What Is an SPA (Share Purchase Agreement)? The Structure of the Definitive M&A Agreement and an Overview of Its Key Provisions

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

A few days after you sign the letter of intent and receive the legal due diligence report, the seller's attorney sends over a draft share purchase agreement running to dozens of pages. The table of contents lists unfamiliar chapters such as conditions precedent, representations and warranties, covenants and indemnification, and simply glancing at it does not tell you which chapter determines your company's burden. The first problem the person in charge on the buyer's side faces is deciding in what order to read this thick draft.

An SPA (Share Purchase Agreement) is the definitive agreement that the seller and buyer conclude in an M&A transaction carried out by acquiring shares. Whereas a letter of intent (LOI) is a document that is not legally binding except for certain provisions such as confidentiality and exclusive negotiation, the SPA, on the basis of the facts confirmed in legal DD, fixes who will do what and when, and who bears the burden if those premises collapse.

Where the SPA Sits and Who the Parties Are

As a rule, there are two parties: the seller and the buyer. In theory it is conceivable to add the target company as a party, but where the seller holds 100% of the shares and controls the target company, it is sufficient to impose obligations concerning the target company on the seller. For a company that is operated independently of the seller, it may also be undesirable to disclose all of the contract terms to the target company. For these reasons, in practice the target company is almost never a party. There may be multiple sellers; typical cases are where members of a founding family hold the shares separately, or where officers and employees are shareholders.

The share transfer provision is drafted along the lines of: "In accordance with the provisions of this Agreement, the Seller shall transfer to the Buyer, on the Closing Date, all of the issued shares of the Target Company held by the Seller, and the Buyer shall, in accordance with the provisions of this Agreement, acquire the same." At first reading this looks like an unconditional promise of sale, but it is not. The single phrase "in accordance with the provisions of this Agreement" is the drafting device that reads in the rule that the transfer will not take place unless the conditions precedent are satisfied.

The Skeleton of the Agreement

A typical SPA consists of the following chapters.

• Preamble and definitions
• Share transfer
• Purchase price and price adjustment
• Closing
• Conditions precedent
• Representations and warranties
• Covenants (pre-closing and post-closing)
• Indemnification
• Termination
• General provisions (confidentiality, allocation of expenses, governing law, jurisdiction, etc.)

These chapters refer to one another. That the seller's representations and warranties are true and accurate in material respects, and that the seller has performed the matters it must perform by closing, are conditions precedent to the buyer paying the purchase price. If a material breach of representations and warranties is discovered before closing, the buyer can refuse to close on the grounds that a condition precedent is unsatisfied and exit the transaction under the termination provision. If a breach comes to light after closing, the buyer claims compensation for its losses under the indemnification provision. The structure is that a single fact connects to conditions precedent, termination or indemnification, depending on the stage of the transaction.

Purchase Price and Closing

Closing is the day on which the seller delivers the shares and the buyer pays the purchase price. A model provision states that the seller transfers the shares by delivering the share certificates in exchange for receiving payment of the full purchase price, and the buyer pays the purchase price in exchange for receiving delivery of the share certificates, and it goes so far as to specify the deadline for notifying the bank account for payment and who bears the transfer fees. For a company that does not issue share certificates, the central step becomes updating the shareholder register in place of delivering share certificates.

Besides paying an amount fixed at signing, the purchase price may be settled by a method under which the required adjustment amount is settled after the balance sheet as of the closing date is finalized. If the adjustment amount is positive, the buyer pays the seller; if negative, the seller pays the buyer, within a certain number of business days from the date of finalization. The calculation items for price adjustment and the procedure for objections are covered in Designing Indemnification, Price Adjustment and Closing.

Conditions Precedent (Conditions to Closing)

Conditions precedent (CPs) are an agreement that the parties will perform their closing obligations only if all of the specified conditions are satisfied. There are many circumstances in which the transaction cannot be carried out until a procedure is completed, such as where the acquisition of shares requires a permit or a filing with a government authority. By including conditions precedent, the parties can create a state in which they need not carry out the transaction until the conditions are met. Combined with a provision allowing termination if the transaction has not been carried out by a certain date, each party obtains the right to exit the transaction if the conditions are not satisfied by that date.

The same goal can also be achieved by signing the agreement only after the conditions have been met. Under that approach, however, the counterparty can refuse to sign not only where the conditions are not satisfied but for other reasons, and in some cases for no reason at all. Even if there is room to claim damages based on culpa in contrahendo, performance of the transaction that would otherwise have been carried out cannot be compelled. Signing first and including conditions precedent has the significance of limiting the situations in which each party can exit the transaction.

In a model provision, the conditions precedent to each party's performance of its obligations are listed as follows: that the counterparty's representations and warranties are true and accurate in material respects as of the signing date and the closing date; that the counterparty has performed in material respects the matters it must perform or comply with by closing; and that the permits and the like required before closing, such as the filing with the Japan Fair Trade Commission under Article 10, Paragraph 2 of the Antimonopoly Act, have been obtained or completed, the statutory waiting period has elapsed, and no measures preventing the transaction, such as a cease and desist order, have been taken. It is customary to provide that a condition precedent may be waived at the discretion of the party it benefits, and that such a waiver does not preclude claims for indemnification and the like.

Article 10, Paragraph 2 of the Antimonopoly Act requires, among other things, that where a company whose total domestic sales exceed JPY 20 billion acquires shares in a company whose domestic sales (including those of its subsidiaries) exceed JPY 5 billion and its voting rights ratio will thereby exceed 20%, it must notify the Japan Fair Trade Commission of the share acquisition plan in advance. A company that has made the notification may not acquire the shares until 30 days have passed from the date the notification was accepted (Paragraph 8 of the same Article). In transactions requiring notification, the expiry of this waiting period is made a condition precedent, and the closing date is set by working backward.

There is debate over the nature of conditions precedent under Japanese law: one view treats them as conditions precedent within the meaning of Article 127, Paragraph 1 of the Civil Code, and another treats them as conditions to the performance of obligations.

Representations and Warranties

Representations and warranties are statements by which one party to a contract represents to the other that certain matters are true and accurate as of a certain point in time and guarantees their content. The concept developed in Anglo-American law; it is not a system that Japanese civil and commercial law originally contemplated, and it was imported as a functional concept in practice. Japanese court decisions are relatively few, and it cannot be said that a body of case law has been established. For this reason, when including such a provision, care is needed to draft it so that the intended legal effect can be read from the text, in light of the function the parties expect it to serve.

Put simply, the function of representations and warranties is risk allocation. The parties decide on the transaction terms, including the purchase price, and on whether to proceed, on the premise that the target company is in a certain condition. Representations and warranties together with indemnification are the mechanism by which the contract determines in advance whether the seller or the buyer bears the burden if that premise collapses.

In a model provision, the seller represents and warrants to the buyer that each of the matters set out in an exhibit is true and accurate as of the signing date and the closing date. The seller's representations and warranties often include, in addition to matters concerning the seller itself and matters concerning the target shares, matters concerning the target company that formed the basis for setting the transaction terms. There are also sample provisions stating that the fact that the buyer knew or could have known of facts that may constitute a breach does not affect the effect of the representations and warranties or the remedies.

LegalAgent has a set position on how exceptions (carve-outs) should be drafted. Some seller-side drafts seek to take broad exceptions using wording such as "except as disclosed" or "no such matters exist other than those disclosed to the Buyer." What was disclosed, when and to whom readily becomes a matter of dispute later, and the scope of the representations and warranties and the indemnification becomes vague, so we do not accept this wording on the buyer's side. If exceptions are to be made, the contracts or facts to be excepted are identified individually, by contract name, parties, date of execution and amount. If there are many, they are listed one by one in an exhibit, and the main text refers to the exhibit. A provision stating that the seller's liability is not denied because the buyer knew of a matter is inconsistent with an abstract disclosure exemption, so the two are not allowed to coexist in the same agreement.

The perspective of a founder giving representations and warranties as the seller is covered in Risks Founders Tend to Overlook in SPA Representations and Warranties.

Covenants (Obligations Before and After Closing)

Covenants are agreements, incidental to the acquisition, by which each party promises the other to do or not to do certain things. They derive from covenants in Anglo-American law, and under Japanese law they are generally regarded as ancillary contractual obligations apart from the principal obligation of selling and buying the shares. It is thought that if a covenant is breached, liability for nonperformance of obligations can be pursued under Article 415 of the Civil Code even without an indemnification provision.

Pre-closing covenants have two purposes. One is to preserve, or bring about, from the signing date to the closing date, the condition of the target company that formed the basis of the purchase price and the other contract terms. A typical example is the obligation not to dispose of assets, borrow, increase capital or change officers' remuneration beyond the ordinary course of business without the buyer's consent. The other is to advance the procedures necessary to carry out the transaction. This includes the resolution approving the transfer under the Companies Act, obtaining permits or making filings, and obtaining consents under change of control clauses in the contracts of major business partners.

Post-closing covenants are obligations to protect the value of the business the buyer has acquired. They provide for the seller's non-competition obligation, cooperation by management and founders in the handover, and, where the target company continues to use the trade name or trademarks of the seller's group, the conditions for that use and when it must stop. Arrangements concerning the retention of management are covered in Key Person Clauses and Retention.

Indemnification and Termination

Indemnification is an agreement that, where a party has breached its representations and warranties, its covenants or any other obligation, it will compensate the losses the counterparty has suffered as a result. It resembles damages under Japanese law, but its distinctive feature is that the parties agree on contractual limits on the method and scope of indemnification. Its content includes a cap on liability, a claim period, a threshold excluding minor losses (basket), an exclusion under which the cap does not apply in cases of willful misconduct or gross negligence, and a provision deeming losses incurred by the target company to be losses of the buyer.

In practice, the prevailing view is that the legal nature of indemnification for breach of representations and warranties is a contract of guarantee against loss. Even after the Civil Code amendment reorganized warranty against defects as contractual non-conformity liability, the same understanding is considered appropriate. There is also a view that it functions as a price correction where facts underlying the calculation of the acquisition price turn out to be inaccurate. The design of caps, periods and baskets is covered in Designing Indemnification, Price Adjustment and Closing, and the method of covering losses from breaches of representations and warranties with insurance is covered in W&I Insurance.

Termination provisions are included because there is a period between the signing date and the closing date, in preparation for unexpected circumstances arising during that period. A model provision states that each party may, only until closing, terminate by written notice where the counterparty's representations and warranties have been breached in material respects, where the counterparty has breached its contractual obligations in material respects, where a petition for the commencement of insolvency proceedings or the like has been filed with respect to the counterparty, or where the share transfer has not been carried out by a certain date for reasons not attributable to the terminating party. Even after termination, provisions such as indemnification, confidentiality, governing law and jurisdiction remain in effect.

Connecting to Procedures Under the Companies Act

Most shares of unlisted companies are shares with restrictions on transfer. Article 136 of the Companies Act provides: "A shareholder of shares with restrictions on transfer who intends to transfer the shares with restrictions on transfer held by that shareholder to another person (excluding the stock company that issued the shares with restrictions on transfer) may request that the stock company determine whether or not to approve the acquisition of the shares with restrictions on transfer by that other person." Under Article 139, Paragraph 1 of the Companies Act, the decision whether to approve "must be made by resolution of a shareholders' meeting (or of the board of directors, in the case of a company with a board of directors); provided, however, that this does not apply if the articles of incorporation provide otherwise," and under Paragraph 2 of the same Article the company notifies the requesting party of the content of the decision.

The Companies Act also determines the effect of the transfer and the requirements for asserting it against others. Article 130, Paragraph 1 of the Companies Act provides: "The transfer of shares may not be asserted against the stock company or any other third party unless the name or title and address of the person that acquired the shares are stated or recorded in the shareholder register," and Paragraph 2 of the same Article modifies this so that, for a company issuing share certificates, the transfer cannot be asserted against "the stock company" without updating the register. The transfer of shares of a company issuing share certificates does not take effect unless the share certificates are delivered (Article 128, Paragraph 1 of the Companies Act).

Translating these rules into the SPA, the flow is to make obtaining the resolution approving the transfer a pre-closing covenant of the seller or a condition precedent to closing, to submit the request to update the shareholder register on the closing date, and, for a company issuing share certificates, to deliver the share certificates. The minutes of the approval resolution, a certificate of the matters stated in the shareholder register, and a seal certificate are listed in the agreement as documents to be delivered on the closing date. In transactions large enough to require notification under the Antimonopoly Act, the notification and the expiry of the waiting period are likewise made conditions precedent.

The Order in Which the Buyer Should Read the Draft

If you read the seller's draft in order from Article 1, you will finish without seeing where each provision connects. At LegalAgent, we conduct buyer-side reviews in the following order.

First, we read the conditions precedent and the termination provisions side by side, and confirm in which cases the buyer must carry out the transaction and in which cases it can exit. Next, we check the exhibit to the representations and warranties and how the exceptions are drafted, looking at whether the exceptions are identified by contract name, date and amount, and whether they amount to an exemption referring to acts of disclosure in general. Third, in the covenants, we confirm what the seller is required to do by closing, and whether obtaining consents from business partners and making permit filings are obligations of the seller. Fourth, we compare the cap, claim period and exclusions under the indemnification provisions with the results of the legal DD, and check whether the risks discovered are addressed. If there is a price adjustment clause, we finally check the definitions and the procedure for objections.

Known risks identified in legal DD are not dealt with by having the seller "disclose" them, but by building them into the text of the agreement. There are four places to allocate them. Having the seller remedy the issue by closing and making the remedy a condition precedent. Making it a special indemnity under which losses arising from the fact are compensated outside the cap. Making the remedial obligation a pre- or post-closing covenant. Reflecting the expected loss in the purchase price. Which to choose is decided by the size of the amount, the likelihood of occurrence and the seller's financial resources.

One task you can do the day after receiving the draft is to make a list of whether each item of the representations and warranties carries qualifiers such as "in material respects" or "to the Seller's knowledge." Items with qualifiers are areas where the remedies narrow even if there is a breach. With such a list, you can discuss in negotiations which qualifiers should be removed and which can be accepted, separately.

How to conduct legal DD is covered in What Is Legal Due Diligence?, choosing between a share transfer and a business transfer in The Difference Between a Share Transfer and a Business Transfer, and a guide to attorney fees in Attorney Fees for M&A.

Frequently asked questions

What is an SPA (share purchase agreement)?

It is the definitive agreement that the seller and buyer conclude in an M&A carried out through the acquisition of shares. After the letter of intent (LOI) and legal due diligence, it finalizes the transfer price, closing, conditions precedent, representations and warranties, covenants, indemnification and termination.

What are conditions precedent (CPs) in an SPA?

They are an agreement that a party will perform its closing obligations only if all of the specified conditions have been satisfied. Typical examples include the counterparty's representations and warranties being true and accurate in all material respects and the completion of permits and approvals or Antimonopoly Act filings, and they are combined with a clause allowing termination if they are not satisfied by a certain date.

How should exceptions to representations and warranties be drafted?

Avoid wording that refers to the act of disclosure in general, such as "except as disclosed," because it leads to disputes over what was disclosed, when and to whom; instead, identify each exception individually by contract name, parties, execution date and amount. If there are many, list them one by one in a schedule.

What procedures does the Companies Act require for a share transfer in an unlisted company?

For shares with restrictions on transfer, a request for approval of the transfer under Article 136 of the Companies Act and an approval resolution under Article 139 (by the shareholders' meeting or the board of directors) are required. To assert the transfer against the company or third parties, the entry of the transferee's name in the shareholder register under Article 130 is required, and in a company that issues share certificates, delivery of the share certificates is a requirement for the transfer to take effect (Article 128, Paragraph 1).