There are a number of reasons why parties to a joint venture might prefer a purely contractual arrangement (rather than establishing a separate legal entity in which they invest):
- The parties may prefer to retain control over their own assets, business and employees, rather than transferring them to a joint venture vehicle.
- There will be fewer administrative and filing requirements when establishing a purely contractual arrangement.
- A contractual joint venture avoids the relative formality and permanence of a corporate structure. A purely contractual arrangement is likely to be easier to terminate and unwind than a joint venture operated through a separate legal entity.
- A contractual joint venture has no effect on the direct taxation of the joint venture parties as there is no transfer of their respective businesses to a separate legal entity.
Types of contractual joint venture
The term contractual joint venture covers a number of different types of unincorporated venture. Examples of where a purely contractual arrangement might be used include:
- Research and development or technology collaborations.
- Joint tenders for a particular project under a bidding or consortium agreement.
- Construction or property development projects.
- Resource sharing arrangements.
- The development of a new product.
- Strategic alliances.
- Projects where the participants make their contributions at different stages of the project.
Purpose of the venture
The parties should each be clear from the outset as to the main aims of the venture as this will determine what the contractual obligations between them ought to be:
- What is the main or sole purpose of the venture?
- Is the purpose of the venture to carry out a specific project, for example to tender for a particular project or the development of a specific property?
- Is it intended that the project will be ongoing for an unlimited period of time?
- What are the parties’ commercial and strategic objectives?
We are now well into the school summer holidays which, in my experience, has two effects on the legal sector, particularly insolvency. The first is that a good many key decision makers, be they licensed insolvency practitioners, directors of distressed companies or those facing significant individual debt problems, go on holiday and, understandably, do not think about their legal matters or obligations. The other effect is that those who are left behind in the office have to deal with even more work than usual, and cover for their colleagues’ or clients’ absence.
However, if you are an individual faced with debt problems or indeed a director/sole trader/partner of a business that is facing significant problems, the holiday period is likely to be one of the most dangerous times to ignore the troubles and hope they will go away. Those who are owed money are unlikely to accept being fobbed off with explanations for a delay in payment due to holidays, or lack of response to their Letters of Claim for the same reason. The Courts are still open and operating (albeit on shorter hours), process servers and bailiffs are still visiting premises and serving bankruptcy and winding-up petitions or removing goods as part payment towards debts, and the banks are still functioning.
While appointment takers from licensed insolvency practitioner offices may be absent, they will not have left the office unattended. Their partners will still be present, and their senior managers more than capable of assisting you when restructuring your debts and moving forward. The same applies to law firms, of course, though it may take them slightly longer than they would wish to respond to your requests for help.
Therefore, while the temptation to ignore your problems and enjoy your holiday might be overwhelmingly tempting, do not think that the holiday period is a sufficient excuse that no action will be taken against you as a result. If you need assistance, I would urge you to either contact this firm or a licensed insolvency practitioner who is a member of R3, the Association of Business Recovery Professionals, whose website address is www.r3.org.uk
0117 9453 044
The Disclosure Letter is a critical document in any acquisition of the shares of a private company. Sellers that do not make adequate disclosures expose themselves to potential claims for breach of warranties, whilst a Purchaser that does not treat the exercise with significant care may take on liabilities which it could otherwise have avoided. By accepting disclosures made by way of a Disclosure Letter, the Purchaser accepts the commercial risks from the matters disclosed.
1. Reasons for using a Disclosure Letter
The Sale Agreement will normally provide that no liability shall attach to the Sellers, in respect of what would otherwise be a breach of warranty, to the extent that the circumstances constituting the breach are disclosed to the Purchaser in the Disclosure Letter. It will inevitably be the case that no company is in such a perfect condition that the Sellers can give all warranties in an unqualified form. The Sellers (with their professional advisors), will need to consider each and every warranty in detail and the implications of that warranty upon the business. Carefully worded disclosures will be needed to qualify liability under the warranties. This will usually be accompanied by a substantial amount of relevant documentary information, much of which may already have been supplied in connection with the replies to the Purchaser’s due diligence enquires.
2. Examples of standard disclosures
If one takes the common items which appear in the warranties, there are certain areas where the Sellers’ solicitors would always be looking to prompt the Sellers to consider possible disclosures. The most common area relate to ownership of assets, litigation and taxation. There is also almost always a warranty to the effect that the assets of the Company are the unencumbered absolute property of the Company. This particular warranty could give rise to three possible sets of disclosures: (1) There could be retention of title provisions affecting materials or goods purchased from a third party; (2) There could be a charge over all assets to secure bank borrowings; and (3) There could be assets used in the business which are subject to a lease, purchase, lease or hire purchase agreement.
Details of these exceptions to the warranties should be disclosed and copies of any relevant documents supplied.
The litigation element could involve contractual disputes with suppliers, warranty claims being made by customers or litigation with former members of staff. In the case of taxation, there will almost always be something to disclose as an exception to the warranties, which normally requires the Sellers to state that all tax returns are submitted and are up to date, and that all liabilities have been agreed. Drafting of the appropriate disclosures will, of course, require the input of solicitors/accountants.
In buying the shares of a target company, a Purchaser cannot avoid taking over the liabilities and commitments of that company. It is therefore normal for a Purchaser of a private company to receive assurances in the form of statements of fact as to those liabilities and commitments. These assurances, in legal terms, take the form of warranties which, if breached, will give rise to a claim for damages against the Sellers by the Purchaser.
There are five main ways of mitigating the potential liabilities of the Sellers. These are to:
- negotiate the extent and detail of the warranties;
- negotiate the basis of liability;
- include specific exceptions;
- include Sellers’ protections; and
- take out warranty insurance cover.
Each of these categories is examined below.
1. Negotiation of warranties
It is common for the warranties schedule (which is initially prepared by the Purchaser’s solicitors) to form the bulk of the Sale Agreement, sometimes running to 40 or 50 pages in length. However, there is obviously a limit to the degree of comfort which a Purchaser can reasonably expect to receive. In acting for the Sellers in reviewing a warranties schedule, the Sellers’ solicitors will need to assess in relation to each warranty what the Sellers can reasonably be expected to give. Some warranties are included merely to confirm or establish factual detail, but others which are onerous should be deleted in full or be sufficiently watered down. It is critical that the drafting of each of the warranties is precise, so that their meaning and effect is clear and fully understood by the Sellers required to give the warranties.
The Sellers should be able, and will be required to warrant certain statements of fact (for example, that the company is not involved in litigation). At the other end of the spectrum are warranties which are either more subjective (for example, has the company sufficient working capital) or which seek to commit the Sellers to warrant forward into the future (for example, the accuracy of a profit forecast). In both these cases, the Purchaser cannot expect the Sellers to give the warranties in such loose terms. What the Purchaser can expect the Sellers to do in such circumstances is to provide full and up to date details and copies of all relevant information, so that the Purchaser can form its own views. Ultimately, if the issue cannot be resolved through the respective parties’ solicitors, it will be a commercial decision for either the Sellers or the Purchaser as to whether, or in what form, the warranty is included.
This guide considers the legal aspects of due diligence from two angles:-
- The process of legal due diligence; and
- The legal issues in general relating to a due diligence exercise.
Due Diligence is carried out by the Purchaser and its advisers and, as such, these notes necessarily concentrate on the Purchaser’s position. However, the Sellers’ perspective is also considered below.
2. Relations with other advisers
The Purchaser’s solicitors will need to be informed of the other professionals with whom they will be working, and the ambit of each of their investigations. They will also need to be told of any due diligence which the Purchaser will be undertaking itself. These are obvious points, but the last thing the Purchaser will want is the duplication of work and costs.
Where more than one professional is involved, it is perhaps inevitable that the Sellers will face requests for the same information from different sources. This can be irritating, but the problem can be avoided by good communications (at the outset and throughout), and the circulation of information between the Purchaser’s different advisers.
3. Why undertake legal due diligence?
A common reaction is that this process will inevitably cost a significant amount and only tell the Purchaser something it already knows. But there are strong arguments in favour of a legal due diligence programme:-
- Prior knowledge is better than litigation;
- Possible discovery of attempts to deliberately conceal information by the Sellers;
- Necessary consents and releases will be identified; and
- Possible discovery of previously unidentified problems.
It is possible for a Purchaser to buy a company relying just on warranties and indemnities and what the Sellers are prepared to disclose to the Purchaser against the warranties in the formal Disclosure Letter. However, if things go wrong, the Sellers have the money, and the Purchaser faces the costs and the uncertainty of bringing its case to court. Litigation can also be time consuming and if the Sellers are individuals who have taken their assets abroad, there can be many obstacles to a successful claim.
The extent to which a business relies on its intellectual property rights (“IPRs”) will inevitably depend on the nature of the business.
However, the increasing dependence of business on technology means that this is an area which must always be considered when a business is sold. In cases where the business enjoys substantial revenues from the exploitation of IPRs, the value of these intangible assets may well exceed that of the tangible assets.
This guide considers the legal aspects of IPRs on the sale of a business principally from the perspective of a Purchaser, since it is the Purchaser who will be concerned to ensure that all relevant IPRs will continue to be available to the ongoing business. From the Seller’s point of view, the subject of valuation of IPRs may only surface when a disposal is imminent. The Purchaser will generally wish to carry out an independent IPR audit, including making relevant searches, in addition to the protection derived from the Sellers’ warranties.
2. Forms of IPRs
The range of IPRs which need to be considered on the sale of a business are:
- Trade marks/service marks;
- Design rights;
- Copyright; and
- Trade secrets and confidential information generally.
3. Intellectual Property Issues
Matters which need to be established on the acquisition of a business include:
- what IPRs are used in the business?
- which of these are critical to the business?
- who owns those IPRs?
- are there any restrictions on the use of any IPRs in the business?
- which IPRs are registered and which are unregistered?
- are the unregistered IPRs registrable?
Sellers who decide that they wish to sell their business have a choice of options over which a Purchaser may or may not be able to exert influence. Sellers can either choose to sell the assets of their business or, more commonly, they can sell their shares in the company which owns those assets. The purchase of an established business is likely to be a very involved process. At the outset, Purchasers need to prepare themselves to deal with a substantial amount of detailed and lengthy documentation. A significant amount of the Purchaser’s management time is also likely to be taken up, although establishing good reporting structures and lines of communication with all its professional advisors at an early stage, will reap benefits later.
Whether or not the Purchaser’s solicitors get involved with negotiating the transaction will depend very much upon the relationship they have with the Purchaser, or whether the Purchaser has an independent financial advisor. In any event, the Purchaser’s solicitors will benefit from being involved in a transaction from as early as possible, simply because the deal may otherwise incorporate terms which are difficult, if not impossible, to perform for legal reasons. In those circumstances, the deal will inevitably have to be re-negotiated at a later stage.
2. Heads of Agreement
The main terms of a transaction are sometimes set out in a Heads of Agreement. These can be useful and will usually be binding to a certain extent, leaving time for other elements of the deal to be negotiated. The binding obligations could well be not to negotiate with any third party during a particular period, to allow the Purchaser full access for investigation, and to negotiate in good faith with a view to achieving completion by a particular date. Purchasers sometimes like Heads of Agreement to be executed, even if non-binding, since this is regarded as the moral commitment by the Sellers to sell the target company, and thus justifies the Purchaser’s expense of proceeding with its initial investigations.
3. Due Diligence
In the vast majority of cases, the main purpose of the transaction is the acquisition of the underlying business of the target company, and its continuation as a successful going concern. To do this, the Purchaser will want to satisfy itself that it has made a thorough enquiry into the financial aspects of the business, its profitability (or the reasons for its lack of profitability) and the prospects for the future of the business. It will want to ensure that the business can be carried on, should it so wish, in the same manner as it was by the Sellers, once it is under its control.