Split vs Simultaneous Exchange and Completion in M&A
What is the difference between split and simultaneous exchange and completion in M&A? When may a transaction need to be split, and what are the key risks for clients? This article considers those key questions.
Much like when buying a house, exchange in a corporate transaction (such as an asset or share sale) is when the parties sign the sale and purchase agreement, at which point, the seller and buyer have made a binding legal commitment to each other to proceed with the transaction on the terms set out in the sale agreement.
Completion is when the transaction legally completes and is the time at which ownership and control of, and liability for, the business or assets passes to the buyer (unless the sale agreement has specified something different).
In reality, exchange and completion often happen at the same time (known as “simultaneous” exchange and completion) and so parties are unaware of the separate concept of exchange because focus is on the end goal of completion. In these circumstances, there is no need to distinguish between the two concepts. However in other cases, there is a valid commercial reason as to why exchange of sale contracts should take place first with completion following on at a later date. This is known as “split” exchange and completion and parties contemplating a transaction should be aware of its usage and implications on a deal.
The period between exchange and completion on a split transaction is often referred to as the “interim period” and needs careful consideration in the scope of the wider transaction.
Why split exchange and completion?
As outlined above, most transactions exchange and complete simultaneously. The most common reason for splitting exchange and completion is that certain conditions need to be satisfied before completion can take place. In these circumstances, sale contracts would be exchanged, but completion would be dependent on the satisfaction of certain, specified matters.
Transactions that may require a split exchange and completion include where there is a requirement for third-party consent(s) prior to completion, such as approval from the issuing authority to transfer a licence that is important to the operation of the business, or consent from a key customer or supplier, where the value of the business depends on the continuation of that licence or relationship. Other requirements may include putting financing arrangements in place or completing a corporate restructure.
Sometimes, the parties may choose to include a gap between exchange and completion, simply to allow the parties to prepare for the acquisition.
So, what are the risks?
Split exchanges and completions by virtue of their nature create a window during which the parties are legally committed to the transaction, but where legal completion (ie sale/transfer to the buyer) has not yet taken place. It often results in a situation where the buyer commits to buying a business over which they have no control throughout the interim period, which can present substantial buyer risk.
During the interim period, it is usual for the seller to continue to operate the business, however the buyer will, for the reasons outlined above, take a keen interest in what is happening during that window. A buyer may have concern that given that during the interim period, the business remains under seller ownership and control, events unfavourable to the buyer may take place, over which the buyer has no control. At its most extreme, the business may change materially before completion. The issue for the buyer is that, provided any conditions are satisfied as outlined above, it will be legally bound to complete the purchase, often giving rise to understandable legitimate concern.
Consideration must be given as to expectations for the business during the interim period. Again, this is a delicate balance of a buyer wanting to clearly set out what the seller may or may not do, whilst the seller may well assert that their hands should not be unfairly tied whilst they are still the legal owners of the business. Too tight restrictions in themselves may very well hinder business performance and progression during an interim period which is directly contrary to what a buyer will want to see.
There is also ‘execution risk’. A transaction may become less attractive after exchange, but the buyer may have limited ability to walk away unless specific termination rights or conditions have been negotiated and these should be given clear consideration at the outset. From a seller perspective, it is committed to the buyer and may face uncertainty over when (or whether) completion will occur and there needs to be an equitable balance between the seller and the buyer’s commercial interests.
Can the pitfalls be avoided?
Depending on the conditions, the risks associated with split exchange and completion can be avoided. Even where they cannot be eliminated entirely, there are many ways to mitigate the risks.
As said, where possible, the parties should consider whether the relevant issues can be dealt with before exchange and, in an ideal world, the parties should record in as much detail as possible commonly agreed intentions and commercial workings at the heads of terms (pre-contract) stage.
The parties should avoid brushing key commercial aspects of a transaction to one side in the hope that they can be resolved at a later stage as this risks increased delays whilst negotiations take place, increased professional costs and even abortion of the transaction if the parties simply cannot become aligned.
Early engagement with regulators and third parties can also help minimise, or even avoid, the need for a period between signing and completion, and can effectively help to assess whether satisfaction of any completion conditions will, or are likely to, present a problem. Ultimately, split exchange and completion is often unavoidable where regulatory or other conditions stand between signing and completion however the likelihood of satisfaction of these conditions and an understanding of realistic timings should be well within the contemplation and appreciation of both buyer and seller before terms are agreed. The objective in these circumstances is therefore to understand and control the risks an interim period may create rather than eliminating it altogether.
The sale contract should envisage and clearly state any conditions required for completion to take place, setting out specific obligations on either party to satisfy those conditions (if relevant). Timing is always a key consideration, and a long stop date should be agreed and recorded by which any conditions must be satisfied, otherwise the deal will not proceed. It is prudent to acknowledge that in some cases, even with the best will and intent, there may be slippage on timings, and the sale agreement should record how the parties wish to proceed in those circumstances. A buyer should therefore give thought as to the circumstances in which it may be permitted not to proceed to completion. This can be a difficult balance – protecting the buyer’s legitimate business interests whilst also providing comfort to the seller that the buyer will not be unfairly allowed to backtrack out of a previously agreed deal.
Another key method for the buyer to protect its position in circumstances where the risk cannot be entirely avoided is, as mentioned, to impose interim operating conditions on the seller, restricting the seller as to matters such as corporate acquisitions, asset disposals, entering into new contracts over a certain value, capital expenditure and borrowing, and certain employment matters. Depending on the specific deal, the buyer may insist on an outright ban on these matters, or it might permit the seller to carry out such matters provided it has obtained the buyer’s consent. As discussed above, whilst these types of clauses are the norm, legitimate buyer concerns need to be carefully balanced against the seller’s rights and abilities to control and operate a business which during the interim period is still theirs.
The contract should also allocate the risks of the interim period clearly which again should have been considered and recorded at heads of terms stage. This may include tightly drafted conditions precedent, appropriate longstop dates and termination rights. A prudent buyer should also insist on the right to access information so that it can monitor the target business between exchange and completion.
It is imperative that each party understands its obligations during the interim period. For buyers and sellers alike, understanding those risks at the outset can help to properly manage and frame expectations on both sides. As with many aspects of legal transactions, it is important to discuss and agree all matters upfront at the outset, to be clearly recorded in heads of terms. Failure to give adequate consideration to such key issues at the start of negotiations (often assuming that they can be flushed out at a later stage) is fraught with issues if it transpires that the buyer and the seller have quite different expectations and assumptions around the key points in issue.
How can we help?
Given the risks involved, it is important that your sale and purchase agreement is carefully drafted to clearly reflect the terms of your deal and protect your interests. Key concerns and issues should be discussed and agreed at the heads of terms stage. Choosing a solicitor who understands your transaction and has experience dealing with these issues can help give you confidence that the right protections are in place.
If you are considering or undertaking a corporate transaction and would like advice on the legal issues involved, our Corporate team would be happy to help. Please contact us at corporate@chadlaw.co.uk or call 0113 225 8811 and ask to speak to a member of the Corporate team.
