Session: Contract Structure And Effective Drafting South Africa 2015 BUILDING LAW FIRM CAPACITY TO SERVICE COMMERCIAL LAW TRANSACTIONS: WHAT LAW SCHOOL DID NOT TEACH YOU Presented by LEAD in co-sponsorship with ISLP and with the assistance of the Black Corporate and Commercial Attorneys Network (BCCAN) Session: Contract Structure And Effective Drafting South Africa 2015 Legal_1:31852538

WHY DO WE DRAFT WRITTEN CONTRACTS AND NOT JUST SHAKE HANDS?

REASONS FOR CONTRACTS Confirmation: the intent of the parties (offer and acceptance) Clarity: to avoid later disputes and save costs Completeness: to ensure all essential and material issues are covered Enforcement: to obviate lack of trust and provide evidence of the agreement and its terms

PURPOSE OF A CONTRACT Contracts attempt to articulate: The rights and obligations of the parties Provisions for events or contingencies that while not expected, may occur Provisions that avoid any undesired default provisions of any applicable law Remedies and means of enforcing or avoiding the rights and obligations

REMEMBER THE BASIC PRINCIPLES OF CONTRACT LAW Mutual assent – a clear expression of the parties’ intent to contract Offer and acceptance Consideration – bargain for exchange

THE GOAL OF DRAFTING – A PRECISE DOCUMENT REFLECTING THE INTENT OF THE PARTIES Four elements of precision: Accuracy Completeness Exactness Able to withstand hostile, critical review

WHERE TO START?

SOME RULES ABOUT USING PRECEDENTS 8

USE THEM Do not be afraid to be a shameless plagiarizer. Imitation is the sincerest form of flattery. Lawyer use other lawyers’ documents as precedents all the time. But….. Never use anything that you do not understand or that does not belong in your transaction. Read every word of the precedent. Take forms and precedents as models to be corrected, modified and changed as you feel is necessary. Use your own good judgment and common sense.

BUILDING BLOCKS OF A CONTRACT A contract is: A cast of characters. A statement of duties. An allocation of risks. A statement of conditions and covenants. A “Book of Remedies”. A contract should reflect a meeting of the minds of the parties. 10 10

The party with “the pen” PRELIMINARIES Identify: The law The parties The facts The client objectives The party with “the pen”

BUILDING A CONTRACT If we use our “building blocks” as a guide, what categories of provisions must go into a well drafted contract? Review of the “building blocks”: (i) a cast of characters, (ii) a statement of duties, (iii) an allocation of risks, (iv) a statement of conditions and covenants, and (v) a “Book of Remedies”. 12 12

THE FORM OF TRANSACTIONAL DOCUMENTS Title, date and introductory clause Description of parties Preambles/recitals Traditional recital of consideration Definitions or defined terms Core substantive provisions (purchase price; adjustment; delivery, closing) Representations, warranties Covenants, conditions indemnities, guarantees, releases

THE FORM OF TRANSACTIONAL DOCUMENTS (cont’d) Events of default and remedies Boilerplate (read it! do not assume its completeness, accuracy or relevance to your transaction) Signature block Exhibits and attachments

WHO SHOULD BE THE PARTIES Consider who should be the parties? Necessary – e.g. – The owners of the assets or shares being sold Desirable – e.g. – an entity or person who has net worth as guarantor or indemnitor

IDENTIFY THEM CLEARLY Person Usually identified by name and residential address – e.g.: Steven Spronz, having an address at [Insert address]. Company The World’s Best Cookies, Ltd., having an address at [Insert address].

IDENTIFY THEM CLEARLY (cont’d) Partnership [Not a separate legal person] The partnership between Tembe Shanagaan (Identity Number 7206225043083) and Susan Links (Identity Number 74052942067082) called the “Surprise Partnership” formed by the partnership agreement dated 21 July 2014 having its principal place of business at ●

IDENTIFY THEM CLEARLY (continued) Trust Tom Hanks and Rita Wilson, as trustees of the Huge Family Trust dated June 1, 2105. The Jade Trust, acting by its trustee, Professional Trustee Corp., a company registered in the British Virgin Islands under registration number ____ and having a registered address at ________.

CAPACITY Tom Jones acting in his capacity as agent for Jane Hills by virtue of the Power of Attorney dated 1 January 2014; Distinguish between: Principal Agent Trustee Contracting for the benefit of a third party (i.e. acting as principal but rights are in favour of a third party who can accept them) Guarantor or indemnitor

Duties of the Parties to Achieve the Purpose of the Contract Statement of the obligation which is the point of the contract: “Seller shall sell to Buyer and Buyer shall purchase from Seller…”; Lender shall loan to Borrower, and Borrower shall borrow from Lender…” Statement of the consideration to be given for benefit obtained from the contract.

Allocation of Risks ALLOCATION OF RISKS What tool is used in every contract, of every type, to allocate risks between the parties?

Representations and Warranties The Representations and Warranties are the heart of every contract. Why? Reason: They provide the basis on which most lawsuits regarding commercial contracts are brought. Representations and Warranties can limit the risks associated with caveat emptor/voetstoots. If a representation or warranty is shown to be false, the aggrieved party can generally recover damages…..unless the contract specifically states otherwise. 22

What Is the Effect of a Representation and Warranty? Shifts the risk on that point from one party to the other. “Borrower represents that there is no litigation pending or threatened against Borrower or any of the Borrower’s assets.” What is the risk, and now does the foregoing rep/warranty allocate that risk?

If you are the buyer, what categories of representations and warranties do you want? Representations and Warranties about the seller and the contract. Representations and warranties about whatever is being purchased. If shares are being purchased, the buyer wants representations both about the shares about the assets of the business. 24

6 Key Representations 1. Enforceability of the obligation 2. Title to and ownership of all assets [and shares] and ability to sell 3. Financial condition/statements of the Business 4. Absence of undisclosed liabilities and claims 5. Sufficiency of assets 6. Compliance with all laws 25

Representations and Warranties about the Seller (if you represent the Buyer) If seller is an individual or an entity: (Examples and not an exhaustive list) legal capacity to make a contract; legal right to sell the business (whether shares or assets) without having to obtain the consent of any person, or that all required consents have been obtained; seller has paid all personal taxes seller owes; no claims against seller that could conceivably affect seller’s ownership of, control over, or right to sell the business. 26

Representations and Warranties about the Borrower (if you represent the Lender) The same list as in the preceding slide. Plus other representations that might be applicable in a loan transactions, but all will generally fall into the same six groupings of key representations we looked at in an earlier slide.

(Examples and not an exhaustive list) Additional Representations and Warranties about the Seller (if Seller is an entity) If seller is an entity: (Examples and not an exhaustive list) Due organization and valid existence; Ownership interests are free of liens and claims; plus all the reps one wants from a seller who is an individual. What else would you want to know about the seller? What would you want to know about the lender if this were a loan transaction? 28

Representations about the Business and its Assets (the Subject Matter of the Contract) (Examples; not an exhaustive list) Owned free and clear of claims, liens and encumbrances. Equipment is in good operating condition. Building is structurally sound and free of leaks. Land is free of environmental contamination. No litigation affecting the business or its assets, and no claims threatened against the business. All taxes paid. Financials for the past “X” years are true, correct and complete. What other reps and warranties about the business can you think of? 29

Representations and Warranties are only a snapshot Representations and warranties are only a snapsnot. That is, they are made as of a particular moment. As of what moment should that be? As of the date the contract is signed? What is the problem with that? 30

Solving the Rep and Warranty “Snapshot” problem State that the representations and warranties are to be true and correct at the date of the closing, not just at the date the contract is signed. Provide, if possible, for the representations and warranties to survive the closing. 31

If you are the seller or lender, what representations and warranties do you want to make? None! But as a practical matter, if seller or lender wants to sell the business, seller must, make some reps and warranties to meet the reasonable expectations of the buyer. What representations, in the abstract, do you think a seller or a lender can or shold be able to live with? 32

Goal of the Seller with respect to representations and warranties Make as few reps and warranties as possible. Prevent the reps and warranties from surviving the closing. If buyer insists on survival of reps and warranties, limit the period of post-closing survival. Limit damages for breach of reps and warranties. 33

Deal Protection Provisions for Sellers/Risk Avoidance A seller should not represent a better business than it is selling. Standard qualifiers to protect the seller from over representing, and to reduce seller’s risk: Materiality Knowledge Judicious use of disclosure schedule Thresholds, and Baskets, and Caps.

Evaluating and Negotiating Reps and Warranties Evaluating a representation or warranty is a fact-finding exercise which is called “due diligence”. 35

Covenants Promise of a party to do something or refrain from doing something after the date that the contract is signed. Note: Although the basic promises of seller to sell and buyer to buy are indeed covenants, those are not the types of promises we are talking about for this section of the contract. 36

Categories of Covenants Promises made by a party to take certain actions (affirmative covenants). Promises to refrain from taking certain actions (negative covenants). Financial covenants. 37

Evaluating and Negotiating Covenants Covenants are based upon facts not yet known. For this reason the party burdened by the covenant will try to remove from the obligation as much as possible (called a “carveout”), and/or allow a limited deviance, usually expressed in financial terms, from the covenant (“basket”). 38

Suspensive Conditions Also known as “conditions precedent” because their fulfillment precedes the benefitted party’s obligation to perform. Significance: If a suspensive condition is not met, the benefitted party does not have to perform. What suspensive conditions would you want as buyer’s counsel? As seller’s counsel? 39

Examples of Suspensive Conditions This is not an exhaustive list. Reps and Warranties shall be true at the closing date. Financial obligations shall be met. There shall be no material change in the conduct or financial performance of the business between date of contract and date of closing. The business shall not be or become in breach of any of its obligations. Corporate approvals, if any are required. Third party approvals, if any are required. 40

Thinking About Conditions and Covenants Here we use the word “covenant” to mean any promise. In this limited sense, the statement of a warranty is a promise that the facts set forth in the warranty are true. The breach of a covenant or a representation/warranty may entitle the aggrieved party to damages. The breach of a suspensive condition allows the aggrieved party to avoid performance. Which right would you rather have? Answer: You want both. Why? You want your client to be able to suspend its performance as well as seek damages. How to get both? State that the truth of each of representation and warranty is a suspensive condition as well as a covenant/representation/warranty. 41

Are You Likely To Get Both? That is, is the other party likely to allow the breach of a representation to give the aggrieved party the right not to perform, and maybe get out of the contract? Maybe not. It will depend upon the relative bargaining power of the parties. However, you should ask for it anyway. 42

Indemnities Recourse for breaches of the agreement discovered after the closing Why have an indemnity clause and not just rely on your ability to sue for breach? clarity to include expenses to frame particular remedies to include all matters for which party wants recourse to specify the process 43

Inter-Relationship of the 4 Mechanisms Representation and Warranty Seller represents and warrants to Buyer that since the date of the Financial Statements, Seller has not taken any of the following actions: Paid a dividend or made any other distribution. …….

Inter-Relationships - 2 Covenant Seller agrees and covenants that from the date hereof (date contract is signed) Seller shall not take any of the following actions: Pay a dividend or make any other distribution. ……….. ………...

Inter-Relationships - 3 Condition It is a condition of closing for the benefit of Buyer that (a) all representations and warranties of Seller are true and correct [in all material respects] as of the date they were made and as of the date of the closing, (b) all covenants of Seller have been fully performed [in all material respects]. Example: If seller had declared a dividend, buyer is not obligated to complete the transaction.

Inter-Relationships - 4 Indemnity Seller shall defend, indemnify and hold harmless Buyer from and against any breach by Seller of any provision of this Agreement, including, without limitation, Seller’s representations, warranties or covenants contained herein. Example: If Seller had paid a dividend, the indemnity would permit Buyer to claim all damages associated with the breach.

Remedies Does a contract have to state remedies? No, not if the parties are prepared to let a court fashion remedies based upon existing statutory and common law, and perhaps the court’s sense of equity. Problem: Nobody knows what remedies the court will fashion? 48

Remedies (continued) In order to avoid the uncertainty of what a court might order, a party will usually want to specify the remedies to which it will be entitled in the event of a breach by the other party. What remedies are there, and what remedies do you want for your client if you represent the buyer? If you represent the seller? 49

“Boilerplate” Provisions Clauses that appear, or should appear, in every contract regardless of the subject matter of the contract, and regardless of the jurisdiction in which the contract is being performed. 50

“Boilerplate” (continued) (Examples; not an exhaustive list) “Notices” provision. Governing law; jurisdiction and venue. Waivers. Resolution of Disputes. Entire Agreement. Modification. Section Headings, Gender References, Singular/Plural. Time of the Essence. Assignment Rights (or no rights to assign). Severability. Counterparts; Manner of Delivery of Signed Contract. 51

Definitions Purpose: Clarity. A clearly drafted agreement reflects a meeting of the minds. Definitions can be set forth (i) in the text of the document, (ii) in a separate section of the contract listing and setting forth the definitions, or (iii) both in the text of the contract and in a separate section of the contract which lists the defined terms and states where in the agreement they are defined. 52