The Private Share Purchase Agreement: Basics and Best Practices

Defining Private Share Purchase Agreements

A private share purchase agreement is a contract between a buyer and a seller of shares in a company. The buyer agrees to purchase the shares from the seller, and the seller agrees to sell them. Private share purchase agreements are typically used in sales of relatively small numbers of shares, or for smaller stakes in large businesses. In other words, when a small number of shares are acquired for investment purposes, or to acquire minority, not majority, interests in a company, private share purchase agreements are common.
For example, in connection with an initial public offering of shares in a company , the founders and early investors will typically agree to a private share purchase agreement to effect the transfer of some of their shares to a private investor or their company’s investment banker. This provides liquidity to those early shareholders while not overwhelming the market with shares that would tend to drive the price down.
Private share purchase agreements may also be used to launch a new business or division in a larger company by acquiring shares of existing companies or divisions. Suppose a group of employees want to launch a new video travel company that has been incubating in one division of a large publishing company. They may agree to a private share purchase transaction to acquire the assets of the new company from the large publishing company.
Private share purchase agreements may only involve the straightforward transfer of shares, or they may be consummated as part of a larger transaction involving a business asset purchase and/or a debt finance transaction.

Elements of a Private Share Purchase Agreement

The private share purchase agreement encompasses the understanding struck between the purchasing party and the selling shareholders. In instances where the shares are being sold by the selling shareholders to another party, the private share purchase agreement contains information regarding the compensation the shareholders will receive for the shares. It also details the provisions that will regulate the purchase and the manner in which the stock will be transferred. The parties involved include the purchasers and sellers as well as the corporation which is transferring the shares. It also extends to shareholders which any corporation has. Parentheses in the agreement can be placed around the name of the seller of shares to indicate they are joint sellers. The purchase price is the amount that is necessary for the purchaser to pay the seller for the transfer of shares. This may include promissory notes, cash and/or property/exemptions. This amount can be used to settle claims against the corporation or it can be paid directly to the seller. There are even instances where the seller is permitted to keep the shares as collateral for the loan. The terms of payment are the discrete particulars deciding how the seller is being compensated for the shares. The payment from the purchaser to the seller for the stock can be made in installments or through lump sum as a cash transaction. Everything from the amount to the method of payment is decided by the shareholder and is included in the private share purchase agreement.

Key Legal Considerations in Drafting

Due diligence and appropriate commercial arrangements are fundamental to a well drafted private share purchase agreement. However, both parties to the transaction must also consider the following legal issues when negotiating the terms of their private share purchase agreement:
Regulatory compliance
The legal position in relation to taxation, foreign investment, competition/environmental/labour/financial services laws, currency movement restrictions and industry sector regulations are all relevant to the form of the transaction itself or the content of the share purchase agreement, and/or the terms for the completion of the proposed transaction.
Appropriate legal and financial advice should be sought to ensure that compliance with these requirements occurs early in the transaction timetable to avoid delay or future disagreements over obligations. For example, security clearances may be required before an entity can give effect to an acquisition.
Tax issues
Parties should consider the taxation implications that accrue from an acquisition and the nature of the transaction (asset based or share purchase). This will include GST, CGT, stamp duty, FBT, land tax and income tax laws and considerations.
Timing
If due diligence is required before a share purchase transaction can be completed, the parties should consider the anticipated period of time required to carry out and complete this process. Although a share purchase transaction can often be completed more quickly than an asset based acquisition where specific regulatory approvals are required, the conditions for a technical breach of contract claim may nevertheless need to be negotiated at the outset and become a consideration for certain material changes to the transaction in light of the due diligence outcome. This may require additional time to be built in for the transaction timetable.
Indemnity caps
The parties should consider whether indemnities for specific areas of concern should be agreed, if particular warranties or other provisions are agreed to. The parties should also determine the extent of liability for breaches of all warranties, and the method of determining such liability.
Other legal issues
Consideration should also be given (but only where applicable) to other terms of a share purchase agreement including any concurrent sale of business, confidentiality and restraint of trade issues, payment terms, dispute resolution procedures, severability, assignment and force majeure.

Negotiating the Deal: Tips for Buyers and Sellers

Effective negotiation is essential to a successful private share purchase agreement. Both buyers and sellers must understand their positions and remain flexible during the process to enable fairness and equity between the parties.
The buyer’s main concern is to ensure that they are not acquiring any unanticipated liabilities (tax or other) and to confirm that they are receiving the business that they perceive they are purchasing. The seller wants to maximize the amount they are receiving while minimizing any liabilities post closing. Where the parties have established a degree of trust can go a long way in minimising potential post purchase issues, but where trust is lacking they should consider common law related measures and additional protections, such as clauses restricting the information the vendor may disclose to competing companies and persons, and restrictive covenant provisions to minimise post closing competition or "theft" of key employees.
Carefully assessing favourable tax treatments is critical to both parties and such treatments can significantly impact the main objectives of both the buyer and seller. One method of reducing tax exposure is the rollover procedure which defers the capital gains tax liability. Timing of the deal can also affect the tax treatment and therefore the price. All of these factors, among others, must be considered during negotiations.

Common Provisions in Share Purchase Agreements

When it comes to investing in a private company, it is important to understand the different roles of the parties to a share purchase agreement and the relationship the share purchase agreement has to those parties. Before contemplating a share purchase agreement, the investor should consider the different roles that the parties are going to have with each other and to third parties, since those roles will play an important part in structuring the deal.
The most common clauses included in a share purchase agreement are representations and warranties, indemnities, and covenant agreements.
Representations and warranties are contractual statements made by the vendor (the seller) about the assets and liabilities of the business on the date the agreement is signed (the date of purchase).
Indemnification clauses are contractual commitments by the vendor to "save harmless" the purchaser for losses resulting from breaches of the representation and warranties . Indemnification clauses may also be used for other specific matters or events such as taxes, litigation, environmental, or intellectual property. It is common for the purchaser to require security for the indemnification clause, either through escrowing all or a portion of the purchase price or by retaining an agent or escrow agent that will hold the funds for a certain period after the date of purchase.
Covenant agreements, which are also known as non-competition, non-solicitation, and confidentiality agreements, may be included in all share purchase agreements. They are most commonly used when the vendor has existing relationships with the customers and suppliers of the business. A typical covenant agreement would preclude the vendor from competing with the business for a certain period of time. The duration of the covenant agreement will depend on the nature of the business being purchased and the relationships the vendor has with customers, suppliers and employees of the business.

Pitfalls to Avoid in Share Purchase Agreements

Good faith negotiations are often subverted by confusing terms, legal jargon and poorly defined expectations. This is especially true in private share purchase agreements if buyers and sellers are unable to identify the key terms of the deal, and the assurances or protections that the sale promises to either party. In a private share purchase agreement, the seller has an obligation to sell its shares in the target company to the buyer on the conditions set out in the agreement. The buyer, meanwhile, is obligated to buy those shares on the conditions set out in the agreement.
A number of common pitfalls and mistakes in the drafting process can be avoided by parties to private share purchase agreements. For example, many parties mistakenly think that simply recording the transaction in their share purchase agreement will make their contract enforceable. Unfortunately, contracts are not respected by the courts because of what is stated, but because of what the courts can infer from the intention of the parties. If you browse the internet or speak to lawyers about private share purchase agreements, they often cite a 2010 judgment from Mr. Justice Harris of the British Columbia Supreme Court. In Central City Brewers and Distillery Ltd. v. Barton Brewing Co. Ltd., the parties intended to enter into a share purchase agreement. Ultimately, the contract signed between the parties was never implemented and the actual transaction was never completed. The parties did not have the benefit of the contract in the interim because Justice Harris determined that the parties had never intended for that contract to lead to a completed sale. When the buyer brought a claim against the seller for breach of that agreement, it was dismissed. The lesson here, however, applies equally to the seller as well as the buyer. If you intend for the completed sale of shares to occur at a future date, you should sign a formal share purchase agreement and ensure that the terms of that agreement are satisfied.
There are more pitfalls in the drafting of private share purchase agreements and the list is not exhaustive. Private share purchase agreements must also include considerations around representations, warranties, indemnities and covenants. What happens if one party doesn’t keep its promise? What if the other party breaches the agreement? How long is the seller expected to remain at risk if the representations or warranties work out poorly? How is the transaction financed and structured? What if the seller wants to be certain that its investment has paid off before the transaction is final? Each of these concerns can be addressed in the agreement to avoid disputes down the road.
While the buyer and seller do not need to anticipate every eventuality, some of these contingencies occur often enough that they should be considered early in the drafting process. The simplest way to address many of these risks is to spend time ensuring your agreement accurately reflects your intentions. In the end, private share purchase agreements are about dividing the risks between the parties in a clear manner. Parties can only divide their risks with the information in the share purchase agreement.

The Private Transaction Advisor’s Role

The parties to a Private Sale of Shares are encouraged to engage legal counsel and financial advisors early in the sales process to ensure that the terms of sale are properly documented, that the parties are making informed decisions and that all closing conditions are satisfied. Lawyers can advise on matters including due diligence, security registrations, non-competition covenants, co-sale rights, representations, warranties, indemnities, financing, and the legal and tax impact of certain deal terms. Financial advisors can typically assist the vendor and its counsel in negotiating deal terms that involve valuation, employment, vesting, and payouts.
Legal counsel should also ensure that the target is not on any regulatory watchlist of other organizations (e.g., military contractors), as sale of the target’s shares could trigger a delayed review by and approval from those oversight organizations. Counsel should also ensure that on a sale of a public company’s shares that the take-over bid rules are complied with. Other regulatory matters that may trigger a requirement for a filing include breaches of laws relating to money laundering, banking regulations, export licensing and taxation.
If the target is a private company, it may fall under the purview of the Canada Business Corporations Act (CBCA) or a provincial business corporation act. The CBCA sets out a number of requirements for disclosure and valuation in the context of a corporate sale. Legal counsel and/or valuation experts must ensure that sales of shares made under these statutes (such as sales of more than 10% of the issued and outstanding shares of a company) follow the appropriate valuation rules, such as those required under subsection 190(4) of the CBCA under a compulsory acquisition context.
In the case of a public company, securities laws will apply, along with statutory requirements for disclosure. Even if the Private Sale involves only the sale of a minority interest, it must be carefully considered in light of securities laws, as issuers are always encouraged to improve liquidity through disclosure in ways that may essentially bring them within the purview of these requirements, especially if they even briefly (even if not intended) become a reporting issuer. If the investor will become the controlling shareholder, transaction documents and disclosure documents must be prepared that comply with specific provisions of both the CBCA and those of any applicable provincial Securities legislation. Issues that are generally considered by issuing companies in the context of a control transaction include: the possibility of growth once control has been achieved; protection for minority shareholders; capital market activity and the potential for liquidity; leverage of financial resources; strategic alliances; the ability of related entities to work together; synergies between related companies; and congruent philosophies.
Selling shareholders may consider the "law of the country that would govern the Sale of Shares" in relation to closing. For instance, if a selling shareholder resides in a jurisdiction other than Canada, Canadian Courts may not enforce a choice of law clause requiring arbitration in Canada. It is therefore helpful to consult with counsel familiar with the laws of the selling shareholder’s jurisdiction to determine the possible availability of relief should a dispute arise.

Conclusion: The Value of Fortifying Agreements

Private share purchase agreements are an essential component of most private transactions. They are typically entered into between purchasers and vendors of shares in private companies (i.e. shares of Canadian private companies) in connection with the acquisition by the purchasers of the vendor’s shares in such companies. In addition to the requisite general provisions typically included in any shareholder agreement (such as provisions relating to directors, officers, dividends, the appointment of an auditor, financial statements, and such other matters), a private share purchase agreement generally also includes special provisions that are typical of transactions involving the share capital of a corporation, but not typically found in any other type of agreement . Such special provisions will often include representations and warranties by the vendor in respect of both the vendor and the collective assets of the target company, covenants by the vendor in respect of the conduct of the business of the target company pending the completion of the proposed acquisition, the right of the purchaser to complete financial, legal and other due diligence in respect of the target company, the right of the purchaser to receive, in most cases, an audited financial statement of the target company, the right of the purchaser in certain cases to appoint a director of the target company, the delivery of 20 days’ prior notice to the target company of the purchaser’s intent to complete a proposed transaction, and the right of the purchaser, in most cases, to require the vendor to repurchase the shares of the target company from the purchaser in the event such purchaser discovers that any such representation and warranty is untrue, inaccurate or misleading in a material respect. The foregoing, as well as all other possible provisions which may be included in a private share purchase agreement, should always be specifically negotiated and drafted pursuant to the wishes of the purchaser and the vendor, respectively, and based on all the relevant facts and circumstances leading up to the planned completion of such proposed share purchase transaction. A private share purchase agreement may be lengthy and complicated and should be taken seriously by all parties involved. Failure to appropriately negotiate and draft its provisions, or mistakenly fail to include such provisions in the first instance, may result in the purchaser and/or the vendor not having adequate protection in the event of any subsequent dispute.