Authors
Introduction
The market to acquire control of Colombian companies has intensified in recent years, with local and international buyers investing in our country. This has led to the internationalization of the language of share purchase agreements (“SPA”) used by Colombian lawyers, especially, by using concepts imported from common law. The adoption of this language greatly facilitates communication between foreign clients and lawyers and makes transactions flow more easily. However, those buyers and sellers who place their faith in Colombian lawyers should not lose sight of the fact that, being an imported contractual language, it has its limitations when it comes to applying it in Colombia. Therefore, the parties involved in the negotiation of SPAs of Colombian companies, must ensure that they keep this in mind when receiving legal advice in the country.
When seeking to buy a controlling position in a company, the transaction does not only refer to the acquisition of a certain number of shares, but mainly to the purchase of an organization that has a life of its own and is made up of a business culture, a business projection, assets, workers who make autonomous decisions and, in general, elements that interact to create added value. Bearing this in mind, the parties, especially the buyer, may not be able to identify all the possible contingencies of conducting the target’s business.
This is why the negotiation of declarations and guarantees (“D&G”) in share purchase agreements becomes so important. D&G come from common law practice and are widespread in the Colombian legal mergers and acquisitions practice. They go hand in hand with the indemnity clause, in which the parties agree the amount of the claim that the buyer can seek from the seller in case of falsehoods in the D&G. However, what happens when the D&G are inaccurate or, if after the transaction is completed, new contingencies appear that had not been disclosed by the seller?
In this article we seek to explain the contractual and legal figures that the parties of a SPA must keep in mind to claim the breach of a contract once the transaction is completed, with the aim that buyers and sellers can have informed conversations with their advisors and ensure that they are receiving adequate protection of their interests. To be more precise, we will focus on explaining the D&G clause and the indemnity clause, and then explain how they interact with two relevant contractual figures of the Colombian system, such as the acción redhibitoria and the relative nullity of the contract due to error in the quality of the asset (error en la calidad de la cosa)
Contractual breach: Representations and guarantees, indemnity clause and the acción redhibitoria
To begin with, the legal nature of the D&G is contractual and is based on the autonomy of the will of the parties. This means that these are clauses that are not incorporated in Colombian law, and that it is the parties -through the clause- that have the burden of distributing the risks of the sale of the shares. D&G assume that, if a contractual party makes an affirmation that leads to the closing of the legal transaction, then it must guarantee its veracity and respond for the consequences if they are not true. 1 Ultimately, this can be expressed as a statement of the following type: “The Company has no liabilities or obligations for a value greater than 20% of total assets. Likewise, each one of the equity obligations was disclosed in Exhibit A of this contract.”
It is important to highlight that in SPAs, the Supreme Court of Justice has specified that the object of the contract is not the assets of the company, but rather the certificates representing participation in the company. 2 Therefore, it is of vital importance that the parties stipulate, given the economic purpose of the contract, that the contractual object will not only cover the titles, but also the company's assets. 3 At this point, the D&G clause is especially important, together with the indemnity clause, because through these, the parties will state the characteristics of the company and the amount the buyer will be compensated in they are inaccurate. Similarly, it is relevant that the parties agree upon the statute of limitations of the indemnity clause, since in the event of their silence, the guarantee will be valid for two years from the signing of the contract (art. 932 Code of Commerce). 4
Consequently, this clause ends up being a recognition of the economic purpose of the contract, which truly extends to acquiring a company. In addition, it has proven to be one of the most common contractual mechanisms to claim breach due to irregularities of the company that is the object of the transaction.
Likewise, the parties must keep in mind that in any sale that is celebrated under the Colombian legal system, the seller is responsible for the obligation of saneamiento. This obligation implies that the seller "is obliged to provide the buyer with a peaceful and useful possession of the asset sold”. 5 This implies that "the asset must materially serve the purpose for which it is intended according to its nature." 6 Hence, when the asset suffers from material defects that prevent it from being used according to its nature, the seller will have breached the contract and the buyer will have the right to file a acción redhibitoria for hidden defects of the asset that was sold. 7
In SPAs the acción redhibitoria is a legal figure that the parties must not ignore. In this regard, it is important to specify that the object of the contract is not the company, but the share certificates. This would mean that, in turn, the obligation of saneamiento would only fall on the company’s shares. However, the Supreme Court of Justice has recognized that the parties may extend the obligation of saneamiento to cover the company. 8 Therefore, the obligation of saneamiento could also be applied in the event of inaccuracies or defects of the company as part of the contractual object. 9
Now, it is of vital importance that the parties bear in mind that the acción redhibitoria gives rise to the buyer requesting the rescission of the contract or the reduction of the price depending on whether the good does not serve its natural use or serves it imperfectly. 10 Additionally, the statute of limitations of the acción redhibitoria is six months for movable assets such as shares. 11
Vices in the consent: relative nullity of the contract due to error in the quality of the asset (error en la calidad de la cosa)
Now, once the nature of the D&G has been explained, it is worth reaffirming the fact that the obligatory nature of this clause within the contract is ancillary to the main obligation of the SPA, which is the transfer of ownership of the shares in question. Despite this, arbitration awards have proposed that although the nature of the D&G is ancillary (since its very origin is in common law), its relationship with the main obligation is such that, in the first place, they could be understood as part of the pre-contractual duty of information, duty that comes from the principle of good faith (Art. 871 Civil Code). Secondly, since the veracity of these can be a determining cause to carry out the contract, D&Gs have a privileged role in the contract that cannot be covered by considering them as ancillary. Such is their importance, for the two reasons mentioned above, that arbitral awards have positioned them as part of the consent requirement within the contract. 12
To reach the above conclusion, it is important to remember that, according to Colombian law, in the signing of any contract, the parties must have: legal capacity, consent free of vices, and the contract must fall on a lawful object and cause. Taking this into account, the arbitral justice has developed the argument set out in the previous paragraph by saying that the falsehood of D&Gs cannot only lead to the claim of the agreed indemnities, but it can also lead to the relative nullity of the contract, since they would represent a vice in consent. 13
The vices in consent, in turn, can be due to force, fraud or error, in this case, the vice in consent would be due to error in the quality of the asset (error en la calidad de la cosa).
Lastly, although the declaration of the relative nullity of the contract due to the falsehood of the D&G is an additional possibility to the claim for indemnities, or the exercise of the acción redhibitoria, this claim must first be alleged by one of the parties in accordance with the article 1743 of the Civil Code. Thus, it is important that the interested buyer or his/her attorney remembers this arbitral award at the time of resolving any dispute in a litigious manner, since it is not an alternative the judge can exercise ex officio.
Conclusions
Based on everything said in this article, it must be concluded that even though SPAs are drafted with the same legal figures as those used in common law, it does not mean that they will have the same effects. Therefore, it is important that the parties ensure that the contracts are drafted in a manner consistent with Colombian law, so that, in the event of a breach of the agreement by any of the parties, an ordinary or arbitral judge will grant the effects that the parties intended. Said effects are not always peaceful, and there are differences between the ordinary jurisdiction and the arbitral jurisdiction, for which correct legal advice is of vital importance when entering a SPA in Colombia.
Bibliography
- Arbitral Award of Balclin Investmets s.l., Altra Inversiones S.A.S. and others against Jairo Gutiérrez Robayo, Jimena Gross Mejía and others. Judgment of September 14, 2011. Arbitrators: Ernesto Rengifo García, Jorge Cubides Camacho and Carlos Gustavo Arrieta Padilla.
- Congress of the Republic of Colombia. Civil Code. Law 84 of 1873. Official Gazette No. 2,867 of May 31, 1873
- Gomez Estrada, Cesar. Of the main civil contracts. Fourth edition. Colombia: Editorial Temis S.A., 2008. ISBN: 978-958-35-0656-7
- President of the Republic of Colombia. Commercial Code. Decree 410 of 1971. Official Gazette No. 33,339 of June 16, 1971
- Supreme Court of Justice of Colombia. Civil Cassation Chamber. Judgment of December 16, 2013. Judge Rapporteur: Ariel Salazar Ramírez. File No. 248433
