Corporate Law Update
- The court interprets the terms of an equity commitment letter provided by a series of funds in connection with an acquisition
The High Court has interpreted the terms of an equity commitment letter provided by various funds to a company formed to acquire the shares in a target business.
Lopesan Touristik S.A. v Apollo  EWHC 2141 (Comm) concerned the sale and purchase of shares in a company that owned a hotel in Gran Canaria in the Canary Islands. The terms of the transaction were set out in a share sale agreement governed by Spanish law (the SPA).
The buyer was a vehicle ultimately owned by several private equity funds and formed for the purpose of acquiring real estate assets in the hotel sector. It relied on cash injections by the private equity funds to finance its acquisitions.
As a result, as part of the proposed sale and purchase, the funds entered into an equity commitment letter (the ECL) with the buyer and the seller, governed by English law, under which they promised to pay the buyer an amount sufficient to allow it to pay the purchase price for the shares, termed the “Commitment” in the letter. The ECL specifically stated that the seller was entitled to enforce the funds’ obligation to pay the Commitment to the buyer.
This mechanism is not uncommon where the buyer on paper is an entity of little substance and the underlying buyer is one or a series of funds. It is designed to give a seller protection and comfort that the sale will not fall through for lack of funds, leaving the seller with recourse against a counterparty that may have few or no assets.
During the Covid-19 pandemic, the hotel industry suffered significantly. The buyer claimed that, as a result, the seller would no longer be able to repeat the warranties and representations it had given at signing immediately before completing the deal, which was a condition of the sale and purchase. As a result, the buyer purported to terminate the SPA and pull out of the deal.
The seller launched proceedings in the Spanish courts to compel the buyer to go through with the purchase.
In parallel, the seller brought proceedings against the funds to enforce the ECL. This precipitated a dispute over whether the funds were in fact obliged to make the payment to the buyer under the letter.
The relevant provisions of the ECL are set out below. We have abridged the clauses for ease of reading, but otherwise we have set them out in their original structure, as this is relevant to how the court interpreted them.
2.1 The [funds] hereby agree, on the terms and subject to the condition set forth herein and in the [SPA], to contribute … to [the buyer] … in cash in immediately available funds an amount equal to €93,000,000 required by [the buyer] to complete the acquisition of the Shares at Completion in accordance with the terms of the [SPA] (… the “Commitment”) immediately prior to the Completion Date.
2.3 The funding of the Commitment is, solely for the purposes of funding, and to the extent necessary to fund, that portion of the [purchase price] … to be paid by [the buyer] pursuant to and in accordance with the [SPA] on the Completion Date. The [funds] shall not, under any circumstances, be obligated to contribute, or cause to be contributed, to [the buyer] or to any other person or entity, an amount exceeding the Commitment. … [In] no event shall the funds have any obligation to make … any payment or contribution … other than to fund the [purchase price] in connection with the Completion and the sale of the Shares to the [buyer].
3.1 The [funds’] obligation to fund the Commitment … is subject to the satisfaction, or waiver, of all of the conditions precedent to the obligations of [the buyer] to consummate the transactions contemplated by the [SPA] which are to occur on the Completion Date (other than those conditions that by their nature are to be or can only be satisfied at Completion or are not satisfied as a result of a breach by [the buyer]).
5.1 The [funds’] obligation to fund … the Commitment is subject to … (b) [the buyer] becoming obligated unconditionally under the [SPA] to effect the Completion. The obligation of the [funds] to fund … the Commitment will terminate automatically and immediately (at which time the [funds’] obligations under this Letter shall be discharged) upon the earlier to occur of (i) the consummation of Completion, (ii) the valid termination of the [SPA] in accordance with its terms, (iii) 1 January 2021, or (iv) the assertion by the [seller] … of any claim against any [fund] in connection with the [SPA] or any transaction contemplated hereby or thereby, except for (x) claims by the [seller] against the [fund] under the SPA] and (y) claims by the [seller] against the [funds] to enforce the [buyer’s] rights under this Letter. …
5.2 The only claims to be made by the Seller under this Letter shall be brought by it … solely to give effect to Completion … and for no other reason.
6.2 … the Seller is entitled … to specifically enforce the obligations of the [funds] for the purposes of Completion but for no other purposes …
Following some initial debate, the parties ultimately agreed that, if the funds were required to pay the Commitment to the buyer, they were to do so by not later than 11:59 p.m. on the day before the date scheduled for completion. Completion was to take place ten business days after the conditions in the SPA were satisfied, unless the parties agreed to an earlier completion date.
However, the parties disagreed on numerous other issues. These were framed as different issues, but to a large extent the funds’ arguments can be distilled to four simple assertions.
- Clauses 2.1, 2.3, 5.2 and 6.2 of the ECL all made it clear that the only purpose of the Commitment was to fund completion of the sale and purchase. If it became clear that the buyer would not be completing the purchase, the obligation to pay the Commitment would fall away and the funds would not be required to make any payment to the buyer.
- Clause 5.1 of the ECL set a longstop date of 1 January 2021 for paying the Commitment. If completion of the sale and purchase could not happen before then, the funds were not required to pay the Commitment to the buyer (or, if they had already paid it, the buyer would be required to pay it back to them).
- Clause 5.1 of the ECL set conditions on payment of the Commitment. If the Commitment became due and payable but were not yet paid, and one of the conditions in the ECL subsequently “failed”, the obligation should fall away and the funds should not be required to pay the Commitment. This might happen if, for example, the SPA were terminated or it was clear that either party could not be in a position to complete. There was no point in requiring the funds to pay the Commitment to the buyer, only for the buyer to have to pay it back to the funds.
- The Commitment was only being made for the purpose of completing the sale and purchase. Therefore, if the purchase price were lowered for some reason (for example, due to a counterclaim by the buyer or a price adjustment), the funds were required to pay only the amount needed by the buyer to complete the purchase, and not the full amount of the Commitment.
What did the court say?
The court said that the ECL created two important points in time:
- The point at which the obligation to pay the Commitment was triggered. By virtue of clause 3.1 of the ECL, this was when the conditions precedent in the SPA had all been waived or satisfied. In practice, this meant when the parties had received merger control clearance.
- The point at which the funds were required to pay the Commitment. By virtue of clause 2.1, this was to take place no later than 11:59 p.m. on the day before the date scheduled for completion. This could be determined because, under the SPA, completion would take place ten business days after the SPA conditions were satisfied, unless the parties agreed an earlier date.
Once the SPA conditions had been satisfied, therefore, the funds were required to pay the Commitment immediately prior to the completion date.
The court agreed that, if the SPA were terminated before the date for paying the Commitment, then the funds would be discharged from their obligation; there would be no need to pay the Commitment.
However, if the date for payment arrived without any of the conditions in the ECL failing, the funds would be required to pay the Commitment. This was the case even if one of the ECL conditions were to fail (for example, if the SPA were terminated) after the date for payment.
Once the payment had become due, the funds were required to pay it; failure to do so would be a breach of the ECL. It was not open to the funds to delay the payment after it had become due on the grounds that completion would or might not happen (for example, as in this case, because the buyer was alleging it had terminated the SPA).
If completion were never to occur, the buyer would be required to pay the Commitment back to the funds. However, this did not mean the funds could “wait and see” whether completion would take place before paying the Commitment. They had to pay it immediately before the date on which completion was to take place under the SPA.
The court said that clause 5.1 set a longstop date of 1 January 2021 for triggering the obligation to pay the Commitment, not for actual payment. If the conditions in the SPA were not satisfied before 1 January 2021, the payment under the ECL would never become due. However, once the obligation to pay the Commitment was triggered, it had to be paid, even if payment fell due after 1 January 2021 (for example, because of a dispute or because completion was delayed).
This may seem surprising at first: clause 5.1 seems to say quite clearly that the funds’ obligation to pay the Commitment is discharged and falls away on 1 January 2021 (if it has not already fallen away before then), and there is nothing in the clause to suggest this is qualified in any way.
However, the decision makes sense in the context of the transaction. If the obligation, once triggered, were to fall away on 1 January 2021 come what may, the ECL would be vulnerable to genuine delays to completion, leaving the seller without assurance that the buyer would have funds to complete. It might also, in theory, also allow the funds to engineer a delay so as to avoid the funding obligation.
The court agreed that it was clear that the Commitment could be used only to fund completion of the purchase under the SPA. However, this did not mean that the funds could withhold payment of the Commitment simply because they claimed that completion would not occur. Once the Commitment had become payable, the funds were required to pay it to the buyer. If it later became clear that completion would not occur, the buyer would then need to pay the Commitment back to the funds.
Finally, the court did not agree that the funds could pay a lower amount were the purchase price adjusted downwards. Clause 2.1 specifically defined the Commitment as €93,000,000, and this was the amount the funds were required to pay in any event. If, in the event, the buyer did not need the full amount, it would need to pay the balance back to the funds.
What does this mean for me?
It is perhaps trite to say that this decision shows the need for clear and careful drafting. The clauses of the ECL were, in some places, rather cumbersome. This is not always a failing of the persons who drafted them but often the product of negotiations and compromises between the parties. However, as in this case, the result is often drafting that is open to different interpretations.
It is common for a buyer backed by private equity funds to be asked to provide an equity commitment letter to demonstrate the funds’ commitment to financing the acquisition. These letters by and large adopt a relatively standard form, although they should always be tailored to the circumstances of the particular acquisition.
When agreeing the terms of any equity commitment, the parties should ensure certain matters are set out clearly in the commitment letter.
- When is the obligation to make the commitment triggered? Often, this will be when all conditions to the sale (if any) have been fulfilled and the sale has become unconditional. However, it might not be possible to satisfy certain conditions until completion itself or the last minute before completion. This might include repetition of the seller’s warranties, there being no material adverse change, and delivery of certain documents and records. The letter will need to deal with these specifically.
- When is the payment to be made? By timing the payment as close to completion as possible, the parties can reduce the risk of some supervening event delaying or preventing completion, potentially leaving the funds without the cash in question for an uncertain period of time. However, the parties will need to leave enough time to allow the private equity funds to assemble the equity commitment and transfer it to the buyer ready for completion.
- What happens if there is a delay to completion? This could happen for any number of reasons, including where the parties end up in a dispute over a term of the sale agreement, or where one party decides to postpone completion because the other party has not complied with all of its obligations or is not in a position to complete. The ECL should make it clear whether the timing of the commitment payment is to move with completion.
- What happens if the acquisition aborts? The parties should consider setting out the position where one party validly terminates the sale agreement, both before the commitment payment has become due and where it has become due but has not yet been paid. There is likely to be little value in the sponsor funds sending money to their acquisition vehicle only to request the money straight back again. However, a seller will need to ensure that the mechanism is not open to abuse so as to delay making the commitment on what could be spurious grounds.
- Should there be a longstop for payment? The backing funds may understandably be reluctant to extend what could amount to an open-ended commitment. Setting some kind of backstop date beyond which the commitment falls away will often be sensible. However, again, a seller may need to scrutinise this to ensure that delays attributable to the buyer or the funds do not cause the commitment to fall away.
- What is the purpose of the payment? The commitment under an ECL should always cover the funds needed for the buyer to complete the sale. However, it is also common for the commitment to cover any damages that might be payable as a result of the buyer breaching the terms of the SPA (although that was not covered by the ECL in this case).