minority shareholders' discount

Minority Shareholders’ Discount: Meaning of Fair Value

Minority shareholders’ discount is a controversial topic. In the recent High Court case, Re Euro Accessories Ltd [2021] EWHC 47, it was held that a minority shareholder should receive less than the shareholding pro rata to the value of the entire issued share capital. Taken at face value this is an unsurprising conclusion given that it is a well enshrined principle that a minority shareholding, due to its lack of control over a company, cannot expect to receive a buyout amounting to a pro rata valuation of the entire issued share capital. Many view this as prejudicial against minority shareholders. The important thing to take away from this case is that minority shareholders should pay close attention to articles of association and shareholders agreements, with a view to defining what exactly ‘fair value’ of their shares will be when it comes to their transfer, so that they do not fall foul of the minority shareholders’ discount.

Minority shareholders’ discount – Re Euro Accessories

The facts of this recent case are as follows. The company was incorporated by the majority shareholder (MAJ) on 15 December 2000. The minority shareholder to be (MIN) joined the company in 2003 as a sales representative. On 22nd February 2008 MAJ voluntarily transferred 24.99% of the then issued share capital of the company to MIN. This is significant because by retaining 75% or more of the shareholding, MAJ would still be able to pass special resolutions. A special resolution can, among other things, alter the articles of association. Articles of association regulate the internal affairs of a company including the issue and transfer of shares and therefore, if worded accordingly, have the capacity to take advantage of a minority shareholders’ discount.

In early 2010, the relationship between MAJ and MIN came to an end and on 31 January 2010, MIN resigned from the company. MAJ wanted to purchase MIN’s 24.99% shares which MIN was also happy to sell. Issues arose around the value of such shares, with offer and counteroffer being consistently rejected.

Minority shareholders’ discount – ‘fair value’

MAJ finally decided to use his majority control of the company to pass three special resolutions on 9 March 2016 under his sole signature and hence take advantage of the minority shareholders’ discount. One resolution had the effect of amending the articles by inserting several new articles. New article 6A provided:

  • “6A The MIN Shareholder may at any time be required to transfer all their shares (“Sale Shares”) to the MAJ Shareholder (“Sale Option”).
  • 6A 1 The MAJ Shareholder may only have the right to acquire the Sale Shares by giving written notice to the MIN Shareholder (“Option Notice”) at any time before the transfer of the Sales Shares to the MAJ Shareholder. The Option Notice shall specify:
  • that the MIN Shareholder is required to transfer all Shares pursuant to this Article 6A,
  • the consideration payable for the Sale Shares which shall be for fair value, and
  • the proposed date of transfer (“Transfer Date”) which shall be such date as the MAJ Shareholder may specify.”

After article 6A was adopted, MAJ wrote to MIN saying that he wished to exercise the option to acquire all of MIN’s shares. MAJ valued consideration for the shares at £175,000. MIN did not sign or return the stock transfer form. MAJ, however, with 75% of shares could still execute the transfer form, and did so on 30 August 2016.

The parties eventually used a third party, a chartered accountant, to value the Company and report on the appropriate minority shareholders’ discount to be applied, based on a sale in the open market on the transfer date. The chartered accountant concluded that the company was worth £2.18 million, so that on a pro-rata basis MIN’s 24.99% shareholding was worth £545,000. Applying the minority shareholders’ discount was deemed to mean a 55% discount and so it was calculated that MIN should receive £245,000.

Re Euro Accessories – High Court decision

The court dismissed MIN’s petition against the chartered accountant’s assessment and therefore deemed £245,000 to represent ‘fair value’. It gave a number of reasons for this. Most importantly the court highlighted the importance of interpreting articles of association on the “natural and ordinary meaning of the words used” and any facts about the company that would be reasonably ascertainable by any reader of the company’s constitution or public filings at Companies House. Therefore, the background to the relationship between MAJ and MIN including the breakdown in their relationship were irrelevant. All the court could do was interpret the wording in the updated articles of association and conclude what ‘fair value’ would mean. Even though the circumstances around which MAJ passed the special resolution to amend the articles was, given the background, clearly prejudicial against MIN.

The courts relied upon the principle established in Short v Treasury Commissioners [1948] 1 KB 116 and recently reaffirmed in Shanda Games Ltd v Maso Capital Investments Ltd [2020] UKPC 2 that MIN could not insist on being paid something to which his shares did not entitle him to and that he did not own. Therefore, MIN could not insist on payment for a proportionate part of the controlling stake which MAJ thereby built up, or a pro rata part of the value of the company’s net assets or business undertakings. The economic concept of minority shareholders’ discount applied because nothing in the articles of association suggested it would be otherwise.

Interpretation of articles of association

In Cosmetic Warriors Ltd v Gerrie [2017] EWCA Civ 324 it was mentioned that articles of association need to be interpreted in accordance with the ordinary principles of contract law. This was why it was hard for MIN to argue that the High Court should imply any other principles outside of the wording in the articles, given that English contract law is predicated on the concept of contractual certainty. With contracts, and therefore articles of association, the court is looking at:

  • “what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean”, which it does by focusing on the meaning of the relevant words in their documentary, factual and commercial context;
  • meaning must be accessed considering (as set out in Arnold v Britton [2015] AC 1619, by Lord Neuberger PSC at paragraph 15):
  • “the natural and ordinary meaning of the clause,
  • any other relevant provision of the contract,
  • the overall purpose of the clause and the contract,
  • the facts and circumstances known or assumed by the parties at the time that the document was executed, and
  • commercial common sense, but
  • disregarding subjective evidence of any party’s intentions.”

It was on this point (f) that MIN failed to convince the court that MAJ’s prejudicial reason for changing the articles of association was an admissible piece of evidence. All the court could do was look at the less subjective elements of the dispute. However, it is also important to highlight the difference between articles of association and contracts. This includes:

  • Articles of association can be altered by a special resolution without the consent of all the contracting parties.
  • Articles of association are not undermined (defeasible) on the grounds of misrepresentation, common law mistake in equity, undue influence or duress or rectification on the grounds of mistake. Therefore, it could be argued, minority shareholders have less principles (than in contract law) beyond the scope of the wording of the articles to rely on.
  • It is not permissible to imply into articles of association a term based on extrinsic evidence of surrounding circumstances. This is because, as stated in Bratton Seymour Service Co Ltd v Oxborough [1992] B.C.C. 471, ‘the consequence would be prejudicial to third parties, namely, potential shareholders who are entitled to look to and rely on articles of association as registered’.

Minority shareholders’ discount – valuation of shares on sale

In Short v Treasury Commissioners [1948] (referred to above) the issue was whether the Crown could acquire individual minority share tranches of the company it was acquiring at a discount. The Court of Appeal held the individual shareholders were not entitled to the pro rata value of their shareholdings. This became the precedent upon which minority shareholder’s discount was based. It was reaffirmed recently in Bratton Seymour v Oxborough (mentioned above) when Lady Arden stated:

“In the opinion of the Board, it is a general principle of share valuation that (unless there is some indication to the contrary) the court should value the actual shareholding which the shareholder has to sell and not some hypothetical share. This is because in a merger, the offeror does not acquire control from any individual minority shareholder. Accordingly, in the absence of some indication to the contrary, or special circumstances, the minority shareholder’s shares should be valued as a minority shareholding and not on a pro rata basis.”

Here to help

The ruling in Re Euro Accessories confirms that minority shareholders should be extra cautious where articles of association allow for the acquisition of shares at fair value. The case hinged on the fact that ‘fair value’ was not defined in the articles and so the courts held that a minority discount would be applied (not pro rata value). It is therefore in the interests of minority shareholders to try and define it. They should also aim to include a provision, as is widely practised, which states that there will be no discount for transfer of minority holdings. Getting legal advice around any articles of association you sign up to or any shareholders agreement you agree to, is going to be important.

EM law specialises in corporate law. Get in touch if you need advice on articles of association, shareholders agreements or have any questions about minority shareholders’ discount.

Selling A Software Business

Selling a Software Business - Things to Consider

Software comes in all shapes and sizes, serving a diversity of customers broadened by the internet and strengthened by the onset of generations for whom its application is second nature. Whilst selling a software business will meet unique challenges, there are a number of common threads when considering the legal side. This blog covers a range of topics that, if the seller takes on board, could ensure a buyer’s trust and cooperation when negotiating an agreement.

Selling a Software Business - Intellectual Property Rights

A likely first thing on the mind of a buyer will be to understand and secure all intellectual property rights in the target software. This will mean carrying out due diligence and if necessary obtaining an assignment from the owners of such rights. The business and its licensors should own all the relevant rights but if things haven't been done properly the owners could, for example, be consultants to the business. Difficulties arise when dealing with previous consultants who take such rights with them after leaving the developers or business which originally created such software. A seller should therefore do all it can to review intellectual property rights when creating software that it may one day wish to sell. If all else fails, indemnities may be the only way to ensure a buyer is comfortable with the purchase.

Software often uses licenced-in intellectual property rights from third parties. Having a strong understanding of exactly what these are and whether it is possible to grant sub-licences under them should be considered. This will mean reviewing the software’s process of production to ensure that no such rights are missed.

Open source software (OSS) is software code that is usually made available to developers for free and can be licenced in a variety of ways. It would be a incorrect to assume that OSS is licenced in an unrestricted manner at all times, even though in recent years it has generally become less restrictive. BlackDuck is a tool which offers companies the opportunity to search the source code of products for any OSS. Any unclear licences can then be satisfied and again it is likely that a buyer will want indemnities or warranties to ensure that all the OSS has been dealt with. At the very least OSS usually requires an acknowledgement of the original author.

Selling a Software Business - Existing Customers

When selling a software business, a buyer is going to want to assess the revenues of your business, the reliability of such revenue and risks involved with providing services to each customer. Issues likely to arise in customer contracts include:

  • Limits and exclusions of liability.
  • Post-contract services such as maintenance and support obligations.
  • Termination rights - whether through an explicit change of control clause or termination periods, or by unclear drafting in the contract. Much can rest upon whether or not a buyer can rely upon long-term customers to continue to use the software after purchase.
  • Non-compete, exclusivity and similar restrictions. As well as affecting the software’s freedom to operate under such restrictions, they may give rise to competition law issues.

Selling a Software Business - Employee retention

Employees can in some cases be as valuable as the software itself, especially if the buyer is looking to develop the software. Employees often have a breadth of knowledge and experience with a piece of software that is difficult to put onto paper. If key employees are lost then as much information as possible should be put down in the software documentation. Employee retention or at least a point of contact with former employees of a software business may well be the pre-requisite of such an acquisition.

Selling a Software Business - Technology Infrastructure

The issue of technological infrastructure is changing. Before the existence of such readily available online platforms with which companies can access and build their own software, technological infrastructure was, for the most part, hardware. This meant that infrastructure was often difficult to integrate into a buyer’s system.

A seller needs to consider whether the technological infrastructure is shared with anyone (say a subsidiary or other company in the seller’s group), whether they plan to integrate the software into the buyer’s technological infrastructure and whether the software is in any way being provided by a third party:

  • Infrastructure shared with other members of the seller’s group – a number of solutions exist to this issue, the most common being licensing or transitional services arrangement within the group that is often limited in time and to particular services.
  • Integration in to buyer’s infrastructure – as well as technical issues of integration and compatibility, if the infrastructure is duplicated, the target should undertake an assessment of whether these duplications can be eliminated and if the seller can terminate relevant supplier contracts.
  • Third parties – it used to be the case that companies using software would share a server with other companies and such hardware would have to be maintained to reach the requirements of each company. With the trend towards virtualisation of the computing environment, seller’s will often be beholden to a variety of third-party platforms to provide cloud space and hosting capabilities. Sellers should therefore review their position in relation to all such third parties to ensure they have the necessary rights to transfer ownership of any such agreements.

Selling a Software Business - Data protection

Data protection is an increasingly important issue for any software business. In assessing your business, and its IT systems, it is important to understand what personal data is handled, the protections and policies surrounding this, including any instances of breach of these policies, and the applicable laws such as the UK GDPR (for information on how Brexit has affected data protection law read our blog). It is attractive for a buyer to know that the seller takes data protection seriously and has built-in mechanisms to support it.

Developments in software supply have accounted for an increased risk in data protection. Subscription based services which often store customer data on the sellers platform (for instance, if it supplies software under a software as a service (SaaS) model) run into such issues as an obligation is created to secure and lawfully process the personal data being stored by the seller. Software often used to be sold anonymously, and without updates, external content, or other means to identify the user, and the seller was not storing personal data for its customers (because there were usually no logins or other data collections linked to a cloud-based platform). Data protection law is forever morphing in response to the rapidly developing technological landscape and so it could be wise to review your position at multiple points along the timeline of implementing the acquisition of a software business.


Cybersecurity is set to become an increasingly important issue for sellers in any software acquisition. On 10 May 2018, the Network and Information Systems Regulations 2018 (SI 2018/506) (NIS Regulations) came into force. They place minimum cybersecurity and incident notification obligations on relevant digital service providers. If the software qualifies as an in-scope digital service provider under the relevant legislation, then it will be important for the seller to understand:

  • What network and information systems it relies upon to provide its services.
  • What measures it takes to manage the risks posed to the security of those systems (including with a view to ensuring continuity of its digital services).
  • What means it has of monitoring and assessing any incidents that have a substantial impact on the provision of its digital service.
  • How it reports such incidents to the Information Commissioner's Office (ICO), the UK regulator in this area, and in what timescales.
  • Failure to abide by the minimum cybersecurity standards and incident notification requirements set out in the NIS Regulations, can attract substantial regulatory fines in the UK of up to £17 million. Relevant digital service providers are also under an obligation to ensure that they have adequate documentation available to enable the ICO to verify compliance with the relevant security obligations, meaning that in practice the ICO may request to see (and buyers will want to diligence) various policies including those relating to system security, incident handling, security monitoring, business continuity management, and compliance with international standards.

Here to help

Selling a software business comes with a range of challenges, whether or not it involves software. Software does, however, introduce some specific issues. The greatest change in recent times has been from software sold for on-premises installation, to software being available to sell via, in most instances, a SaaS platform. This means that, as a software business owner, you are more likely to rely upon third parties to deliver your services. Making sure that your relationship with these third parties is transferrable to a buyer is important. Equally significant is the likelihood of intellectual property rights being scrutinised by a potential buyer. Knowing that you own all aspects of the business you intend to sell will always be high on a buyer’s list of assurances. Software has a uniquely high chance of infringing IPR’s without being aware of it. For more information on this read our blogs Open Source Software and Legal Protection of Software.

EM law specialises in technology and corporate law. Get in touch if you need advice on selling a software business or have any questions on the above.

Heads Of Terms

Heads Of Terms For Buying A Company

When buying a company, heads of terms (also known as letters of intent, memoranda of understanding and heads of agreement) are by and large contained in a short document that sets out the principle terms of an agreement. Heads of terms constitute serious intent, and may have moral power, yet are not necessarily binding. This will rely upon the substance of the heads of terms and the goals of the parties.

Heads of Terms Purpose

Heads of terms will not always be valuable with regards to arranging an exchange and they might be of more use to one side than the other, yet heads of terms can assist with avoiding mistaken assumptions and give a helpful guide when consenting to a proper arrangement. Parties should be wary that an exchange of the heads of terms can slow down over marks of pointless detail, which in actuality ought to appropriately be tended to at a later stage. This can postpone readiness of the full contract and increase the length and cost of dealings.


Generally, the heads of terms should cover the bargain at hand and significant components as opposed to routine ones. Often the two parties treat the heads of terms as a practice of the real agreement. Time spent arranging the heads of terms ought to be limited to talking about the bargain on a basic level. Contentions over the fine print ought to be left for the final arrangements.

Below are some examples of suggested principles to be applied to heads of terms:

  • State the exception and defer the rule - If it is fundamental that, for example, certain sellers will not join in the giving of warranties and indemnities, or that only very limited warranties will be given, the heads should say so. If not, it should be sufficient to indicate that the final agreement is expected to include warranties, indemnities (and limitations on them) appropriate to a transaction of this type.
  • State the principle and defer the detail - Unless an issue is very complicated or unusual, the heads of terms should state the principle underlying the issue and leave the detail for the formal agreement. For example, if there is to be a post-completion audit and balancing payment based on net asset value, that is probably all that needs to be said in the heads of terms. Timing, agreed adjustments to the accounts and accountants that prepare the initial version can be dealt with later. If, however, the parties have agreed a specific unusual formula for calculating the net asset value this may need to be set out in the heads of terms to avoid any later disagreement.
  • Consider carefully, and take professional advice, before making significant concessions - If one side wants the agreement to be governed by foreign law, the other party should understand how this may affect its rights before making this concession. Similarly, both parties should take advice on the tax consequences of the basic deal structure. Such issues highlight the importance of taking appropriate advice or at least including reservations to the extent this has not yet been possible.

Are Heads of Terms legally binding?

Heads of terms may be fully binding or partly binding or not binding at all. Typically, however, they are not legally binding apart from sections dealing with confidentiality (where the parties agree to keep their discussions confidential) and exclusivity (where the seller agrees not to talk with any other potential buyer for an agreed period while the buyer carries out due diligence and hopefully concludes the purchase). Where the heads of terms include provisions that are intended to be binding, these must be clearly identified and the legal requirements for creation of a valid contract must be satisfied. Among other things, under English law:

  • The terms must be sufficiently certain to be enforceable. An "agreement" to continue negotiations in good faith, for example, is nothing more than an "agreement to agree" and normally unenforceable (Walford v Miles). Much depends on the facts however.
  • Unless the heads of terms are executed as a deed, there must be consideration moving from the party benefiting from the agreement to the other party, either in the form of a promise in return, or a payment, action or forbearance. Where there is no actual consideration, however, and execution as a deed alone is relied upon, specific performance is unlikely to be available. For more information on the specific formalities relating to the execution of deed by a company, see section 46 Companies Act 2006.

Third parties

Regard should also be had to the implications of the Contracts (Rights of Third Parties) Act 1999. If a term expressly provides that a third party has the right to enforce that term, or if the term purports to confer a benefit on a third party, then that term may give the third party directly enforceable rights. For example, a parent company, or another group subsidiary of a party to the heads of terms may wish to benefit from the confidentiality provisions. Where there is more than one prospective buyer, the seller may intend the successful buyer to have the benefit of confidentiality undertakings given by the others. On the other hand, if there is a risk that a term may be enforceable by a third party and the parties do not wish to create any third party rights, then an express exclusion should be included to that effect.

Reasons for using Heads of Terms

Whether or not the parties draw up heads of terms is purely a matter of choice: there are both advantages and disadvantages. The perceived advantages of using heads of terms are:

  • Moral commitment. Heads of terms are usually considered to confirm a moral commitment on both sides to observe the terms agreed (which can be an advantage or disadvantage depending on the circumstances).
  • Complex transactions. Where a transaction is complex, heads of terms can help focus the negotiations, bring out any misunderstandings and, by highlighting major issues at an early stage, prevent the parties wasting time and money if those issues cannot be resolved at this stage.
  • Framework for binding commitments. Heads of terms frequently contain a binding exclusivity agreement, a confidentiality agreement and, in some cases, provide for payment of costs and break fees in the event of negotiations breaking down. Obtaining exclusivity for a limited period, and some protection against wasted costs, should enable the buyer to proceed with more confidence.
  • Third parties. Where a deal has to be explained and sold in advance to persons not directly involved in the negotiations, the heads of terms can provide a useful statement of the key terms of the proposed deal.
  • Basis for clearance submissions. Heads of terms can provide the basis of a joint submission for clearance or guidance from the relevant competition authorities and might assist in the preparation of tax clearance applications.
  • Basis for instructing advisers. Draft heads of terms can sometimes be a helpful tool for the parties to instruct their respective advisers.
  • Provide seller with a tactical advantage. Because heads of terms are normally prepared early in the transaction process, before the buyer has commenced detailed due diligence, the seller will know considerably more about the business being sold than the buyer.

Reasons against using heads of terms

  • Limit room for manoeuvre. Heads of terms carry strong force, so they can limit room for manoeuvre in the subsequent negotiations. They should therefore be approached with caution, especially on the part of a buyer, who at this stage normally has much less information than the other side. If the buyer is required to sign heads of terms, then consideration should be given to inserting into the document the key assumptions on which the buyer is relying. This was illustrated by the ill-fated acquisition of PRB by Astra Holdings PLC in 1989. PRB went into liquidation a year after the acquisition and the Department of Trade and Industry (now BEIS) launched an investigation into the matter. In their report, the inspectors mentioned the fact that Astra had, before taking legal advice, entered into heads of terms which included certain unfavourable terms (the acquisition agreement was to be drafted by the seller's lawyers, governed by Belgian law and was to contain only limited warranties). Although it was not legally binding, it severely tied Astra's hands in the subsequent negotiations. It was the seller's "firm view that the [heads of terms] had set the agreed goal posts, and they did not want them moved".
  • Create legal relations inadvertently. In some jurisdictions, heads of terms can create a legally binding agreement between the parties unless an express term is included to the effect that there is no intent to create legal relations.
  • Accelerate need for public announcement of deal. Where either party is a listed company, an AIM company or otherwise has financial instruments that bring the company within the Market Abuse Regulation (596/2014/EU) it will need to consider whether one effect of negotiating and signing heads of terms may be to precipitate an early announcement of the deal.
  • Adverse tax consequences. In the UK, the heads of terms can be evidence of an "arrangement" which restricts the ability of the parties subsequently to take advantage of certain tax reliefs.
  • Increase in workload. The time taken to agree heads of terms may be disproportionate to the benefit. Care needs to be taken to avoid effectively negotiating the main agreement twice.

Here to help

Drafting heads of terms can be an exciting moment in pursuit of a deal. It is crucial to have an insight into how best to play your hand and what the legal consequences will be of your commercial strategy. The most significant legal question will be whether or not any of the terms are binding.

A document will usually be enforceable when it is adopted into a parent contract and is subsequently agreed upon. Until that point, a heads of terms will not usually be legally binding (Fletcher Challenge Energy Ltd v Electricity Corp of New Zealand Ltd [2002]). However, such documents can be legally binding if the agreement document contains terms or language which explicitly indicates a binding intention. Equally, a letter which contains no expression of whether its terms were intended to be binding can be found to be binding due to language used. (RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH & Co KG [2008]) This is also dependent on the circumstances of the transaction and includes the conduct of the parties themselves.

If you have any questions on heads of terms or need help drafting such a document please contact Neil Williamson.

Due Diligence When Buying A Business

Due Diligence When Buying A Business

This blog considers the purpose, scope and practical aspects of due diligence when buying a business. In the past, studies have shown that, for a number of reasons, a large number of acquisitions fail to meet expected targets and some high-profile disasters have brought the question of acquisition planning and management sharply into focus. It is therefore crucial that there is good management of the acquisition process and, in particular, the due diligence exercise.

Purpose of due diligence when buying a business

On any significant acquisition, the prospective buyer will want to be sure that the seller and (in the case of a share purchase) the target company have good title to the assets being bought and to know the full extent of any liabilities it will assume. For acquisitions subject to English law, the principle of caveat emptor, or buyer beware, will apply. It is therefore essential that the buyer carries out its own investigation of the target business at the negotiating stage through a due diligence review.

The primary purpose of carrying out due diligence when buying a business is to obtain sufficient information about the target's business to enable the buyer (or other parties with an interest in the transaction) to decide whether the proposed acquisition represents a sound commercial investment. Due diligence is effectively an audit of the target's affairs - legal, business and financial. It is therefore a crucial bargaining tool for the buyer.

Business due diligence when buying a business

Business due diligence looks at broader issues such as the market in which the business operates, competitors, the business' strengths and weaknesses, production, sales and marketing, and research and development. Obviously, some of the results of this part of the due diligence review will be relevant to the legal investigation which focuses on the full extent of any liabilities the buyer will assume.

Financial due diligence when buying a business

As part of the due diligence process, the buyer may instruct accountants to prepare a report on the financial aspects of the target business. This financial due diligence is not the equivalent of an audit, and accountants' reports will usually make this clear. However, financial due diligence should focus on those areas of the target's financial affairs that are material to the buyer's decision so that the buyer can assess the financial risks and opportunities of the deal and whether, given these risks and opportunities, the target business will fit well into the buyer's strategy.

Legal due diligence when buying a business

The legal due diligence exercise will focus on a number of core areas mainly to establish the ownership structure in the target, the target’s position under its key customer and supplier contracts, whether any litigation is ongoing and the extent to which the target is behaving in a legally compliant way.

On the basis of this information, the buyer can determine whether it is appropriate to:

  • Proceed with the transaction on terms that have been negotiated.
  • Seek to renegotiate the terms of the acquisition to reflect any issues or liabilities identified during the due diligence process.
  • Withdraw from the transaction.

In addition to identifying any issues that may affect the buyer's decision to enter into the transaction (or the terms on which it is prepared to proceed), the information revealed during the legal due diligence exercise will assist the buyer and its solicitors in:

  • Determining the scope of the warranties that should be included in the share purchase agreement (SPA).
  • Identifying any areas of risk that should be subject to specific indemnities.

Who carries out due diligence when buying a business?

It is essential that the acquisition team is made up of appropriate people under clear leadership and with good reporting structures. The team carrying out the due diligence must involve the buyer's own personnel as well as its legal and financial advisers and accountants. Only the buyer's own personnel will be able to make effective judgements as to the commercial importance and potential risk brought to light by the information uncovered.

Due Diligence Questionnaire

The cornerstone of any due diligence exercise is the questionnaire or information request which sets out the areas of investigation and a list of questions and enquiries to be put to the seller. These questions will usually be supplemented by further requests as the negotiations proceed and as the buyer learns more about the target.

Confidentiality and data protection

Although a seller will typically require prospective buyers to enter into a confidentiality agreement, these are difficult to enforce in practice. Where the buyer is a competitor or potential competitor, a seller may be particularly reluctant to disclose sensitive information about the target business until it can be sure that the sale will go through. The knowledge that a business is for sale can also be unsettling for employees, customers and suppliers. At worst, it can lead to a permanent loss of customers; even at best it may involve loss of sales and possibly key staff during the course of the sale process. In some cases, the seller will wish to keep confidential from all but the most senior management its intention to sell the target. Of necessity, this will limit the scope of the information available for a full due diligence enquiry.

The seller will want to ensure that no approaches are made to its customers, suppliers, management or employees either with a view to poaching them or obtaining more information. On an auction sale particularly, although confidentiality undertakings are required as a matter of practice, it is more difficult to maintain confidentiality because of the number of parties involved. The seller may be reluctant to risk the consequences of a breach of security during the information-gathering process or may be concerned that the only purpose of obtaining more information is to renegotiate the price. Bridging the gap in expectations between the seller, who is concerned to restrict the release of information, and the buyer, who will want to gather as much information as possible, is a crucial element of the initial stages of any transaction.

The due diligence report

Once the enquiry is complete, the information will be summarised in the due diligence report, which should cover the business, financial, legal and other specialist areas of the investigation. For certain transactions, this may be a fairly informal report focusing only on matters material to the transaction. For others, it will comprise a complete audit of the target's business including an in-depth summary of the target's material contracts. Some clients may wish to have a board presentation in addition to a written report. In any event, the due diligence report should be easy to read and have an index. It should be written in a clear and concise manner and should be free of legal jargon, bearing in mind that it will be read by non-lawyers. The executive summary - the part of the report that everyone will read - should summarise all of the key findings of the due diligence review

International transactions

International transactions, by their very nature, throw up a number of added risks and challenges. These fall broadly into three categories:

  • On a practical level, there may be difficulties relating to language, the added number of people involved, time differences, and so on.
  • Buyers should carefully assess the impact of a foreign country's law on a transaction.
  • In some jurisdictions, investigations of the level which have now become invariable practice in the UK or US may be seen as damaging the spirit of mutual trust between seller and buyer or even as a sign of mistrust or bad faith on the part of the buyer.

Here to help

This blog is only an introduction to due diligence when buying a business. If you have any questions about due diligence more specifically or if you need help undertaking such an investigation please contact our specialist corporate lawyers.

National Security And Investment Bill

National Security and Investment Bill

On 11 November 2020, the National Security and Investment Bill 2019-21 was introduced to the House of Commons and given its first reading. The Bill will establish a new statutory regime for government scrutiny of, and intervention in, investments for the purposes of protecting national security and follows the government's 2017 and 2018 Green and White Papers on the national security and infrastructure investment review.

National Security and Investment Bill Purpose

The Bill will enable the Secretary of State to "call in" statutorily defined acquisitions of control over qualifying entities and assets (trigger events) to undertake a national security assessment (whether or not they have been notified to the government). Proposed acquirers of shares or voting rights in companies and other entities operating in sensitive sectors of the economy will be required to notify to and obtain approval from the Secretary of State before completing their acquisition. The National Security and Investment Bill also creates, where there is no requirement to notify, a voluntary notification system to encourage notifications from parties who consider that their trigger event may raise national security concerns. It includes five-year retrospective call-in powers, allowing for post-completion review of non-notified transactions, and, where parties fail to notify a trigger event that is subject to mandatory notification, a call-in power at any time.

Trigger Events

The following would trigger a requirement to notify the Secretary of State:

  • The acquisition of more than 25% of the votes or shares in a qualifying entity.
  • The acquisition of more than 50% of the votes or shares in a qualifying entity.
  • The acquisition of 75% or more of the votes and shares in a qualifying entity.
  • The acquisition of voting rights that enable or prevent the passage of any class of resolution governing the affairs of the qualifying entity.
  • The acquisition of material influence over a qualifying entity’s policy.
  • The acquisition of a right or interest in, or in relation to, a qualifying asset providing the ability to:
    • use the asset, or use it to a greater extent than prior to the acquisition; or
    • direct or control how the asset is used, or direct or control how the asset is used to a greater extent than prior to the acquisition.

A qualifying entity is an entity engaged in the sectors referred to below.

National Security and Investment Bill Consultation

The government has published a consultation on proposed draft definitions of 17 sensitive sectors in which it will be mandatory to notify and gain approval for certain types of transactions, covering, for example, energy, telecommunications, artificial intelligence, defence, engineering biology, cryptographic authentication, computing hardware, and military and dual use. It invites comments on these definitions by 6 January 2021.

Policy Intent

The government has also published a Statutory Statement of Policy Intent describing how the Secretary of State expects to use the call-in power, and the three risk factors (target risk, trigger event risk and acquirer risk) that the Secretary of State expects to consider when deciding whether to use it. Once a transaction is notified or called in, assessment should be carried out within a 30-working day review period (which is extendable in certain circumstances).

The National Security and Investment Bill gives the Secretary of State powers to impose remedies to address risks to national security (including the imposition of conditions, prohibition and unwinding) and sanctions for non-compliance with the regime, which include fines of up to 5% of worldwide turnover or £10 million (whichever is the greater) and imprisonment of up to five years. Transactions covered by mandatory notification that take place without clearance will be legally void.

The Bill also sets out provisions for interaction with the Competition and Markets Authority (CMA) and amendment of the Enterprise Act 2002. These include removal of section 23A, which sets out the criteria for a merger to be a "relevant merger situation", thereby qualifying it for investigation by the CMA and repeal of the Enterprise Act 2002 (Share of Supply Test) (Amendment) Order 2018, the Enterprise Act 2002 (Turnover Test) (Amendment) Order 2018, the Enterprise Act 2002 (Share of Supply) (Amendment) Order 2020 and the Enterprise Act 2002 (Turnover Test) (Amendment) Order 2020.

National Security and Investment Bill Specified sectors

The list of specified sectors will be set out in secondary legislation, the definitions of which will be kept under review to reflect any changes in the risks facing the UK.

The government is consulting on proposed draft definitions to set out the parts of the economy in which it will be mandatory to notify and gain approval for certain types of transactions. These cover 17 sectors:

  • Advanced materials.
  • Advanced robotics.
  • Artificial intelligence.
  • Civil nuclear.
  • Communications.
  • Computing hardware.
  • Critical suppliers to the government.
  • Critical suppliers to the emergency services.
  • Cryptographic authentication.
  • Data infrastructure.
  • Defence.
  • Energy.
  • Engineering biology.
  • Military and dual use.
  • Quantum technologies.
  • Satellite and space technologies.
  • Transport.

The consultation document sets out the government's proposed definitions for the types of entity within each sector that could come under the National Security and Investment Bill's mandatory regime. The definitions differ from those in the 2018 and 2020 Enterprise Act merger control amendments, which, as noted, were only ever intended as short-term measures and will be repealed by the Bill.

The deadline for commenting on the proposed definitions is 6 January 2021.


To date, very few transactions have been reviewed on national security grounds under the current UK framework, most recently Gardner Aerospace/ Northern AerospaceAdvent/ CobhamConnect Bidco/ InmarsatGardner Aerospace / Impcross and Aerostar/ Mettis. The Gardner/Impcross and Aerostar/Mettis transactions were abandoned following government opposition.

Currently, the Secretary of State has the right to intervene and take decisions on mergers only in strictly defined circumstances, where a defined public interest is at stake. National security is one of the grounds set out in the Enterprise Act upon which the Secretary of State can intervene. The government lowered the thresholds for intervention for the development or production of military items and dual-use items, and computing hardware and quantum technology sectors in June 2018 and for the advanced materials, Artificial Intelligence and cryptographic authentication sectors in June 2020.

Competition and Markets Authority

The CMA currently has a role in assessing jurisdictional and competition aspects of such mergers, providing advice to the Secretary of State. Under the National Security and Investment Bill, the CMA will no longer have a role in national security reviews. The Bill separates the national security assessment from the CMA's merger control assessment. However, it also gives the Secretary of State power to overrule the CMA, meaning that, in the event of a conflict, the national security review may take precedence over the merger control assessment.

If you have any questions on the National Security Investment Bill or corporate law more generally please contact our specialist corporate lawyers.

EM Law IR 35

IR35 - New Rules

Despite controversy and calls for the government to reconsider their plans, the changes to IR35 will be implemented in April 2020. But what exactly are the IR35 rules, and what can you do to prepare for these changes? This blog takes a look at the IR35 legislation and aims to answer some of your burning questions. 

What is IR35?

Contractors who work through an intermediary, such as a personal service company, enjoy a certain level of tax efficiency. While they are not entitled to employee benefits such as holiday pay or sick pay, their tax status often enables them to take home more net pay than an employee in the same role. The benefit for an employer of hiring an individual in this way is that they don’t have to organise PAYE or contribute to National Insurance. Brought into law in April 2000, IR35 was designed to crackdown on the use of this corporate structure as a means of avoiding tax. 

How does it work?

IR35 effectively determines whether an individual is a bona fide contractor or a ‘disguised employee’ for the purposes of paying tax. If it is concluded that an individual is a ‘disguised employee’, they will be deemed to be inside IR35 and will be subject to National Insurance and Income Tax. If it is concluded that an individual is actually a contractor, then they will be deemed to be outside IR35 and will not be caught by the rules. 

Most of the questions that need to be answered in order to determine whether an arrangement will be caught by the IR35 legislation are relatively straightforward and are set out in the legislation itself. However, one of the key questions that needs to be answered is whether the worker would have been an employee of the client if they had been working directly for it, and this question is less straightforward. HMRC has provided guidance on the factors that it considers to be the most important in determining an individual’s employment status. These factors include whether there is personal service, mutuality of obligation, employee-type benefits and whether the individual provides his or her own equipment. 

What are the IR35 changes?

Extension to private sector

In April 2020, IR35 will be extended to the private sector for large and medium-sized organisations. The 2020 changes will bring IR35 in the private sector into line with the public sector by shifting the liability for defining a worker as employed or self-employed from the individual to the organisation which engages them. The public sector, including major employers such as the NHS, have been responsible for this since April 2017. It will therefore be the private sector end user who will be the subject of any HMRC enquiry and of any demand for tax due. 

Exemption for small companies 

In the public sector, where the IR35 rules already apply, the size of an organisation is irrelevant. However, in the private sector, HMRC has confirmed that small companies will be excluded from the new rules. The government has estimated that, as a result of the exception, 95% of end users will not need to apply the reform. But what is classed as a small company?

In its latest guidance, HMRC has defined a small company as a limited company that meets at least two of the following criteria:

  • An annual turnover of not more than £10.2 million;
  • A Balance Sheet total of not more than £5.1 million; and/or
  • Not more than 50 employees. 

Where a private company satisfies these requirements, the individual will continue to ‘self-assess’ and account for Income Tax and National Insurance where it is concluded that the rules apply. Where a private company does not satisfy these requirements, they will be subject to IR35. Until the draft legislation is published, we cannot say for sure how this exception will be applied to unincorporated entities and limited liability partnerships. 

What can you do to prepare?

The 2020 changes to IR35 are being introduced to make life easier for HMRC. Instead of pursuing thousands of individual workers, HMRC will pursue large employers, at a fraction of the recovery and administration costs. 

Although the changes will not come into force until 2020, organisation is key. Large and medium-sized organisations should consider undertaking a review of their use of contractors, setting out who they are currently contracting with and on what basis. Organisations can also make use of an online tool called CEST, however this should be approached with caution. CEST has come under criticism in the past few months and should not be used as a substitute for a full and proper investigation. 

As part of their review, large and medium-sized organisations should evaluate any contracts that they have in place with individual contractors. In order to limit the risk of IR35 applying, some of the following should be considered:

  • Including a right of substitution clause within the contract. This clause should be drafted so that it is as wide-ranging as possible.
  • Avoiding an obligation to provide and accept work. Including a notice period may point towards a conclusion that there is a mutuality of obligation, so this should be avoided. 
  • Structuring contracts, where possible, by reference to completion of a project or a piece of work, rather than by duration. Similarly, payment should be structured by reference to completion of a project, rather than time worked. 
  • If possible, requiring the individual to provide their own equipment, rather than providing equipment to them. 
  • Integrating the individual into the company no more than is absolutely necessary.
  • Although not determinative, stating in the contract that the relationship is not intended to be one of employment. 

Whilst it is important that contracts are drafted in such a way as to reduce the risk of IR35 applying, it is also important that the practical reality is in accordance with those terms. A carefully drafted contract will not avoid being caught by IR35, unless it also reflects the reality of the situation. IR35 is a complex area of law so speaking to a lawyer or tax specialist early on and before starting your review is recommended.  

Final words

The cases brought against public sector employees have highlighted the fact sensitive nature of the legislation. Currently no easily applicable checklist exists making it difficult for big businesses to apply blanket procedures to ensure adherence to IR35 with multiple contractors. The government promised to improve the employment status tests in the Good Work Plan but is yet to do so. Unfortunately at this time employee status will be best analysed on a case by case basis.

The changes to IR35 will throw up all sorts of administrative challenges for large and medium-sized organisations. Those who start planning now will find themselves ahead of the game and ensure that the right level of resource is in place when needed. If you are a business and you think that IR35 may impact upon your operations then do get in touch.

EM Law Contract Lawyers London

You want to sign a contract before your company is incorporated? Think again!

This blog explains the problems with pre-incorporation contracts and sets out what you can do if you find yourself in this situation.

What is incorporation?

A company does not legally exist until it is incorporated. Incorporation is the process by which a new or existing business registers as a company. Once a company is incorporated, it will receive a certificate of incorporation confirming its existence and showing the company number and date of formation. Before a company is incorporated, it cannot enter into commercial contracts. Consequently, nobody can sign a contract for that company as an agent. A contract entered into by a party on behalf of a company, where that company has not yet been formed, is called a pre-incorporation contract.

The law

The general rule relating to pre-incorporation contracts is set out in section 51 of the Companies Act 2006. The section states that:

“A contract that purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as one made with the person purporting to act for the company or as agent for it, and he is personally liable on the contract accordingly.”

This means that anyone who signs a contract on behalf of a company before that company is incorporated will be liable as if they were the contracting party. Section 51 also has dual effect, as confirmed in the case of Braymist Ltd v Wise Finance. As well as having personal liability, the person who signs on behalf of a company can personally enforce the pre-incorporation contract.

What exactly is an "agreement to the contrary"?

There has been some disagreement over the years as to the exact meaning of “agreement to the contrary”. Thankfully, case law has provided some clarity. If you can prove that there is an “agreement to the contrary” you may be able to negate liability and get yourself off the hook.

In Phonogram v Lane, Lord Denning took the phrase “subject to any agreement to the contrary” to mean that for a person to avoid personal liability the contract would have to expressly provide for his exclusion.  

In Royal Mail Estates Ltd v Maples Teesdale, Mr Johnathan Klein took a similar but even more restrictive approach. Mr Johnathan Klein stated that an “agreement to the contrary” would only exist if it could be established that, by relevant words properly construed, the parties intended that the contract would not take effect as one made with that person. In other words, there was only a contrary agreement if there was found to be an agreement between the parties by which they intended to exclude the effect of section 36C(1), which is now section 51 Companies Act 2006.

In the case the defendant firm of solicitors signed the contract “for and on behalf of the buyer”. The contract related to the sale and purchase of a property in London and included a clause which stated that the benefit of the contract was personal to the buyer. As both parties were unaware that the company in question had not in fact been incorporated Mr Klein concluded that the contract was not drafted with section 36C(1) in mind. The terms in question were clearly intended for a different purpose, which was to prevent or restrict a third party from becoming a buyer by way of an assignment of sub-sale.

The fact that the defendants here were a firm of solicitors shows just how easy it is to be caught out by section 51. Proving that there was “an agreement to the contrary” is a high hurdle to overcome.

What can I do to avoid liability?

As the saying goes, prevention is better than cure. As the risk sits with the person who has signed the contract, it is extremely important for that person to carry out appropriate checks to confirm that the company in question has been properly incorporated, and continues its corporate existence, before a contract is concluded. If you have already signed a pre-incorporation contract on behalf of a company, and you cannot prove an “agreement to the contrary”, you may still be able to avoid personal liability as explained below.

  • Novation

A novation is a three-way agreement that extinguishes one contract and replaces it with another, in which a third party takes up the rights and obligations of one of the original parties. In this scenario, the third party taking up those rights and obligations would be the company. All parties to the original contract, as well as the company, must consent to a novation for it to be valid. In addition, consideration must be provided. The various promises between the parties to the novation are generally regarded as adequate consideration however some parties may prefer to novate under a deed just to be sure.

  • Ratification

Ratification is a process by which a party can give retrospective authority to someone who has entered into an agreement on their behalf. Although some commentators suggest that ratification may be of assistance in these circumstances, we do not consider that ratification is possible in the case of pre-incorporation contracts. There are a number of conditions that must be met for an action to be capable of being ratified. One of these conditions is that the principal (here, the company) must be in existence at the time of the contract. As a company is not legally in existence before it is incorporated, these conditions will not be satisfied.

Final words

This blog should serve as a timely reminder of the risks of signing documents on behalf of a company; and in particular where a company itself is not in existence. If you have any questions about pre-incorporation contracts or contractual issues more generally please contact Neil Williamson or Joanna McKenzie or you can find out more about our legal services by clicking here.

Warranty Claim Teoco v Aircom EM Law Photo by Kaique Rocha

Share Purchase Agreement Claim Fails Because It Didn’t Follow Contract Procedure - Teoco UK Ltd v Aircom Jersey 4 Ltd & Anor [2018] EWCA Civ 23 (18 January 2018) 


In November 2013 Aicom and Aircom Global (the Respondents) signed a share purchase agreement in which the Respondents sold their shares in two companies that were part of their corporate group to Teoco for £41 million.

In February 2015 Teoco’s lawyers wrote to the Respondents lawyers claiming damages of approximately £3.4 million for breach of warranty or an indemnity in relation to tax said to be owed by two subsidiaries of one of the companies that Teoco had purchased. The letter was stated to constitute “notification in accordance with clause 24 and Schedule 4 of the SPA of the existence of Claims, being either Warranty Claims or Tax Claims, as further detailed below”, and which went on to set out details of the potential tax liabilities of the subsidiaries in Brazil and the Philippines.

In June 2015 Teoco’s lawyers issued a further letter providing more detail around how the level of damages was arrived at.

In August 2015 Teoco issued proceedings in the High Court.

On 18 December 2015 the Respondents applied to the High Court to strike out Teoco’s claim on the basis that it did not follow the procedure for making claims as set out in the share purchase agreement.

On 28 April 2016 the High Court ruled in favour of the Respondents and dismissed Teoco’s claim.

Teoco appealed.

The Appeal Decision

The Court of Appeal dismissed the appeal.

Lord Justice Newey examined the SPA and noted that Clause 10 of the SPA imposed limitations on the Sellers' potential liabilities. It stated:

“The liability of the Sellers under or in respect of any claim for breach of this agreement shall be limited by, and all claims for breach of this agreement shall be dealt with in accordance with, the provisions set out in schedule 4.”

The key provisions of schedule 4 in the SPA read as follows:

“4. Notice of Claims

No Seller shall be liable for any Claim unless the Purchaser has given notice to the Seller of such Claim setting out reasonable details of the Claim (including the grounds on which it is based and the Purchaser's good faith estimate of the amount of the Claim (detailing the Purchaser's calculation of the loss, liability or damage alleged to have been suffered or incurred)).

5. Time limits for Claims

5.1 No Seller shall be liable for any Claim unless the Purchaser has given notice of such Claim in accordance with paragraph 4, as soon as reasonably practicable after the Purchaser Group becomes aware that the Purchaser has such a Claim, and in any event on or before 31 July 2015.”

Judge Newey reviewed the letters that Teoco’s lawyers had sent to the Respondents’ lawyers and concluded that they did not constitute sufficient notice under paragraph 4 of Schedule 4 of the SPA. He found that the letters did not make specific reference to the warranties that the Respondents had allegedly breached or the grounds upon which the tax indemnity was triggered and therefore could not be considered to have been “setting out” the “grounds” of a claim.


I suspect most non-lawyers would find the decision harsh. In their February and June letters Teoco’s lawyers set out the nature of the claim in detail. Paragraph 4 of Schedule 4 in the SPA did not explicitly state that Teoco would have to make specific reference to the warranties that were breached or how the indemnity in the SPA was triggered in order to bring a claim. Wouldn’t justice be served, you may ask, if the court allowed the claim to be heard and then decided on its merits rather than thrown out on a technicality?

As a lawyer I am not so surprised by the decision (yes, hindsight is a wonderful thing!) because I read court cases all the time. I am used to seeing how somebody not quite getting it right or missing something altogether can lead to a court decision that has serious negative consequences for one of the parties.

Lessons to be learned:

  • don’t let the seller put claims limitation clauses in a share purchase agreement that you, if you are the buyer, are not totally clear on;
  • pay massive attention to detail when you are bringing a claim.

If you are buying or selling a company or need any other help with a share purchase agreement please get in touch.