Important clauses in a business transfer agreement

April 1, 2022

There are various modes in which a business can be restructured such as compromise/arrangement, reorganization of capital, merger/amalgamation, demerger, acquisition/takeover, slump sale, and other similar modes. In any merger and acquisition of a business, a transfer takes place and it is important to know how such a transfer is acquired and what has been acquired along with such transfer. This business restructured transaction is what makes or breaks the deal.  When such transfer is prepared, then the provisions should be made which select the mode of transfer of business, successor liability, legal compliance, taxation, stamp duty, and outweigh the things that can be compromised to those transactions in future. The primary motive behind such business rearrangement is to prosper both in profits and size, and this process can be either by way of gradual transverse or by selling off the business undertaking very fast.

The selling of the business undertaking can happen in two ways, one is an entity sale and the other is an asset sale. Usually, an asset sale is preferred by the buyer because he can avail of the early depreciation benefits and avoid acquiring the former company’s liabilities, and an entity sale is preferred by the seller because they have to pay taxes at a long-term capital gain rate as compared to the higher ordinary income tax rate applicable on asset sales.

Hence, keeping in mind the benefit of both seller and buyer, a midway has been adopted, which is known as “business transfer” or “slump sale”. In this blog, we will understand this new mode of acquisition and analyze in-depth the important clauses in a business transfer agreement.

Before exploring the concept of business agreement, let’s understand the concept of business and slump sales.

What is the business?

The term business has been defined under section 2(17) of the Goods and Services Act, 2017 which includes a wide range of activities such as trade, commerce, profession, manufacture, adventure, vocation, wager, supply or acquisition of capital goods and services, and other activity or transaction which is incidental or ancillary these activities, whether or not there is any pecuniary benefit.

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What is a slump sale?

The term slump sale and business transfer agreement has been used interchangeably. However, the “slump sale” is a mere method of corporate restructuring and is one of the widely used ways when the company goes forward to sell its undertaking. Slump sale is generally undertaken for the following reasons:

  • It improves the performance of the business.
  • It improves the focus by eliminating the negative synergy and facilitating strategic investment.
  • It avails tax and regulatory advantages attached to it.

This concept of slump sale has been ushered by the Finance Act, 1999 under section 2(42C) and section 50B of the Income Tax Act, 1961 where the former provides the definition of slump sale and later one provides the mode of computation of tax on slump sale. According to section 2(42C), it means the transfer of one or more undertakings by selling them, for a fixed lump sum consideration, along with transferring the assets and liabilities of such business undertakings to the buyer, without values being assigned to the individual assets and liabilities. Hence, under the slump sale, the business is sold on a “going concern basis” which means there is the transfer of all assets/ liabilities, contracts, employees, etc so that the business can carry on its activities in a similar manner before such sale.

The essential elements of slump sales are as follows:

  1. Sale of the undertaking

In this, the mode of transfer of an undertaking must be a sale. Even if one out of several undertakings were sold, it would still amount to a slump sale. Hence, Section 2(42C) defines a slump sale that it is only a transfer as a result of a sale that can be construed as a slump sale. Consequently, when the transfer could not be said to be a result of sale therefore the provision of section 2(42C) would not apply.

  1. Going concern basis

It means the ability to continue the business activity after the transaction. The literal meaning of slump is dropping or falling heavily and therefore, this slump sale is operational to undertakings in financial loss, but in the absence of such a situation, this process of slump sale can also be used even for the transfer of the profit-generating company.

  1. Assets and Liabilities

In a slump sale, an undertaking is transferred as a whole, meaning both assets and liabilities are transferred. Otherwise, the provision of slump sales will not be applied.

  1. Lump-sum consideration without assigning values to the asset

 Consideration should be as a whole and not attributed separately to assets. It should be a one-time consideration and not in installments or any other mode.

What is a business transfer agreement?

A business transfer agreement is a legal document in which there is an agreement between the transferor company and transferee company to execute a slump sale where every asset and liability of one or more units is transferred, sold, leased, or assigned to another for lump sum consideration. This agreement is structured to give effect to a comprehensive sale of assets and liabilities of one entity to another entity. It is in the form of a purchase and transfer of ownership agreement wherein details regarding the sale of the business and its assets are encapsulated. The focus area of this agreement is the type of transfer, type of sale, tax liability, terms of sale, representation of parties, list of assets, liabilities, capitals, loans, contracts, customers, employees, insurances, intellectual property and related matters are essentially mentioned.

A business transfer agreement is typically structured in two ways. One is an “agreement to sell”, in which the business undertaking is to be sold in the manner laid down in the agreement following the intention of the parties, and the other one is when the agreement consummates the sale of the business undertaking.

Mode of execution of a business transfer agreement

A business transfer agreement can be executed by the following methods:

  • Agreement to sell: In this, the intention of the parties is listed to execute the transfer of the business, however, it does not affect the transfer immediately but only provides for the procedure of such transfer,`
  • Deed of conveyance: Through a deed of conveyance the agreement to sell is executed in actuality and the agreement to sell comes into force after the actual sale or transfer of the assets and liabilities to the purchaser.

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What are the important clauses in a business transfer agreement?

To give effect to a sale or transfer of business by the method of slump sale, a business transfer agreement is entered into by and between the parties, wherein the entire business undertaking is transferred to the purchaser on a going concern basis, i.e., the business is being transferred in a running condition. A business transfer agreement gives an overview of the type of transaction, terms of sale and details transfer, representations and warranties of the seller and the purchaser, condition precedents, etc. Following are the important clauses in a business transfer agreement:

  1. Parties to the agreement

It is the most important clause in a business transfer agreement. This clause describes the parties who are entering into the said agreement and embodies their correspondence details clearly to identify them. It also includes the residential status of the business because a non-resident is not allowed to conduct business in India without having a functional place of business in the territory of India.

  1. Recital clause

It is the most important clause in a business transfer agreement. This clause is necessary to give an overview of the general background of the circumstances under which the parties are agreeing. It is not an operative clause but only a substantive clause, which gives an idea about the present stand of the parties, that might be useful for the interpretation of the agreement as a whole or some clauses in the future. Thus, it highlights the intention of the parties agreeing.

  1. Transfer and description of transfer

It is the most essential clause in a business transfer agreement. This is the operative clause in which the process and procedure of the transfer are explained. This clause defines the nature of the transaction between the parties and lists out the procedure of the transaction. All the assets and liabilities are either listed in this clause or a separate schedule has been attached for the same. Hence, this clause should be drafted in a precise manner without leaving any scope of ambiguity.

  1. Specific requirement

The next important clause in a business transfer agreement is the specific requirement. The specific requirements related to the assignment of the contract and assumption of liabilities should be included in this clause if not covered under the transfer clause. For example, Liabilities for taxes relating to the assets and the undertakings for all taxable periods can be incorporated in this clause.

  1. Purchase consideration

It is the next important clause in a business transfer agreement. It is crucial to draft the purchase consideration clause with extreme diligence because most disputes in the contractual relation arise due to discrepancies regarding the payment. This clause should specify how the payment is to be done and received by the parties, the consequences for the delayed payment or non-payment, and also state the nature, amount, currency, and mode of payment that will be adopted by the purchaser.

  1. Representation and warranties of the parties

It is another important clause in a business transfer agreement. This clause states the representations made by both the parties, upon which they have agreed to enter into an agreement and if they breach any of the representation, then the agreement can be terminated. Warranties are the affirmation made by the parties to assure to do certain things and guarantees made by them to their representations. In a business transfer agreement, a promise has been made by the seller to the assets and liabilities and the buyer ensures that he has the legal capacity to buy them. Hence, this clause gives protection to the future rights of the parties.

  1. Intellectual property concerning brand usage

It is the most important clause in a business transfer agreement. Intellectual property refers to the creation of minds such as inventions, dramatic and artistic works, industrial designs, symbols, names, and images used in commerce. It is essential to enlist intellectual property like patents, trademarks, copyrights, and industrial designs so that the owner can have the exclusive right over it and earn money from them.

  1. Conditions precedent and condition subsequent

This is another important clause in a business transfer agreement. This clause clearly defines the conditions which are to be fulfilled by the parties before executing the transfer of business under the agreement such as the fulfillment of tax liabilities. The conditions precedent and subsequent should be specific and not generic. Further, additional conditions precedent and subsequent may have to be added based on the outcome of the due diligence exercise, and in compliance with the laws.

  1. Tax Cooperation and allocation of taxes

To specify each party’s obligations concerning tax liability, it is essential to draft this clause because tax is one of the major aspects that have to be regulated and looked into while undertaking the transfer of the business. For example, both parties should furnish the information relating to the filing of tax returns. Hence, incorporate this important clause in a business transfer agreement.

  1. Employees

Whether the existing employees will be transferred or not when the business is being transferred must be laid down in this clause. The procedures for the transfer of employees should also be mentioned so that employees have knowledge about their rights and obligations when the business is taken over. Hence, it is the most important clause in a business transfer agreement.

  1. Confidentiality

This clause is essential to safeguard the interest of the parties and keep their information protected. In this clause, the information exchanges between the parties should be kept secret and the leakage of such information should have detrimental effects. Therefore, It is the most important clause in a business transfer agreement.

  1. Indemnification

It is the most important clause in a business transfer agreement. Indemnification means security against legal liability for others’ actions. When a business is transferred, it may be possible that the business brings liabilities along with it in the form of loans and other encumbrances. Hence, this clause should foresee and incorporate all the possible situations of indemnity.

  1. Term and termination

This clause specifies the duration for which the agreement shall be in force and stand valid. The termination clause specifies the circumstances under which the agreement is terminated such as breach of the condition precedent or duties by either of the parties. Hence, incorporate this important clause in a business transfer agreement.

  1. Dispute resolution

This is another important clause in a business transfer agreement. In case of any conflict arising in respect of the agreement, this clause will provide the method for settling such a dispute and determining the distribution of the cost among the parties.

  1. Governing law and jurisdiction

This clause specifies under what laws will the agreement and any matter incidental thereto be governed and where does the jurisdiction of the dispute lie. This becomes essential, especially in cases of international entities. Hence, it is the most important clause in a business transfer agreement.

Conclusion

The Business Transfer Agreement is a very crucial document for completing business transactions as it helps to improve the performance of business post-integration. The transfer of business also lets the company focus on core areas, thereby optimizing operational synergies. Also, when this agreement is in the form of a sales contract, the Seal will be subject to stamp duty under Article 5(c) of Annex I. If you want to know more about a Business Transfer Agreement, contact eSahayak.

About Author

Shaily is a law student, pursuing B.Com LLb. (Hons) from University Institute of Legal Studies, Panjab University.

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