A Sale and Purchase Agreement (SPA) is the foundational legal document governing the transfer of assets or shares in complex business arrangements, most notably in mergers and acquisitions (M&A). This legally binding contract formalizes the negotiated terms between a buyer and a seller. The SPA outlines the rights and obligations of each party, providing a comprehensive framework that ensures the deal progresses toward a successful conclusion.
Defining the Sale and Purchase Agreement
The SPA is a legally binding contract used for the sale of a company’s shares, its specific assets, or other large, complex items. It is structured as an “agreement to sell” rather than an immediate “contract of sale.” A contract of sale involves the immediate transfer of ownership and risk, which is rare in large-scale M&A.
An agreement to sell is an executory contract where the transfer of title is contingent upon the fulfillment of specified conditions at a future date, known as the closing. This structure is necessary because complex transactions require a significant lag time between the initial agreement and the final transfer of ownership. The SPA details the precise conditions that must be satisfied during this interim period to legally obligate the parties to complete the sale.
The Importance of the SPA in Transactions
The SPA’s primary function is to codify the allocation of risks between the buyer and the seller from the moment the contract is signed. It transitions the understanding from a non-binding letter of intent into a legally enforceable commitment. By establishing clear obligations and expectations, the agreement provides both parties with certainty regarding the deal’s structure and the ultimate transaction price.
The SPA also dictates how the business must be operated during the period between signing and closing. This ensures the buyer receives the business in a condition similar to what was valued during due diligence. The detailed provisions of the SPA mitigate the potential for future disputes by preemptively addressing a wide range of possible issues.
Core Commercial Terms and Mechanics
Every SPA must precisely define the basic economic and structural components of the transaction. This includes the clear identification of the selling and purchasing parties and the exact assets or shares being transferred. The document stipulates the total purchase price, which is often subject to various adjustments to account for changes in the business’s financial position between signing and closing.
A common adjustment is the working capital adjustment, which compares a pre-agreed target level to the actual level at closing. If the actual amount differs from the target, the purchase price is adjusted dollar-for-dollar. The SPA also specifies the closing date, includes a governing law clause, and may utilize an escrow account to secure potential post-closing claims.
The purchase price may also be subject to an earn-out, which is a contingent payment based on the target company’s post-closing performance. This ties a portion of the seller’s compensation to the achievement of future financial benchmarks, such as specific revenue or EBITDA targets. Earn-outs are used when the buyer and seller disagree on the company’s future valuation or when value depends heavily on future growth.
Understanding Representations and Warranties
Representations and Warranties (R&Ws) are statements of fact about the business or assets being sold, made by the seller at the time the SPA is signed. A representation is a statement of past or existing fact, such as that the company’s financial statements are accurate. A warranty is an assurance that these facts are true, coupled with a promise that the seller will compensate the buyer if they prove false.
These clauses are a mechanism for risk allocation, allowing the buyer to seek financial recovery if the business is not as represented. Common R&Ws cover the seller’s authority to enter the agreement, the absence of undisclosed litigation, and compliance with all applicable laws. The seller can limit their exposure by including specific disclosures in a schedule attached to the SPA, notifying the buyer of known exceptions to the R&Ws.
R&Ws are often subject to materiality limitations, which determine the threshold for a breach. For instance, a representation might be qualified by “material adverse effect,” meaning a breach only occurs if the inaccuracy is significant enough to substantially harm the business. Some R&Ws may also be subject to a “materiality scrape,” which removes the materiality qualifier when calculating the resulting loss, thereby increasing the buyer’s potential recovery.
Covenants and Conditions for Closing
Covenants are promises by the parties to perform, or refrain from performing, certain actions. Pre-closing covenants, often referred to as interim operating covenants, govern the seller’s conduct of the business between the signing of the SPA and the closing date. A standard negative covenant requires the seller to operate the business only in the “ordinary course of business,” preventing actions like incurring new debt or selling significant assets without the buyer’s consent.
Conditions Precedent, in contrast to covenants, are events that must occur or be satisfied before the parties are obligated to close the transaction. Failure to satisfy a condition means the non-breaching party can typically terminate the agreement without liability. Common conditions include the receipt of necessary regulatory approvals and the obtaining of third-party consents for the transfer of material contracts.
The distinction between a covenant and a condition is significant because a breach of a covenant typically gives rise to a claim for damages. Conversely, the failure of a condition usually provides the right to walk away from the deal. The continued accuracy of the R&Ws is itself often a condition precedent, linking the two concepts directly to the buyer’s obligation to complete the purchase.
Legal Remedies and Indemnification
Indemnification is the core mechanism in the SPA that addresses what happens when the terms of the agreement are breached. It is a contractual promise by one party (the indemnitor, usually the seller) to compensate the other (the indemnitee, usually the buyer) for specific losses resulting from a breach of an R&W or a covenant. This provision is the buyer’s primary means of recovering value lost due to inaccuracies discovered after the closing.
The seller’s liability under indemnification is almost always subject to negotiated limitations. A “cap” sets the maximum aggregate amount the seller can be forced to pay, often a percentage of the purchase price. A “basket” sets a threshold of loss that the buyer must exceed before any indemnification claim can be made.
Baskets can be structured as a “tipping” basket, where the seller pays from the first dollar once the threshold is met, or a “deductible” basket, where the seller only pays the amount exceeding the threshold. Claims are also subject to a “survival period,” which is a time limit after the closing date during which a claim can be brought. General R&Ws often have a survival period of 12 to 24 months, while fundamental R&Ws may survive indefinitely.
Beyond indemnification, other legal remedies include termination rights if a material breach occurs. Another element is the equitable remedy of specific performance, which is a court order compelling a party to complete the transaction when monetary damages are inadequate.
Common Variations of the SPA
The structure of the Sale and Purchase Agreement primarily varies based on whether the transaction involves the transfer of shares or assets. A Share Purchase Agreement (SPA) involves the buyer acquiring the equity of the target company from its shareholders. In this structure, the buyer inherits the entire legal entity, including all its assets and all its liabilities, both known and unknown.
An Asset Purchase Agreement (APA), by contrast, involves the buyer acquiring only specific, cherry-picked assets and explicitly assumed liabilities directly from the target company. The original legal entity remains with the seller, retaining all non-transferred assets and all unassumed liabilities. The APA is generally preferred by buyers seeking to limit their exposure to unknown historical risks, while the SPA is often favored by sellers for its cleaner break from the business.
Beyond business acquisitions, SPAs are also widely used in other sectors, such as in real estate. In real estate, the agreement is tailored to include contingencies specific to the property, such as inspection or financing approval clauses.