Application of common law clauses in contracts for the purchase of shares of Colombian companies
The market for acquiring 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 stock purchase agreement (“SPA”) language used by Colombian lawyers, including using concepts imported from common law. The adoption of this language greatly facilitates communication between foreign clients and lawyers and makes transactions more fluid. However, buyers and sellers who trust Colombian lawyers should not lose sight of the fact that, being an imported contractual language, it has its limits when it comes to applying it in Colombia. Therefore, parties involved in negotiating SPAs of Colombian companies should be careful to keep this in mind when receiving legal advice in the country.
When seeking to acquire a position of control in a company, the transaction does not refer only to the acquisition of a certain number of shares, but mainly to the purchase of an organization which has a life of its own and is made up of a corporate culture, a commercial projection, assets, workers who make autonomous decisions and, in general, elements that interact to create added value. With this in mind, the parties, including the acquirer, may not be able to identify all possible contingencies in the conduct of the target’s business.
This is why the negotiation of representations and warranties (“D&G”) in stock purchase agreements becomes so important. D&G originated from common law and are widely used in Colombian legal practice of mergers and acquisitions. They go hand in hand with the indemnification clause, in which the parties agree on the amount of the claim that the buyer can demand from the seller in the event of lies in the D&G. However, what happens when the D&Gs are inaccurate, or if after the transaction is concluded new contingencies arise that were not disclosed by the seller?
In this article, we seek to explain the contractual and legal numbers that parties to a SPA should keep in mind in order to invoke breach of contract once the transaction has been concluded, with the aim that buyers and sellers can have informed conversations with their advisers and ensure that their interests are adequately protected. To be more specific, we will focus on explaining the D&G clause and the indemnification clause, then explain how they interact with two relevant contractual figures of the Colombian system, such as the action redhibitoria and the relative nullity of the contract due to an error in the quality of the asset (error in the quality of the cosa)
Breach of Contract: Representations and Warranties, Indemnification Clause and action redhibitoria
To begin with, the legal nature of D&G is contractual and based on the autonomy of the will of the parties. This means that these are clauses that are not incorporated into Colombian law and that it is the parties – through the clause – who are responsible for spreading the risks of the sale of the shares. D&G assumes that, if a contracted party makes an assertion that leads to the closing of the legal transaction, then it must guarantee its truth and be liable for the consequences if it is not true. 1 Ultimately, this can be expressed by a statement of the following type: “The Company has no liabilities or obligations for a value greater than 20% of the total assets. Likewise, each of the principal obligations has been disclosed in Schedule A of this contract.”
It is important to point out that in SPAs, the Supreme Court of Justice has clarified that the object of the contract is not the company’s assets, but rather the representative certificates of participation in the company. 2 It is therefore essential that the parties stipulate, taking into account the economic object of the contract, that the contractual object does not relate only to the securities, but also to the assets of the company. 3 At this stage, the D&G clause is particularly important, as well as the indemnification clause, because through these the parties will indicate the characteristics of the company and the amount of the indemnification of the buyer in which they are inaccurate. Similarly, it is important that the parties agree on the limitation period of the indemnification clause, since in the event of their silence, the guarantee will be valid for two years from the signing of the contract (art. 932 Commercial Code). 4
Therefore, this clause ends up being an acknowledgment of the economic purpose of the contract, which truly extends to the acquisition of a business. In addition, it has proven to be one of the most common contractual mechanisms for invoking default due to irregularities of the company being transacted.
Likewise, the parties must bear in mind that in any sale celebrated under the Colombian legal system, the seller is responsible for the obligation to saneamiento. This obligation implies that the seller “is obliged to provide the buyer with peaceful and useful possession of the property sold”. 5 This implies that “the good must materially serve the use for which it is intended according to its nature. 6 Hence, when the good suffers from material defects which prevent it from being used in accordance with its nature, the seller will have broken the contract and the buyer will have the right to lodge a complaint. action redhibitoria hidden defects of the property sold. 7
In SPAs, the action redhibitoria is a legal figure that the parties should not ignore. In this respect, it is important to specify that the object of the contract is not the company, but the equity securities. This would mean that, in turn, the obligation to saneamiento would only accrue to the shares of the company. However, the Supreme Court of Justice has recognized that the parties may extend the obligation to saneamiento to cover the business. 8 Therefore, the obligation to saneamiento may also apply in the event of inaccuracies or defects of the company within the framework of the contractual object. 9
Now, it is vitally important that the parties bear in mind that the action redhibitoria gives rise to the buyer requesting the termination of the contract or the reduction of the price depending on whether the good does not serve its natural purpose or serves it imperfectly. 10 In addition, the limitation period of the action redhibitoria is six months for movable property such as shares. 11
Defects in the consent: relative nullity of the contract due to error in the quality of the good (error in the quality of the cosa)
However, once the nature of the D&G has been clarified, it should be reaffirmed that the mandatory nature of this clause within the contract is incidental to the main obligation of the SPA, which is the transfer of ownership of the shares in question. Despite this, the arbitral awards have proposed that although the nature of the D&G is incidental (since its very origin is common law), its relationship to the primary obligation is such that, in the first place, they could be understood as part the pre-contractual duty of information, a duty which derives from the principle of good faith (art. 871 Civil Code). Secondly, since the veracity of these can be a determining cause to execute the contract, the D&G have a privileged role in the contract which cannot be covered by considering them as auxiliaries. Their importance is such, for the two reasons mentioned above, that arbitral awards have positioned them as part of the consent requirement in the contract. 12
To reach the above conclusion, it is important to remember that according to Colombian law, when signing any contract, the parties must have: legal capacity, consent free from defects, and the contract must be based on a lawful object and cause. Taking this into account, the arbitral justice developed the argument set out in the previous paragraph, saying that the D&G’s lie 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 defect in the consent. 13
The defects of the consent, in turn, can be due to force, fraud or error, in this case the defect of the consent would be due to an error in the quality of the asset (error in the quality of the cosa).
Finally, although the declaration of relative nullity of the contract due to falsity of the D&G is an additional possibility to the request for indemnities, or to the exercise of the action redhibitoria, this claim must first be asserted by one of the parties in accordance with article 1743 of the Civil Code. Thus, it is important that the interested buyer or his lawyer remember this arbitration award when resolving any dispute in a litigious manner, since it is not an alternative that the judge can exercise. ex officio.
From all that is said in this article, it must be concluded that even if the SPAs are drafted with the same legal figures as those used in common law, this 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 violation of the agreement by one of the parties, an ordinary judge or arbitrator will grant the effects which the parties intended. These effects are not always peaceful and there are differences between ordinary jurisdiction and arbitration jurisdiction, for which correct legal advice is of vital importance when entering a SPA in Colombia.
- Arbitral award of Balclin Investmets sl, Altra Inversiones SAS and others against Jairo Gutiérrez Robayo, Jimena Gross Mejía and others. Judgment of September 14, 2011. Referees: Ernesto Rengifo García, Jorge Cubides Camacho and Carlos Gustavo Arrieta Padilla.
- Congress of the Republic of Colombia. Civil Code. Law 84 of 1873. Official Journal No. 2,867 of May 31, 1873
- Gomez Estrada, Caesar. Main civil contracts. Fourth edition. Colombia: Editorial Temis SA, 2008. ISBN: 978-958-35-0656-7
- President of the Republic of Colombia. Trade code. Decree 410 of 1971. Official Journal No. 33 339 of June 16, 1971
- Supreme Court of Justice of Colombia. Civil Cassation Chamber. Judgment of December 16, 2013. Reporting Judge: Ariel Salazar Ramírez. File No. 248433