In some share purchase transactions, the parties adopt a pricing structure whereby the purchase price is not fixed before the share purchase agreement is signed. Instead, the transaction proceeds on the basis of a provisional price which is subsequently adjusted after completion has taken place on the basis of a set of special purpose transaction accounts (known as completion accounts) relating to the target company and drawn up to the transaction completion date. The purpose of completion accounts is to ensure that the price actually paid by a buyer reflects the true net asset value of the company on the date that the deal is done.
In Shafi v Rutherford, the Court of Appeal considered the construction of a provision in a share purchase agreement governing the accounting policies to be applied when drawing up completion accounts, by reference to which the final purchase price for the transaction was to be calculated. The provision in question required the completion accounts to be prepared in accordance with the accounting policies, principles, practices and procedures adopted by the target company in the preparation of its last annual accounts. During the process of drawing up and agreeing the completion accounts, a dispute arose concerning the proper treatment of certain equipment leases, and an expert was appointed to resolve the issue.
The expert found that the target’s previous accounting practice of treating the leases as operating leases (instead of finance leases) was incorrect and it did not comply with the requirements of the applicable accounting standards. However, the expert also concluded that the disputed provision of the share purchase agreement bound him to treat the leases in the completion accounts in the same way as they had been treated in the last accounts, so preventing him from applying the correct policy in the completion accounts.
The court held that the expert had erred in his conclusions and that his determination was invalid and unenforceable accordingly. It construed the relevant provision in the share purchase agreement as requiring the completion accounts to be prepared applying the correct accounting policy, supplemented if necessary by reference to practices adopted by the target. It did not mean the accounts should be drawn up on the basis of policies in fact adopted by the target company, regardless of whether their treatment of liabilities was right or wrong. In the relevant circumstances, the court could see no reason why the parties would have wished to carry forward an erroneous accounting treatment of liabilities.
The accounting policies and practices to be applied when drawing up completion accounts is an area that is particularly susceptible to post-completion disputes, and this case serves to emphasise the importance of taking particular care when drafting the related SPA provisions. While each decision on the meaning of a particular provision in an agreement depends on its particular language and context, this judgment does suggest that if the parties expect the completion accounts for their transaction to be prepared on a basis that is consistent with target’s last annual accounts, regardless of whether the policies and practices actually applied by the target comply in all respects with the accounting standards governing those accounts (which is often the position that sellers will want to achieve), express wording to that effect should be used in the share purchase agreement.
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