A trap for the unwary – drafting an anti-embarrassment clause

August 2015 | EXPERT BRIEFING | MERGERS & ACQUISITIONS

financierworldwide.com

An anti-embarrassment clause will provide that the seller will receive an additional payment (Additional Consideration) for the sale asset if the buyer resells the sale asset within a certain period of time, typically a period of between one and three years after completion of the original sale (Restricted Period).

An anti-embarrassment clause might be relevant where a management buyout team acquires a business which has not been extensively marketed to third party purchasers (possibly for confidentiality reasons), where there is pre-pack sale by an administrator, which has only been marketed for a limited period before sale due to a need to retain business goodwill, where assets have been acquired as part of a rescue or restructuring exercise, or where one party buys an interest in a joint venture from the other joint venture partner and the relationship between the parties has broken down.

In each of the above examples, a full marketing and sale of the asset would not have been possible or desirable. There is therefore a risk that the buyer may acquire the asset at less than its full market value and may be in a position to sell the sale asset within a short period at a substantial premium, thereby ‘embarrassing’ the seller.

Other reasons for including an anti-embarrassment clause might be that for some other reason the value of the asset is inherently uncertain at the time of sale or that the seller simply wishes, as part of the terms of the deal, to share in any future uplift in value.

Structure of an anti-embarrassment clause

An anti-embarrassment clause will provide that an amount of Additional Consideration will be payable to the seller if a trigger event occurs during the Restricted Period. A trigger event will be a disposal (whether by one transaction or a series of transactions) of all, or a substantial portion, of the sale asset to a third party. The Additional Consideration payable by the buyer will usually be a percentage of the uplift in the price of the sale asset, sometimes on a sliding scale depending on whether the sale takes place early or later on during the Restricted Period.

One of the problems for the draftsman when drafting an anti-embarrassment clause is that it can be difficult to anticipate future events and ensure that such a clause cannot be easily circumvented, for example, by structuring the sale as a ‘put and call option’ exercisable outside the Restricted Period. Therefore, it is also usual to include a number of anti-avoidance provisions.

Anti-avoidance provisions

It should be borne in mind that the anti-avoidance provisions should be generally qualified so as not to prevent a director of the buyer taking any action that conflicts with his duties as a director of buyer. If this qualification is not included, the anti avoidance provisions may be void.

Information. The buyer has an obligation to notify the seller if a trigger event occurs and to provide evidence of the amount of the Additional Consideration due.

Good faith. The buyer has an obligation to act in good faith during the Restricted Period and not to take any steps intended to avoid or reduce any payment of Additional Consideration.

No arrangements. The buyer undertakes not to enter into any arrangement that has the purpose of concluding a trigger event after the expiry of the Restricted Period. In the recent case of Starbev GP Limited vs. Interbrew Central European Holding BV the court considered what ‘purpose’ meant in a clause of this nature. The court found that the ordinary principle is that the relevant purpose is the dominant one. In that case, the judge also found that the dominant purpose of the arrangements in question was indeed that of reducing payments under the anti-embarrassment clause. So the anti-avoidance clause had its desired effect but the case very aptly illustrates the difficulty faced by the draftsman of such a clause.

Additional protections. It is also usual to include a warranty by the buyer that it is not intending to sell the sale asset during the Restricted Period. While this is not an ant- avoidance clause , such a warranty is a useful additional protection. However it can be difficult to prove the buyer’s intention at the time of sale and, of course, it does not prevent the buyer from changing its mind after completion.

Determination of disputes

A determination of disputes clause provides that (in the absence of agreement) an expert appointed by the president for the time being of the Institute of Chartered Accountants shall determine any disputes arising between the buyer and the seller in relation to the anti-embarrassment clause. Such a clause potentially has the benefit of providing a less costly and confidential method of resolving disputes between the parties than engaging in litigation.

Conclusions

The drafting of an anti-embarrassment clause has to be very carefully considered and is by no means straightforward. Where the seller has sufficient bargaining power and the circumstances are appropriate it may be better for the seller to retain an interest in the sale asset or take a charge over the sale asset for any payment of Additional Consideration as further protection. The draftsman needs to take care not to be embarrassed by his own anti-embarrassment clause.

Paul Gilks is a partner at Kerman & Co LLP. He can be contacted on +44 (0)20 7539 7254 or by email: paul.gilks@kermanco.com.

Paul Gilks

Kerman & Co LLP