Share or Asset Deal: What’s the difference?
Whether you’re buying a property directly or buying the shares in a company which owns a property, there is a process of disclosure and due diligence which must be undertaken. However, there are key differences in how these are dealt with, depending on which transaction type is chosen. This article will focus on the key transactional differences rather than the tax implications which, whilst obviously crucial, are a topic in themselves.
Warranties and Representations
In a share purchase, there are no implied representations or warranties. Instead all warranties must be incorporated into the share purchase agreement (the “SPA”). The seller will provide a series of confirmatory statements (for example, if the seller is providing replies to enquiries, it will need to warrant that these are accurate), which it then discloses against in a disclosure letter. This is similar to the disclosures made against a Certificate of Title in a commercial real estate financing.
The extent of the warranties provided by the seller will vary depending on how important the property is in the context of the overall transaction and the bargaining position of the parties. If, for example, the property is low value, or the buyer has been involved with the property in the past, then the warranties may be fairly brief.
If a warranty turns out to be untrue and as a result, the value of the company is reduced, the buyer can make a claim for damages for breach of contract. Damages for breach of warranty are based on the difference between what the shares are actually worth compared to what they would have been worth had the warranty been true (which is likely to be the price paid for them by the buyer). A breach of warranty would not normally allow the SPA to be terminated unless exchange and completion of the SPA was occurring on different days and the breach was absolutely crucial to the contract.
By contrast, on an asset purchase the seller will provides replies to standard enquiries (CPSEs) plus any additional enquiries which the buyer may raise as part of its due diligence. The principle of caveat emptor (which applies equally to share and asset purchases), means that the buyer must make its own enquiries to pick up on any issues with the property.
If the seller gives an untrue or inaccurate response to any of the enquiries, which the buyer has relied on when entering into the sale agreement, the buyer has the right to make a claim for misrepresentation. This is a tortious claim, which may entitle the buyer to rescind the contract and/or to claim damages.
This is broadly similar for both a share and asset sale, with a suite of searches in relation to the property being carried out. Index Map, Local Authority, Drainage & Water, Gas, Electricity and Highways are the main searches typically ordered. A survey of the property may be undertaken, and if relevant an environmental report obtained. If the property isn’t key to the company’s business, the searches carried out will be less extensive than on an asset purchase. In a share sale the searches are typically listed out in, and appended to, the disclosure letter.
There’s often a “catch-all” disclosure in the share sale disclosure letter which states that the buyer is deemed to know everything that its solicitor knows and that it could reasonably be expected to know about (although this may well be resisted by the buyer). It’s therefore important for a buyer’s solicitor to ensure that all reports and surveys are forwarded to the buyer, and that anything else which might be disclosed in a data room by the seller is sent across for the buyer’s review.
Asset Management Considerations
A key difference between a share and asset purchase is how monies held by the seller in connection with the lettings at the property are dealt with.
For example, if there’s a service charge in connection with the management of the property, there may be shortfalls where there are service charge caps or tenants in arrears with their payments.
On an asset purchase the service charge will be addressed in the sale contract, with final accounts being provided by the seller within a fixed period after completion, and the buyer either collecting in arrears to make up any shortfall to be paid across to the seller, or if the accounts show a surplus, the excess being paid by the seller to the buyer.
With a share sale, it’s important to remember that service charge monies in a landlord’s account are not part of the assets of the company because they are held for specific expenditure in accordance with the terms of the leases, which will contain mechanisms for repaying the money or crediting it against tenants’ accounts. This therefore must be taken into account when the company is valued. If there are service charge arrears or shortfalls, this is a liability for the company. This may either decrease the company price, or the service charge accounts can be entirely removed from the completion accounts and dealt with by way of a later adjustment between the seller and buyer.
There may also be rent arrears, which on an asset sale will again be addressed in the sale contract. Differing approaches to dealing with arrears can be taken – the buyer may take responsibility for collecting the arrears from the tenant(s) and accounting to the seller for their share, or the buyer may pay the amount of arrears to the seller on completion and then assume responsibility to collect in and keep the monies.
On a share sale, the arrears may lead to a price reduction if it seems unlikely that they will ever be paid. Alternatively, they will not be dealt with as part of a purchase price adjustment but instead will be paid across to the seller if and when received by the buyer.
Landlords will often collect rent deposits from tenants as security for any breach of the tenant’s lease obligations. These monies will be held in accordance with a rent deposit deed, and will either be charged to, or held in trust by, the landlord to use in the event of the tenant defaulting.
On an asset purchase, the rent deposits will need to be specifically dealt with in the sale agreement. Depending on the date of the lease, the rent deposit deed will state that any buyer is automatically bound by its terms, or alternatively the deposit deed may need to be assigned to the buyer on completion.
The amount of the deposits held by the landlord will also be dealt with in the completion statement and deducted from the overall purchase price being paid by the buyer.
On a share sale, the rent deposits held by the landlord can’t be included as part of the company’s assets and valuation, because the monies remain the property of the tenants in accordance with the rent deposit deed. The landlord entity will remain the same after the share sale has completed, because, although the shares have transferred, the landlord, from a tenant’s perspective, remains the same. This means that no further action usually needs to be taken in relation to the deposits.
On an asset purchase, if there’s an issue with the title to the property (for example, there’s a restriction as to use or a restrictive covenant within a missing deed) then it’s usually possible to obtain title defects’ indemnity insurance. These policies will cover either the property value or its development value and need to be reviewed and negotiated to ensure that there aren’t any excessive caveats which will restrict the buyer’s potential to make a claim. Title indemnity insurance is typically in perpetuity, meaning that it will last for the life of the property. Sellers will often pay the premium on behalf of the buyer if a policy isn’t already in place.
On a share sale, the buyer may consider obtaining warranty and indemnity insurance (W&I Insurance) if it isn’t satisfied about the financial strength of the seller or is concerned about enforcement for breach of warranty in a different jurisdiction. This type of insurance has grown in popularity. The seller can cap its liability with the buyer then making an insurance claim for any breach of warranty. The insurers will do their own due diligence to evaluate the level of potential risk and will typically carve out any particular areas of concern. This type of insurance policy can be taken out by either the seller or the buyer, but the premium can be costly. In contrast to title indemnity insurance, the policy’s term typically runs for the duration of the warranties as set out in the SPA.
For more information about indemnity insurance, please click here.
The amount of due diligence to be carried out on a share purchase will depend on how essential the property is to the company’s business. The buyer will want to make sure that there are no issues relating to the title or any occupational tenants. These will be flushed out via the searches, title review, in replies to enquiries and, on a share purchase, the disclosure letter. Even if the property is of lesser importance to the purchase of the company, on a share purchase the seller’s accounts need to be checked carefully to ensure that any costs relating to leases and service charge are properly dealt with and to ensure a fair valuation.
This note reflects our opinion and views as of 27 September 2021 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.
Louise is a Knowledge Development Lawyer in our Commercial Real Estate team.