Definitive Agreement

What is a definitive agreement?

Definitive agreement (final contract, main contract) refers to the legally binding contract in which the parties to a corporate transaction settle all terms conclusively. In a company purchase, this is the purchase agreement for shares or assets (in English share purchase agreement, SPA for short, or asset purchase agreement). In a financing round, they are the participation agreement, the shareholders' agreement and the amended articles of association.

The term comes from US practice. The phrase “entered into a definitive agreement to acquire” in US press releases means: the purchase agreement has been signed, but closing is usually still pending. The definitive agreement replaces the letter of intent or the term sheet, the key points of which are predominantly non-binding. The relationship resembles that between a reservation and the notarised purchase contract when buying a flat: only the final contract binds both sides. The definitive agreement is drafted and negotiated by the parties' law firms in parallel with the buyer's review of the company (due diligence). It becomes binding on signing.

From letter of intent to final contract

Letter of intent and term sheet record what the parties have agreed in principle: price, structure, key terms and timetable. They usually contain the express reservation that a commitment arises only with the definitive agreement (subject to definitive agreement). The definitive agreement turns the key points into enforceable obligations and regulates everything that was open until then. Deviations from the letter of intent are legally possible, because only the final contract applies. An entire-agreement clause generally makes clear that earlier arrangements lose their effect.

Who submits the first draft depends on the procedure. In an auction process, the seller's side usually provides the bidders with a draft contract, which they return with their requested changes together with the binding offer. In individual negotiations, the buyer's law firm often drafts, and in financing rounds often the law firm of the lead investor, that is, the investor leading the round. Results of due diligence flow into warranties, indemnities and occasionally into the purchase price.

Components of a company purchase agreement

A German company purchase agreement typically regulates the following points:

• Subject of the purchase: in a share deal, the shares; in an asset deal, the assets, contracts and employment relationships to be individually identified.
• Purchase price and mechanism: a fixed price based on an earlier reference date (locked box) or an adjustment after closing accounts as of the closing date (completion accounts), plus, where applicable, earn-out, retention or vendor loan.
• Closing: the conditions to closing, a long-stop date and the steps on the closing day.
• Warranties and indemnities: independent warranties of the sellers on legal, financial and tax matters, and indemnities for known individual risks, for example taxes of earlier years.
• Liability regime: baskets, liability caps, limitation periods and knowledge rules. The statutory warranty law is largely excluded.
• Obligations of the sellers: continuing in the ordinary course of business until closing, non-competition and non-solicitation covenants.
• Final provisions: choice of law, jurisdiction or arbitration, costs and notices.

The contract documents of a financing round

In a German financing round, the definitive agreement usually consists of two or three documents. The participation agreement governs the capital increase, subscription of the new shares, amount and due date of the contributions and warranties of the company and the founders. The shareholders' agreement contains the permanent rules among the shareholders, such as consent requirements, co-sale rights and drag-along obligations, distribution of proceeds, anti-dilution protection, and vesting and leaver rules. The amended articles of association are added. Participation agreement and shareholders' agreement are often combined in one deed.

In the US market, the same content is spread across several standard contracts, such as the stock purchase agreement, the investors' rights agreement and the voting agreement. Additional agreements with individual investors (side letters) are also common in Germany. If they form a unit with the participation agreement, the same formal requirements apply to them.

Form and notarisation in Germany

The purchase of shares in a GmbH (German limited liability company) requires notarisation (Beurkundung), both the obligation to assign and the assignment itself (Section 15(3) and (4) of the German Limited Liability Companies Act, GmbHG). The form applies to the entire contract with all arrangements that belong to it according to the will of the parties. Side arrangements outside the deed endanger the validity of the contract. A defect of form in the obligation is, however, cured by the validly notarised assignment (Section 15(4) sentence 2 GmbHG).

In an asset deal there is no general formal requirement. Notarisation is required, however, if real estate (Section 311b(1) of the German Civil Code, BGB) or shares in a subsidiary GmbH are sold along with it. If essentially the entire assets of the seller pass, the parties often have the contract notarised as a precaution with a view to Section 311b(3) BGB. In a financing round, the capital increase resolution must be notarised (Section 53 GmbHG). The declaration of acceptance by which an investor subscribes the new shares requires notarisation or notarial authentication (Beglaubigung) (Section 55(1) GmbHG). Because shareholders' agreements regularly contain obligations to transfer shares, for example drag-along obligations or call options, they are notarised in their entirety in practice.

The notary in principle reads out the deed including its annexes. Extensive annexes are therefore often notarised in advance in a reference deed to which the main contract refers (Section 13a of the German Notarisation Act, Beurkundungsgesetz, BeurkG). Once the assignment has become effective, the notary who prepared the deed submits the amended list of shareholders to the commercial register (Section 40(2) GmbHG). Only with its inclusion does the acquirer count as a shareholder towards the company (Section 16(1) GmbHG).

Signing and closing

Closing is the point in time at which the shares actually pass and the purchase price is paid. If no conditions to closing are agreed, signing and closing can coincide. More often there is a period in between in which clearances from merger control or investment screening, consents from contract partners or the buyer's financing are outstanding. During this time the sellers' conduct obligations apply, and the warranties are, depending on the contract, confirmed again at closing. The assignment of the shares is usually already declared at signing, but conditional on payment of the purchase price.

Practical example: definitive agreement in the sale of an IT GmbH

A buyer and the three shareholders of an IT services GmbH sign a letter of intent. Agreed are an enterprise value of EUR 18 million on a basis “free of cash and financial debt”, a retention, “customary warranties” and signing within eight weeks. In the definitive agreement, these become the following provisions:

• Locked box as of 31 December with net financial debt of EUR 2.4 million: purchase price 18 minus 2.4 = EUR 15.6 million
• Retention of 10% of the purchase price in an escrow account for 18 months: EUR 1.56 million
• a catalogue of 42 individual warranties, under which the content of the data room counts as disclosed
• liability cap of 20% of the purchase price, that is, EUR 3.12 million, excluding the warranties on title to the shares and the tax indemnity
• as a condition to closing, the consent of the largest customer, whose framework agreement contains a termination right on a change of control

The annexes are notarised in a reference deed a week before the appointment. A single line of the letter of intent has thus become several pages of contract text with their own need for negotiation. Six weeks after signing, the customer's consent is in hand, the purchase price is paid and the conditional assignment becomes effective.

Distinction: definitive agreement, MoU, term sheet and preliminary contract

• Memorandum of understanding (MoU): a declaration of intent that in a company purchase largely corresponds to the letter of intent. It too remains predominantly non-binding and is replaced by the definitive agreement.
• Term sheet: summarises the terms of a financing round. They are implemented in the participation agreement and the shareholders' agreement.
• Preliminary contract: already binds to conclusion of the main contract and, in the purchase of shares in a GmbH, likewise requires notarial form. A letter of intent is generally not a preliminary contract.
• Signing: denotes the act of signature or notarisation, not the document itself.

Common mistakes

• Arrangements outside the deed. Promises in emails or side letters that belong to the transaction but are not notarised endanger the validity of the contract in a share purchase.
• Open key points from the letter of intent. Formulas such as “customary warranties” move the actual negotiation into the contract phase, in which the sellers no longer have alternatives.
• Annexes too late. Disclosures, financial information and contract lists that are ready only shortly before the notary appointment postpone signing or are adopted unchecked.
• US model without adaptation. Contract templates under US law do not fit German warranty and company law without more and have to be transferred to the GmbH.
• Unclear conditions to closing. If the long-stop date and the legal consequences of a condition not being met are missing, the contract remains in limbo.

Frequently asked questions

What is the difference between a letter of intent and a definitive agreement?

The letter of intent is a predominantly non-binding declaration of intent, the definitive agreement the binding contract. The letter of intent records price, structure and timetable as key points; usually only exclusivity, confidentiality and cost rules are binding in it. The definitive agreement regulates all details and creates the obligation to transfer and to pay.

Is a definitive agreement always binding?

Yes, if it has been validly concluded in the required form. Its effects may, however, depend on conditions to closing. If the notarial form is missing in a share purchase, it is invalid until cured by the notarised assignment.

Must a definitive agreement be notarised?

In the purchase of GmbH shares, always. In an asset deal only if real estate or GmbH shares are sold along with it; if essentially the entire assets of the seller pass, it is notarised as a precaution. Participation agreement and shareholders' agreement of a financing round are notarised in practice because they contain obligations to transfer.

Can a definitive agreement be concluded and notarised in English?

Yes. A notary can, on request, notarise in another language if he or she is sufficiently proficient in it (Section 5(2) BeurkG). Parties who do not understand the language of the deed need a translation.

How long does it take from the letter of intent to signing?

Often several weeks to a few months. The duration depends on the scope of due diligence, on the number of parties and on how complete the documents and annexes are at the start of negotiations.

The Roemer Capital view

Between letter of intent and notarisation, Roemer Capital keeps a list of open points for clients. It sets every economic commitment from the letter of intent or term sheet against its implementation in the draft contract. This makes visible where a draft deviates from the agreed key points. Roemer Capital calculates purchase price mechanics, retention and liability amounts with figures from the financial model before they are negotiated.

The contract is drafted and negotiated by the client's law firm. Roemer Capital coordinates timetable, annexes and data room so that the notary appointment does not fail for lack of documents. In financing rounds, the same applies to the participation agreement and the shareholders' agreement.