In a M&A transactions, it is essential to map all contingencies of the target company, through complete due diligence.
However, there are situations in which some contingencies are not possible to be identified until the closing of the Share Purchase Agreement (SPA), or even if they are, it is not possible to quantify them precisely.
This is why a special care must be taken with the contingency and indemnity clause, thus preventing the buyer from ending up assuming an unknown liability, or on other occasions turning their investment into a loss.
We highlight 4 key points of attention and alternatives to mitigate the risks of these clauses:
1. Identification of Liabilities: Once due diligence has been completed, the buyer must objectively list the liabilities identified in the SPA, and whenever possible limit the related values. In these cases, there must already be an express clause on the seller’s responsibility, including the possibility of discounting and/or offsetting future installment payments.
2. Delimitation of Responsibilities: It is important to delimit the responsibility of each party for the company’s identified liabilities, which can be fully assumed by the buyer or distributed between the buyer and seller, based on a time frame or the nature of the liability. Furthermore, liability for unidentified liabilities, but which may materialize after the closing of the transaction, also needs to be foreseen, according to the nature of the business. It is common, in these cases, for losses whose triggering event occurred prior to the signing of the SPA to be entirely the responsibility of the seller.
3. Limitation of Indemnities: Criteria for limiting indemnity amounts can be established in the SPA, and the following concepts can be used: (i) De minimis: restricts the duty to indemnify irrelevant liabilities; (ii) Basket: duty to compensate occurs when a certain value is reached; (iii) Cap: maximum limitation of the compensation to be paid; and (iv) Temporal Scale: duty to be compensated is limited to a certain period after the closing of the transaction.
4. Creation of Escrow Account: In cases where the identified liability is representative, it is possible to establish the obligation to create an Escrow account, in which certain price payment amounts will be blocked, being released to the buyer as the period of payment has elapsed. De constitution of the identified liability or reaching any other trigger established by the parties. In these cases, it is essential that the values are indicated in advance and objectively.
To operationalize these points, it is essential to determine in the SPA the procedures for notifying and conducting contingency processes, such as who will conduct it, who will bear the expenses, and how guarantees will be provided, bringing greater security to the parties.
The preparation of the SPA is an extremely complex process, which requires mutual effort from the parties involved to align each of the provisions. The highlighted points must be structured according to the particularities of each operation, eliminating possible doubts and future discussions between the parties involved.
