Are non-binding preliminary agreements before the execution of a definitive agreement typical in real estate business combinations, and does this depend on the ownership structure of the target? Can such non-binding agreements be judicially enforced?
Non-binding preliminary agreements are unusual in the context of the acquisition of a public company because the equivalent document is the indicative offer letter submitted by the bidder to the target’s board of directors of the target company.
Under Rule 21.2 of the City Code on Takeovers and Mergers (the Takeover Code), offer-related arrangements, such as inducement (or break) fee arrangements between the target company and bidders, are prohibited during an offer period or when an offer is reasonably in contemplation, except in limited circumstances. The parties are, however, permitted to enter into, among others, a commitment to maintaining the confidentiality of information, and a commitment not to solicit employees, customers or suppliers and irrevocable commitments and letters of intent if those commitments do not contain any other provisions prohibited by the Takeover Code. These confidentiality and solicitation commitments are usually binding.
Where a leak occurs in the context of an acquisition or disposal being made by or of a public company, the listed entity or entities will be required under the Listing Rules, the Alternative Investment Market Rules for Companies (the AIM Rules) Rules and, if applicable, the Takeover Code to put out an announcement of the possible transaction, although that announcement will not be binding on the parties. However, if the Takeover Code applies, any announcement will trigger the commencement of an offer period and the requirement for the identified bidder to announce a firm intention to make an offer or announce that it does not intend to make an offer by 5pm on the 28th day following the date of the announcement in which it is first identified unless the Panel on Takeovers and Mergers (the Panel) consents to an extension of the deadline.
Letters of intent in private real estate combinations are normally expressed to be non-binding and the English courts will typically respect the parties’ stated intention that this document cannot be enforced.
Heads of terms are also generally expressed to be non-binding, save for specific provisions declared to be binding and capable of enforcement. Again, the English courts will respect the intentions of the parties and will only enforce those particular provisions that the parties have agreed to be binding. Typically, the binding provisions are those relating to a period of exclusivity for the buyer (where the seller agrees not to deal with any third party), limited process obligations during the exclusivity period and confidentiality obligations.Typical provisions
Describe some of the provisions contained in a purchase agreement that are specific to real estate business combinations. Describe any standard provisions that are contained in such agreements.
The deal could be the purchase of a property (an asset deal) or the purchase of shares in a corporate vehicle that owns a property (a share deal).
In an asset deal, a seller will invariably give no W&Is in the contract at all, except a standard form of title guarantee. The usual guarantee in effect warrants that the seller’s title is not subject to any charges or rights, etc (except any that the seller does not know about) and that the seller has the right to sell the property. However, this is qualified in the contract by setting out a generic list of matters that the buyer has to agree it is buying subject to. In other words, the risk is with the buyer, who must undertake title due diligence and searches to ascertain what the title may be subject to.
Also, in an asset deal, the seller will usually provide replies to standard form pre-contract enquiries and specific enquiries raised by the buyer’s solicitor. There may be a ground for action by the buyer if those replies are found to be wrong, fraudulent or negligent. However, liability for those replies is often qualified in the contract, so that the seller is only liable for deliberate or fraudulent misrepresentations. If a seller is liable, then the claim post-completion would usually be for damages, but if a claim is made pre-completion it may be possible to rescind the contract.
In a share deal, a seller will again try to avoid giving any warranties relating to the property, usually on the basis that the buyer is undertaking its due diligence. Some basic warranties are nevertheless given in these circumstances, for example:
- the company has title to the property;
- the company has not granted charges over or otherwise encumbered the property;
- the company does not own and has not previously held any interests in other property; and
- the company uses the property only for the business and does not use any other property for that purpose.
In some share deals, the buyer does not undertake full title due diligence and instead relies upon a title certificate or a report issued by the seller’s solicitors. Occasionally, a seller will give a full suite of property warranties, covering all of the matters that would otherwise be covered by a title report and searches, but this is rare.
In all cases, a seller will seek to avoid giving warranties as to the environmental condition of the property and require the buyer to satisfy itself by undertaking an environmental survey or search. Similarly, with planning issues, a seller will seek to pass the risk to the buyer but it is not unusual for a seller to warrant certain planning matters, such as payment of monies under planning consent obligations or that it has not received notice of any planning enforcement action.Stakebuilding
Are there any limitations on a buyer’s ability to gradually acquire an interest in a public company in the context of a real estate business combination? Are these limitations typically built into organisational documents or inherent in applicable state or regulatory related regimes?
The limitations on a bidder’s ability to gradually acquire an interest in a public company in the context of a real estate business combination are, in the United Kingdom, generally set out in applicable laws and regulations. They do not differ from the acquisition of an interest in a non-real estate public company.
The key consideration is the Takeover Code, which permits a bidder (together with any persons acting in concert with him or her) to build a stake in a public company up to 29.9 per cent, without triggering the mandatory offer provisions in Rule 9 of the Takeover Code. Except with the consent of the Panel, the acquisition of further shares in a company where a shareholder (together with persons acting in concert with it) holds between 30 and 50 per cent of the voting rights will trigger an obligation to make a mandatory offer to all shareholders.
If a buyer wishes to keep its interest in a publicly traded company secret, then the limitation on acquiring shares in that company is less than 3 per cent of the issued share capital. This is because, under Rule 5 of the Disclosure Guidance and Transparency Rules (DTR5), that applies to both Main Market (LR 9.2.6A and 9.2.6B) and AIM companies, subject to certain limited exceptions, a person must notify the company (and the Financial Conduct Authority) as soon as possible, and in any event, within two trading days, of the percentage of voting rights it holds or is deemed to hold through a direct or indirect holding of financial instruments if the percentage of those voting rights reaches, exceeds or falls below 3 per cent, and each 1 per cent threshold above that as a result of an acquisition or disposal of shares or financial instruments; or reaches, exceeds or falls below one of the applicable thresholds set out above as a result of events changing the breakdown of voting rights and based on the total voting rights notified to the market by the company. Similar requirements are also set out in Rule 17 of the AIM Rules.
Also, in the context of a public company takeover, there are further dealing and position-disclosure requirements during an offer period set out in Rule 8 of the Takeover Code that apply alongside DTR5. Although not strictly limitations on a bidder’s ability to build a stake, they might be seen as practical limitations if the bidder wishes to try and maintain secrecy around its shareholding, particularly in any competitive offer situation.
Part 22 of the Companies Act 2006 grants public companies the right to investigate who has an interest in its issued share capital. Section 793 of the Companies Act 2006 gives a public company the power to send a notice requiring a person it knows or has reasonable cause to believe, has an interest in its shares (or to have had an interest during the past three years) to confirm or deny the fact, and, if the former, to disclose certain information about the interest, including information about any other person with an interest in the shares. This limits the ability of a potential buyer to gradually build a stake in a public company through a nominee company thinking that its true identity will not have to be disclosed.
Any bidder looking to gradually acquire an interest in a public company to possibly make a formal offer for that company in the future should also be mindful of:
- any standstill provisions that might have been entered into with the target company that would prevent it from acquiring any shares for a certain period (usually until a firm intention to make an offer announcement has been made);
- Rule 6 of the Takeover Code on equality of treatment in relation to price;
- Rule 11 of the Takeover Code on equality of treatment in relation to the form of consideration;
- the risk of being left with an interest in the company if it decides not to make an offer; and
- whether the acquisition of shares could make any squeeze-out more difficult in the case of a contractual offer or impact on the likelihood of any scheme being approved because in the case of a vote on that offer or scheme the bidder will not be able to vote using those shares.
Describe some of the key issues that typically arise between a seller and a buyer when negotiating the purchase agreement for a real estate business combination, with an emphasis on building in certainty of closing. How are these issues typically resolved?
An asset deal will have a fixed completion date in the contract, or if completion is subject to conditions, it will be a fixed period after satisfaction of the conditions. The completion date will, therefore, be ascertainable and if completion does not occur on time then, in most cases, that will be because of the default of one party or other, who could then be liable for damages for breach of contract, for an action for specific performance or any express remedies in the contract such as (in the case of a buyer’s default) interest on the purchase price, termination of the contract and the loss of any deposit.
A share deal will often have a simultaneous exchange and completion but if not the above comments will apply. If it is simultaneous then there is a risk that either party decides to pull out of the deal. If that happens, then the other party will have no recourse against the withdrawing party, unless they have agreed on some form of protection at the beginning of the deal that is incorporated into a separate preliminary contract (often a lock-out agreement or confidentiality agreement) or dealt with by way of a solicitor’s undertaking. These remedies are typically the loss of a deposit paid upfront or an obligation to pay towards costs.
If there is a period between exchange and completion the following points should be addressed:
- how the seller manages and deals with the property up to completion (what it can and cannot do, matters where it needs the buyer’s prior consent);
- risk in the property (who has the obligation to insure the building and what happens if there is any damage in that period);
- whether the seller is liable to maintain any security in respect of the property; and
- payment of a deposit on exchange (typically, 5 per cent or 10 per cent of the price – a higher deposit is at risk of being void unless there are good reasons for a larger sum to justify it being a fair reflection of the potential loss arising from non-performance).
In the case of the acquisition of a public real estate company, the key document will not be a sale-and-purchase agreement, but an offer or scheme document. Assuming the offer is not hostile, there are limited negotiations regarding these documents as the process of agreeing them is much more collaborative, with all parties ensuring that the necessary disclosure requirements of the Takeover Code have been met and the correct message about the proposed acquisition is delivered to the shareholders.Environmental liability
Who typically bears responsibility for environmental remediation following the closing of a real estate business combination? What contractual provisions regarding environmental liability do parties usually agree?
It is for the buyer and seller in any transaction to agree where future liability for environmental remediation should lie. In a typical scenario, the seller will wish to divest itself of all liabilities and the buyer is only usually willing to take liability for contamination that is in situ within the land that is being transferred as part of the deal.
The negotiation is usually over liability for contamination that may have historically escaped the land being transferred under the deal. Unless the buyer expressly agrees to take on that liability, it cannot be held liable under the Part 2A contaminated land regime under the Environmental Protection Act 1990. It will only be liable under that regime for contamination that lies within the site, and the original polluter will retain liability for anything that has escaped the site.
In the case of a business or a share sale, liability for contamination that the business has caused or contributed to on sites that have been occupied or developed historically but the business no longer has an interest in will usually continue to lie with the business. The buyer will often obtain warranties and indemnities from the seller against those liabilities, but these will usually be time-limited for, say, three to five years, after which the buyer will be fully responsible. Alternatively, insurance may be obtained.
Where contamination is suspected the buyer will usually commission intrusive investigations to establish the extent of the contamination and any remediation that is required – and the purchase price will reflect the cost of any remediation that is found to be required. On the basis that the cost of remediation has been taken into account in agreeing on the price, the buyer will assume liability for that remediation. There are instances though where a buyer will require the seller to remediate the site before the sale completes.
Where contamination or the escape of contamination is an unknown, whoever assumes liability may obtain environmental insurance to indemnify against the risk of remediation works needing to be carried out. Usually, the better the information (ie, reports and surveys) there is to enable the insurer to assess the risk, the lower the premium.
The contractual provisions in any land deal will usually recite the fact that the buyer has been allowed to investigate the site and that the state and condition of the land have been taken into account in the purchase price. This allows the seller to benefit from the sold-with-information exclusion from liability under the Part 2A regime, which applies where the seller and the buyer are both within the Class A liability group (ie, both have caused or knowingly permitted the presence of a significant contaminant in, on, or under the land).
Where a site is due to be developed or redeveloped, ground investigations and remediation will usually be required under the planning regime. Again, the buyer in this instance is likely to carry out its investigations to ascertain the degree of contamination before buying the site, and liability for that remediation will generally lie with the party that is carrying out the development.Other typical liability issues
What other liability issues are typically major points of negotiation in the context of a real estate business combination?
When acquiring a real estate business a purchaser will wish to evaluate whether the asset or assets within the business being acquired also bring with them potential liabilities. These could include the following.
The physical state of the property
Liabilities arising because of the poor physical condition of the property. Market practice is for no warranties to be given by the seller as to the state and condition of the property. The buyer is expected to carry out its physical due diligence before purchase and is expected to acquire with full knowledge of any physical defects.
If the pre-transaction surveys and investigations reveal defects in the physical condition of the property, the buyer should negotiate a price reduction or walk away from the deal as there is unlikely to be redress against the seller for anything relating to the state and condition of the property after completion.
Liability for physical defects may be mitigated by the purchaser having the ability to claim against a building contractor or other professional adviser under a collateral warranty or third-party right. The sale-and-purchase agreement can be drafted so that the benefit of these is passed to the buyer on completion.
The property may be subject to financial obligations, such as an obligation to pay overage to a third party on the occurrence of certain events or an obligation to pay a rent charge. Details of these should be revealed in the legal due-diligence phase and if they are of concern, the buyer may negotiate a price reduction or require that the seller procures their release as a pre-condition to sale.
Insufficient rental income
If the property assets are not fully let or fully income-producing, where, for example, rent-free periods are in place or service charge caps have been agreed with some tenants, it is common for the buyer to insist on the purchase agreement including a rent top-up or a rent guarantee so that the seller is obliged to make additional income payments (either overtime after completion or as a lump sum on completion) to compensate for the reduced rent or vacant units.
The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) may operate to transfer the employment of employees who principally provide their services concerning, or who are wholly or mainly assigned to, the property assets from their current employer to the buyer or its managing agents.
The buyer could inherit liabilities to these employees, such as payment of their wages and pension obligations. Specialist employment law advice should be sought.
It is important to establish whether the corporate entity being acquired has any liability under leases of the property where it is no longer the tenant. If the lease was granted before 1995, this could be a liability as an original tenant. For leases granted after 1995, this could be liability under an authorised guarantee agreement.Sellers’ representations regarding leases
In the context of a real estate business combination, what are the typical representations and covenants made by a seller regarding existing and new leases?
Since the reason for a real estate business combination is the acquisition of the real estate assets, this type of transaction invariably involves:
- the seller populating a data room with all the information about a property, including leases to which it is subject, that would be made available to a buyer on an asset acquisition;
- the buyer undertaking full due diligence of the materials in the data room;
- the buyer undertaking a full suite of the usual conveyancing searches to obtain information about the property available from public sources; and
- the buyer raising enquiries about any matters relating to the property which are of interest to it and receiving replies to those enquiries which are warranted in the sale-and-purchase agreement.
Consequently, the typical representations and covenants made by a seller in respect of leases in the sale-and-purchase agreement are very limited. The sale-and-purchase agreement would usually include brief details of the occupational interests to which the property or properties are subject (eg, date, parties and document type). The seller may warrant that the information in the schedule is true, complete and accurate and that the leases detailed in the schedule are the only leases which exist at the property.
Other general warranties in the sale-and-purchase agreement may apply to the leases. For example, warranties as to the capacity of the seller to enter into contracts generally, the absence of any breach of contract, the absence of litigation and default under contracts and that no termination events having occurred. However, warranties specifically relating to the occupational leases at the assets (except those mentioned above) would be unusual.