TO: Mohammed, CEO, Thor Electric Motors Ltd FROM: Legal Counsel DATE: 24 May 2024 RE: Proposed Acquisition of Apollo Autonomous Systems Ltd: Preliminary Advice
This memorandum provides preliminary advice on the proposed acquisition of Apollo Autonomous Systems Ltd (‘Apollo’) by Thor Electric Motors Ltd (‘Thor’). It addresses the four specific questions you have raised concerning transaction structure, Heads of Terms, post-acquisition arrangements for Dr Rebecca Rahman, and the applicable legal frameworks.
C1. Transaction Structure: Share vs. Asset Acquisition
You have asked for advice on whether to structure this transaction as an acquisition of the shares in Apollo or as an acquisition of its business and assets. Both structures have distinct advantages and disadvantages for Thor as the buyer.
Share Acquisition
In a share acquisition, Thor would purchase all of Rebecca’s shares in Apollo. Apollo would become a wholly-owned subsidiary of Thor. The key consequence is that Thor acquires the entire corporate entity of Apollo, including all its assets, liabilities, and obligations, whether they are known or unknown.¹ This is often referred to as acquiring the company ‘warts and all’.
- Advantages for Thor:
- Simplicity and Continuity: A share transfer is often administratively simpler than transferring numerous individual assets. The business continues uninterrupted, with existing contracts (subject to any change of control clauses), employees, and licenses remaining in place within the Apollo corporate entity. This would be beneficial for retaining the MoD contract, provided consent is obtained.
- Acquisition of Entire Business: This structure ensures Thor acquires all of Apollo's assets, including the critical software and intellectual property (IP), without the need for complex individual assignments.
- Disadvantages for Thor:
- Inheritance of Liabilities: This is the most significant risk. Thor would inherit all of Apollo’s liabilities. Based on our due diligence, this includes the potential damages from the employment litigation brought by Daniel, the substantial tax claim from HMRC, and the obligations under the expensive real estate lease.
Asset Acquisition
In an asset acquisition, Thor would agree to purchase specific, identified assets from Apollo (e.g., its IP, software, and key equipment). Apollo itself would remain a separate entity owned by Rebecca, holding the cash proceeds of the sale and any assets and liabilities not transferred to Thor.
- Advantages for Thor:
- ‘Cherry-Picking’ Assets and Liabilities: This is the main attraction of an asset sale. Thor could select the desirable assets (the software and IP) and leave the unwanted liabilities (the litigation, tax claim, and lease) behind with Apollo. This provides a ‘clean’ start and avoids exposure to Apollo’s historical problems.
- Disadvantages for Thor:
- Complexity: An asset sale can be significantly more complex to execute. Each asset must be legally identified and transferred, which can be difficult and time-consuming, especially for intangible assets like IP.
- Third-Party Consents: Contracts are not automatically transferred. The MoD contract, for instance, cannot simply be assigned; it would need to be ‘novated’, which requires the consent of the MoD, Apollo, and Thor. The MoD may refuse or use the opportunity to renegotiate terms.
- Employee Transfers: While the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) may automatically transfer employees to Thor if the transaction constitutes the transfer of a business, this area can be complex.² There is a risk of losing key personnel if the process is not managed carefully.
- Seller Preference: A seller like Rebecca will almost always prefer a share sale. An asset sale leaves her with a company that still holds significant liabilities, and she would be responsible for settling them before winding up the company to extract the sale proceeds. Furthermore, the tax treatment of a share sale is typically more favourable for an individual seller.³
Recommendation
Given the significant liabilities identified within Apollo, an asset acquisition appears safer for Thor at first glance. However, the commercial objectives are to acquire the technology and secure Rebecca’s services seamlessly. An asset acquisition creates significant practical hurdles in transferring the MoD contract and ensuring the smooth transfer of the entire technical team and associated know-how.
Therefore, the recommended approach is a share acquisition, but with the risks mitigated through comprehensive contractual protections in the Share Purchase Agreement (SPA). These protections would take the form of:
- Warranties: Formal assurances from Rebecca about the state of the company (e.g., that there is no other litigation pending).
- Indemnities: A promise from Rebecca to reimburse Thor on a pound-for-pound basis for specific, identified risks, such as the tax claim from HMRC and the employment litigation costs.
This structure is more likely to be acceptable to Rebecca and better achieves the strategic goal of acquiring Apollo as a functioning, integrated technology business. The negotiation of strong warranties and indemnities will be critical to protecting Thor’s position.
C2. Heads of Terms
You asked about the legal and commercial function of Heads of Terms (HoT).
Purpose of Heads of Terms
HoT (also known as a Letter of Intent or Memorandum of Understanding) are a document agreed and signed by the parties at the beginning of a transaction. Their primary purpose is to outline the key commercial terms of the proposed acquisition in principle before the parties commit significant time and expense to detailed due diligence and drafting the final SPA.⁴
Commercially, the HoT serve several functions:
- They act as a non-binding roadmap for the transaction.
- They confirm the parties’ serious intent to proceed.
- They can be used to identify and resolve potential deal-breakers at an early stage.
- They provide a framework for the lawyers to draft the definitive legal agreements.
Key terms typically covered include the proposed price, the transaction structure (share or asset sale), key conditions to be met before completion, and an indicative timeline.
Legal Status: Binding or Non-Binding?
It is standard practice for the majority of the HoT to be expressly stated as not legally binding and ‘subject to contract’. This ensures that neither party is locked into the deal before a full SPA has been negotiated and signed. English law respects the parties' intentions, so clear language is essential to avoid a court concluding that a binding agreement has been formed prematurely.⁵
However, it is also standard practice to ‘carve out’ certain clauses from the ‘subject to contract’ provision and make them legally binding. These clauses are designed to govern the parties' conduct during the negotiation period. The following clauses are typically made legally binding:
- Confidentiality: Although a Non-Disclosure Agreement is already in place, this clause reinforces the obligation on both parties to keep the negotiations and any information disclosed confidential.
- Exclusivity (or ‘Lock-out’): This is a critical provision for Thor. It would legally oblige Rebecca not to solicit, enter into, or continue negotiations with any other potential buyer for a specified period. This gives Thor the security to invest in due diligence costs, knowing Apollo cannot be sold to a rival during that time. An agreement to negotiate for a fixed period with one party is enforceable.⁶
- Costs: This clause specifies how each party's costs will be handled, particularly if the deal does not proceed. Typically, each party agrees to bear its own costs.
- Governing Law and Jurisdiction: This provides certainty by specifying that the HoT (and the future SPA) will be governed by English law and subject to the exclusive jurisdiction of the English courts.
In summary, the HoT should be a hybrid document: the main commercial terms should be non-binding, while the procedural clauses governing the negotiation period should be legally binding to provide Thor with necessary protection.
C3. Rebecca’s Position: Minority Shareholder and Employee
If the proposed deal proceeds, Rebecca will become a 5% shareholder and the Chief Technology Officer (CTO) of Thor. You have asked for advice on this from her perspective.
Key Legal Document for a Minority Shareholder
As a 5% shareholder, Rebecca would have very limited influence over the company under statutory law. She would be unable to pass or block ordinary (>50%) or special (>75%) shareholder resolutions.⁷ Therefore, the key legal document she would seek is a Shareholders’ Agreement (SHA).
An SHA is a private contract between some or all of the shareholders and, often, the company itself. Its purpose is to govern the relationship between the shareholders and regulate the management of the company. It sits alongside the company’s articles of association but, unlike the articles, its contents are not public. For a minority shareholder like Rebecca, an SHA is the primary mechanism for obtaining contractual rights that go beyond the basic provisions of the Companies Act 2006.
Most Important Clauses for Rebecca
From her position as a 5% minority shareholder, the following clauses in an SHA would be most important to protect her investment and influence:
- Minority Veto Rights (Consent Matters): This is the most crucial protection. Rebecca would seek a contractual right to veto certain key corporate decisions. While she will not get a say on day-to-day management, she could reasonably request a veto over fundamental changes that could prejudice her position, such as:
- The issue of new shares (which would dilute her 5% holding).
- Any sale of the entire business or its main assets.
- Changes to the company’s articles of association.
- Taking on significant debt above an agreed threshold.
Negotiating these rights as a 5% shareholder will be challenging, but they are vital for protecting her investment.
- Anti-Dilution and Pre-emption Rights: Rebecca would want to ensure her 5% stake is not diluted by future share issues. She would seek a contractual pre-emption right, obliging Thor to offer her a pro-rata share of any new shares issued, allowing her to maintain her percentage. While a statutory right exists under the Companies Act 2006, it can be disapplied, so a contractual right in the SHA is stronger.⁸
- ‘Tag-Along’ Rights: This clause would protect her if Thor’s majority shareholders decide to sell their shares. It would give her the right to ‘tag along’ and sell her shares to the same buyer on the same terms and at the same price. This prevents her from being left behind as a minority shareholder with a new, unknown controlling party.
- Information Rights: As a minority shareholder, her statutory right to information is limited. The SHA can grant her enhanced rights to receive regular management accounts, business plans, and budgets, allowing her to monitor the company’s performance and the value of her investment.
Enforcing Rights as Chief Technology Officer
Rebecca should not seek to enforce her rights and responsibilities as CTO under the SHA. Her roles as a shareholder (owner) and an employee (CTO) are legally distinct and should be documented separately.
Her employment relationship with Thor should be governed by a Service Agreement (i.e., an employment contract). This document will set out her duties, remuneration, notice period, bonus structure, and any post-employment restrictive covenants.
Mixing employment terms into the SHA is inappropriate for several reasons:
- Confidentiality: Her salary and other employment terms are a private matter between her and the company, not for all other shareholders to see.
- Purpose: The SHA governs shareholder rights, while the service agreement governs employment obligations. Combining them creates confusion.
- Flexibility: Amending a service agreement is a simple matter between the employer and employee. Amending an SHA typically requires the agreement of all shareholder signatories, making it very inflexible for managing an employment relationship.
Therefore, Rebecca should be advised to ensure she has a robust Service Agreement for her role as CTO, which is entirely separate from the SHA governing her rights as a shareholder.
C4. Applicable Legal and Regulatory Frameworks
Your belief that only the Takeover Code is relevant to this acquisition is incorrect.
The Takeover Code
The Takeover Code does not apply to this transaction. The Code’s rules regulate the process of acquiring public companies in the UK.⁹ As both Thor and Apollo are private limited companies, this transaction falls outside its scope.
Other Applicable Frameworks
Several other legal and regulatory frameworks are highly relevant and must be considered:
- Companies Act 2006: This is the foundational statute governing all UK companies. It will dictate the legal process for transferring the shares from Rebecca to Thor, the duties of the directors of both companies in approving the transaction, and the rights of shareholders.
- National Security and Investment Act 2021 (NSIA): This framework is of critical importance. The NSIA gives the government powers to scrutinise and intervene in acquisitions that could harm the UK’s national security. The acquisition of a company involved in developing ‘sophisticated artificial intelligence software for autonomous driving’ falls within one of the 17 mandatory notification sectors specified by the Act (specifically, Artificial Intelligence).¹⁰ This means the transaction will require mandatory notification to the government’s Investment Security Unit before it is completed. Failure to notify and obtain clearance will render the acquisition legally void.
- Competition Law: The acquisition could be subject to review by the Competition and Markets Authority (CMA) under the Enterprise Act 2002. The CMA has jurisdiction to investigate a merger if it meets certain thresholds, namely if the target’s UK turnover exceeds £70 million, or if the combined businesses will supply at least 25% of particular goods or services in the UK.¹¹ Given Thor is a large international group, it is possible these thresholds could be met. We would need to conduct an analysis to determine if a voluntary notification to the CMA is advisable to avoid a later investigation.
In conclusion, the Takeover Code is not relevant. However, compliance with the Companies Act 2006, and particularly the mandatory notification regime under the NSIA 2021 and potential review under UK competition law, will be essential legal considerations for this transaction.
*
Footnotes
¹ See generally, R Hollington, Hollington on Shareholders' Rights (10th edn, Sweet & Maxwell 2021) ch 17. ² Transfer of Undertakings (Protection of Employment) Regulations 2006, SI 2006/246. ³ For example, under current rules, a seller of shares may be able to claim Business Asset Disposal Relief, which reduces the rate of capital gains tax. ⁴ M-A Williams, The Law and Practice of Mergers and Acquisitions in the UK (4th edn, Bloomsbury Professional 2022) 4.1. ⁵ RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH & Co KG (UK Production) [2010] UKSC 14, [2010] 1 WLR 753. ⁶ Walford v Miles [1992] 2 AC 128 (HL). ⁷ Companies Act 2006, ss 282-283. ⁸ ibid, s 561. ⁹ The Panel on Takeovers and Mergers, The Takeover Code (14th edn, 2022) Introduction 2.1. ¹⁰ National Security and Investment Act 2021, s 6; The National Security and Investment Act 2021 (Notifiable Acquisition) (Specification of Qualifying Entities) Regulations 2021, SI 2021/1264, Schedule, Part 1, para 1. ¹¹ Enterprise Act 2002, s 23.
Bibliography
Legislation
Companies Act 2006
Enterprise Act 2002
National Security and Investment Act 2021
The National Security and Investment Act 2021 (Notifiable Acquisition) (Specification of Qualifying Entities) Regulations 2021, SI 2021/1264
Transfer of Undertakings (Protection of Employment) Regulations 2006, SI 2006/246
Cases
RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH & Co KG (UK Production) [2010] UKSC 14, [2010] 1 WLR 753
Walford v Miles [1992] 2 AC 128 (HL)
Books and Other Materials
Hollington R, Hollington on Shareholders' Rights (10th edn, Sweet & Maxwell 2021)
The Panel on Takeovers and Mergers, The Takeover Code (14th edn, 2022)
Williams M-A, The Law and Practice of Mergers and Acquisitions in the UK (4th edn, Bloomsbury Professional 2022)
