of Deferred Consideration
This one was a bit more subtle but really came back to bite the buyer. While the SPA allowed the buyer to offset future payments against certain SPA claims, it only applied if a court had "finally determined" that claim.
Since the tax claim came from HMRC, not a court, and the SPA hadn’t been drafted to capture tax authority and regulator fines and penalties, the buyer had no right to offset tax covenant liabilities against a large deferred consideration payment. The buyer had no faith they would see the money again if they paid the seller and then made the indemnity claim through the courts. So they didn’t pay and tried to rely on the set-off provision.
Change of Control and Acceleration of Deferred Consideration
After completion, the buyer (controlled by a JV of three investors) faced issues when one investor left, causing a technical buyer change of control. As is standard under the terms of an SPA, this allowed the seller to demand immediate payment in full of the deferred consideration. While the seller initially showed no intention to enforce this, the buyer’s lawyer should have advised the buyer to obtain the seller’s written waiver (as mere delay in enforcing a right does not constitute a waiver of that right).
A year later, due to the tax fraud investigation and ensuing conflicts, the seller relied on the change of control trigger to demand full payment. When it wasn’t paid, the seller enforced the share charge given as security for the deferred consideration and took back control of the target company.
Conclusion
Astonishingly, all these issues came from one poorly written SPA. There were further problems, but the word count of this article means we must stop here! How did this happen, you may ask. It turned out that the buyer had instructed a direct access employment barrister who fancied themselves as an investor and a dab hand with SPAs. Though the SPA seemed “standard”, it had various mistakes and errors of judgement.
This is a cautionary tale for advisors biting off more than they can – or should – chew as the barrister now faces a negligence claim. Their actions ultimately resulted in the buyer acquiring a company it should never have bought and then losing control of it when the seller took back the shares. Now the buyer faces an expensive legal battle for damages, all of which could have been avoided with the right legal guidance from the start.
How Can We Help?
Laura Brunnen, founder of Threadneedle Law, has over 20 years of top-level M&A corporate law experience, and knows when to enhance legal safeguards. At Threadneedle Law we offer a familiar level of professionalism and insight without the red tape. If you're an astute corporate exec or business leader who understands the value of working with an experienced, quality legal adviser who delivers swift solutions and a bespoke approach with a human touch, contact us on info@threadneedle.law
For further information or to discuss potential share sales or purchase price adjustments, please contact laura@threadneedle.law or visit www.threadneedle.law
