What Is a Share Purchase Agreement?
A share purchase agreement (SPA) is a legal agreement between a buyer and seller in respect of shares in a company. The buyer agrees to purchase shares from a seller who is selling its shares in the company to the buyer. The purpose of a share purchase agreement is to confirm that the buyer is going to purchase from the seller the seller’s shareholdings in the company, for a certain purchase price and on certain terms and conditions.
A typical initial representation in an SPA would be that a party entering into an SPA, being a shareholder in a company, is the registered shareholder of the shares in issue in the company as set out in the Schedule attached to the SPA.
A share purchase agreement is different from a purchase agreement for the assets of a company (asset sale) in that in a share purchase agreement the purchase is of the shares of a company and not the underlying assets. An asset purchase agreement would typically include a list of assets being purchased by the buyer with a corresponding list of assets that are excluded. For example, the buyer would be purchasing the corporate assets of the company listed in the SPA and not the assets such as bank accounts, money, letting property, trade marks, goodwill and other agreements, bonds/government bonds issued, book debts, customer lists, goodwill, concessions, business, stocks, etc . The SPA confirms that the sale price of the shares includes all the assets in the company and if the buyer is unhappy with any of the assets, then it should decline to enter into the purchase.
A share purchase agreement would need to contain other information including details such as (i) the names of the parties (ii) a recital explaining the context of the agreement, including the consideration, (iii) the number of shares and the parties’ names (the purchaser and seller), (iv) the particulars of the company by name and registration number, (v) the purchase price (cash and/or shares), (vi) the effective date, (vii) assignment rights, and (viii) warranties or representations.
The inclusion of warranties in a SPA is of critical importance to the seller. The seller will wish to ensure that the warranties protect them and require the buyer to indemnify the seller in the event the warranties are incorrect. Warranties, or representations and warranties, are often relatively short and simple statements confirming basic facts about the company being sold. They typically avoid legal jargon and are written in plain English. Examples of warranties are: ownership of all material assets in the company and no legal claim against company assets.
Share purchase agreements are critical in the sale of a business in Canada. They assist to protect the assets, value, and history of the company being sold.
Key Components of a Share Purchase Agreement
There are a number of key elements that are almost always included in a Canadian share purchase agreement. These include the purchase price and adjustment to the purchase price, conditions of closing, representations and warranties, indemnities, baskets and escrows, adjustments for post-closing income taxes, intellectual property and confidentiality.
1. Purchase Price
The agreement will set out the purchase price to be paid for the shares being sold either as a fixed dollar amount or by using a formula (e.g., multiple of revenue or EBITDA). The purchase price may be payable on the date of closing in cash, with the balance being satisfied by the issue of promissory notes with interest or payable in installments over a number of years with interest. Deposits will be subject to the conditions of release set out in the agreement, and a break fee if they are released and the transaction does not close.
Any adjustments to the purchase price will be set out in the agreement. The parties will agree on the date at which a variety of economic factors will be assessed in order to determine the final purchase price, for example, net debt, current assets and liabilities and working capital. The agreement may also allocate various tax attributes to the purchase price such as surplus tax accounts, non-capital loss carryforwards, investment tax credit carryforwards, scientific research and experimental development expenditures, etc.
2. Conditions of Closing
The agreement will state the conditions that must be satisfied in order for the parties to proceed with closing the transaction. Typically, these include obtaining all necessary consents, confirmations, approvals and orders (such as obtaining approval under the Competition Act) and the completion and delivery of all documents, certificates and opinions required.
3. Representations and Warranties
The parties will provide each other with their respective representations and warranties in the agreement. Generally, the seller will provide more representations and warranties than the buyer. The representations and warranties should be as specific and as broad as possible, and should cover all aspects of the target’s business (or parcel of real estate). For example, the representations and warranties may include: title to shares, subsistence, trade names, title to assets, intellectual property, confidentiality, environmental matters, leases, trade secrets and any lawsuits that are pending or threatened.
4. Indemnities
Indemnity provisions covering claims made after closing are common. The agreement will specify which representations and warranties are indemnified by the seller and any limitations on the amount of liability. The seller may also cap its total liabilities at an amount that may represent a significant percentage of the purchase price or an aggregate limit (larger amounts are now being capped with respect to environmental claims). The dollar amounts should be clearly set out. The indemnities should also identify the circumstances giving rise to the claim (i.e., whether or not the it has to have been previously disclosed in the disclosure schedule), the threshold of loss before an indemnity applies and any caps on indemnification (which may vary from category to category). The parties should consult their accountants to provide reasonable estimates of any taxes, loss of relief from tax, tax attributes and accounting treatment applicable to the parties.
5. Baskets and Escrows
Baskets come in two varieties. A "deductible basket" means that the buyer is only indemnified if it has incurred losses over a specified dollar amount before it may seek indemnification. An "aggregate basket" means that the buyer is only indemnified if its losses total a specified amount, so that it may recover damages in respect of the total loss rather than on a claim-by-claim basis. These baskets are designed to shift a portion of the business risks to the buyer (e.g., litigation from past actions, contingent liabilities, unquantified losses), whereas escrows serve to protect the buyer from the risk that the seller may not be able to respond to existing and future claims. An escrow involves a partial holdback of the purchase price until after closing. The escrow is held in trust by a third party. This allows the claimants to make claims directly against the escrow; thus, the shares continue to be held for the benefit of the buyer so that they are available as a remedy. The amount held in escrow is a compromise between the seller, who wants the entire purchase price paid on the closing date, and the buyer, who wants to cover itself against subsequent claims.
Legal Implications in Canada
A share purchase agreement (SPA) in Canada must comply with both federal and provincial laws. In particular, the SPA and associated closing items need to be considered in light of Canadian laws governing corporate law and mergers and acquisitions, income tax laws, securities law and, if the parties or any of the involved entities are foreign, foreign investment regulations.
All SPAs should be reviewed for compliance with provisions of the relevant corporate statute (e.g., the Canada Business Corporations Act (CBCA), the business corporation acts of each of the provinces and territories of Canada, the Canada Not-for-profit Corporations Act (NFP Act) and the Ontario Not-for-Profit Corporations Act, 2010 (ONCA)) based on the jurisdiction where the target (the vendor in the case of a share sale) is incorporated. The relevant corporate statute involves requirements respecting documents such as articles, by-laws, corporate organization, corporate procedure, director/trustee appointments and removals, restrictions on powers, issuance and transfer of shares and maintenance of a shareholders register. Particularly where the parties to the agreement are private corporations organized under one of the provincial statutes, the parties do not have the protections of – and are not subject to – the CBCA, so compliance with corporate statutes often comes down to the provinces in which the parties are organized.
In addition, SPAs must be reviewed against merger control legislation, income tax law, securities law and, depending on the residency of the buyer, the seller or the target, foreign investment regulations.
Merger control legislation
The federal Competition Act, RSC 1970, c C-23 (as amended), governs the legal requirements in Canada with respect to corporate takeovers. Section 109 of the act requires that where an acquirer (or group of acquirers) makes an acquisition of voting shares in an issuer with a value of more than $5 million (and the acquirer is not in control of that issuer and is not an affiliate), prior notification must be filed with the Commissioner of Competition at the Competition Bureau. In addition, prior review by the Commissioner is required where the aggregate value of the assets or voting shares of all entities that the acquirer controls (or has an interest of more than 10%, 20% or a combination of the two, as specified in the act) exceeds $88 million. The thresholds for notification are adjusted annually (the most recent adjustment having been made on February 1, 2019).
Where the transaction is not a "reviewable transaction" under the act (i.e., where the competition authorities have not prohibited it), an application must be filed with the Competition Bureau for an advance ruling certificate (ARC) respecting the proposed acquisition, or a no-action letter, within a specified period after the transaction is completed to prevent it from being subject to a winding-up order in the event that the transaction is found to have substantially lessened or to prevent a diminution of, competition in a market for a product or service, or otherwise negatively affect the public interest. The prescribed period is 30 days except for complex mergers in which case the prescribed period is extended to 30 days after the day set by the Bureau as the day when it receives sufficient material to determine if the transaction will substantially lessen or prevent a diminution of, competition or otherwise negatively affect the public interest. To qualify for an ARC, the proposed transaction should not create, maintain or strengthen, or be likely to result in, a position of substantial or complete control over a product or service market.
Advance tax rulings
Generally, there is no requirement to obtain an advance tax ruling in Canada with respect to a share purchase agreement unless the parties wish to receive certainty from the Canada Revenue Agency (CRA) respecting the anticipated tax implications of the structure of the transaction. The CRA’s advance ruling service is available to taxpayers in unusual or difficult transactions and where it is impossible or impractical to obtain an answer through other means or where the taxpayer is uncertain about the tax consequences of the proposed transaction. Many of the typical advance ruling requests respect land transfer issues, international taxation issues and cross-border taxation agreements.
Securities Law
Securities law in Canada is complex owing to the nature of the Canadian capital markets. The Canadian Securities Administrators (CSA) established a concept known as the "local market rule" (in effect since August 2006). In general, this rule is to the effect that Canadian issuers of securities are subject to the requirements of the laws of the province or territory in which they are based. Relatedly, any trade or distribution of securities may be subject to the securities laws of the province or territory where the purchaser is located. As a result, the SPA can be affected by securities law where the purchaser is in a jurisdiction other than the home jurisdiction of the vendor, the target or the zones in which the transaction is taking place. Further, if the buyer is non-resident, the SPA may be subject to local foreign investment regulations.
Negotiating a Share Purchase Agreement
Negotiating a Share Purchase Agreement in Canada is an essential step in the process of becoming an owner of a corporation. It is ultimately about coming to a formal agreement by which a purchaser will buy shares of a corporation from one or more vendors. The starting point for this agreement will be an offer made from a purchaser to a vendor. Once an offer has been put out there, the vendor will provide a response, oftentimes in the form of a counter-offer. From there, the back and forth of negotiation pervades until a mutually acceptable agreement is reached. As with any type of business transaction, the goal should be to reach an agreement that is fair to both sides.
In the case of negotiating a share purchase agreement, the entire process hinges on the information provided within a business valuation. This assessment will outline the values of the existing shares in the business being sold, along with the values of any other company-related assets that have been owned and maintained by the vendor. This information will ultimately provide information related to the value of the whole business itself , which will make the process of negotiating a share purchase agreement much easier.
One area where negotiations can become complicated is when the purchaser is trying to acquire a business that hasn’t been thoroughly documented, such as an oral or implied agreement or a handshake deal. If no real records have been kept, the absence of documentation will lead to uncertainty. These types of purchases will be based heavily on the business valuation, which is derived heavily out of projections of future growth and profitability. Because of this, there is a greater potential of a dispute arising during negotiations. It will be up to the parties in the transaction to evaluate the worth of a company such as this and come to an agreement.
To navigate the negotiation of a share purchase agreement successfully, all parties will need to involve legal representatives, who will do their best to reach a deal that works for you. The legal advisors will use their knowledge of the corporate laws in Canada to help complete an effective agreement in a timely manner.
Common Issues and How to Overcome Them
Even the most straightforward share purchase agreement can be run through with red ink by parties that fail to understand their rights and obligations under the agreement, regularly negating the benefits of weeks of negotiation. To avoid disputes over the language of the provisions in the share purchase agreement, proper discussions should be undertaken prior to drafting the agreement so that the parties are on the same page. Beyond this, here are some tips and best practices to keep in mind to avoid common issues that arise when preparing, negotiating or executing a share purchase agreement: The complexities of a share purchase transaction are sometimes elusive to parties which leads to misunderstandings and objections. A deal that looks simple may raise unexpected and expensive objections from a shareholder later on. Thus, sellers and buyers alike should consult with professionals.
How a Lawyer Can Assist with Share Purchase Agreements
The role of a lawyer in share purchase agreements is to ensure that the purchase agreement is drafted and reviewed properly considering as many of the potential issues in the transaction as possible. Doing so before the parties spend significant amounts of resources on the transaction prevents the wasted costs typically incurred when parties have to abort a transaction or try to recover funds from the other side. A lawyer will typically have experience preparing and negotiating similar share purchase agreement’s so, thus, be able to spot common potential issues that the purchaser may be exposed to such as:
As part of the process, a lawyer will also typically be in a position to confirm that members of the other side are who they say they are. As an example, the company issuing the shares or its nominees should have their own lawyers that are able to provide documentation confirming that the individuals being introduced to the purchaser or its advisors do, indeed, have proper authority to act on behalf of the vendor .
A lawyer is also typically involved in preparing or at least assisting in the preparation of most other documents needing attention for the transaction to be completed. Often, even non-legal issues such as representations of the vendor and the writing necessary to allow one party to breach the contract without penalty if, for example, any representation or other critical part of the contract is found to be incorrect (the representations and warranties), often involve substantial involvement of lawyers.
In addition to providing legal advice typically solicited in advance of a closing date, lawyers may also be asked to oversee the closing procedure to ensure that the closing is conducted in a proper manner so as to prevent incidents of fraud or errors.