An anti-embarrassment clause requires a buyer of an asset to provide the seller with an additional payment if he or she resells the asset at a higher price within a certain period of time.
In share sale and purchase agreements it is often referred to as anti-embarrassment because it supposedly prevents the seller from being embarrassed about having sold the shares below their true value.
In land sales agreements this type of provision is commonly known as overage.
This type of provision is used either where the value of the asset (such as shares) is uncertain at the time of sale (such as where there is asymmetric information between the buyer and the seller, or where a market doesn’t exist to establish easily what a market value might be), or where the seller believes that the buyer might be able to obtain a better price as a result of additional work or different circumstances.
A management team might buy out a business from a professional investor. The seller is concerned that, being closer to the day to day business, the buyers may have better information about the future prospects of the business. The seller therefore insists on an anti-embarrassment clause in order to make sure that the price is fair.
A seller requires cash at short notice, and therefore is willing to sell shares to a buyer at discount to their market price. He or she uses a anti-embarrassment clause to make sure that if the buyer resells them within a short time frame, the seller shares in some of the profit.
A buyer purchases the shares of one of the partners in a joint venture company where the relationship has broken down and the venture is stagnating. The remaining partner is difficult about who he or she will work with and therefore the pool of potential buyers is small. The selling partner agrees to a sale at a below-accounting value price conditional on sharing some of the uplift if the project turns out to be successful and the shares are sold as planned later.
Structuring the anti-embarrassment provision
The general structure of the clause is that an additional amount (additional consideration) will be payable if a trigger event happens during a certain time period.
The additional consideration, the trigger event or events and the time period can all then be defined.
The additional consideration is likely to be a percentage of the difference between the price at which the buyer buys the shares and the price at which he or she resells them. It may be further modified by the time between the two transactions, and/or the number of shares resold (the purchase of a controlling stake in a company via a majority shareholding usually commands a higher price per share than a non-controlling stake).
The trigger is usually a disposal of more than a certain percentage of the shares within the time period. The disposal may be in one or more transactions.
The time period may be measured in months or years depending on the circumstances. It may be qualified in some way, for example, it may be longer if something else happens.
As well as these, anti-avoidance measures need to be included. It can very easy to circumvent an anti-embarrassment clause by using option agreements to forward date further transactions beyond the time period during which the anti-embarrassment clause is active.
To add to complications, the anti-avoidance measures should not conflict the directors of the buyer with the legal obligations that they have as directors. If directors are conflicted, the anti-avoidance measures may not be binding.
Anti-avoidance measures usually include requirements for the buyer:
- to disclose information in a timely manner, if a trigger event occurs. Such information would include the proposed resale price and might include other information about the transaction.
- to act in good faith towards the seller, i.e. not to act in any way that avoids the payment or reduces it.
- not to enter into any agreement that has the purpose of concluding the resale transaction after the expiry of the anti-embarrassment provision in order to reduce payments to the original seller.
Additionally, the seller may seek a warranty from the buyer it currently does not intend to sell the asset while the provision is in place. In practice, establishing such intention exists is difficult for the seller, but this warranty may act as a deterrent.
As with all well drafted agreements, there should be a mechanism for disputes to be resolved outside of litigation in order to reduce costs. Mediation is often preferred over other forms of ADR, but it would also be valid to have an expert (such as a qualified, experienced accountant or lawyer) decide how to resolve a dispute.
Drafting an anti-embarrassment clause that can be relied upon by both sides is difficult and requires some knowledge of the situations in which it might be used. Other arrangements, such as a cross option to buy at a future date, or a retained interest in the asset, might be more suitable to give the same level of protection to the seller.