Back to back agreements

26 March, 2012

The recent case of Raad Chalabi, Mohammed Al-Bassam, S P Degree Limited, Scalenine Limited v Jaffar Agha-Jaffar and Bashar Chalabi [2011] EWCA Civ 15351 highlights the importance of considering all of the potential scenarios when negotiating and drafting the contracts and documentation for back to back sales of shares and assets held by companies.

In this case, the five claimants each owned a company within a group. They proposed to sell each of these companies to TSS Inc but made clear in the negotiations that they were only willing to give very limited warranties and refused to provide TSS Inc with the types of warranties which a buyer would expect in a sale of this nature. It was therefore decided that a back to back agreement would be used whereby the claimants would sell their shares in the companies to the defendants and on the same day the defendants would subsequently sell the companies to TSS Inc. The price was negotiated and it was determined that each of the three claimants would receive one fifth of the purchase price. 

The new sale structure resulted in a liability to tax which TSS Inc consented to cover by way of an indemnity. The defendants and certain group companies subsequently received a sum from TSS Inc. representing the tax indemnity, in addition to the amount which had already been calculated to cover the purchase price.

All three of the sale agreements contained warranties which stated that the claimants would receive three fifths or more of the consideration which the defendants would obtain from TSS Inc. The claimants received an amount totalling three fifths of the purchase price and asserted that there had been a breach of the above warranty because the defendants had actually received a further sum relating to the tax indemnity. 

It was held that the tax indemnities should not be defined as consideration for the purposes of the warranty and that there was consequently no breach. The judgment turned on the specific facts of the case. Both parties had initially considered the potential tax liability which would result from an asset sale and so were aware of this possibility from the start of the transaction. It was emphasised that if the indemnity was treated as part of the price paid then the claimants would be entitled to a windfall of three fifths of the indemnity and the defendants would still be required to cover the tax liability whilst only receiving two fifths of the sum paid to cover it.

The judgment confirms that in situations such as these the court is likely to favour the most commercially sensible solution. The case illustrates the importance of ensuring that the definition of ‘price’ in a consideration warranty is clearly defined so that all of the parties are certain what will and will not be included.  

 

1Link to judgment: Raad Chalabi, Mohammed Al-Bassam, S P Degree Limited, Scalenine Limited v Jaffar Agha-Jaffar and Bashar Chalabi [2011] EWCA Civ 1535

 

Reviewed in 2015