A shareholders’ agreement is a contract that contains the rights and obligations of the shareholders in a company. It typically supplements either a share purchase agreement or a share subscription agreement. You can read more about them in my post on the documents that you will come across during M&A transactions.
Almost every shareholders agreement looks similar. You will see a title, a table of contents, a recital clause, an interpretation clause, and introductory clauses describing the transaction. These clauses have been discussed in detail in myLaw.net’s course on Advanced Commercial Contracts. In this post, I will explain the conditions precedent clause, which is typically seen in all shareholders agreements.
A condition precedent is usually a legal term describing a condition or event that must occur before a contract is considered in effect or any obligations are expected of either party. Here are a few examples.
A is purchasing 100% of the shares in a company whose main business is selling computers to the public. The company does not manufacture computers itself but sells the computers it receives from different distributors. From A’s perspective, the company’s relationship with its distributors is key because if the distributors don’t provide computers to the company, it will have nothing to sell. Many of the distributors’ contracts with the company require their prior approval before a 100% transfer of shares takes place. A would only want his obligation (to purchase shares and pay consideration for them) to be triggered once the company receives these approvals. The receipt of these approvals therefore, is a condition precedent that must be fulfilled by the company before the transaction is effective.
Take another example. B, a non-resident investor who has an investment in an IT company in Mumbai, wants to invest in an IT company in New Delhi. One of the terms of the transaction is that B must sell his interest in the Mumbai-based company before making the investment. So, the sale of those shares in the Mumbai-based company is a condition precedent that B must fulfill before he can invest in the Delhi-based company.
If these conditions are not fulfilled, there will be no deal. Common conditions precedent in M&A transactions include those in relation to obtaining approvals from the regulators, firing or hiring particular employees, ensuring that sufficient cash is available in the company, obtaining approvals from third parties, and ensuring that lease agreements are in place.
On whom is the obligation cast?
Let’s take a closer look at the examples above. You will see that the obligation to fulfill the condition precedent in the examples is cast on different parties. In the first example, the obligation to obtain approvals from distributors is cast on the investee company, that is, the company in which the investment is being made. In the second example, it is cast on the foreign investor. Conditions precedent can thus differ on the basis of the party on which the obligation to fulfill it, is cast. Some obligations can be cast on the investee company, some on the investor, and some jointly on the investee company and its shareholders.
For instance, C is a foreign investor who wants to invest in a company operating in a sector where the approval of the Reserve Bank of India is required for any foreign investment. Typically, the burden of obtaining this approval is cast jointly on all parties because each party’s cooperation is required for obtaining this approval.
While drafting a conditions precedent clause, you must take care to identify the party on whom the obligation to fulfill a particular condition is imposed. This is vital as each party is responsible to fulfill its own obligations in relation to the conditions precedent. While casting an obligation on the investee company, you should examine whether it is also useful to cast the obligation on its shareholders (or at least the majority shareholders) if they control the operations of the company.
The right to waive a condition precedent
Another point vital to this discussion is whether conditions precedent can be waived. Look at the first example. Assume that the investee company has only obtained approvals from fifty percent of its distributors. A, the investor, would really want the deal to go through and should be happy with approvals from these distributors if they are the major ones and would want to waive the condition that approvals must be obtained from all the distributors. Once A has waived the fulfillment of this condition, the deal can go through. The right to waive the fulfillment of a condition precedent is very important in all M&A transactions. Always include this right when you are drafting a condition precedent. The important point to keep in mind is that the person who has the right to waive the condition must be different from the person who is obliged to fulfill the condition.
In the first example, the right to waive the fulfillment of the condition in relation to obtaining consents from distributors must be with A and not the investee company. The investee company can never have the right to waive fulfillment of a condition that it is obliged to fulfill. Similarly, in the second example, the right to waive the condition in relation to withdrawal from the Mumbai-based IT company is on the investee company and not B, the investor.
Since these are all contractual rights, it is up to the parties to decide whether they would like to waive the conditions in part or in full. As a lawyer, your duty is to ask these questions from your client before you start drafting so that you can use the words that are appropriate to your client’s interests.
When should the conditions precedent be met?
Finally, always insert a date by which all the conditions precedent must be met. This is typically called the ‘long stop date’ and is important to ensure that there is no undue delay in the performance of the contract or the fulfillment of the conditions. Parties know that they must fulfill the conditions precedent by a specific date. While drafting this clause however, always include the following or similar words:
“The Conditions Precedent must be satisfied by April 20, 2015 or any date as may be mutually agreed between the Parties.”
The words in plain text above give the parties to a contract the right to mutually agree and extend the time for the fulfillment of the conditions. If, for example, regulatory approval — a condition precedent for a particular deal — takes longer than anticipated, the parties should have the right to extend the long stop date if they feel the need to do so. This is also important because if conditions precedent are not satisfied, the transaction is terminated, and parties must have the flexibility to prevent this.
As you start drafting conditions precedent, you will realise that there are many nuances to the manner in which you draft these conditions. For instance, you may use the words ‘use all reasonable efforts’ to dilute the obligation on a party. In such cases, that party only has to show that it has used all reasonable efforts to fulfill the condition and that will be enough (even if the condition has not been fulfilled).
Keep drafting and with practice, you will get better at drafting conditions precedent clauses.
(Deepa Mookerjee is part of the faculty on myLaw.net.)
Shareholders’ agreements govern the rights and obligations of the shareholders. The company is also made a party to such agreements so as to make it binding on the company. Among other things, they set out the various rights of shareholders and provide for the conduct of business, the transfer of securities, and how to resolve deadlocks. Often, the company is also made a party to such an agreement and in an investment transaction, this is done at a “closing” by holding board and shareholders’ meetings that result in the amending of the original articles of association.
