Contribution agreements – a guide for sellers

What is a contribution agreement and why might you need one when selling your business?

When several people sell shares in a company together, it’s easy to assume they’ll simply share any future liabilities fairly. In practice, however, it isn’t always that straightforward.

A contribution agreement (sometimes called an allocation or apportionment agreement), is a separate agreement between the sellers that sets out how responsibility for claims and, importantly, certain sale proceeds will be divided between them. It usually sits alongside the share purchase agreement (SPA).

While the SPA governs the sale between the buyer and the sellers, a contribution agreement governs the relationship between the sellers themselves. The buyer often does not see a copy of this agreement, and it operates solely between the sellers.

Many sellers will want the contribution agreement to be in place on completion, but it is also possible for this to be entered into after a share sale.

Why are contribution agreements needed?

Many SPAs make the sellers jointly and severally liable for warranties and indemnities. This means the buyer can often recover the full amount of a claim from any one seller, rather than pursuing everyone separately.

From the buyer’s perspective, this makes sense and is often an item which they will not concede on in negotiations. For the sellers, however, it can create an unfair outcome if one individual ends up paying more than their fair share simply because they are the easiest person to pursue.

A contribution agreement addresses this by setting out how liability will ultimately be shared between the sellers. If one seller pays more than their agreed share, the agreement provides a mechanism for recovering the balance from the others.

Contribution agreements are more than just sharing liability

Contribution agreements are often thought of as a way of allocating liability if a buyer brings a claim after completion. While that is a key function, they can also be used to record how completion monies, deferred consideration, earn-outs and other future payments will be shared between the sellers.

This can be particularly important where the commercial agreement between the sellers differs from their legal shareholdings. For example, sellers may agree that completion proceeds or future earn-out payments should be divided differently, for example, to reflect previous investments or additional time that they have put into the business etc.

Recording this in a contribution agreement helps avoid uncertainty and disputes later on.

Agreeing responsibilities in advance

In the case of liability, rather than leaving difficult conversations until after a claim arises, a contribution agreement allows sellers to agree upfront how responsibility should be divided.

This might be based on:

• The proportion of sale proceeds each seller receives;
• Each person’s shareholding;
• Responsibility for the issue giving rise to the claim; or
• A combination of these approaches.

The right solution will depend on the transaction and the sellers’ commercial agreement.

Couples selling together

Contribution agreements can be particularly useful where spouses or civil partners are both selling shares, or for SME businesses where there are multiple sets of partners who own the business.

The agreement can make it clear how liability is shared between them, who deals with claims from the buyer and how any settlement decisions are made. It can also record how sale proceeds and future payments are intended to be divided if that differs from the legal ownership of the shares.

It can also deal with the scenario of what happens to rights/liabilities if one of the partners were to pass away.

Deferred payments and earn-outs

Where part of the purchase price is paid after completion, contribution agreements can deal with how deferred consideration, escrow funds or earn-out payments are shared, how any deductions made by the buyer affect each seller and who ultimately bears the cost if payments are reduced following a claim under the SPA.

To summarise the importance of contribution agreements

A contribution agreement won’t prevent a buyer from bringing a claim, nor does it reduce the sellers’ obligations under the SPA.

Instead, it provides clarity and certainty between the sellers themselves, both in relation to future liabilities and how sale proceeds are shared.

How can Morr & Co help?

Our Corporate & Commercial team regularly advise business owners and shareholders on all aspects of business sales, including putting suitable contribution agreements in place. Considering these arrangements early in the process helps ensure they reflect the agreed commercial position between the sellers and minimises the risk of disputes after completion.

If you have any questions or would like any further information on the content of this article, please do not hesitate to contact us on 0333 038 9100 or email info@morrlaw.com.

Disclaimer
Although correct at the time of publication, the contents of this newsletter/blog are intended for general information purposes only and shall not be deemed to be, or constitute, legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article. Please contact us for the latest legal position.