PRACTICAL LAW DRAFTING NOTES TO BVCA SUBSCRIPTION AND SHAREHOLDERS' AGREEMENT FOR EARLY STAGE INVESTMENTS

Last reviewed November 2017, unless otherwise stated

The commentary contained in these drafting notes may be used as a guide for drafting only and does not constitute legal advice

DRAFTING NOTES TO ACCOMPANY THE BVCA SUBSCRIPTION AND SHAREHOLDERS' AGREEMENT FOR EARLY STAGE INVESTMENTS

General document notes

The two principal documents involved in a venture capital investment will be:

A subscription and shareholders' agreement, also known as an investment agreement. This will often be a single document, although it may be split into two separate documents, a subscription agreement and a shareholder or investor rights agreement.

New articles of association of the company in which the investment is being made. The articles form part of the company's constitution and govern the internal management of the company's affairs. The articles are subject to the requirements of the Companies Act 2006 (CA 2006). For more information, see BVCA Articles, Drafting note, General document notes.

In these drafting notes:

The BVCA industry standard articles of association and subscription and shareholders' agreement are referred to as the Articles and the SSA, respectively.

The company in which the investment is being made is referred to as the Company.

Unless provided otherwise, capitalised terms used in these drafting notes have the same meaning as given to them in the Articles.

These drafting notes are based on the form of SSA published on the BVCA website in October 2014 and so do not take account of changes made to the SSA after that date. Users of the Articles and the SSA should satisfy themselves that the provisions of those documents reflect the current law and are suitable for purpose. Unless otherwise indicated, these drafting notes are up to date as at November 2017.

Please note that drafting notes relating to data protection issues have not been reviewed since September 2016. Also, UK data protection law will change on 25 May 2018, when the EU General Data Protection Regulation (GDPR) takes effect, replacing the Data Protection Act 1998 (see EU General Data Protection Regulation toolkit for information on the new Regulation). These drafting notes do not take account of the need to comply with the GDPR from May 2018.

What is a subscription and shareholders' agreement?

The subscription and shareholders' agreement will, unless issues have arisen during the due diligence exercise, reflect the provisions of the term sheet. Unlike the term sheet, all of the provisions of a subscription and shareholders' agreement are intended to be legally binding.

The subscription and shareholders' agreement will usually be made between:

The investors.

The management of the company (and, possibly, other existing shareholders, such as employees).

The company.

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It records the commercial terms of the arrangement between the parties and will include specific details of the investment round (or rounds), including the number and class of shares to be subscribed for by the investors, payment terms and warranties about the condition of the company.

The warranties will be qualified by the terms of a disclosure letter (or letters if there are a series of investment rounds) which will refer to supporting documents (usually referred to as a "disclosure bundle") and will specifically set out any issues that the management and the company think the investors should know of, prior to completion of the investment.

One agreement or two?

Early stage companies seeking venture capital investment may undertake a number of funding rounds over a period of years. For example, a life sciences start-up seeking to develop a compound for clinical testing will often require an injection of cash at each stage of development. In those circumstances, it will be appropriate to consider whether the investors should enter into a single subscription and shareholders' agreement which sets out both the investment mechanics and the provisions regulating their ongoing participation in the company as shareholders, or whether the subscription agreement should be a separate document from the shareholders' agreement.

A separate subscription agreement should mean that, on each subsequent funding round, the incoming investors need only negotiate and execute a short document setting out the mechanics and terms of their subscription, including any warranties from the company and management team. Each subscription agreement would be a standalone document, unaffected by any other.

The approach described above ought then to allow for a single shareholders' agreement (also known as an investor rights agreement), setting out the investors' rights. On each funding round, any new incoming investor should adhere to that agreement alongside the existing investors (although some changes may be required to reflect the term sheet of any new investment round). As well as reducing the amount of documentation required on each funding round, a uniform set of rights for investors should more easily allow the investors to monitor management's compliance with the provisions set out in that agreement. This approach is common to US venture capital transactions.

Should provisions be included in the SSA or the Articles?

The parties should consider which provisions should be included in the SSA and which should be in the articles of association. The SSA binds only the parties to it; the articles of association bind all of the company's shareholders and the company.

However, it is common for a subscription and shareholders' agreement to include a provision stating that, in the event of conflict between the articles and the subscription and shareholders' agreement, the terms of the subscription and shareholders' agreement shall prevail (for an example, see clause 27 of the SSA).

Generally, a subscription and shareholders' agreement will also contain provisions protecting the investors' interests. In addition to the warranties referred to above, these protections include rights to board representation, information rights, consent rights and non-compete restrictions (see respectively, clauses 8, 9, 10 and 14 of the SSA).

The articles of association will include details of the rights attached to the different classes of shares, the procedure for the issue and transfer of shares and the procedure for holding shareholder and board meetings.

Drafting assumptions

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The SSA assumes that:

The Company is a private company limited by shares registered in England and Wales.

If the Company has any subsidiaries, each of them is a private company limited by shares registered in England and Wales.

Before completion of the investment, the Company's share capital is made up of ordinary shares only.

This will be the Company's first round of venture capital investment.

The investment will be made by one or more venture capital investors.

The Investors' obligation to invest will be conditional and will require the Company and the Founders to give a full set of Warranties to the Investors.

Each Investor will subscribe for a preferred class of Series A Shares. No other shares will be issued at completion.

The investment may be made in more than one tranche.

No Investor will subscribe for preference (non-equity) shares or loan notes in the Company.

The transaction will not involve any third party lending at completion.

There will be no delay between exchange and completion, which will occur simultaneously.

US securities laws or ERISA provisions are not to be included. The SSA includes sample provisions in Appendix B to the SSA. For notes on those sample provisions, see Drafting note, Appendix B: US securities law requirements and ERISA.

Simple contract or deed

The SSA provides alternative execution blocks that would allow this agreement to be executed under hand as a simple contract, or as a deed.

A shareholders' agreement will often be executed as a deed, for two main reasons:

To avoid concerns about whether or not consideration is provided to the managers for their obligations under the agreement, in particular the restrictive covenants that they will be asked to give under clause 14.

As a power of attorney must be executed as a deed under section 1 of the Powers of Attorney Act 1971. Paragraph 16 of schedule 7 to the SSA contains a power of attorney given by the Founders in relation to the signing of elections pursuant to section 431(1) of ITEPA 2003.

It is also considered that the use of a deed extends the limitation period from 6 years to 12 years. This is a subsidiary reason to those set out above and the BVCA Legal and Technical Committee considers that this advantage is not, on its own, of sufficient significance in the context of the SSA to necessitate the SSA being in the form of a deed.

Execution of the SSA under hand as a simple contract would alleviate the inherent difficulties of executing a document as a deed. The required power of attorney found in paragraph 16 of

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schedule 7 to the SSA could instead be given by way of a separate deed, deliverable at completion.

In light of the potential issue relating to the adequacy of consideration given to the Founders for their undertakings and obligations under the SSA, the BVCA Venture Committee and Legal & Technical Committee sought Counsel's opinion on the validity of the agreement if executed under hand. Counsel's opinion, delivered on 14 September 2014, is available on the BVCA's website and the question of execution of this SSA should be considered in light of that opinion.

If the SSA is to include termination of a Prior Agreement (see clause 22.2) and that Prior Agreement was executed as a deed, this SSA ought also to be executed as a deed (see Drafting note, Clause 22.2: Prior Agreements).

If the SSA is to be executed as a deed, delete clause 30 (and renumber the rest of the agreement as appropriate). If it is to be signed under hand, clause 30 should be included and the power of attorney provision must be removed from paragraph 16 of schedule 7.

There are an increasing number of instances where the parties to a transaction wish to execute documents electronically, including through web or app-based signature platforms. To assist in this regard, a joint working party (JWP) of The Law Society Company Law Committee and The City of London Law Society Company Law and Financial Law Committees has published guidance on the use of electronic signatures in commercial contracts.

For more on execution generally, see Practice note, Execution of deeds and documents.

Parties

This part of the agreement identifies the parties to the agreement.

The document assumes that the investment will be made by a number of investors participating in a syndicated investment. If the investment is syndicated, consider whether to appoint a lead investor to take charge of negotiating the terms of the investment.

If a lead investor is appointed, consider on what basis it is to be appointed and whether it, (rather than a majority of the investors, as in the SSA (see Drafting note, Clause 1: Investor Majority) should have the ability to take other key decisions under the agreement, (such as when to bring claims under the Warranties).

If the investment is not syndicated, amend the parties clause by inserting the investor's details and delete Part 1 of schedule 1 to the SSA. Consequential amendments will also be required throughout the document. For example, the definition of "Investor Majority" in clause 1 will not be necessary. In such circumstances, consider whether some or all of the decisions reserved to an Investor Majority should require the sole investor's approval instead.

The Founders are listed in Part 2 of schedule 1 to the SSA. They are likely to include the Company's Founders and some (or all) of the Company's directors.

The SSA also includes optional provisions allowing other Shareholders to be parties to the agreement. Whether the Investors require those other Shareholders, if any, to sign up to the restrictions and obligations imposed by the SSA will depend on, among other things, the proportion of voting rights held by each of them and their importance to the business of the Company (or the wider group of companies). Investors may insist on all Shareholders being parties to the SSA to provide comfort that all Shareholders have accepted the preferential rights granted to the Investors. The Investors may consider that such acceptance may make it more difficult for a disgruntled Shareholder to claim that he has been unfairly prejudiced by the investment and the Investors' associated preferential rights.

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If all Shareholders are to be parties to the agreement, it may be more administratively difficult to vary the terms of the SSA if such a variation would require the consent of all the parties. In that case, the Investors may seek a variation clause on terms as set out in clause 23, under which a specified percentage of the Shareholders may bind all Shareholders to a variation (see Drafting note, Clause 23.1: Variation).

Introduction

This section, sometimes called the recitals, briefly describes the background and purpose of the agreement. It can be a useful point to introduce any unusual or complicated features of the agreement, which can be defined and then picked up later in the agreement.

As a matter of general construction, this part of the agreement does not form part of the operative provisions. It does not have direct legal consequences, although in cases of dispute, it may be used as an interpretative guide to operative provisions which are subsequently found to be obscure or ambiguous in meaning or otherwise the subject of dispute.

Clause 1: Definitions

The main purpose of a definitions clause is to reduce repetition within the body of the SSA, making the document shorter and easier to read. It also gives specific meanings to particular words used. This avoids ambiguity and also makes clear that the term is intended to include matters which it might not otherwise be found to include (or vice versa). The definitions and rules of interpretation in clause 2 apply to the whole of the document.

Drafting issues

Care should be taken with definitions, as the construction of key parts of the SSA may depend upon them.

Be consistent: where a capitalised term is used, don't introduce it without capitals elsewhere in the document, or use a different form of words to mean the same thing.

Examine each definition carefully to make sure it means what you intend it to mean, and where necessary, change the drafting to reflect the intention of the parties.

Where a defined term is likely to be used in a particular clause, schedule or paragraph only, it may be preferable to include the definition at the beginning of the relevant clause, schedule or paragraph (for example, see the definition of "Confidential information" in clause 15.3). This approach can be particularly useful where the definition relates to a specialist area, and the contractual provisions relating to that area will be negotiated separately by practitioners in that field.

If a term is defined in the body of the agreement, but used in multiple clauses, it may be helpful to include a cross reference in clause 2 to the clause containing the relevant definition.

The CA 2006 and other statutes contain a number of definitions that may be useful to incorporate in the agreement by reference. However, it is generally unwise to include a provision incorporating all definitions used in all acts, since some of these may be wider than the parties realise (for example, "director"). A risk in using terms as defined by statute (and not by the parties) is that the courts may interpret the statutory definition in a manner which may have unexpected or even adverse consequences in an agreement.

For further information on interpretation generally, see:

Standard clause, Interpretation and the related drafting notes.

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Practice note, Contracts: interpretation.

Clause 1: Adequate Procedures

This term is used in paragraph 10 of schedule 7, which sets out the undertaking from the Founders and the Company that the Company has and will maintain in place Adequate Procedures designed to prevent any Associated Person from undertaking any conduct that would give rise to an offence under section 7 of the Bribery Act 2010.

Section 7 of the Bribery Act does not define "adequate procedures" but section 9 of the Bribery Act requires the Secretary of State to publish guidance on the procedures that companies can put in place to prevent bribery by their associated persons. The Ministry of Justice published adequate procedures guidance on 30 March 2011. For more information, see Practice note, Bribery Act 2010: anti-corruption policies.

Clause 1: Additional New Shares

See Drafting note, Clause 3.3: Additional New Shares.

Clause 1: Business

This definition explains the current business of the Company. It is principally used in relation to the business undertakings of clause 11 and in certain Warranties. In particular:

The warranty at paragraph 2.3 of Part 1 to schedule 5 states that the Warrantors are not aware of any information not Disclosed that is relevant to the Business.

Under paragraph 3 of Part 2 to schedule 6, the Founders and the Company undertake not to make any change to the nature of the Business without Investor Director Consent.

As such, it will be important to carefully consider the definition to ensure that it accurately reflects the nature of the Company's business at the point of Completion.

Given the effect of clause 2.15, if the Company forms part of a wider group, it may be necessary to adapt the definition of "Business" to encompass the business of those other Group Companies (see Drafting note, Clause 2.15: References to the Company).

Clause 1: Claim

This term only relates to claims made under the Warranties. Under clause 22.5, the only available remedy for a Claim is an action for damages. For any other claim under this agreement, the remedies of injunction or specific performance may also be available. The Investors should consider whether to extend this definition to cover any other claim under the agreement.

Clause 1: Company Website

See Drafting note, Warranty 10.14: Company website.

Clause 1: Completion

In the context of a venture capital investment, completion is the point at which the Investors release their subscription monies to the Company and the Company issues the Series A Shares to the Investors.

As Completion cannot occur until all of the Completion Conditions have been satisfied or waived, Completion need not take place on the same date as the SSA is signed (also known

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as "exchange"). This may be the case where, for example, completion of the investment is subject to regulatory or third party consents. For considerations relevant to a split exchange and completion, see Drafting note, Clause 4: Completion.

In most venture capital investments, however, the Investors will wait until all Completion Conditions are capable of being satisfied before dating the agreement, allowing exchange and Completion to occur simultaneously.

Clause 1: Computer System

See:

Drafting note, Warranty 10.18: Third party and shared IT assets and computer data.

Drafting note, Warranty 10.19: Computer System.

Drafting note, Warranty 10.20: Disaster recovery.

Clause 1: Data Protection Legislation and Data Protection Principles

See Drafting note, Warranty 14.6: Data protection.

Clause 1: Deed of Adherence

If any person who is not already a party to this agreement acquires shares through allotment or transfer, he will be required to execute a deed under which he agrees to adhere to and observe the terms of the SSA. In particular, see clause 3.3, and clauses 13.2 and 13.3. For more information, see Drafting note, Clause 13.2: Deed of Adherence.

Clause 1: Disclosed

Disclosure is the process by which the Company and the other Warrantors make general and specific disclosures against the Warranties given in clause 5 and set out in schedule 5. If the Warrantors fail to disclose a relevant matter in respect of the Warranties they may be sued by the Investors for breach of Warranty. The Warrantors usually make their disclosures in a disclosure letter and attach relevant documents to that letter to support their disclosures (the disclosure bundle).

The meaning given to this term is important as it sets the standard to which disclosure must be made in order for the disclosure to be effective in qualifying a Warranty. The question of what constitutes "fairly disclosed" has been considered in a number of cases, and most recently in Infiniteland Limited and another v Artisan Contracting Ltd and Artisan (UK) PLC [2005] EWCA Civ 758 and MAN Nutzfahrzeuge AG and others v Freightliner Limited [2005] EWHC 2347, which indicated that the courts may be prepared to look to the strict drafting of an agreement in assessing the adequacy of disclosure. In light of these cases, Investors should not assume that there is an overriding requirement for a disclosure to be full, clear and accurate to be effective in qualifying a Warranty, unless additional wording is expressly included. The definition in the SSA provides that a disclosure must be fair (but not full, clear and accurate) and include sufficient detail and explanation to clearly identify the nature, scope and full implications of the matters disclosed.

If the investment is made in more than one tranche, include the reference to the Further Disclosure Letter.

For further information relating to the standard of disclosure, see Practice note, Disclosure: acquisitions: How full and complete must disclosure be? and When is a disclosure fair?

Clause 1: Disclosure Letter

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The disclosure letter is given by the Company and the other Warrantors to the Investors. It sets out qualifications to the Warranties set out in Part 1 of schedule 5 to the SSA.

In the majority of venture capital transactions, the disclosure letter is addressed from the Warrantors to the Investors. In some circumstances, it may be more convenient for the letter to be written on the Warrantors' behalf by their solicitors (for example where there are a large number of individual Warrantors), but this approach is rare in practice.

The disclosure letter will usually have a bundle of documents attached to it, which contains copies of all documentation that is being disclosed. This bundle is referred to as the disclosure bundle.

If exchange of agreements and completion of the transaction will take place simultaneously, it is not strictly necessary to refer to the Disclosure Letter as being in the "agreed form" as, in practice, neither party will proceed to Completion unless they are happy with the form and content of the letter. However, it may assist in managing the transaction and the document production process to specifically refer to the Disclosure Letter as being in "agreed form".

For a sample disclosure letter, see Standard document, Disclosure letter: non-leveraged investments.

Clause 1: Encumbrance

This term can be widely construed, and may include many kinds of restriction on a person's ability to deal freely with shares or assets in their ownership or control.

Always consider the context in which the term is used, particularly where any Warranties or representations are given that shares or assets are "free from encumbrances"; for example, see paragraphs 9.3, 10.18 and 11.3 of Part 1 to schedule 5.

Paragraph 10 of Part 2 to schedule 6 restricts the Company's ability to create any Encumbrance over any of its assets without Investor Director Consent.

Clause 1: ERISA

See Drafting note, clause 38: ERISA.

Clause 1: First Tranche Shares

Include this definition if the Investors' subscription for Series A Shares is to be split into two tranches. If there is only one round of investment, delete this definition and amend the definition of New Shares as appropriate.

Clause 1: Further Disclosure Letter

This term will only be required if the investment is to be made in two tranches. If the investment is to be made in a single tranche at Completion, delete this definition.

Clause 1: Further Relevant Change Letter

See Drafting note, Confirmation of relevant change to PSC register on Completion.

Clause 1: Grant Funding

This term is only used in warranty 14.7 of Part 1 to schedule 5.

Clause 1: Group Companies

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Although the Company may not be a member of a corporate group at the time the SSA is entered into, it would be prudent to retain Group Company references in the SSA to cater for possible future corporate structure changes.

In the SSA, the Subsidiaries include each entity that is a subsidiary of the Company within the meaning of section 1159 of the CA 2006. At Completion, this should only comprise those whose details are set out in Part 2 of schedule 2 and any other company that is, for the time being, a subsidiary within the meaning of section 1159 of the CA 2006.

Clause 1: Intellectual Property

For a discussion of the drafting of such a definition, see Standard clause, Definition of intellectual property rights and the related drafting notes.

Clause 1: Investor Director Consent

Typically, Investors will expressly set out those matters that a company or its directors cannot undertake without consent. Often those matters will be split between those that require consent from the Investors themselves (see Drafting note, Clause 1: Investor Majority Consent) and those that require the consent of Investor Directors appointed by the Investors (see Drafting note, Clause 1: Investor Directors). One of the reasons for drawing a distinction between Investor Majority Consent and Investor Director Consent matters is because an Investor Director has a duty to act in the best interests of the shareholders as a whole (see Drafting note, Clause 8.2: Investor Directors and observers). Accordingly these wider considerations may fetter his or her discretion in circumstances where they would not fetter the discretion of an Investor Majority.

For those matters reserved for the Investor Directors, this agreement provides alternatives for how Investor Director Consent may be obtained by the Company. Consent must either be obtained from all Investor Directors or a specified number of them, according to the drafting. Where there are (or the SSA allows for) more than two Investor Directors in office appointed by different Investors, the Company ought to request something less than unanimity for greater ease of administration.

Clause 1: Investor Directors

At and from Completion, each Investor has the right to appoint a director to the Board, provided it holds a minimum percentage of the Equity Shares. Alternatively, the SSA may vest the right to appoint Investor Directors in the Investor Majority. For more information, see Drafting note Clause 8.2: Investor Directors and observers.

Clause 1: Investor Majority

Typically, Investors will expressly set out those matters that a company or its directors cannot undertake without consent. Often those matters will be split between those that require consent from the Investors themselves and those that require the consent of Investor Directors appointed by the Investors (see Drafting note, Clause 1: Investor Director Consent). However, where there are multiple Investors, the process of obtaining consent from each of them may take time, leading to delay in matters which may require the Board to act quickly.

As a result, a syndicate of Investors will often agree between themselves that a defined group of Investors may give consent on behalf of all Investors. That group is usually defined by reference to Investors together holding a minimum percentage of all Shares held by Investors. The precise percentage will be agreed on a case-by-case basis, according to the relative holding of each Investor. That percentage threshold will usually be determined exclusively between the Investors, according to the relative holdings of Series A Shares held by each of them.

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Note that the definition only refers to Series A Shares. Ordinary Shares held by an Investor following a conversion of Shares under Article 9 of the Articles will not be included for the purposes of calculating the Investor Majority threshold

If the investment is not syndicated, this definition is unlikely to be needed.

Clause 1: Investor Majority Consent

See Drafting note, Investor Majority.

Clause 1: Investors

See Drafting note, Clause 13.2: Deed of Adherence.

Clause 1: IPO

An IPO is the sale of shares to the public for the first time. Prior to an IPO, companies that sell shares to investors are considered privately held. An IPO is the first time that a company tries to raise funds on a public market such as a stock exchange. Other terms used to describe this are flotation, float, going public and listing. When a company's shares are traded on a stock market such as the official list of the UK Listing Authority or NASDAQ, it is referred to as being "listed" (see clause 12).

Clause 1: Key Employee

Consider tailoring the definition of Key Employee in order to avoid future disputes as to what amounts to a "management grade" or a "senior capacity". The definition is relevant to the scope of the non-poaching covenant to which the Founders are subject under clause 14.1(b)(v). The concept of a Key Employee may also be a useful reference point when considering possible amendments to the scope of the employment warranty in paragraph 13.1 of Part 1 to schedule 5 (see Drafting note, Warranty 13.1: Employee details).

Clause 1: Management Accounts

Management accounts are usually prepared on a periodic basis by a company for internal purposes only. They are not subject to the same requirements as annual accounts and need not be audited. As such, an Investor is unlikely to place as much reliance on Management Accounts as it will on annual accounts. However, such accounts will allow Investors to regularly monitor the Company's financial performance. As such, a subscription and shareholders' agreement will usually require the Board to produce Management Accounts and regularly deliver them to the Investors (clause 9.1), including on Completion (paragraph 2, Part 1, schedule 4). Investors will also require the Warrantors to provide warranty comfort in relation to those internal accounts (paragraph 5, Part 1, schedule 5).

Clause 1: Member of the same Fund Group

This term is used in clause 15.2(a) to define those persons to whom an Investor may disclose confidential information for the purposes of reviewing existing investments and investment proposals.

The term has the meaning given to it in the Articles. For more, see BVCA Articles, Drafting note, Article 2: Member of the same Fund Group.

Clause 1: Member of the same Group

This term is used in clause 15.2(a) to define those persons to whom an Investor may disclose confidential information for the purposes of reviewing existing investments and investment proposals.

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This term has the meaning given to it in the Articles. For more, see BVCA Articles, Drafting note, Article 2: Member of the same Group.

Clause 1: Milestone Date

This term is used in clause 4.3 to set the longstop date for satisfaction or waiver of the Second Completion Conditions. If not satisfied or waived by that date, no Investor will be required to subscribe for its Second Tranche Shares (although it may voluntarily complete such subscription at any time before the Milestone Date under clause 4.4). Although fixed by the agreement, the Milestone Date may be extended by agreement between the Company and an Investor Majority if the optional words in square brackets are included.

If there is only one round of investment, this term, together with the terms "Milestone Determination" and "Milestones", may be deleted.

Clause 1: Milestones

This term sets out the contractual targets to be met by the Company on or before the Milestone Date in order to oblige the Investors to subscribe additional monies for the Second Tranche Shares. For more information, see Drafting note, Clause 4.3: Second Completion.

If there is only one round of investment, this term, together with the terms "Milestone Date" and "Milestone Determination", may be deleted.

Clause 1: New Shares

Include this term if the Investors' subscription for Series A Shares is to be made in a single tranche at Completion. If the investment is to be made in two tranches, delete this term and instead use the definitions of First Tranche Shares and Second Tranche Shares in this agreement.

Clause 1: Off-the-Shelf Software

See Drafting note, Warranty 10.4: Intellectual Property licences.

Clause 1: Open Source Code

See Drafting note, Warranties 10.16 and 10.17: Open-source software.

Clause 1: Pension Scheme

This term is used in the pensions Warranties of paragraph 13 of Part 1 to schedule 5. As drafted, it assumes that the Pension Scheme will be a group personal pension scheme. If due diligence reveals the scheme to be a stakeholder or occupational scheme, amend this definition as appropriate. In that case, it will also be necessary to tailor paragraph 13.7 of Part 1 to schedule 5. Further due diligence and specialist pensions advice may also be necessary.

Clause 1: Period

The restrictive covenants at clause 14.1(b) restrict a Founder's activities after ceasing to be employed by, or an officer of, the group. Those restrictions are drafted by reference to the Founder's role within the group during a specified period before he left employment or office with the group. The term "Period" defines that specified period as two years before the Termination Date. For more information, see Drafting note, Clause 14: Restrictive covenants.

Clause 1: Permitted Transferees

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This term is used in clause 8.2 only, which allows each Investor to appoint and maintain in office an Investor Director, subject to a minimum shareholding requirement (see Drafting note, Clause 8.2: Investor Directors and observers). Under clause 15 of the Articles, an Investor may transfer Shares to any of its Permitted Transferees without restriction. The right to appoint an Investor Director may be conditional on an Investor holding a certain proportion of the Series A Shares. That threshold may not be met by an Investor that has transferred Shares to Permitted Transferees. To avoid an Investor losing the appointment right, clause 8.2 treats Shares held by Permitted Transferees as being held by the Investor that transferred those Shares.

For information on the definition of "Permitted Transferees", see BVCA Articles, Drafting notes, Article 2: Permitted Transferee and Article 15.1: Permitted Transfers: general.

Clause 1: Prior Agreement

See Drafting note, Clause 22.2: Prior Agreements.

Clause 1: Relevant Change Letter

See Drafting note, Confirmation of relevant change to PSC register on Completion.

Clause 1: Sale

This term is tied to the definitions of Share Sale and Asset Sale set out in the Articles, and is one of the exit routes available to investors. The term is used in clause 9.6 (Information Rights), clauses 12.1 to 12.3 (Sale or IPO) and in Part 1 of schedule 6 (Matters requiring Investor Majority Consent).

In some circumstances, it may be appropriate to include a definition of "Exit" which includes not only an asset or share sale, but also an IPO.

Clause 1: Second Completion

This term may be deleted if the investment is to be made in a single round.

For more information, see Drafting note, Clause 4.3: Second Completion.

Clause 1: Second Completion Conditions

This term may be deleted if the investment is to be made in a single round.

For more information, see Drafting note, Clause 4.3: Second Completion.

Clause 1: Second Completion Date

This term may be deleted if the investment is to be made in a single round.

For more information, see Drafting note, Clause 4.3: Second Completion.

Clause 1: Second Tranche Shares

This term may be deleted if the investment is to be made in a single round.

For more information, see Drafting note, Clause 4.3: Second Completion.

Clause 1: Series A Shares

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The Investors will subscribe for Series A Shares under the SSA, while the Founders and Employees will typically hold Ordinary Shares. The Series A Shares form part of the Company's equity share capital (as defined by section 548 of the CA 2006), but constitutes a separate class from the Ordinary Shares for the purposes of section 629 of the CA 2006. They will have preferential rights over other classes of Shares, including:

A right to contribute to decisions reserved to the Investor Majority under the Articles and the SSA.

A return on capital (Article 5).

A priority entitlement to proceeds on a Share Sale or Asset Sale (Article 6).

Anti-dilution protection (Article 10).

If Appendix A of the Articles is included, a preferential, cumulative dividend.

Depending on the drafting, priority pre-emption rights on any new issue or transfer of Shares (Articles 13 and 16).

While the SSA uses the term "Series A Shares", investor shares are also commonly defined as Preferred Shares or A Ordinary Shares.

Clause 1: Service Agreements

The Investors are likely to require each director and certain key employees to enter into new service agreements at Completion in a form acceptable to them, although this may not be necessary for all transactions.

If the Investors do not require new service agreements to be executed at Completion, it will be necessary to amend this definition, given the references to Service Agreements in Part 2 of schedule 4, part 2 of schedule 6 and schedule 7 of the SSA. It will also be necessary to delete clauses 4.2(b)(v) and (c), and amend the Completion Conditions in schedule 4.

Clause 1: Shareholder

Under section 724 of the CA 2006, a private company may hold its own shares in treasury. In that case, the company must be included in its own register of members as a holder of its own shares (section 124(2), CA 2006).

The SSA places certain obligations on the Shareholders, being all those parties to this agreement who hold Shares (including any person who later becomes a party by executing a Deed of Adherence). The definition of a "Shareholder" in the Articles differs in that it does not require a holder of Shares also to be a party to the SSA.

The words in brackets in the definition of "Shareholder" ensure that any right, power or obligation conferred where the term Shareholder is used will not be available to the Company as a result of it holding Treasury Shares. Matching exclusions are made in the Articles.

Consider whether this exclusion is appropriate in every instance the term Shareholder is used in these Articles, or whether the Company ought to be considered a holder of particular shares for any provision of these Articles. Note, however, that the Company's ability to exercise the right attached to Treasury Shares will be limited by section 726 of the CA 2006.

Clause 1: Share Option Plan

Clause 7 of the SSA sets out an optional provision obliging the Company to establish a Share Option Plan (see Drafting note, Clause 7: Share Option Plan).

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Under clause 13.2, any issue of Shares (or sale of Treasury Shares) by the Company may not proceed unless the recipient first executes a Deed of Adherence. An exception to that general rule is where such Shares are being allotted or transferred, or options are being granted over such Shares, in accordance with the Share Option Plan. Such an allotment or transfer will also not be subject to Investor Majority Consent, as a result of the optional carve-out in paragraph 2 of Part 1 to schedule 6 (Matters requiring Investor Majority Consent). For more on the requirement for a Deed of Adherence, see Drafting note, Clause 13.2: Deed of Adherence.

Note that a share option scheme that permits the grant of options to non-employees, such as non-executive directors or consultants, will not be an "employees' share scheme" for the purposes of the CA 2006.

Clause 1: Social Obligations

The Warranties at paragraph 20 of Part 1 to schedule 5 relate to compliance with Social Obligations. These cover all employment and health and safety laws relating to the relationship between a Group Company and its employees. The definition is very wide, and would include:

Contracts of employment.

Statutory employment and discrimination laws, including EU legislation and local employment laws in any overseas jurisdictions in which the company may operate.

Statutory health and safety obligations.

Common law duties of care towards employees.

Collective agreements or other arrangements with trade unions or other employee representative bodies such as works councils, whether legally enforceable or not.

Obligations under any "code of practice", such as the statutory codes of practice produced by Acas, the Equality and Human Rights Commission or the Information Commissioner's Office. Compliance with those codes is not in itself mandatory under English law, but breach may be taken into account by a court or tribunal in determining whether a relevant legal obligation has been broken.

The term is also used in paragraph 7 of schedule 7, under which the Company undertakes to comply with its Social Obligations.

Clause 1: Successor Entity

This term is used in clause 2.15 only. It addresses a group structure change through the insertion of a new holding company between the Company and the Shareholders shortly before an IPO. As such a structure change is likely to be made for administrative, tax or regulatory reasons, and provided the shareholding structure of the new holding company is substantially the same as that of the Company before the restructuring, references to the Company in those clauses of this agreement that are set out in clause 2.15 are deemed also to include reference to such a Successor Entity. For more information, see Drafting note, Clause 2.15: References to the Company.

Clause 1: Taxation

The definition of "Taxation" is widely drafted but should be uncontentious. Consider including a reference to "amounts treated as tax" to include items such as the charge to tax under section 455 of the CTA 2010 on close company loans to participators that are written off.

While interest and penalties are not included in the definition, they are separately referred to in the Warranties.

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Clause 1: Taxing Authority

Note that this definition would include Revenue Scotland, the body established to administer Scotland's devolved taxes.

Clause 1: Termination Date

This term is used to define the date from which a Founder becomes bound to observe the restrictive covenants in clauses 14.1(b) and 14.1(c). Also see Drafting note, Clause 1: Period.

Clause 1: Warrantors

The SSA provides for the Warranties to be given by both the Company and each of the Founders. Consider whether it is appropriate for all of the Founders to give all the Warranties. For example, if the Warrantors include directors of Subsidiaries, should those individuals be required to give Warranties in respect of other Group Companies?

Clause 1: Workers

The concept of a "worker" is intended to cover both an employee in the traditional sense (an individual working under a contract of service or apprenticeship) and any other individual who works under a contract (whether express or implied) to provide personal service, but who falls into a grey area between employment and genuine self-employment. Many statutory employment rights now cover workers, including discrimination law, working time and minimum wage legislation, protection from unlawful deductions from pay, pensions auto-enrolment, and protection from victimisation for asserting statutory rights.

Adopting an explicit definition of "Worker" in the agreement avoids the problems caused by the fact that the various pieces of legislation in which this term appears contain similar but slightly differing definitions. This agreement adopts the definition in section 88 of the Pensions Act 2008. By virtue of section 89 an agency worker is usually treated as a worker of the agency, and would only be a worker of the company if there is either a direct contractual relationship between the company and the agency worker, or the company pays the agency worker directly (both of which are unusual in this context).

The archetypal agency worker agreement, where the worker has no direct contractual relationship with the hirer and is paid by the agency, is therefore excluded from this definition. If the company makes use of agency workers, the Investors may wish to include them in the definition of Workers (or include a separate definition of agency worker), based on the definition in regulation 3 of the Agency Workers Regulations 2010 (SI 2010/93). This will enable the warranties and disclosures to flush out any disputes concerning potential breaches of those regulations, for which the company may be liable.

In the SSA, the term "Workers" is used only in the definition of "Social Obligations" (see Drafting note, Clause 1: Social Obligations).

Clause 2: Interpretation

The main purpose of an interpretation clause is to provide general notes to allow a reader to understand and interpret common terms used within the agreement. This avoids ambiguity and also makes clear that the term or reference is intended to include matters which it might not otherwise be found to include (or vice versa). The rules of interpretation in clause 2 apply to the whole of the SSA.

For further information on interpretation generally, including in relation to a number of provisions set out in clauses 2.1 to 2.16, see:

Standard clause, Interpretation and the related drafting notes.

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Practice note, Contracts: interpretation.

Clause 2.2: Alternate Investor Directors

Article 26 of the Articles confers power on each director to appoint an alternate to act in his place (see BVCA Articles, Drafting note, Article 26: Alternate directors). Clause 2.2 makes it clear that references in this agreement to an Investor Director are to be read as including any alternate appointed by such an Investor Director. In practice, if any alternate is appointed by an Investor Director, it is likely to be another employee or partner of the general partner of the appointing Investor.

Clause 2.3: Person

Section 61 of the Law of Property Act 1925 (LPA 1925) provides that "person" includes a corporation. Clause 2.3 expressly extends the scope of that term to include unincorporated associations and partnerships, whether or not they have separate legal personality.

Clause 2.5: agreed form documents

It is often necessary to refer in the SSA to ancillary documents that do not form part of the principal agreement, but which are in a form agreed between the principal parties. Under clause 2.5, these should be initialled by, or on behalf of, the relevant parties to identify them as such at exchange, although it is increasingly common for the lawyers advising the respective parties to agree the form of those documents by email. Note that the SSA provides for agreed form documents to be agreed only by the Company and the Investors. Consider whether the Founders should also agree the form of some (or all) of these documents.

Clause 2.7: Personal representatives

Clause 2.7 extends references to a party who is an individual to include that party's personal representatives. For each reference to a party in the SSA, consider the effect of including a party's personal representatives and whether such inclusion is appropriate.

Clause 2.9: Lists of words

The ejusdem generis rule provides that where a general provision is qualified in any way by examples that point to a confined interpretation of the general wording, the court will interpret the general words only to relate to matters of the same class as the examples given.

While the ejusdem generis rule is not always rigidly applied, it is good drafting practice to address the risk that it might be invoked. A common approach to this is to introduce any list with the words "including without limitation" or "in particular but without limitation". Clause 2.9 avoids the need to repeat such wording in each instance and also sets out more fully what the draftsman is trying to achieve by including these words.

It also establishes that various words (such as "includes") have a consistent meaning when used in the agreement, to avoid the risk that a court would construe different words differently.

Clauses 2.10 and 2.11: Treasury Shares

Under section 724 of the CA 2006, a private company may hold its own shares in treasury. In that case, the company must be included in its own register of members as a holder of its own shares (section 124(2), CA 2006). A number of provisions of the SSA confer rights, or impose obligations, upon the holders of Shares and set out provisions related to the Company's issued Shares. Including clauses 2.10 and 2.11 will ensure that the Company is not considered a holder of any such Shares for the purpose of any provision of the SSA.

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Consider whether this exclusion is appropriate in every instance, or whether the Company ought to be considered a holder of particular shares for any provision of this agreement. Note, however, that the Company's ability to exercise the right attached to Treasury Shares will be limited by section 726 of the CA 2006.

Clause 2.12: Gender

Section 61 of the LPA 1925 provides that "the masculine includes the feminine and vice versa", but does not cover references to entities whose gender is neuter, such as companies. Including this provision avoids any argument.

Clause 2.13: References to legislation and secondary legislation

If the parties wish to ensure that references to legislation are updated to refer to future amendments as they occur during the life of the agreement, they should include an express clause to that effect.

This may be relevant, for example, in the context of the Second Completion Warranties. Paragraph 14.1 of Part 1 to schedule 5 includes a warranty, given at Completion, that the Company has complied with all applicable statutory requirements. Paragraph 1 of Part 2 to schedule 5 requires the Warrantors to confirm, at Second Completion, that the Warranties in Part 1 of that schedule remain true, accurate and not misleading, subject to anything Disclosed in the Disclosure Letter. Should the statutory requirements applicable to the Company change between Completion and Second Completion, the later disclosure exercise should take account of the Company's compliance with updated legislation, not the legislation in force at Completion.

Clause 2.13 also refers to subordinate legislation under a statute or statutory provision. It should be included as the operative provisions of many statutes are found in subordinate legislation.

Certain alterations introduced by amending legislation may have significant, unanticipated effects on the parties' rights and obligations. The final words of clause 2.13 are designed to prevent the parties' obligations from becoming more onerous as a result of a change in legislation, but the parties may prefer to include a specific right for any party materially adversely affected by a subsequent change in legislation to terminate the agreement altogether.

Clause 2.14: Connected persons

Section 1122 of the CTA 2010 sets out various circumstances where one person is connected with another. Section 1122 is widely drafted and confirms that two or more persons "acting together" to secure or exercise control of a company are connected with each other and with other persons acting on their instructions to secure or exercise such control.

"Acting together" is not defined by legislation but its meaning has been considered in Foulser v Macdougall [2007] EWCA Civ 8 and Steele v EVC International [1996] 69 TC 88. In Steele, Morritt J confirmed that the performance and observation of a shareholders' agreement can constitute acting together. For HMRC's guidance on the meaning of the phrase, see HMRC, CG14622 - Connected persons: companies: 2 or more persons acting together to control.

Other examples include:

Husbands and wives (and civil partners), their relatives and relatives' spouses, are connected. 'Relative' means brother, sister, ancestor or lineal descendant.

Companies are connected where the same person has control of both, or where a person has control of one and persons connected with him have control of the other.

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A company is connected with another person if that person (and persons connected with him) has control of it.

Examples of use of the term "connected" in the SSA are found in the Warranties in paragraph 12 of Part 1 to schedule 5 and paragraph 16 of Part 2 to schedule 6.

Clause 2.15: References to the Company

Clause 2.15 is an important clause of the SSA. It provides that, in each of the clauses and schedules listed, a reference to the Company is to be construed, where appropriate in the context, as including a reference to each other Group Company and any Successor Entity. References in those clauses and schedules to the Board include a reference to the directors of each such other Group Company and Successor Entity.

The immediate impact of the clause where the Company has one or more Subsidiaries before Completion, is that the Warrantors must read each Warranty as referring to every Group Company, not just the Company. As such, it will be important for the Warrantors' legal advisers to make them aware of this fact at an early stage.

Beyond Completion, clause 2.15 will continue to have significance as the restrictions and obligations under this agreement must, where relevant in the context, be read as referring to each Group Company, which will include any Subsidiary acquired after Completion. For example, paragraph 1 of Part 1 to schedule 6 requires Investor Majority Consent to any change in the Company's share capital. The effect of clause 2.15 is also to restrict changes to the share capital of any Subsidiary.

Of particular importance to the Founders will be the scope of the restrictive covenants (clause 14) and confidentiality obligations (clause 15). When negotiating those provisions and when observing them, the Founders should be aware of the effect that clause 2.15 might have on the obligations to which they are, or may become, subject.

Given the breadth of the provisions to which clause 2.15 applies, it will be essential to check each relevant provision to ensure that the effect of clause 2.15 is appropriate in the context and to avoid its application giving an unintended meaning to any particular clause or paragraph.

Clause 2.16: Investor Majority may give consent on behalf of Investor Directors

Clause 2.16 is an administrative provision to address the situation where the Company requires the consent of an Investor Director (or Investor Director Consent) but obtaining that consent is not possible as such Investor Director has not been appointed by the relevant Investor. In such case, consent may instead be given by an Investor Majority.

Investor Majority consent will also be required in place of Investor Director consent where such an Investor Director considers that giving a particular consent may give rise to a conflict of interest (in particular in relation to any of the matters requiring Investor Director consent under part 2 of schedule 6; see Drafting note, Clause 10: Matters requiring consent).

Clause 3: Subscriptions

The SSA assumes that each Investor will subscribe for a new class of Series A Shares in the Company's share capital, rather than purchasing shares already in issue from one or more existing shareholders.

Conditions

The SSA is drafted on the basis that the Investors' subscriptions will take place at the same time as exchange (when the parties date the SSA). However, the obligation of the Investors to

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subscribe for the New Shares is conditional on certain formalities taking place (clause 4.1) and these are set out in Part 1 of schedule 4. If any of these Conditions is not satisfied, the subscriptions will not take place, unless the Investors waive any unfulfilled Condition, in accordance with clause 4.1.

Issue of shares

Clause 3.1 refers to the "allotment and issue" of shares to the Investors. Section 529 of the CA 2006 provides that shares are allotted when a person acquires the unconditional right to be included in the allotting Company's register of members. Although not defined by statute, shares are considered to be "issued" once an allottee's name is included in the register of members. At that point, under section 112 of the CA 2006, a person is deemed to be a member of the Company.

Clause 3.2: Second Tranche Shares

The SSA includes an optional mechanism allowing the Investors to make their subscriptions in two parts. A common reason for separating an investment into different stages will be if the Investors' money is to fund a programme of works with identifiable stages. In this agreement, those stages are referred to as "Milestones". Subject to the other Second Completion Conditions being met, if the Company meets those Milestones, the Investors will be obliged to complete their subscriptions for Second Tranche Shares. As such, it will be important to carefully draft the definition of Milestones, to ensure that it is sufficiently specific that the parties have little room to disagree over whether or not they have been met.

As noted in Drafting note, Clause 3: Subscriptions, it will also be important to ensure that pre-emption rights do not apply to an allotment of Second Tranche Shares. If Article 13.8(f) of the Articles is not included in the Articles, the Investors will require the existing shareholders to waive pre-emption rights in respect of an allotment under clause 3.2. That waiver may be given immediately before Second Tranche Completion or, more likely, before the Investors subscribe for the First Tranche Shares. The latter approach is adopted in paragraph 1(c) of Part 1 to schedule 4.

If the investment will not be separated into separate tranches, delete clauses 3.2, 4.3 to 4.7 and Part 2 of schedule 4. Consequential amendments will also be required to remove references to First and Second Tranche Shares.

Clause 3.3: Additional New Shares

Clause 3.3 includes optional wording allowing the Company to secure further rounds of investor funding in the future. At the time the Investors propose to subscribe for the First Tranche Shares, the Company may require additional finance, but appropriate investors may not have been identified.

The definition of "Additional New Shares" prescribes a minimum subscription price for such shares. That price will often be the same as the Starting Price under the Articles, which sets the price below which the anti-dilution provisions of Article 10 will apply.

Clause 3.4: Custodian arrangements

Clause 3.4 provides the Investors with flexibility to direct that the shares for which they subscribe may be registered in the name of a nominee or custodian. A typical UK fund will be structured as a limited partnership formed under the Limited Partnerships Act 1907. Such a partnership does not have its own legal personality and so cannot hold shares in its own name. For this reason, Investors typically seek the right to register shares subscribed by a fund in the name of a nominee.

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If clause 3.2 is omitted (as there is only a single funding round), use the definition of "New Shares" and delete references to the First and Second Tranche Shares.

Clause 3.5: pre-emption waiver

See Drafting note, Paragraph 1, Part 1, schedule 4: Agreed form resolutions. Note, however, that if paragraph 1(c) of Part 1 to schedule 4 or Article 13.8(f) of the Articles is included, clause 3.5 is not strictly necessary.

Clause 4: Completion

This clause sets out details of the mechanics to completion.

Completion of the Investors' subscriptions for Series A Shares (or first tranche subscription, as the case may be) will not take place until each of the Conditions set out in Part 1 of schedule 4 has been satisfied or waived by the Investors. In practice, these Conditions are often satisfied before the SSA is executed, allowing exchange (also known as "signing") and Completion (or "closing") to occur simultaneously. Simultaneous exchange and completion eliminates transaction risk during the intervening period. For detailed guidance on preparing for and organising the completion process in the context of a share acquisition (which will also largely apply to an early stage venture capital investment), see Practice note, Exchange and completion: share purchases).

By convention, Completion normally takes place at the offices of the Investors' solicitors. For more complicated transactions, it may in practice be more convenient for Completion to take place at the offices of the Company's solicitors, if those advisers are responsible for producing the bulk of the completion documents.

It is increasingly common for a virtual Completion to take place, without a face-to-face meeting between the parties. For consideration of some of the issues arising on a virtual closing, see Practice note, Execution of deeds and documents: Virtual signings and closings.

It will be necessary to consider a number of issues when drafting a completion clause, which will include:

If there is to be a gap between the date when the parties enter into the SSA and Completion (for example, where certain regulatory or third party consents are required before Completion), additional drafting will be required. Consider adding in a long stop date by which the Conditions must be fulfilled and an obligation, on the parties who are responsible for fulfilment of the Conditions, to let the Investors know of any delay or failure to satisfy the Conditions. Where there is a gap between exchange and Completion, the Investors will usually insist that the Warranties are repeated at Completion (see Drafting note, Clause 5.1: Warranty obligation: When are the Warranties given?).

If there is a gap between exchange and Completion, the Investors should consider whether they require additional protection in terms of the way that the Company runs its business between exchange and Completion.

Where the agreement is conditional, consider whether the Conditions provide the Investors with adequate protection in the interim period or whether additional controls (in addition to those already included in the agreement, such as those matters requiring the consent of the Investors or the Investor Directors (see clause 10)) are required.

Consider whether to include a specific Completion Date or whether Completion should take place a specified number of days after the Conditions have been satisfied.

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Carefully consider the mechanics to Completion. The mechanics set out in clause 4 are typical to an early stage venture capital investment. However, it will be necessary to determine whether to specify any additional transaction-specific requirements (such as additional board appointments or resignations, or execution of additional agreed form documents). If there is to be more than one round of investment (see clauses 4.3 to 4.7), are there any relevant conditions to Second Completion other than the Second Completion Conditions (see Part 2 of schedule 4)?

The Company should resist Completion requirements that are vague or subjective and catch-all requirements of the kind which entitle the Investors to call for "such other documents as it considers necessary or desirable". The Company should require the Investors to be as specific as possible about these requirements.

Clause 4.2(a): Money transfers

The timing of money transfers can be one of the more complicated arrangements to be made at a completion meeting. An Investor will be reluctant to transfer subscription monies until it has certainty and the Company reluctant to issue shares without receipt of funds. For further discussion of the issues, as well as common solutions in practice, see Practice note, Exchange and completion: share purchases: Completion payment arrangements.

The exact timing of events and the point at which money will change hands should be agreed by the parties in advance of Completion.

Clause 4.2(b): Issue of shares

The distinction between an allotment of shares and their issue is discussed in Drafting note, Clause 3: Subscriptions.

Clause 4.3: Second Completion

Include clauses 4.3 to 4.6 (and clause 4.7, if appropriate) if the Investors' subscriptions are to be made in two tranches.

Second Completion is conditional on satisfaction or waiver of the Second Tranche Conditions set out in Part 2 of schedule 4. In particular, where relevant, the pre-agreed Milestones must have been met. In that case, clause 4.3 establishes a long-stop date for Second Completion. If the Milestones are not met by the date, the Investors will not be required to subscribe for the Second Tranche Shares. However, that long stop date may be extended by agreement between the Company and an Investor Majority (see Drafting note, Clause 1: Milestone Date).

Unlike subscription for the First Tranche Shares, clause 4.3 provides that an Investor Majority may, on behalf of all the Investors, determine whether the Second Tranche Conditions have been satisfied and, if not, waive any such condition. An Investor that is not connected to the others (for example by virtue of having a common general partner) may resist this clause in light of the consequences for failing to subscribe for its Second Tranche Shares, as set out in optional clause 4.7.

Clause 4.4: Early subscription for Second Tranche Shares

While clause 4.3 sets out a conditional obligation for the Investors to subscribe for the Second Tranche Shares, clause 4.4 sets out an unconditional, discretionary right for an Investor to proceed with its subscription at any time before the Milestone Date. An Investor may have a number of reasons for electing to subscribe early, but such a decision will often stem from an immediate need to protect the value of its initial investment, or to take advantage of a commercial opportunity requiring a cash injection. As such a voluntary subscription may be made without satisfaction of the Second Tranche Conditions. An Investor contemplating this

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option should consider whether it would be prepared to do so without obtaining a formal Further Disclosure Letter.

Clause 4.7: Failure to subscribe for Second Tranche Shares

Clause 4.7 sets out the consequences for an Investor that fails to subscribe for Second Tranche Shares when required to do so. This clause operates as a "pay to play" provision, as such a failure will have an impact on the value of an Investor's initial subscription through:

The conversion of its existing Series A Shares into Ordinary Shares (clause 4.7(b)). For more, see the drafting notes to Article 9 of the Articles.

The dilution of its equity proportion by the issue of the Second Tranche Shares to the other Investors.

It is possible that a court may consider clause 4.7(b) to be a penalty and therefore unenforceable. As such, it will be important to take advice on this provision if its inclusion is contemplated. Factors relevant to the court's decision might include (among others):

The potential impact that the operation of clause 4.7(b) may have on the value of a defaulting Investor's shareholding in the Company.

The fact that clause 4.7(b) is triggered by a breach of a contractual obligation.

The potential argument that the threat of conversion of Series A Shares into Ordinary Shares is designed to deter Investors from breach of their obligation to subscribe for Second Tranche Shares.

For further consideration of this issue, see Practice notes, Damages for breach of contract: an overview and Contracts: agreed remedies.

For an alternative or additional form of "pay to play" provision, resulting in the loss of anti-dilution protection, see Appendix D to the Articles. The mechanism set out in that Appendix D, if included in the Articles, would not apply in the event of a failure to subscribe for Second Tranche Shares, as such shares fall outside the definition of "New Securities", provided that Article 13.8(f) is included in the Articles.

Clause 5: Warranties

Warranties are contractual statements as to the condition of the Company and are usually set out in a separate schedule of the SSA (see schedule 5). They allocate risk between the parties and provide the basis for a claim against the Warrantors for financial compensation in the event of breach. A thorough due diligence exercise should provide the Investors with a good picture of the value of the Company, but will not on its own provide any financial recourse. The caveat emptor (buyer beware) principle, which underlies English contract law, applies and so the Investors should specifically provide in the SSA for any warranty protection that they require.

In a venture capital transaction, however, the Warranties also serve the purpose of forcing pre-contract disclosure by the Warrantors. An Investor will always prefer to know of a problem in advance, as it then has the opportunity to walk away, argue for a price adjustment or seek specific contractual protection. This will particularly be the case where the transaction does not involve an acquisition from a third party seller. Investors may be more reluctant to bring a claim against a Company in which it has invested, or against the Founders who may be key to running the business, than against a former owner that is no longer involved in the Company's future.

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The clauses setting out the basis on which the Warranties are given (clauses 5 and 6), as well as the Warranties themselves (schedule 5), contain the Investors' principal contractual protection in relation to the investment, and are often heavily negotiated as a result.

Clause 5.1: Warranty obligation

Who gives the Warranties?

As noted in Drafting note, Clause 5: Warranties, the Warranties serve two main purposes:

To force disclosure as to the state of the Company before the investment is made.

To allocate risk and to provide a contractual remedy for the Investors in the event that the state of the Company is not as it seems.

In the SSA, the Warranties are given by both the Company and each of the Founders. As the Company will be the recipient of the investment monies, the Investors would expect to be able to pursue the Company for the recovery of some or all of those monies in the event of Warranty breach.

The Founders, usually those responsible for managing the day-to-day activities of the business, are likely to possess the greatest knowledge of those matters in which the Investors are interested (and which the Investors will often not be able to discover through their own due diligence). While the Founders may also be Company directors, and so will lead the Company's contribution to the disclosure exercise, the Investors will usually require each Founder to give the same Warranties in his individual capacity. Although each Founder's potential liability for breach of Warranty is usually capped (see clause 6.3(b)), this element of personal responsibility is, at least in part, intended to ensure that the Founders give proper attention and consideration to the disclosure exercise.

The Existing Shareholders, if they are included as parties to this agreement, are not required to give Warranties under the SSA. This is on the basis that such shareholders will not have managerial responsibility and so are less likely to have information relevant to the Warranties. It is also unlikely that the Investors would consider pursuing non-management employees or other shareholders for a breach of Warranty. If any Existing Shareholder does have particular responsibility for, or knowledge of, a particular aspect of the business, the Investors may consider including that individual as a Warrantor in respect of certain Warranties.

When are the Warranties given?

Clause 5.1 states that the Warranties are given at the date of the agreement, on the basis that there is no delay between exchange and Completion. If the parties anticipate a delay, the Investors would usually require the Warranties to be repeated at completion. The Investors may also seek a right to rescind the agreement if any Warranty is breached between exchange and completion (and, possibly, in the event of any other material adverse change to the business during that period).

Legal issues

The Warranties are given severally (as opposed to jointly, or jointly and severally) by each Warrantor. Several liability means that each Warrantor agrees individual obligations with the Investors and will not be liable for breach by another. As each Warrantor is making a separate promise, it also means that the other Warrantors are not released from their obligations and their potential liability is not reduced if one Warrantor discharges his obligations to the Investors.

The Investors may prefer to seek that the Warranties are given jointly and severally by the Warrantors. This means that the collective obligations undertaken by the

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Warrantors and their liability for breach or non-performance of those obligations can be enforced equally against any or all of them. In principle, investors would be able to choose to proceed against any or all of the Warrantors for all losses arising from a breach, irrespective of who is responsible for the breach. If one of the Warrantors meets a claim, then the others will have no further liability to the Investors for that claim. The Warrantor who meets the claim, or settles it in good faith, would normally have a right of contribution from the other Warrantors under the Civil Liability (Contribution) Act 1978. However, see clause 5.6 which modifies that position (and see Drafting note, Clause 5.6: No counterclaims).

In practice, whether the Warranties are given severally, or jointly and severally, it is common for the financial liability of each Warrantor under the Warranties to be capped (see clause 6.3 and Drafting note, Clause 6.3: Ceiling on claims). So, an Investor seeking to claim a sum in excess of any cap would have to join more than one Founder to the Claim (unless the Investor claims against the Company). The nature of the significant majority of the Warranties and the fact that each Warrantor is giving identical Warranties means that the question of who is responsible for a breach may not always be helpful.

For further background, see Practice note, Joint, several and joint and several liability.

In response to the Warranties, the Warrantors will produce a Disclosure Letter setting out where the actual position differs from the position stated in schedule 4. The Investors will not be able to bring a claim for breach of Warranty to the extent that the matters set out in the Disclosure Letter are fairly disclosed to the Investors with sufficient explanation and detail to enable the Investors to identify clearly the nature, scope and full implications of the matters disclosed (see Drafting note, Clause 1: Disclosed). For information on matters not disclosed in the Disclosure Letter of which the Investors might be aware, see Drafting note, Clause 5.5: Investor knowledge.

Clause 5.2: Second Completion Warranties

If the SSA includes clause 4.3 (Second Completion), the Investors are likely to require additional warranty protection. The Warranty obligation in clause 5.2 is drafted in the same terms as clause 5.1, save that the later Warranties are given on the date of subscription for the Second Tranche Shares.

The Warranties to be given immediately prior to those subscriptions are set out in Part 2 of schedule 4. Although much shorter than the Warranties set out in Part 1 of schedule 4, paragraph 1 of Part 2 asks the Warrantors to confirm that the Part 1 Warranties remain true, accurate and not misleading. As such, the Warrantors should disclose, in the Further Disclosure Letter, any change in the Company's position since the date of the initial Warranties. Any such change will not affect the Warrantors' liability under clause 5.1, provided any change only arose after the date of the agreement.

Clause 5.3: Warranties are independent

The statement in clause 5.3 that each warranty is independent of the other is to clarify that the warranties are not to be read as qualifying any other warranty, if there is a degree of overlap. For the purposes of disclosure, each warranty should be read independently of the others.

Clause 5.3 includes additional wording to the effect that no warranty is to be qualified by any other statement in the SSA. The Warrantors should be wary of allowing this wording, as provisions of the SSA that are intended to qualify the Warranties (or any of them) may not always be expressed as having that effect.

The Warrantors are also likely to want to resist the statement that no disclosure letter will limit the Warranties. Instead, the Warrantors may seek to include in any disclosure letter a

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statement that a disclosure made by reference to one warranty is deemed to be a disclosure against any other warranty to which it is relevant. This approach may avoid significant duplication in a disclosure letter, but will require the Investors to review each disclosure carefully and consider whether the matter disclosed is also relevant to any other warranted matter.

Clause 5.4: Warranties survive Completion

The statement in clause 5.4 that the Investors' rights and remedies for a warranty breach are not affected by Completion is designed to avoid the arguably remote risk that a court will consider Completion to render the executory contract (that is, the SSA to be signed by the parties at exchange) as being superseded, potentially rendering the Warranties unenforceable after Completion. However, as Completion takes place in accordance with the provisions of the SSA and does not require execution of an additional contract between the parties, it seems unlikely that the courts could make such a finding. However, it is usual to include this express provision to guard against any risk.

Reference in the second half of clause 5.4 to the Investors' rights and remedies not being affected by pre-contractual investigations aims to ensure that only disclosures made in the Disclosure Letter will limit the Warranties and that the fact that Investors may have conducted due diligence should not limit the potential remedies available to them in the event of a breach of warranty. However, the effectiveness of that provision, where Investors have knowledge that one or more warranties may be untrue, must be considered in light of case law on the validity and enforceability of knowledge-saving provisions (see Drafting note, Clause 5.5: Investor knowledge).

Clause 5.5: Investor knowledge

Clause 5.5 seeks to preserve the Investors' right to bring a claim under the Warranties even if any of them knows at Completion (other than as a result of a disclosure in the Disclosure Letter) that the Warranty in question is untrue. The clause also seeks to preserve Claims where the facts giving rise to the Claim are within the constructive imputed knowledge of an Investor.

Effectiveness of knowledge-saving provisions

There is some doubt as to whether provisions such as clause 5.5 are legally effective.

Eurocopy plc v Teesdale and others [1992] BCLC 1067 suggests that a buyer may not be able to rely on such a clause where it has actual knowledge of certain facts not disclosed in the disclosure letter (see Legal update, Drafting acquisition agreements). It should be noted that this decision was a ruling on a preliminary matter and not a final decision on the clause in question.

Further, the Court of Appeal decision in Infiniteland Ltd and another v Artisan Contracting Ltd and another [2005] EWCA Civ 758 held that a buyer who had actual knowledge of a matter on which it sought to base a warranty claim could not rely on the knowledge saving provision to counter a defence by the seller based on the buyer's actual knowledge (see Legal update, Disclosure: buyer's knowledge). The knowledge-saving provision in Infiniteland expressly excluded the buyer's actual knowledge (so that warranty claims could not be brought in respect of matters within the buyer's actual knowledge). In obiter comments, the court considered that constructive knowledge (of which the buyer ought to be aware) would not prevent the buyer from relying on a provision such as that under consideration in the case. For further consideration of the effect of the buyer's knowledge obtained from a source other than the disclosure letter, see Practice note, Disclosure: acquisitions: Buyer's knowledge.

Additional factors to consider when drafting a knowledge-saving provision include:

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In spite of questions over the validity of knowledge-saving provisions, the Warrantors may wish to resist clause 5.5, arguing that where an Investor knows of the problem before Completion, it has had the opportunity to take the matter into account before committing to the investment. The argument runs that the Warrantors should not be penalised by an Investor's failure to act on the knowledge prior to completion.

Investors should include a knowledge-saving provision wherever possible as (among other things), Investors are unlikely to have absolute control over the information that is given to individuals, and cannot be certain that the recipients of the information understand, or are capable of understanding and evaluating, the implications arising from the information they have received.

An Investor should be mindful that, even if it successfully negotiates a knowledge-saving provision of the type in clause 5.5, it still remains open to question whether a court would allow the Investor to succeed in recovering damages for a breach of warranty that it knew about before concluding the investment. In light of this uncertainty, a prudent way for an Investor to deal with matters discovered during the due diligence process that may constitute a breach of Warranty is to specifically address the known risk before Completion (for example, through a specific indemnity).

The Warrantors may attempt to seek a reverse warranty under which the Investors warrant that they do not have any knowledge that would constitute a breach of Warranty. In the context of an early stage venture capital investment, an Investor is unlikely to consent to the inclusion of such a statement.

Clause 5.6: No counterclaims

As noted in Drafting note, Clause 5.1: Warranty obligation, the Investors may choose which of the Warrantors to pursue in respect of a Claim. A key factor for an Investor in determining who to pursue will be how best to protect its investment. If a Warrantor could seek to limit its loss following a successful Claim by counterclaiming against other Warrantors, the Investors' aim in choosing to pursue a particular Warrantor may be defeated. Clause 5.6 seeks to prevent this scenario by prohibiting the Company from counterclaiming against, or seeking a contribution from, any of the Founders and by prohibiting each Founder from counterclaiming against, or seeking a contribution from, the Company or any other Founder.

Clause 5.7: Awareness

The Warrantors might argue that they should not be liable in respect of any matter that would constitute a breach of Warranty to the extent that they were not aware of that fact. On the other hand, the Investors might argue that as the matter in question arose before their subscription for Series A Shares, they ought not to suffer any loss in value of their shares resulting from the issue in question. The strength of a Warranty will be diluted by the inclusion of awareness. Given this question of risk allocation, the extent to which any Warranties are qualified by the Warrantors' awareness will often be addressed on a case-by-case basis (as is the case in schedule 4).

Clause 5.7 provides how the awareness qualification attached to any Warranty should be interpreted. Each Warrantor is deemed to have his actual knowledge and the knowledge he would have had if he had made reasonable enquiry of all relevant persons. This does not place a positive obligation on the Warrantors to make such enquiries. Rather, they are each deemed to have that knowledge whether or not those enquiries were made and so, to protect themselves, should make those enquiries. This deemed knowledge turns the awareness test from a subjective one (based on the Warrantor's actual knowledge) to an objective one (that is, should the Warrantor have known about the matter in question by making reasonable enquiries?).

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As it may be easier for the Investors to prove that a Warrantor should have been aware, the Warrantors may seek to limit the knowledge they are deemed to possess, for example by limiting the people of whom they are deemed to have made reasonable enquiry. They might also seek to turn the obligation back into a subjective one relating to their actual knowledge, by removing any deemed knowledge and specifically naming those persons of whom they must make enquiry in order to satisfy their obligation. On the other hand, the Investors might seek to impose a more onerous, objective obligation on the Warrantors, such as by deeming the Founders to have made "all due and careful enquiry" of all relevant persons. This will be a matter for negotiation between the Investors and the Warrantors.

Clause 5.8: Founder claims against the Company

In respect of a number of Warranties, the Founders are likely to be reliant on information provided by the Company (and its directors and employees) to make effective disclosures against the Warranties.

The Investors will usually therefore want to ensure that the Founders are not able to take action against the Company (or any Subsidiary or any director, employee or agent) as a result of any information they may have provided to the Founders (or their representatives) in connection with the due diligence or disclosure exercise. A provision to this effect is included at clause 5.8.

As the undertaking in clause 5.8 is given for the benefit not only of the Company, but also of its officers, employees and agents, consider how those intended beneficiaries will enforce the undertaking, given that a number of them are unlikely to be parties to the SSA. For example, this could be catered for in the third party rights clause (clause 26), although this is not common practice.

Clause 5.9: Participation in Claims

If the transaction involves more than one Investor and circumstances come to light which may give rise to a Claim, it is conceivable that not all Investors are of the same mind on whether or not to pursue the Claim. Clause 5.9 seeks to establish procedures for resolving any such tension. In particular, as any Claim may dilute the Company's value and therefore the value of each Investor's shareholding, the requirement for Investor Majority consent before any Claim may be brought will ensure that, within a syndicate of Investors, no single, small Investor could bring a Claim against the wishes of other, larger Investors.

Importantly, although an Investor Majority has the power to determine whether or not such a Claim should proceed, a dissenting Investor may elect not to participate in that Claim (or to withdraw from the Claim before the issue of proceedings). Such an Investor will not suffer any penalty for doing so, but it will not participate in any award of damages if the Claim is successful.

Clause 6: Limitations on Warranty Claims

The Warrantors will usually try to limit their liability for claims under the Warranties for a number of reasons, including the following:

To achieve fairness between the parties, by not leaving potential Claims open-ended in terms of the amount that can be claimed or the time within which Claims can be brought.

To exclude the possibility of being troubled by vexatious or speculative Claims.

To ensure that the Investors are bound to observe rigorously its duty to mitigate its loss.

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To ensure that Claims are a last resort when the liability ought properly to be borne by another party (for example, an insurer).

For further information concerning the limitation of liability in the context of a share acquisition, see Practice note, Warranties and indemnities: acquisitions: Limitation of seller's liability under warranties and indemnities.

Scope of limitations

Investors are not obliged to include any limitations on the Warrantors' liability in the first draft of the SSA. However, it is common practice for Investors to incorporate a basic set of limitations that they are prepared to agree. This approach is taken in clause 6.

Typically, the Warrantors will want to ensure, as a minimum, that their liability in respect of any breach is limited as regards:

The amount that can be claimed.

The period of time within which claims can be brought.

Matters that have been disclosed to the Investors.

Restrictions on their ability to recover from third parties.

Sample limitations of liability covering the above matters are set out in clause 6.2 to clause 6.4 and, in respect of matters disclosed, clause 5.1. However, the precise nature of the limitations will vary from transaction to transaction and will be a matter for negotiation between the parties.

Clause 6.1(a): Fraud

The limitations of clause 6 will not apply if the Claim arises as a result of fraud, dishonesty, wilful concealment or wilful misrepresentation by or on behalf of any of the Warrantors. This may act harshly on an innocent Warrantor, if the relevant default can be attributed to another Warrantor and so the Warrantors may argue that the limitations (or at least the financial liability cap of a Founder) should remain in place for those not responsible for the relevant conduct.

Clause 6.1(b): Warranties not subject to limitations

Clause 6.1(b) provides that none of the Warranty limitations of clause 6 will apply to the following Warranties:

That the Founders are the legal and beneficial owners of the Ordinary Shares listed in Part 1 of schedule 3.

That all of those Shares are fully paid; that no other shares are in issue; that no person has any rights to acquire shares.

That the content of each questionnaire completed by the Founders is true, accurate and not misleading.

An Investor is likely to view a breach of any of these Warranties as fundamentally affecting its understanding of the Company or of the people in which it is investing. As a result, it is common that the ability to make a claim for breach of the Warranties should not be subject to any contractual, financial or temporal limits.

Clause 6.2: Notification of claims

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Clause 6.2 specifies the time limits for notifying Warranty claims. In the absence of agreement to the contrary, the normal period during which a Warranty claim will be actionable is six years if the agreement is signed under hand and 12 years if it is executed as a deed. For further general information in relation to limitation claims, see Practice note, Limitation periods: an overview.

Drafting issues

The parties should endeavour to negotiate a reasonable period within which Warranty claims can be notified. Often, the Warranty period chosen for non-tax related warranties is the period ending a few months after the second audit of the Company after Completion, by which time most major problems should have come to light.

Should tax-related warranties be subject to a different claim period? The statutory period for HMRC to make a discovery assessment for loss of corporation tax is four years after the relevant accounting period. This period is increased to six years where the loss of tax is brought about by careless inaccuracy and 20 years if brought about deliberately. For this reason, Investors will often seek a limitation period of up to seven years for tax warranty claims.

As drafted, the SSA does not include specific environmental or health and safety Warranties (see Drafting note, Warranty 9: Environmental issues). If the nature of the target business merits their inclusion, it may be appropriate to agree a longer limitation period in relation to claims under those Warranties to reflect the fact that it may take longer for issues of this type (such as soil contamination and work-related illnesses) to come to light. A period of two to three years is often considered to be reasonable for environmental and health and safety Warranties, although it is not unknown for longer periods to be agreed. For a form of environmental indemnity containing bespoke provisions for notifying claims, see Standard documents, Environmental indemnity: seller-friendly draft: share purchase agreement and Environmental indemnity: negotiated draft: share purchase agreement.

Although clause 6.2 requires the Investors to notify Claims within a specified period, there is no obligation to progress the Claim expeditiously once notified. When acting for the Warrantors, consider seeking to extend the limitation in clause 6.2 to provide that the Investors will lose the right to pursue the Claim if proceedings are not commenced within a specified period. Whether the Investors will agree to that request may depend on the relative bargaining strengths of the parties. For an example clause of this type, see Standard clause, Seller protection: limitation of liability: share purchase agreement: schedule: paragraph 3.2.

The end of clause 6.2 includes optional wording providing that Investors may still bring a Claim even if reasonable details of that Claim are not given to the Warrantors. Consider whether "reasonable details" is sufficient, or whether the Investors should be subject to some higher notification threshold.

Clause 6.3: Ceiling on Claims

Clause 6.3 sets the maximum aggregate monetary amount that the Investors may recover for all Claims under the Warranties (including, where relevant, the Second Tranche Warranties).

Historically, it has been common practice for the Company's maximum liability to equal the gross sums invested by the Investors. The cap placed on each Founder's personal liability will be set at a much lower amount, often by reference to a multiple of salary (and the value of any bonus and other contractual entitlements). The Investors will usually want to establish a sufficiently material maximum so that each individual Founder is incentivised to give proper attention to the due diligence enquiries and the disclosure exercise.

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Clause 6.3 includes optional wording that, if included, would not bring the Investors' costs in bringing Claims within the aggregate limit. This could mean that the Company becomes liable for a sum in excess of the total funds received from Investors. It could also mean that a Founders' actual liability might significantly exceed the limit set by clause 6.3(b). Investors will argue that contractual damages aim to place a party in the position they would have been in had the breach not occurred. If the liability cap in clause 6.3 includes the costs of Claims, they will never be able to recover 100% of sums invested in the Company. Whether or not that optional wording is included will be a matter for negotiation between the parties.

Clause 6.4: Aggregate de minimis for Claims

Clause 6.4 sets out a minimum Claim value below which Claims cannot be brought. Once the aggregate of all claims reaches this amount, the Claims may be made, and the Warrantors are collectively liable for the entire amount of those claims rather than just the amount by which they exceed the amount set out in this clause.

Consider whether a separate de minimis limit should apply to Claims made under the tax Warranties (paragraph 7, Part 1, schedule 5).

Clause 6.5: De minimis for individual Claims

Optional clause 6.5 sets out a further de minimis threshold under which no individual Claim may be brought unless it exceeds a specified figure. A Claim below that amount would be ignored unless it can be aggregated with other Clams that arise out of the same subject matter, facts, circumstances or events.

Clause 6.6: Exceptions from liability

Clause 6.6 sets out typical circumstances that may, if they occur after Completion, give rise to a technical liability under the Warranties (such as changes in law or HMRC practice, or changes to comply with amended accounting standards). Consider whether the restriction should be restricted to published HMRC practice. It also excludes Claims in respect of matters provided for in the Accounts or Management Accounts, of which the Investors should therefore be aware and have already been taken into account by the Company. It is generally accepted by Investors that they should not be able to make a Claim in such circumstances. Consider whether to include any other circumstances that should not give rise to Warrantor liability.

Clause 6.7: Contingent liabilities

A contingent liability may become time barred if it does not become an actual liability before expiry of the Warranty period set out in clause 6.2. Clause 6.8 avoids this risk by allowing such a Claim provided it is notified within the relevant time limit.

Clause 6.8: Claims capable of remedy

Clause 6.8 provides that where a Claim is capable of remedy, the Warrantors will not liable for it if:

The breach is remedied to the reasonable satisfaction of the Investors within a given time period of the Warrantors receiving the notice.

No Investor suffers any loss in connection with the breach.

This requires the remedial action to be to the satisfaction of all Investors. If the investment is syndicated and this clause is included, consider whether this provision should instead require remedy to the reasonable satisfaction of an Investor Majority. Note, however, that even if the alleged breach is remedied with Investor Majority approval, the Warrantors will not escape liability if any Investor still suffers a loss. The inclusion of these words, preserving a Claim

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where an Investor actually suffers a loss, is likely to be more important where an Investor Majority may agree on behalf of all Investors that a Claim has been remedied.

Consider whether 30 days is an appropriate time limit for remedying Claims. Consider whether it should be calendar days or Business Days.

Clause 6.10: Settlement of Claims in Shares

Although each Founder's liability under the Warranties will be capped (see clause 6.3), that liability will be set at a material financial amount. It is possible that, if a Founder is found liable for Claims up to that amount, he does not have adequate financial resources to meet that liability. Clause 6.10 offers a mechanism under which a Founder may choose to settle all or part of such a liability by transferring Shares registered in his name to the claimants. A Founder's ability to do so will be subject to Investor Majority Consent as, in certain circumstances, a further acquisition of Shares by Investors may have an undesirable outcome (for example if a single investor acquires more than 50% of the Company's voting rights as a result, or if it changes the voting power within the Investor syndicate).

For the purposes of settling Claims, each Share will, if the optional words are included, have a deemed value equal to the lower of its Fair Value and its Subscription Price. It will be necessary to define each of these terms if included in the SSA. Consider whether it would be appropriate to cross-refer to the meaning of "Fair Value" given in the Articles. As Shares in a private company can be difficult to sell, Investors accepting Shares in settlement of a Claim are unlikely to be able to convert those Shares into cash straight away. As a result, the value of those Shares may rise or fall over time, changing the amount the Investors will eventually receive in respect of the Claim.

Clause 6.10 provides that all Shares transferred to Investors under clause 6.10 will be automatically re-designated as Series A Shares. If there are Shareholders who are not party to the SSA, this automatic conversion should also be set out in the Articles, to which each Shareholder is automatically bound under section 33 of the CA 2006. It would then also be necessary to expressly exclude a transfer under clause 6.10 from the pre-emption provisions of Article 16 (whether through an express exclusion, or by providing that a transfer under clause 6.10 constitutes a permitted transfer under Article 15).

Clause 7: Share Option Plan

Clause 7 requires the Company to adopt a Share Option Plan within a specified period of Completion. The main reason for using employee share incentive plans is to recruit, retain and motivate employees. They are also used to help align the interests of employees, particularly senior executives, with those of shareholders.

Employee share incentive plans can also reduce employment costs. Successive governments have taken the view that encouraging equity incentives can improve the general economy. Tax legislation has therefore been used to introduce specific employee share scheme structures that enjoy valuable tax reliefs. For an introduction to share schemes typically employed, see Practice note, Employee Share Schemes: an introduction.

It may not always be appropriate for clause 7 to be included. The Investors' investment model, as well as the Company's current and intended future staffing structure may contribute to that decision. Where clause 7 is included, the SSA does not anticipate that the terms of the Share Option Plan will be agreed before Completion (and note that the Share Option Plan is not one of the "agreed form" documents). However, to the extent that terms are agreed it may be helpful to include them in the SSA. In particular, for example, this may include the vesting schedule for any options granted under the scheme and whether or not options will automatically vest on a Sale or IPO. The Company may also already have such a scheme in place. In that case, the Investors should consider whether they are happy with the terms of that scheme.

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If including clause 7, consider the maximum number of Shares that may be issued under the Share Option Plan. Clause 7 provides two alternatives; the maximum may be set by reference to a fixed number of Shares, or a percentage of the issued share capital (as it stands immediately after Completion, or as it stands from time to time taking into account all options, warrants and other rights to subscribe that have been granted by the Company). The precise formulation will be a matter for determination by the Investors, in discussion with the Founders.

It will also be necessary to consider the scope of any Share Option Plan. A share option scheme that permits the grant of options to non-employees, such as non-executive directors or consultants (as is envisaged by clause 7), will not be an "employees' share scheme" for the purposes of the CA 2006. For information on why it is beneficial for a share scheme to fall within the definition of employees' share scheme in section 1166 of the CA 2006, see Practice note, Benefits of being an employees' share scheme (under Companies Act 2006). It may be prudent to implement separate arrangements for employees and non-employees.

Under Article 13.8(a) of the Articles, any issue of Shares by the Company in accordance with a Share Option Plan will not be subject to pre-emption rights (and so will dilute the Investors' aggregate percentage holding of Shares).

Clause 8.1: Board composition and meetings

While article 3 of the model articles for private companies limited by shares (Model Articles) vests the power of management of the Company's business to the directors, neither the CA 2006 nor the Model Articles prescribe how often a board must formally meet. Instead, article 16 of the Model Articles allows the directors to regulate their proceedings as they see fit.

Article 9 of the Model Articles allows any director (which will include an Investor Director) to call a board meeting. However, Investors will usually include a provision such as clause 8.1, which requires the holding of a minimum number of meetings in each calendar year and at regular intervals. This provision simply sets out the Investors' expectations at the outset of the relationship between the parties.

Clause 8.1 also sets out the initial composition of the Board. Each Investor will want to ensure it is comfortable with the proposed Board composition before Completion.

Clause 8.2: Investor Directors and observers

As noted in Drafting note, Clause 8.1: Board composition and meetings, the Board is empowered to conduct the day-to-day management of the Company's business. The Investors, as Shareholders, will have a certain degree of control over the Board through general meetings and through the restrictions imposed in the SSA (for example, see clause 10 and schedule 6). However, the Investors will also usually seek the right to appoint their own representatives to the Board. This will allow the Investors to monitor the Company's decision making and to ensure that it is well run from an administrative and corporate governance point of view.

Typically, Investors will include the right to appoint representatives to the Board in both the SSA and the Articles, to create both contractual and constitutional rights (see Article 28 of the Articles). Where provisions are included in both documents, ensure that they are consistent.

As an alternative, the SSA may vest the right to appoint an Investor Director in the Investor Majority, in which case clause 8.2 should be amended accordingly. In such a case, the right will not be limited by reference to a minimum holding of Shares, since the right would be attached to the Series A Shares and would last for so long as any Series A Shares are in issue.

Clause 8.2 grants each Investor the right to appoint an Investor Director, subject to a minimum shareholding. If the Articles include permitted transfer provisions for the Investors (see Article

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15 of the Articles), it will be common for any Shares held by an Investor's Permitted Transferees to be taken into account when calculating an Investor's shareholding for the purposes of clause 8.2. This wording should be considered carefully where a number of connected Investors are investing in the Company. Should they each have the right to appoint an Investor Director? If so, should the Shares held by other, connected Investors be attributed to a particular Investor if those other, connected Investors have a separate right to appoint a Board representative?

Any person appointed as an Investor Director will be subject to the same duties and obligations as any other director. This will include the duty to avoid conflicts of interest (section 175, CA 2006). Although Article 31 of the Articles seeks to mitigate the restrictions imposed upon an Investor Director in respect of the conflicts that are most likely to arise, such an Investor Director (and the Investors themselves) must always be mindful of the primacy of the duty to promote the interests of the Company, for the benefit of all Shareholders (section 172, CA 2006). Although appointed by an Investor, such a person may not simply use his office as a director to pursue the interests of his appointor, at the expense of the Company's interests. For this reason, an Investor may separate the investment decisions for the funds invested in the Company from its Investor Director's decisions. This may be achieved by having another investment executive representing the fund's interests when dealing with the Company with respect to those matters that require Investor consent (as opposed to Investor Director consent) (see clause 10).

Also due to potential conflicts of interest and liability issues, an Investor may choose not to exercise its right to appoint an Investor Director. To cater for that scenario, an Investor will often seek the additional right to appoint an observer to attend and speak at Board and committee meetings, but who will not participate in any decisions (clause 8.2(b)). Care should be exercised by any person who is appointed as an observer as, depending on the level of involvement that they have in the proceedings at Board meetings and the management of the Company, they could be regarded as either a shadow director or a de facto director of the Company, which would bring them within the scope of the duties applicable to all directors.

For further general information on directors' duties and shadow directors, see:

Practice note, Directors' general duties under the Companies Act 2006.

Practice note, Directors' duties: corporate governance influences.

Practice note, Directors' duties and shadow directors: joint ventures: The different kinds of directors.

Practice note, Directors' duties and shadow directors: joint ventures: What is a shadow director?

Practice note, Shadow directors: comparison between Companies Act 2006 and 1985.

Practice note, Directors' duties: comparison between Companies Act 2006 and 1985.

Clause 8.4(a): Notice of board meetings

Clause 8.4(a) requires at least five Business Days' notice to be given ahead of every Board and committee meeting. Consider including provision allowing the Investor Directors to consent to a shorter period of notice if a more urgent meeting is needed.

Clause 8.4(b): Minutes of board meetings

Section 248 of the CA 2006 requires every company to take minutes of its board meetings and to keep them for 10 years. Article 15 of the Model Articles extends that requirement to keeping

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a written record of every unanimous or majority decision taken by the directors, whether or not taken at a formal board meeting.

Clause 8.6: Investor Director fees

Article 20 of the Model Articles addresses the remuneration of directors and provides that they are entitled to such remuneration as the directors determine. Clause 8.6 does not seek to contradict that provision of the Model Articles. Instead, it creates a contractual obligation requiring the Company to pay to each Investor as specified a fee in respect of the provision of the Investor Director's (and observer's) services. As such, that fee is payable to the Investor whether or not an Investor Director (or observer) holds office at any given time. Instead, an investor may prefer to charge a fee for arranging or for monitoring its investment. Such an arrangement or monitoring fee would not be linked to the provision of investor directors. However, it is increasingly common for investors not to charge any such fee, whether for the provision or investor directors or otherwise, preferring that cash to remain within the Company.

Clause 8.7: Investor Director expenses

Article 20 of the Model Articles gives companies the discretion as to whether or not to pay expenses. During the consultation process on the draft Model Articles, the Department for Business Innovation and Skills agreed to substitute the word "may" [pay any reasonable expenses] in place of "must". Investors will commonly look to amend this provision to give comfort to Investor Directors that reasonable expenses will be paid.

Where any Investor Director is located abroad, particular care should be given to drafting what the Company considers to be "reasonable expenses". Consider whether that would cover the cost of flights to board meetings (and if so, in what class)? It will not be necessary for directors to attend meetings physically in the same place.

Clause 8.8: Investor Director confidentiality

Without clause 8.8, it could be argued that an Investor Director would not be able to disclose information he learns about the Company to his appointing Investor. As this will not reflect the parties' intentions, clause 8.8 provides an express carve out to the confidentiality restrictions in clause 15. Notwithstanding this clause 8.8, an Investor Director will still be subject to the statutory and common law duties applicable to all directors (see Drafting note, Clause 8.2: Investor Directors and observers).

Clause 8.9: No obligation to disclose information to the Company

Clause 8.9 seeks to protect Investor Directors from claims that they are not acting in the best interests of the Company by failing to disclose business opportunities of which they become aware. As an Investor Director will often also be an employee of his appointing Investor, clause 8.9 seeks to separate the two roles.

Clause 8.10: Remuneration and audit committees

Consider whether the Company is at a stage in its development that warrants additional corporate governance controls such as audit and remuneration committees to be established (clause 8.10). If the investment is made at a very early stage, controls such as these may be unnecessary. If such committees are required, careful consideration should be given to the terms of reference of these committees; for example, the value of establishing committees such as these may be diminished if their recommendations need not be followed by the Board.

Clause 9: Information rights

Clause 9 sets out the information that the Investors will expect to receive on a periodic basis. Consider whether an Investor's right to receive this information should be subject to a

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minimum shareholding requirement, or whether only institutional investors should benefit from this information right.

The Investors should consider the information that they require very carefully, and in the context of each company. For example, it may be unrealistic to ask a small spin-out company to prepare audited accounts due to the time and expense required to do so.

Consider whether there are additional types of information that should be included; for example, details of material litigation or defaults under loan facilities.

Clause 9.1: Management accounts

As they are not regulated by statute, management accounts are not usually prepared to the same standards as annual accounts. Consider the form of the management accounts. If, before the investment, they are in a very simple form, the Investors may require that more sophisticated management accounting is implemented. Again, this should be considered in the context of the Company's stage of development.

Clause 9.3: Audited accounts

The default position under section 474 of the CA 2006 is that every company must submit its annual accounts for audit. Except in respect of its first accounting period, section 424 of the CA 2006 requires the Company to send copies of its annual accounts and reports to each member within nine months of the end of each financial year (or, if earlier, by the date it actually files those accounts and reports with the Registrar of Companies). Clause 9.3 requires delivery to the Investors of the Company's audited accounts (or, if it is part of a group of companies, the group's consolidated accounts) within four months of the end of each accounting reference period.

However, if the Company qualifies as a small company, as determined in accordance with section 382(1) to (6) of the CA 2006 it will, subject to limited exceptions, be exempt from the need to undertake an annual audit. If the Company forms part of a group, the exemption will not be available unless the group qualifies as a small group in relation to a financial year (and how to determine whether a group qualifies as small is set out in section 383 of the CA 2006).

Although members holding at least 10% of the Company's share capital (or of any class) may require the Company to undergo an audit in any financial year under the power conferred by section 476 of the CA 2006, the Investors should consider whether to include section 9.3 by default or, in relation to any accounting reference period in which the Company does take advantage of the audit exemption, what lower standard of information they would accept.

For information on the requirements of the CA 2006 as regards a company's annual report and accounts, see Practice notes, Company accounts and reports: overview and Small and medium-sized companies: accounts and reports: financial years beginning on or after 1 January 2016.

Clause 9.5: Right to receive other information

Clause 9.5 is for the benefit of the Investors. It is widely drafted and obliges the Company to provide an Investor with such other information about the Company as that Investor requests. The Company may seek to resist a clause in this form, or limit it to financial and governance matters.

Clause 9.7: Right to appoint inspecting accountants

The principal purpose of clause 9.7 is to ensure that financial and other information is provided to the Investors in a timely manner. If the Company fails to produce the information in a timely manner, the Investors may reserve the right to appoint an independent firm of accountants to

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review the Company's books and records. If the words in square brackets are omitted from the start of clause 9.7, the Investors will have the right to appoint accountants to inspect the Company's records at any time, whether or not there has been a breach of clauses 9.1 to 9.6.

Clause 10: Matters requiring consent

A venture capital subscription and shareholders' agreement will usually include a covenant by each shareholder to use his powers to procure that the Company does not carry out any of a list of specified matters without first obtaining Investor Majority Consent or Investor Director Consent.

Typically, the Investors will also require the Company to give the same undertakings, to provide greater comfort to the Investors that such action will not be taken. In the SSA, the Shareholders' and the Company's obligations are set out in separate clauses (clause 10.1 and clause 10.2 respectively). The decision in Russell v Northern Bank Development Corp Limited and others [1992] 1 WLR 588 HL suggests that any clause in a subscription and shareholders' agreement to which the company is a party is void to the extent that it fetters the company's statutory powers. Accordingly, a company cannot agree not to allot shares (or not to do so without the consent of a particular shareholder or class of shareholders) as the company's power to allot shares is a statutory power. In view of this, the SSA is drafted with the intention that, if a court found clause 10.2 to be unenforceable (in whole, or in respect of any particular reserved matter in schedule 6), it may be capable of severance (under clause 31), without compromising the undertakings given by the Shareholders under clause 10.1.

In the SSA, the list of reserved matters is set out in Part 1 and Part 2 of schedule 6. Part 1 of schedule 6 sets out a non-exhaustive list of the types of matters that would commonly require Investor Majority Consent. More day-to-day matters, for which consent may be given by an Investor Director, are set out in Part 2 of that schedule. Consider carefully whether each of the matters in the two Parts should be included, or whether there are additional matters of particular concern to the Investors, over which they require a collective right of veto. If including additional matters, consider carefully whether such matters should appear in Part 1 or Part 2 of schedule 6.

Where the Investors are taking a minority stake, such veto rights can raise questions about whether the Company is "controlled" by the Investors for tax purposes (as such control can have adverse tax consequences if there are any corporate investors or corporate members of investors). For tax purposes, control derives not only from share ownership and voting power, but also from any powers conferred by the articles of association or other document regulating the Company (such as a shareholders' agreement).

Whether such rights of veto give control will depend on their nature and scope. Lord Guthrie in CIR v Lithgows Ltd (1960) 39 SC 405 made clear that the ability to obtain an isolated result is not sufficient; control is the power to secure the continuing conduct of the company's affairs in accordance with the will of the controller. In Fenlo Limited v HMRC [2008] SPC 00714, the Special Commissioner held that rights of veto granted to a lender under a loan agreement were insufficient to give the lender control of the borrower because the veto rights were restricted in their scope, negative in nature and their purpose was to protect the lender's financial interests. Accordingly, given the purpose of the vetoes and provided they do not prevent management from running the business on a day-to-day basis, they should not present control issues.

Such rights of veto can also raise questions about the Company's status as a SME pursuant to Commission recommendation of 6 May 2003 concerning the definition of micro, small and medium-sized enterprises (2003/361/EC). This status is important for such matters as R&D tax relilef. To fall within the SME definition, the company must fall below staff, turnover and balance sheet thresholds. In applying these thresholds, account is taken of the staff, turnover and balance sheets of certain linked enterprises. An enterprise will be linked if (among other tests) it has the right to exercise a dominant influence over the company. HMRC regards the

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"linked enterprise" test under 2003/361/EC as "essentially" a test of control (as above) (see HMRC, CIRD91600 - R&D tax relief: SME definition: linked enterprises for 2003 EC SME Recommendation test). However, there is a presumption of no dominant influence if, for example, a venture capital company (which HMRC accepts extends to partnerships engaged in venture capital activities) does not involve itself in the management of the company even if it has rights to protect its investment. For HMRC's guidance, see HMRC, CIRD92100 - R&D tax relief: SME definition: venture capital company, HMRC, CIRD92500 – R&D tax relief: SME definition: control for the purposes of EC SME Recommendations and HMRC, CIRD92550 - R&D tax relief: SME definition: control by venture capital companies).

Clause 11: Business undertakings

Clause 11 includes a number of undertakings that provide the Investors with additional comfort as to the manner in which the Business will be conducted. It includes provisions whereby the Founders agree to promote the best interests of the Company and ensure that its Business is conducted in accordance with the Business Plan (clause 12.1). The Company also agrees that it will apply the proceeds from the investment round in accordance with the Business Plan (clause 12.2).

In addition, each of the Founders and the Company undertake to procure that the Company complies with the undertakings set out in schedule 7 (clause 12.3). These are additional undertakings as to the conduct of the business. The matters identified in schedule 7 are likely to be those areas of particular concern to the Investors and provide an added layer of comfort for them that the Business will be conducted in a manner that they are comfortable with. Failure to comply with the provisions of this clause and the undertakings in schedule 7 would enable the Investors to bring a claim for breach of contract.

Clause 12.1: Sale or IPO

One of the Investors' main objectives will be to secure an exit from its investment in the Company in order to realise a profit for investors in their funds. Under clause 12.1, each party acknowledges this objective. The time period selected for insertion in clause 12.1 is a matter for negotiation, but five years is common.

Clause 12.2: Investor warranties on Exit

Typically, Investors are not willing to give warranties or indemnities on Exit, save in relation to their title to the Shares being sold. Instead they will prefer a clean break from the Company, so that they can be certain of the return they are able to make to their own investors. A buyer will have to seek comfort in the form of warranties and indemnities from the other shareholders, as Investors will usually insist on including clause 12.2 in the SSA at the outset of the investment and it is unlikely to be negotiable.

Clause 12.3: Appointment of professional advisers

As a key objective of the Investors will be to achieve a return on their investment, if an Exit has not been realised within a specified time frame (typically five years), they will reserve the right to appoint professional advisers to examine and report on Exit opportunities. The Investors are likely to insist that the Company picks up the fees of any such advisers.

Clause 12.4: Investor conduct on IPO

An Exit by way of IPO will not actually represent a return on the Investors' monies unless they sell their Shares as part of the IPO. However, on an IPO, it is common for the underwriter to require the Company's major shareholders to retain a proportion of their shares for a specified period, in order to help ensure that there is an orderly market for the Company's securities. This is often referred to as a "lock-up".

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The period of any lock-up will vary and may be anything from six months to two years (and, in exceptional circumstances, even longer). The purpose of clause 12.4 is to ensure that the Shareholders adhere to the relevant market rules and/or the Company's broker's recommendations in relation to any such lock-up.

For more information, see Practice note, Private equity exit routes.

Clause 12.5: Registration rights

Clause 12.5 aims to address the position of an IPO on a US stock market, such as NASDAQ and provides the Investors with both demand and piggyback registration rights. As such, if a US IPO is not a realistic prospect, this clause may be deleted.

Registration rights are a US securities law concept. They are needed because (subject to certain exemptions), securities can only be offered for public sale in the US if they have first been registered with the Securities Exchange Commission. This registration process can be time consuming and costly, and involves the company providing significant amounts of information about its operations and financial condition for inclusion in the registration statement.

Unlike the UK and other European jurisdictions, where it is usual for all of a company's shares to become tradeable on a listing, in the US, a company is not required to register all of its outstanding shares. Any shares that are left unregistered in the US can only be traded in restricted circumstances, and this can greatly diminish their value. Consequently, investors in companies that may consider a US listing usually require the company to grant demand and/or piggy back registration rights.

Demand registration rights (clause 12.5(a)) give the Investors the right to demand registration of their Shares at any time. Piggy back registration rights give Investors the right to have their Shares registered along with any other shares in the Company being registered (clause 13.5(b)). An alternative approach to granting a set number of demand and/or piggy back rights is to provide that the Investors will be given no less favourable registration rights than any other Shareholder. However, the Company will often seek to resist such a provision, as the number of demand rights granted and the conditions under which they can be exercised may increase the Company's cost of raising equity capital in the future.

Some Investors may insist that the Company enters into a full US-style registration rights agreement, rather than rely on provisions such as clause 12.5. In any cases where registration rights are being granted, appropriate US legal advice should be obtained.

For more information, see Practice note, Non-leveraged investments: overview: Registration rights. More detailed information on registration rights is available on the website of the National Venture Capital Association (which represents the US venture capital industry).

Clause 13.1: Restriction on transfer of shares

Article 14.5 of the Articles prohibits a transfer of Shares by a Founder (or Employee, as appropriate) without Investor Majority Consent. It also seeks to restrict any other dealing with the legal or beneficial title to any Share.

Clause 13.1 seeks to repeat that restriction within the SSA, as a direct undertaking to the Investors. This undertaking confers power on the Investors to enforce the restriction directly against the Founders, rather than having to rely on the Company to enforce the restriction in the Articles. This contractual undertaking will allow the Investors to seek to take advantage of normal contractual remedies for breach, or threatened breach, including an injunction to restrain action.

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In some instances, a Founder may negotiate a limited right to transfer Shares, as a carve-out to the prohibition of clause 13.1 (and article 14.5 of the Articles). Such a carve-out may, for example, allow transfers up to a maximum percentage of a Founder's holding, or permit transfers made within a specified timeframe.

Clause 13.2: Deed of Adherence

It is common for the Investors to want to ensure that any person who acquires Shares after the date of the agreement (whether through transfer or a subscription for Shares) agrees to give undertakings to the Investors in the form set out in the SSA (for example, the restrictive covenants). This will usually take effect by the new shareholder signing a Deed of Adherence in favour of the existing parties, under which that shareholder agrees to be bound by the provisions of the agreement as a party. However, where not all shareholders in a company are party to the SSA, consider whether every new shareholder must automatically sign a Deed of Adherence, or whether that requirement should be determined by the parties on a case-by-case basis (for example, according to the seniority of the new shareholder).

The Founders (and the Existing Shareholders, if appropriate) are only required to procure execution of a Deed of Adherence from a transferee of Ordinary Shares or Series A Shares. On the other hand, an issue of shares of any class by the Company triggers an obligation to procure execution of a Deed of Adherence by an allottee.

Section 560(1) of the CA 2006 defines "equity securities" as ordinary shares in the company and rights to subscribe for, or to convert securities into, ordinary shares in the company. As such, the reference to equity securities in clause 7.1 would oblige a person acquiring rights to subscribe for ordinary shares to become a party to the agreement. Consider whether this is necessary in each case. Note also that the term "ordinary shares" in section 560 would not capture shares with a fixed dividend and a fixed return (such as preference shares). However, the inclusion of the word "shares" (in lower case) in clause 13.2 would capture an issue of such shares (but not rights to subscribe for such shares).

Clause 7 also requires the recipient of a sale, transfer or disposal by the Company of Treasury Shares to execute a Deed of Adherence. Under the CA 2006, such a transaction would be treated as an allotment of equity securities, rather than a transfer (section 560(3), CA 2006).

For a sample Deed of Adherence that may be used with this agreement, see Standard document, Deed of Adherence: Shareholders' agreement between individuals.

Clause 14: Restrictive covenants

Restrictive covenants that seek to limit the activities of specified key individuals both during and after their employment with the Company are commonly included in subscription and shareholders' agreements. This is because the investment is often based on the experience of those key individuals. If they were to leave the Company to work for a competitor, they could significantly affect the Company's value.

As the courts generally interpret restrictive covenants strictly and may not enforce them if they are too wide in scope, these provisions are often contained both in the SSA and in the relevant individuals' service agreements, due to the different relationships under the two agreements and potentially different scope of covenants. This can provide the Company with greater protection as one agreement may be enforceable even if the other is not.

Clause 14 imposes a number of restrictions on these specified individuals to the effect that they will not, while working for the Company, be involved in any business that competes with the Company, and for a specified period after the employment, directorship or consultancy ends, they will not carry on a competing business or solicit customers, suppliers or employees from the business. The Investors should consider which individuals whose importance to the future success of the business would merit the requiring them to enter into the covenants at

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clause 14. It may be necessary to consider whether such individual would receive adequate consideration for those covenants under the SSA, as drafted.

Under the common law doctrine of restraint of trade, the UK courts will refuse to enforce a restrictive covenant if the scope of the covenant goes beyond what is reasonable as regards:

The activities which the Founders are prohibited from pursuing when they leave the company.

The geographical scope. The Investors should only extend the area to what is necessary to protect the goodwill and the business (see clause 14.1(b)(i), but note that there are no geographical restrictions during the period any Founder is a director or employee of, or a consultant to, a Group Company).

The duration of the covenant. The covenant at clause 14.1(a) applies for so long as a Founder remains a director or employee of, or a consultant to, a Group Company. However, the covenants at clause 14.1(b) only start to run from a Founder's Termination Date. While the courts may permit a longer period of restriction in a shareholders' agreement than they might in relation to covenants under a contract of employment, the Investors should carefully consider what period of restriction is justifiable. They should also consider including wording to reduce the length of any covenants if the employee is put on garden leave (during which they remain bound by the covenant in clause 14.1(a)). This is now quite common practice and makes it less likely a court would find the covenant to be unreasonable in duration. For example, "The period[s] for which the restrictions in clause 14.1(b) apply shall be reduced by any period that the Founder spends on garden leave immediately before the Termination Date". Note also that, although the High Court has held in one case, Tullett Prebon Plc & Ors v BGC Brokers LP & Ors [2010] EWHC 484 (QB), that the court can take garden leave into account when deciding on the length of any injunction, regardless of any contractual provision, it may still be prudent to include appropriate wording to avoid the argument arising.

Also, if the Articles do not include provision for the compulsory transfer of all Shares held by a director, employee or consultant on leaving the Group, Investors may also wish to consider whether the duration of the restrictions should be linked to the period an individual holds Shares, rather than his directorship, employment or consultancy. If this approach is preferred, the permitted transfer provisions of the Articles will typically require an individual who is subject to these covenants to retain at least some Shares in his own name. This will ensure that such individual may not trigger early expiry of the covenants by transferring his Shares to permitted transferees.

In view of this, the parties should seek to ensure that the restrictive covenants are reasonable. Clause 14.2 states that the restrictions of clause 14 are seen as reasonable by the parties but, if the court does not agree, this clause is also an attempt to persuade the court to delete those restrictions which are unreasonable. Note that the courts will not re-write a clause and so deletion of offending restrictions will only work if obligations are sufficiently distinct to allow parts to be separated. The provisions of this clause should also be read in conjunction with the severance provisions in clause 31 (see Drafting note, clause 31: Severance).

The SSA contains a total prohibition on the Founders' involvement with competing businesses. However, Investors will commonly allow the Founders to hold shares of companies traded on a securities market, even if such a company competes with the Company. Such a carve-out appears in clause 14.1.

By virtue of clause 2.15, references in clause 14 to "the Company" are deemed to include a reference to every other Group Company from time to time. The Founders' legal advisers should make them aware of the implications of this. The Investors' advisers must consider the enforceability of the clause 14 covenants in light of the effect of clause 2.15.

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Note the provisions of clause 22.6, which provides that, if the restrictive covenants are breached, damages may not be a sufficient remedy. That clause would leave open the option for the Investor and/or the Company to seek injunctive relief against a Founder for breach of any of the covenants in clause 14. The Founders may therefore wish to seek to carve out a breach of clause 14.1 from the application of clause 22.6. For further background information on remedies, see Practice note, Equitable remedies: overview.

Clause 14.3: Intellectual property: patentable technology

Clause 14.3 will be relevant if the Company's business relates to patentable technology. If other intellectual property rights are more relevant, for example copyright or design right, then the clause should be adapted accordingly.

As set out above, the clause focuses on patentable material and obliges the Founders to disclose any material or information to the Company which may relate to a patentable product or process. Further, the clause states that the agreement does not operate as an assignment of any right. This would need to be dealt with in a separate agreement. Note that assignments of registered intellectual property rights should be registered at the relevant registry, such as the UK Intellectual Property Office, as soon as possible after the assignment is executed.

If this patent-related material is key to the Company, then consider whether the Founders should also be required to provide warranties and indemnities, for example a warranty that they have not given any third party the right to use the material.

Note that an assignment of the right to apply for patents of inventions is not strictly speaking, an intellectual property right. However, it is important to assign this right for the benefit of the Company.

Clause 14.4: Intellectual property: Founder obligations

Clause 14.4 obliges the Founders to assist with any patent application and to enter into any agreements that are necessary to vest the patent or similar right in the Company.

In the case of Founders who are employees of the Company, even though the Company as employer may have successfully ensured that it owns the rights to any inventions (in preference to the inventing employee/Founder), it could still face a claim for statutory "compensation" from the employee/Founder in respect of that invention if it is patented (see for example, section 40, Patents Act 1977).

Clause 14.5: Employment claims

Clause 14.5 seeks to draw a distinction between obligations undertaken by a Founder under the SSA and the Articles on the one hand, and those undertaken under his service contract with the Company on the other.

Although provisions that require a Founder to sell shares, or that operate automatically to convert shares or cause options to lapse, may be triggered by the termination of his employment or office, those provisions are intended to apply to a Founder in his capacity as a shareholder of the Company. As such, clause 14.5 seeks to prevent a Founder from claiming loss of equity value as part of any contractual claim that is made in his capacity as an employee or officer in connection with the termination of employment.

Note that this clause would not limit the amount recoverable in employment tribunal claims based on statutory employment rights such as unfair dismissal or discrimination. It is not possible to contract out of such claims or limit their scope, except in certain limited circumstances, such as where the parties have entered a settlement agreement on termination, or conciliated a dispute through Acas (see, for example, section 203 of the Employment Rights Act 1996). The result is that any financial loss arising from an unfair or

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discriminatory dismissal is potentially recoverable, including any loss of the value of any shares or options.

Clause 15.1: Confidential information

In the absence of a confidentiality clause, a party wishing to protect commercially sensitive information will have to rely either on any available intellectual property law protection, or on the general law of confidential information. However, a significant amount of sensitive information cannot be protected by intellectual property rights, and a party hoping to rely on the general law of confidential information is reliant on the courts finding that the information was disclosed in circumstances importing an obligation of confidence. As a result, a SSA will almost invariably incorporate some form of confidentiality clause. Subject to the scope of information deemed by the SSA to be Confidential Information, the obligations such as those in clause 15 are unlikely to be contentious. For a more detailed consideration of issues relating to the law of confidential information and confidentiality clauses, see Practice note, Protecting confidential information: overview.

Clause 15.2: Permitted disclosures by Investors

Clause 15.2 sets out those persons to whom an Investor may disclose Confidential Information, as an exception to the general prohibition in clause 15.1.

An Investor will usually insist on being able to disclose Confidential Information to those persons listed in clauses 15.2(a) to (e), as being necessary for the proper management of its funds and portfolio investments.

Whether or not clause 15.2(f) should be included will depend on the bargaining strength of the parties. Investors that are considering syndicating their investment or bringing in additional investors will want the contractual right to disclose Confidential Information to any such potential investor. The Company, on the other hand, may be wary of how broadly the inclusion of this sub-clause would extend the potential pool of permitted disclosees, which may include trade competitors.

In any event, any disclosure of Confidential Information by an Investor under clause 15.2 is subject to the condition that a recipient signs a non-disclosure agreement in respect of any such information.

Clause 15.3: Meaning of Confidential Information

The definition of Confidential Information in clause 15.3 is a key element in a confidentiality clause. It is tempting to make the definition as wide as possible. However, merely describing information as confidential will not necessarily turn information that is not inherently confidential into confidential information, and risks a court holding that the definition is too wide to be enforceable). For example, the courts have determined an entire package of information to be non-confidential, where that package included trivial information that was not confidential. In practice, therefore, it is always necessary to weigh up the risk of using a widely-drawn definition of Confidential Information that may not be upheld by the courts against the risk of using a definition that is too narrow to catch the information to be protected.

Clause 15.3 encompasses all "information or know-how of a secret or confidential nature", which is supplemented with a detailed list of items that is expressed to be non-exhaustive. The operation of the ejusdem generis provision at clause 2.9 means that the detailed list of items at clause 15.3(a) to (c) should not prevent any other information being categorised as Confidential Information, if appropriate. To supplement the operation of that rule, clause 15.3(c)(xi) includes within the definition of Confidential Information any other information which reasonably be expected to be seen as confidential or commercially sensitive.

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If the parties entered into a confidentiality agreement as part of the negotiations leading up to Completion, do the parties intend that agreement to fall away on execution of the SSA? Clause 22.1 (Entire agreement) provides that this agreement constitutes the only agreement between the parties relating to its subject matter and that any previous agreement relating to its subject matter is extinguished.

Sub-clauses 15.3(A) to (F) set out common exceptions to the definition of Confidential Information, based on the manner in which the information is received or disclosed. The inclusion of these carve-outs should not be controversial.

For more on the matters to consider when drafting a confidentiality clause, see Standard clause, Confidentiality and the related drafting notes.

Clause 16: Announcements

The disclosure by any party of Confidential Information is regulated by clause 15. However, more generally, the Investors (and the Company) will usually want to be able to control the flow of information to the press, for reasons that may include potential impact on their reputation as investors, or on the value of their investment. Clause 16.1 sets out a prohibition on public statements or announcements unless:

An Investor Majority and the Board give their written consent in advance.

Such statement or announcement is required by law, any securities exchange, any regulatory authority or by a court order.

The statement or announcement is being made by an Investor to any person covered by the exception to the prohibition on disclosure of Confidential Information set out in clause 15.2.

Strictly speaking, an express carve out for announcements required by applicable law or by an order of any court or other governmental or administrative authority is unnecessary, as a private contractual agreement is invalid to the extent that it requires a breach of the law in order to be performed. However, such exceptions (which usually also appear within non-disclosure agreements; see clause 2(f) of the BVCA Model Confidentiality Letter for Venture Capital Investment) are often included to avoid argument on a redundant issue or to calm any fears or doubts in the minds of the parties.

Consider whether the exceptions set out in clause 16.2 are sufficient and whether they are appropriate in the context of the particular transaction. Are there any additional circumstances in which the parties ought to be permitted to make announcements?

Clause 17: Costs and expenses

Unless a contract expressly states otherwise, each party bears the costs it incurs in negotiating and performing the contract. If each party to the SSA is to pay its own costs and expenses, clause 17 may be omitted, although a clause stating that fact would be useful to rebut any argument that one party had agreed to pay some or all of the costs of another party.

It is, however, common for venture capital investors to require the Company to meet the Investors' transaction costs. Clause 17.1, which sets out such an obligation, is widely drafted. It provides that the Company will bear all legal, accounting and due diligence fees and expenses of the Investors not only in relation to the SSA, but also in relation to every other document referred to in it.

While the Company is unlikely to succeed in resisting this obligation, it should seek to cap the amount it may be required to pay. It should also consider whether to restrict the obligation to paying only the Investors' "reasonable" fees and/or limiting the scope of the fees it will pay.

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The remaining parties to the SSA are left to pay their own costs and expenses (clause 17.2).

Clause 18: Survival and cessation of obligations of the Founders

Clause 18 makes it clear that the obligations of the Founders under the Warranties, the restrictive covenants and the confidentiality clause will survive any transfer of Shares by them or the termination of their employment. However, provided that all of the other obligations under the SSA have been properly performed, any other obligations terminate when the Founder ceases to hold Shares and ceases to be a director, employee or consultant of the Company.

The Investors' will wish to preserve their ability to sue the Founders in their capacity as the original Warrantors, even if they are no longer shareholders or employees of the Company. For example, if a Founder sells his Shares and then resigns, the Investors would want to be able to sue him as a Warrantor, even though he is no longer a Shareholder or an employee of the Company. Also, they would still want to rely on the restrictive covenants to prevent him from joining a competing business.

Always consider the limitation periods for the Warranties (clause 6) in conjunction with clause 18. The Founders should ensure that such a clause does not extend their period of exposure. Clause 18 should also be considered in conjunction with any clauses stating the effect of ceasing to hold Shares (clause 19), particularly if there are any rights that a Founder may want to enforce.

In relation to the restrictive covenants, note that any unduly restrictive or lengthy covenants are unlikely to be enforceable (see clause 14).

Clause 19: Effect of ceasing to hold shares

Clause 19 makes it clear that, with effect from the date that a party ceases to hold any Shares in the Company, that party also ceases to be a party to the agreement, but only for the purposes of receiving benefits and enforcing his rights under the SSA. Clause 19 would not, for example:

Allow a Warrantor to avoid liability for breach of Warranty in respect of any unexpired Warranty period.

Allow a Founder to ignore the restrictive covenants set out in clause 14.

The obligations of a Founder under both of those provisions, as well as the confidentiality provision (clause 15) will continue by virtue of clause 18.

Clause 20: Cumulative remedies

The purpose of clause 20 is to state the parties' intention that the Investors' rights and remedies set out in the agreement are in addition to their rights provided by the general law, and not in substitution for them. Note that this clause operates for the benefit of the Investors only and not for any other party to the SSA.

For further information, see Standard clause, Rights and remedies.

Clause 21: Waiver

A "no waiver" clause seeks to ensure that a party's failure to enforce its contractual rights (whether deliberately or by oversight) in respect of the other party's breach of contract does not result in their losing those rights or remedies.

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If a party breaches its obligation under a contract, the innocent party has a number of options. It may assert its rights against the defaulting party for breach of contract, complain about the breach but take no action, or ignore the breach. If the innocent party takes too long to decide what course of action to take, or does nothing, the innocent party risks losing its right (that is, waiving its right) to take action against the defaulting party for that breach of contract (or similar breaches in the future).

As such, the purpose of a no waiver clause is generally to cover for the following eventualities:

That a failure or delay in exercising a right under the agreement or at common law does not amount to a waiver of that right.

That a waiver of a breach of a term of the agreement does not amount to a waiver of any other breach.

That a waiver of a particular obligation on one occasion will not prevent a party from subsequently requiring compliance with the obligation.

For more information, see Standard clause, Waiver and the related drafting notes.

Clause 22: Entire agreement

The purpose of an entire agreement clause is to prevent the party relying on it from being liable for any statements or representations (including pre-contractual representations) other than those expressly set out in the agreement. The parties will normally wish to ensure that, as a matter of commercial certainty, all of their obligations are recorded in one document. The Warrantors will want to make sure that they cannot subsequently be found liable for representations that are not included in the written agreement.

There are four parts to this entire agreement clause:

Whole agreement. A statement that the document concerned contains the whole agreement between the parties and supersedes any previous agreement (clause 22.1).

Non-reliance. An acknowledgement by the parties that they have not relied on any representation which is not set out in the agreement (clause 22.3). This clause is designed to exclude actions for pre-contractual mis-representations.

Specific waiver of any rights or remedies. Clause 22.4 goes further and constitutes a specific waiver of any rights or remedies that a party may have to claim damages or to rescind the agreement. Note, however, that it is not possible to exclude liability for pre-contractual statements that are made fraudulently.

Exclusion of other remedies. An acceptance that the only remedy the parties will have are for breach of contract (clause 22.5). A clause such as this should always be considered alongside any provisions dealing with remedies in the agreement to avoid possible conflicts.

Note also, that to the extent an entire agreement clause constitutes an exclusion or limitation of liability, it will have to be shown to be reasonable.

For more information, see Practice note, Contracts: entire agreement clauses.

Clause 22.2: Prior Agreements

Include clause 22.2 if an agreement between shareholders in the Company already exists and such agreement is to terminate on execution of this SSA. If such an agreement does exist, consider whether any provisions of that agreement should survive and so be carved out of the

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termination provision of clause 22.2. For instance, if the period of any warranties given under a pre-existing agreement has not yet expired, the recipient of those warranties may wish to preserve the ability to bring a warranty claim under that agreement.

Where a Prior Agreement does exist, it will be necessary to consider whether a deed is required to terminate it. If so, this SSA ought also to be executed as a deed.

For more information, see Practice note, Execution of deeds and documents: when do you need a deed?

Clause 22.6: Damages not an adequate remedy

In relation to the obligations on the parties under this agreement, the parties will usually be more concerned to ensure that each other party actually complies with the obligations, rather than simply being liable for damages on default. For example, they may prefer to prevent a disclosure of Confidential Information by another party by means of an injunction, rather than relying on damages for breach of the agreement after the event.

In clause 22.6, each party acknowledges and agrees that damages may not be an adequate remedy for breach of an undertaking set out in the SSA (other than in respect of warranty claims, which are addressed in clause 22.5). This aims to persuade a court to exercise its discretion in favour of the other parties by granting an injunction, ordering specific performance or other equitable relief.

Both injunctions and orders for specific performance are forms of equitable relief and as such are discretionary. For more information, see:

Practice note, Equitable remedies: overview.

Standard clause, Inadequacy of damages and the related drafting notes.

In relation to its application to the restrictive covenants of clause 14.1, see the last paragraph to Drafting note, Clause 14: Restrictive covenants.

Clause 22.7: No exclusion of liability in the case of fraud

Case law in this area suggests that it is unnecessary to include an express carve-out for fraud from a clause which seeks to exclude liability for misrepresentation (see Practice note, Contracts: entire agreement clauses: Express carve-out in respect of fraud).

Clause 23.1: Variation

A variation clause sets out a prescribed procedure for the parties to follow in order to amend the agreement. It is intended to exclude the possibility of informal, and perhaps inadvertent, oral variations being made to an agreement (although there are doubts as to the effectiveness of preventing oral amendments through the presence of a clause requiring written amendments).

Clause 23.1 does not expressly require a variation of the SSA to be in writing. However, any proposed variation does require the advance written consent of both the Company and of the holders of a specified proportion of holders of the Equity Shares (excluding any Treasury Shares). The SSA does not require the consent of all Shareholders to a variation, to avoid risk that the wishes of the majority could be undermined by a few minority shareholders (as is the case for the variation of the Articles by special resolution under section 21 of the CA 2006). However, to protect any party that does not consent to a variation, if such variation would impose any new obligation on, increase an existing obligation of or, if the words in square brackets are included, vary an express contractual right of such a dissenting party, the specific written consent of that party would be required for the variation.

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The presence of a variation clause such as clause 23.1 does not remove the requirements for a valid variation of contract. In particular, consideration will still be necessary, or it should be executed as a deed.

For further consideration of issues relating to variation, see Practice note, Contracts: variation.

Clauses 23.2 and 23.3: Termination

Where a contract contains no express provision for it to come to an end, the courts may sometimes imply a term that it can be terminated on "reasonable notice" by a party. However, as it may be unclear whether a party wishing to terminate has the right to do so at common law, contracting parties will often include termination rights in agreements providing for automatic termination, or permitting them to terminate, in specified circumstances. Those circumstances may include:

The expiry of a fixed term.

A material breach of the agreement by one or more parties.

An exit-related event (such as an IPO; see clause 23.3).

Insolvency of the business.

Deadlock between management (more common to joint venture agreements).

Contractual agreement between the parties to terminate.

Clause 23.2 allows the Company and a specified proportion of the holders of the Equity Shares (excluding any Treasury Shares) to agree to terminate the SSA (and to bind all parties to that termination). The effect is that not all parties to the SSA need to give their consent to a termination of the agreement. Also, note that the clause does not require the express consent of the Investors or of an Investor Majority. As a result, the Investors will need to carefully consider the percentage figure to be inserted in clause 23.2. Not only will they want to avoid risk that the non-Investor equity shareholders could bind the Investors to a termination decision, but also each individual Investor will need to understand the circumstances in which the agreement might be terminated without their consent.

On termination, the relationship between the parties will cease, save that no party will cease to be liable for a breach that occurred before termination. If any provision of the SSA is intended to survive termination, it should be expressly set out in the agreement. This may be particularly relevant to any confidentiality provisions, restrictive covenants and provisions governing the conduct of claims.

If any third party has rights under the SSA, the parties should consider whether to include express provision in clause 26 (Rights of third parties) to the effect that no consent is required from any such third party to a variation or termination of the agreement. Such a provision is permitted by section 2(3) of the Contracts (Rights of Third Parties) Act 1999.

If the SSA is executed as a deed, note that any termination of it may also require a deed.

Optional clause 23.3 would automatically operate to terminate the agreement on an IPO. In broad terms, special rights and obligations of shareholders tend to be unwound on the company being listed, whether or not any shareholders' agreement expressly provides for termination. So, although clause 23.3 may not be necessary, it may serve as a useful indicator of the intention of the parties on IPO. Again, termination on IPO will not absolve any party's existing liability for a breach that occurs before termination.

For more on termination, see Practice note, Contracts: Termination.

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Clause 24: No partnership

The principal object of a no partnership or agency clause is to exclude the risk of an agreement creating an unwanted partnership or agency relationship between the parties.

A no partnership or agency clause will effectively exclude any implied authority of one party to the agreement to bind the other, and the duties which exist between partners. However, such a clause may not be effective against third parties, since the agreement in which it appears will usually be a private matter between the parties, and outsiders will have no notice of its contents. In practice, situations in which a third party might be able to establish the existence of an implied partnership (for example, between the Investors) will be rare. Any implication of agency arising in favour of a third party is more likely to depend on the conduct of the parties than the terms of any agreement between them.

Whether or not a partnership exists is ultimately a question of fact. The inclusion of a "no partnership" clause is not conclusive, but it is usually included in subscription agreements on the basis that it may help if any question arises as to whether a partnership exists.

For further information, see Standard clause, No partnership or agency.

Clause 25: Assignment and transfer

Clause 25 prohibits assignment, transfer of obligations, subcontracting, delegation or charging or dealing any of the obligations owed under the agreement (clause 25.1). It states that any purported transfer of any kind will be ineffective (clause 25.2). However, there is an exception to this general prohibition where an Investor transfers Shares in the Company to its Permitted Transferees in accordance with the Articles. Provided that the transferee has executed a Deed of Adherence, the Investors are then permitted to assign, in whole or in part, their rights under the SSA (clause 25.3).

The benefit of a contract can, in principle, be freely assigned by the benefiting party. However, this general rule will not apply to a contract which contains an express or implied provision to the contrary, and does not apply where the contract is a personal contract.

Assignment can only be used to transfer the benefit of a contract. However, it may be possible for the performance of contractual obligations to be subcontracted (or delegated) to a third party (since the original party to the contract remains liable for the performance of his subcontractor). An alternative to setting up an assignment/subcontracting arrangement is to novate the contract (see further Practice note, Contracts: novation).

Assignment clauses are included in all kinds of commercial contracts to clarify, exclude or qualify the parties' ability to assign rights under the contract. It is common practice for this clause to deal also with the parties' ability to subcontract their obligations, and otherwise deal with their rights or obligations under the contract to third parties.

Express non-assignment provisions may not prevent assignment by operation of law, but will usually be effective in other cases, if clearly drafted, with the result that any purported legal or equitable assignment will be ineffective as between the would-be assignor and the other original party to the contract. However, it is sometimes possible to circumvent non-assignment provisions (see Practice note, Contracts: assignment: Non-assignment provisions and Circumventing restrictions on assignment).

For more on issues relating to assignment and subcontracting, see Practice notes, Contracts: assignment and Contracts: subcontracts.

Clause 26.1: Exclusion of third party rights

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The common law doctrine of privity of contract provides that the only persons entitled to the benefit of a contract and to enforce rights under it are those persons who are parties to the contract. However, this doctrine has been modified by the statutory rights conferred on third parties by the Contracts (Rights of Third Parties) Act 1999 (Third Party Rights Act). The Third Party Rights Act made it possible for a non-party to enforce a contract term given in that non-party's favour, which had until then been achievable only by indirect routes.

Subject to contrary provision, where the Third Party Rights Act applies:

If a third party would benefit from enforcing a contract term, it may have the right to do so (see Practice note, Contracts: privity and third party rights and obligations: The third party right). Note that the Third Party Rights Act can only operate to confer rights and cannot transfer obligations.

If the contract creates a third party right under the Third Party Rights Act, the parties' freedom to vary or rescind the contract may be limited (see Practice note, Contracts: privity and third party rights and obligations: Variation and rescission).

If these effects are not desired, express wording is required to exclude them. Clause 26 excludes the application of the Third Party Rights Act under the SSA, save to the extent specified in clause 26.2. For more information on the rights of third parties to enforce a contract and the process for excluding those rights, see Practice note, Contracts: privity and third party rights and obligations and the drafting notes in Standard clause, Third party rights.

Clause 26.2: Rights of general partners and management companies

As an exception to clause 26.1, clause 26.2 specifically permits the general partner of an Investor or the management company acting on behalf of an Investor to enforce the rights and benefits of the agreement as if it were a party to it.

In order that a third party may rely upon rights under a contract to enforce one of its terms, the parties should not be permitted to change that contract so as to remove that right, without the third party's consent. The Third Party Rights Act therefore provides that, where a third party has a right to enforce a term of the contract, the parties may not, by agreement, rescind the contract, or vary it in such a way as to extinguish or alter the third party's entitlement under that right, without his consent, if his right has crystallised (section 2(1), Third Party Rights Act).

"Crystallisation" means that either:

The third party has communicated his assent to the term to the contracting party who granted the right (the promisor).

The promisor is aware that the third party has relied on the term.

The promisor can reasonably be expected to have foreseen that the third party would rely on the term and he has in fact relied on it.

This means that, in practice, the parties are subject to the will of the third party before they can amend or, even, terminate the contractual arrangements which they have agreed between themselves. However, the Third Party Rights Act specifically provides that the third party's right to consent to a variation or rescission is subject to any express term of the contract (section 2(3), Third Party Rights Act). For this reason, third party rights clauses often provide that no consent is required from third parties to the variation or rescission of the contract. The parties to the SSA might consider altering clause 26.2 along those lines.

Given the close relationship between a general partner or management company and its funds, their consent to variation of the agreement, if required, should not present any difficulties. If third party rights are conferred on any other, less closely related party, consider

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extending clause 26.2 so that no consent is required from such party to the variation or rescission of the SSA.

Clause 27: Conflict between agreements

It is common for a subscription and shareholders' agreement to be expressed to be the prevailing contract between the parties in the event of any conflict with the articles of association. This ensures that the remedy of an injunction will usually be available to ensure that each party takes the necessary voting action when voting as a shareholder of the Company to give effect to its terms (Greenwell v Porter [1902] 1 Ch 530 and Puddephat v Leigh [1916] 1 Ch 200).

If the agreement covers some of the same matters as the Articles, a provision to the effect that the SSA should take precedence over the Articles on its own might indicate that the agreement should prevail in place of the Articles and should therefore be registered under sections 29 and 30 of the CA 2006. As a result, this provision is typically coupled with a provision that the parties (other than the Company) will exercise their powers to amend any conflicting provisions in the Articles (see clause 27).

Clause 27 is made subject to any applicable law. As a result, this clause will not operate to require the parties to modify the Articles where to do so would constitute an unlawful fetter on the Company's statutory powers.

Clause 28: Counterparts

A counterparts clause can be useful where the parties will be executing separate copies of any agreement. Such a clause should state that each copy of the agreement is an original, so that each party can produce an original if required, for example, for stamp duty or evidentiary purposes. Documents executed in counterpart are normally admissible in English court proceedings under the doctrine of joinder of documents.

The absence of a counterparts clause should not, of itself, invalidate an agreement that is executed by separate counterparts. However, a counterparts clause may help to prevent a party from claiming that an agreement is not binding because there is no one copy that is signed by all the parties, or because he did not know that he was entering into a binding contract by signing an agreement that had not been signed by the other party or parties.

The second sentence of clause 28 provides that the execution and exchange of executed counterparts by electronic transmission or by fax will suffice to bind the parties to this agreement. Its inclusion may help to prevent a party from claiming that an agreement is not binding because there is no one copy that is signed by all the parties, or because he did not know that he was entering into a binding contract by signing an agreement that had not been signed by the other party or parties.

The practice of virtual completions through the exchange of counterparts each executed by a single party avoids the potential difficulties of arranging a completion meeting attended by all signatories or circulating the agreement for execution by every party.

In transactions involving a virtual closing, for some time now, copies of the signed signature pages of agreements have been transmitted in PDF, JPEG or other digital format, attached to emails. This technology has largely replaced the fax, with PDF being the most commonly used format.

However, in light of questions over the effectiveness of this practice following the decision in R (on the application of Mercury Tax Group Ltd and another v HMRC) [2008] EWHC 2721 (Admin), a joint working party (JWP) of The Law Society Company Law Committee and The City of London Law Society Company Law and Financial Law Committees has prepared guidance recording a non-exhaustive range of options available to parties when executing

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documents at virtual signings or completions. The JWP has also published guidance on the use of electronic signatures in commercial contracts (see Drafting note, General document notes: Simple contract or a deed).

The Law Society has published a practice note to assist parties wishing to take a cautious approach to virtual signings in light of the decision in Mercury. It is based on the guidance issued by the JWP, but includes additional guidance mainly where property documents and guarantees are concerned.

Clause 29: Notices

This provision governs the manner in which any notice under the agreement must be given, and the time at which a notice is deemed to be received.

Notice provisions can play an important role as they may determine when (and if) other rights under the agreement are triggered. For example, whether or not a Warranty claim is time barred by the limitation on liability set out in clause 6.2 will depend upon whether notice of that claim has been validly served within the time frame specified in clause 6.2.

For further information in relation to notices generally, see:

Practice note, Notice clauses.

Standard clause, Notices and the related drafting notes.

In drafting a notices clause, there will be a number of issues to consider, including:

As the notices provisions will be interpreted strictly, ensure they are sufficiently detailed and address all relevant circumstances. For example, if an additional Warrantor is included as a party to the agreement, the notice provisions should be expanded to deal with service by and on the Warrantor.

Consider whether signature of a notice should be mandatory (clause 29 does not require signature).

Notices should be required to be given in a language that will be understood by the recipient. If there are overseas parties consider allowing notices to be provided in a language other than English (accompanied by an English translation).

Clause 29.1 includes a mechanism for the parties to make changes to their service details. Consider whether to provide a time period before any notified changes to the service details take effect to avoid a situation whereby notices sent to the correct address at the time of sending are invalid because of a subsequent change of address. As the SSA permits the service of notice by email, this may not be considered necessary.

The parties should consider the intended scope of the notices provision. For instance, is it intended that the provisions should apply to formal notices under the agreement only, or should it also capture all communications between the parties in relation to the agreement?

If any party is resident outside the UK and its address for service of notices is not within the UK, consider whether to permit service by airmail or international courier. Also in such circumstances, consider whether an overseas party should be required to appoint an agent for service in the UK. Where there is a foreign party with no UK office (and the forum for disputes is the English courts), it is a reasonably common compromise to include an overseas address for the service of general notices, but to include a provision appointing a UK based agent for the service of any court

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proceedings. A provision of this type would typically be included in the governing law and jurisdiction clause. For an example clause appointing an agent for service, see clause 1.2 of Standard clause, Jurisdiction.

Clause 30: Consideration

See Drafting note, General document notes: Simple contract or a deed.

Clause 31: Severance

Parties who have entered into an agreement may subsequently find that it contains provisions which are illegal, with the result that all or part of the contract could be void or unenforceable. The purpose of a severance clause is to make clear that, in such a case, the parties intend the agreement to survive by severing the offending provisions from the rest of the agreement.

The doctrine of severance is likely to be applied by the courts whether or not there is an express severance provision. Nevertheless, in practice it is advisable to include an express clause, because:

If a clause is not used, the application of the doctrine of severance by the courts could be more restrictive than under an express clause.

The inclusion of a clause gives some moral weight to how the position should be resolved between the parties, if provisions in the contract prove to be invalid or illegal.

As a general rule, the courts will not make a new contract for the parties, whether by rewriting any provision in an existing contract or by altering its basic nature. Nor is it possible for the contract to confer on the court any additional power to re-write a clause or to reduce either its geographical scope or the period for which it is effective.

This clause is particularly relevant to the enforcement of the restrictive covenants given by the parties, the enforceability of which may ultimately be a matter for the courts.

Clause 32: Governing law

A governing law clause should be included where all parties want all disputes arising under their agreement to be determined in accordance with the substantive laws of a particular country.

Clause 32 is drafted on the assumption that the parties want the law of England and Wales to govern the performance and interpretation of the agreement, and to govern disputes arising under it. If the chosen governing law is not the law of England and Wales, this clause should be amended to reflect this. In such circumstances, a lawyer qualified in the relevant jurisdiction will need to advise on, or draft, the agreement.

Clause 32 covers both contractual and non-contractual obligations and disputes. Even without the phrase "including non-contractual disputes or claims", the wording of the clause is probably sufficiently broad to encompass non-contractual claims which relate to the agreement. However, the addition of this phrase is intended to put the matter beyond doubt.

Where the Company or one of its Subsidiaries is an overseas company, consider any mandatory rules that may apply to the transaction despite the choice of law clause. This could include, for example, a requirement that the agreement be notarised or that transfer duties are paid before the transfer of the Sale Shares can be perfected. Parties whose businesses or operations are in Wales, or do (or could) extend to Wales, should consider whether there are any relevant Assembly Acts or Measures that diverge from the equivalent obligations under the existing laws of England and Wales.

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For further information, see Practice note, Governing law and jurisdiction clauses.

Clause 33: Jurisdiction

A jurisdiction clause should be included where the parties want disputes arising under their agreement to be determined by the courts of a particular country.

A jurisdiction clause is different from a governing law clause as it relates to the place where a dispute will be heard and not to the law which will be applied to the issues in dispute. A governing law clause simply determines the substantive law that will be applied to determine the rights and obligations of the parties and any disputes that may arise, but it does not confirm how disputes are to be resolved. It is therefore important to include both a governing law and dispute resolution provision in the agreement.

Clause 33 is drafted on the assumption that the parties want any disputes under the agreement to be determined by the courts of England and Wales. Consider whether the venue should be exclusive, or whether a party needs the flexibility to start proceedings in another country (for example, the other party's place of residence).

In drafting a jurisdiction clause, ensure that the clause is drafted sufficiently widely to cover all relevant disputes. The words "any claim, dispute or issue" are intended to cover all disputes between the parties without narrowing the range by naming them specifically. The phrase "which may arise out of or in connection with" this agreement is used because it is arguably wider than alternative formulations, such as "arising out of", "related to" or "related directly and/or indirectly to the performance of". This should reduce the scope for parties to bring proceedings other than in the chosen court, thereby reducing the scope for parties to bring proceedings other than in the chosen court, thereby reducing the costs and delay involved in jurisdiction.

If one of the parties is resident overseas, the other party should consider including a clause appointing an agent for service in the UK.

Clause 34: Confirmation by Founders and Investors

The purpose of clauses 34.1 and 34.2 is to ensure that the Founders have no recourse against the Investors, and that no Investor has recourse against any other Investor, as a result of entering into the SSA. As between Investors, clause 34.2 also clarifies that no Investor shall be liable to any other Investor for acting in accordance with the terms of the SSA.

Clause 35: Regulatory matters

Clause 35 is an administrative, but important, provision protecting the Investors. It aims to avoid risk that one party could claim to be the client of an Investor (or its general partner or management company), which would trigger the application of rules relating to clients under the FCA Handbook.

Part 1, schedule 4: Conditions to Completion

See Drafting note, Clause 4: Completion.

Part 1 of schedule 4 sets out the conditions that must be satisfied (or waiver by Investors) before Completion takes place. The matters set out in paragraphs 1 to 7 will be common to most venture capital transactions, although the conditions should be tailored to each transaction. For example investors, particularly US investors, will often seek a separate indemnity agreement for investor directors. The due diligence process is also likely to reveal other matters that the Investors will want the Company to address before they release their investment monies. These matters should be included in part 1 of schedule 4 as Completion Conditions.

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Optional paragraph 4 deals with the adequacy of money laundering checks and requires the Company's Solicitors to confirm to the Investors that those checks have been made. Certain Investors may prefer their own legal advisers to undertake those checks, in which case the condition in paragraph 4 must be amended to reflect the Investors' actual requirements. For information on money laundering offences in the UK, see Practice notes, Money laundering offences in the UK: an overview and Anti-money laundering toolkit.

Clause 2.15, which deems references to the Company to include a reference to each other Group Company in those provisions specified in that clause, does not apply to schedule 4. Consider whether any of the Completion Conditions should extend to matters relating to each Group Company, as well as the Company. For example, if a Subsidiary has ceased to carry on business for the purposes of section 123 of the Insolvency Act 1986, should the Investors be required to proceed with Second Completion (see paragraph 7 of Part 2 to schedule 4)?

Paragraph 1, Part 1, schedule 4: Agreed form resolutions

Lawyers advising the parties will agree the form of the Board and Shareholder resolutions required at Completion. Typically, the Shareholders will be required to:

Authorise the allotment of the Investors' Shares for the purposes of section 551 of the CA 2006.

An allotment of a new class of shares will mean that the directors' power, under section 550 of the CA 2006, to allot shares without shareholder authority, will not be available. Instead, section 551 will apply to the allotment and will require shareholder authority.

Such authority may be set out in the Company's articles of association, or in the terms of an ordinary resolution. It is a condition of the Investors' subscription that that authority be granted by the shareholders (paragraph 1(b), Part 1, schedule 4). Although clause 4.1 allows the Investors to waive any of the Conditions, the Investors will not proceed with the subscriptions if the Company is not authorised to allot the relevant shares.

The authority necessary to allow the allotment and issue of Shares contemplated by clause 3 is set out in Article 13.1 of the Articles. Given Article 13.1 and the requirement for shareholders to adopt those Articles under paragraph 1(d) of part 1 of schedule 4, it may not be necessary to include paragraph 1(b). For more information, see BVCA Articles, Drafting note, Article 13.1: Allotment of Shares.

Ensure that no pre-emption rights, whether under statute or the Company's existing articles of association, arise in respect of the allotment of the Investors' Shares.

Under paragraph 1(d) of part 1 of schedule 4, the existing shareholders must adopt the Articles before the Investors will complete their subscriptions. Article 13 of the Articles requires the Directors to offer any new Shares to the Shareholders, before allotting them to any other person. However, Article 13.8 sets out those categories of Shares to which that pre-emption right will not apply. Optional Article 13.8(f) would, if included, mean that pre-emption rights would not apply to any proposed allotment of Shares to Investors in accordance with the SSA. So, if Article 13.8(f) is included in the Articles, paragraph 1(c) will not be necessary, provided the Articles are adopted before the Company makes those allotments.

However, if that wording is not included, the Investors should insist that, immediately after adopting the Articles, the existing shareholders also pass a special resolution to disapply the pre-emption requirements of Article 13 in respect of the allotments set out in clause 3 of the SSA. Clause 3.5 sets out the obligation on the Shareholders to approve that waiver.

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Adopt the Articles in the form agreed between the parties. Unless the resolution states otherwise, the Articles will take effect immediately upon the passing of the relevant resolution. As such, the Completion matters referred to in clause 4.2 will be subject to relevant provisions of the Articles, rather than any earlier articles of association.

Paragraph 3, Part 1, schedule 4: Founders' questionnaires

The answers to these questionnaires, which set out each Founder's individual circumstances, are to be the subject of a warranty under paragraph 2.4 of Part 1 to schedule 5 (see Drafting note, Warranty 2.4: Questionnaires). Liability for breach of Warranty 2.4 will not be limited under clause 6 (see clause 6.1(b)).

Paragraph 8, Part 1, schedule 4: Relevant Change Letters

Part 21A of the CA 2006 requires all companies within scope (including all UK-incorporated private companies) to keep a register of individuals (PSCs) and certain legal entities (RLEs) with significant control over the company (PSC register). For general information on the PSC regime and its scope, see:

PSC register: who must keep a PSC register: flowchart.

Practice note, PSC register: completing the register.

Practice note, PSC register: identifying people with significant control.

Completion (and Second Completion) may result in an existing PSC or RLE ceasing to have that status, or may result in a change to that status (for example, as a result of dilution following the Investors' subscriptions). Section 790E(3) obliges a company to write to every PSC or RLE it has reasonable cause to believe is affected by a relevant change, unless that company has already been informed of that change (and, in the case of a PSC only, has been informed by or on behalf of that PSC) (section 790E(8), CA 2006).

To ensure that the Company is holding the necessary confirmed information to enable its PSC register to be updated immediately following Completion, the parties may want to include this confirmation as a completion deliverable.

Part 2, schedule 4: Conditions to Second Completion

Part 2 of schedule 4 should be included if the Investors' subscription is to be split into two tranches.

For a discussion of the second Tranche Conditions, including the Milestones, see Drafting note, Clause 4.3: Second Completion.

Paragraph 3, Part 2, schedule 4: Material adverse change to financial position

Paragraph 3 confers power on the Investors not to proceed with Second Completion if it believes there to have been a material adverse change in the Company's financial position or prospects since Completion.

Under paragraph 2.1 of Part 2 to schedule 5, the Warrantors must confirm that they have delivered the latest audited accounts to the Investors and, under paragraph 2.3, disclose any change to the financial position of any Group Company since the date to which those accounts were made up.

However, as the latest accounts may be made up to a date after Completion, any deterioration in the group's financial position or prospects between Completion and the date to which the latest accounts are made up may not trigger a disclosure in the Further Disclosure Letter.

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During that period, the Investors will have received management accounts in accordance with clause 9.1. These accounts should allow Investors to detect any deterioration in performance. In that case, paragraph 3 allows the Investors to choose not to proceed with Second Completion.

The Founders and the Company should insist that any opinion that the Investors deliver under this paragraph (and paragraph 4) must be reasonable.

Paragraph 7, Part 2, schedule 4: Insolvency

The purpose of paragraph 7 is to make the continued solvency of the Company a condition of Second Completion. It effectively seeks confirmation that the Company has not entered into a formal insolvency procedure in England and Wales or become insolvent as a matter of fact. Although the Investors may elect to invest further funds if the Company is in financial distress, they will not want to be under an obligation to do so, given the risk of making a loss on funds invested.

Paragraph 7(d) refers to a company being "deemed unable to pay its debts for the purposes of section 123 of the Insolvency Act 1986". A company is deemed unable to pay its debts under that section if:

It fails to satisfy a statutory demand within three weeks of one being served.

It fails to satisfy the execution of a judgment or other court order.

It is proved to the satisfaction of the court that the company is:

o unable to pay its debts as they fall due; or

o has liabilities that exceed its assets.

(Sections 123(1)(a) and (2), Insolvency Act 1986.)

Paragraph 9, Part 2, schedule 4: Further Relevant Change Letters

See Drafting note, Confirmation of relevant change to PSC register on Completion.

Schedule 5: Warranties

Warranties are contractual statements contained in the SSA. They take the form of assurances from the Warrantors (in this case, the Company and the Founders) as to the condition of the Company and its business.

Warranties serve two main purposes:

To provide Investors with a remedy (a claim for breach of warranty) if the statements made about the company later prove to be incorrect and the value of the company is thereby reduced.

To encourage the Warrantors to disclose known problems to Investors. As the Warrantors' liability under the Warranties is invariably limited to the extent that proper disclosure is made against them, the effect of the Warranties should be to flush out potential problems.

Schedule 5 sets out an example warranty schedule. Its content is fairly comprehensive and covers most aspects of the Company and its business. However, individual warranties must be tailored to each transaction and to the nature of the business that the Company carries out.

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For example, if the Company does not own or develop large amounts of intellectual property, extensive intellectual property warranties may be redundant.

References in these drafting notes to a numbered warranty are to that numbered paragraph of Schedule 5.

In any transaction, it is unlikely that warranty statements can be completely comprehensive. A thorough due diligence exercise should provide the Investors with a good picture of the value of the target company or business. Warranties should not be seen as a substitute for due diligence; the two are complementary. It is always preferable for an Investor to know of a problem in advance.

The Warrantors will want to give as few Warranties as possible. Where they are unable to give a warranty in the form drafted, they should consider:

Disclosing against it in the Disclosure Letter.

Adding a materiality or knowledge qualification such as "so far as the Warrantors are aware" or "save as disclosed". The Investors, however, are likely to resist accepting Warranties qualified by materiality or awareness, as it reduces the comfort they can take from those Warranties.

Rewording the Warranty so that it is in a form that the Warrantors are able to give.

Deleting the Warranty, although note that deleting a warranty without good reason may be counter-productive.

The parties should carefully consider any materiality qualifications, such as the financial limits in the litigation warranty (paragraph 8, schedule 5), in the context of each transaction. What is material for an established company is likely to be different for a recently established university spin-out company.

The Warrantors may wish to consider insuring the risk of any claims arising under the Warranties. Various companies offer specialist policies of this nature. For more information, see Practice note, Warranties and indemnities: acquisitions: Warranty and indemnity insurance.

In the context of any disclosure exercise relating to the Warranties, it will be very important to note the provisions of clause 2.15 (see Drafting note, Clause 2.15: References to the Company). That clause provides that, in specified provisions of the SSA, a reference to the Company, or to the Directors, is to be considered as also including a reference to each Group Company and to the directors of each such Group Company. The Warranties of schedule 5 are included within that list of specified provisions. As a result, if the Company has any Subsidiaries, disclosure against each Warranty should take account of any matters that ought to be disclosed in relation to the Company and to each such Subsidiary. It will be important for those advising the Warrantors on the disclosure exercise to bring this point to their attention.

For further general background about warranties generally, see Practice note, Warranties and indemnities: acquisitions and Drafting note, Clause 5: Warranties.

Warranty 1: Share capital and authority

It will be of paramount importance to how the Investors will model their investment in the Company that they correctly understand the share capital structure and who owns it. Given how fundamental this matter is, the Investors should consider carving the Warranties in paragraphs 1.1 and 1.2 out of the limitations of liability in clause 6. Such a carve-out is included in clause 6.1(b).

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Warranty 1.1 only relates to Shares held by the Founders. Consider including an additional Warranty stating that there are no Shares or options over Shares other than those set out in part 1 of schedule 3. Such a warranty is set out in paragraph 2.2.

Warranty 1.3 is designed to reassure the Investors that the entry by the Warrantors into the SSA will not trigger a breach of, or incur a liability under, any other agreement to which a Warrantor is a party.

Warranty 2: Information

Warranty 2 relates to the information provided to the Investors by the Warrantors during negotiations and in the Disclosure Letter.

Warranty 2.1 may be heavily negotiated. The Investors will be relying on the Disclosure Letter, and may argue that they should have a separate right of recourse if its contents are inaccurate. However, the Warrantors may seek to resist warranting the contents of the Disclosure Letter by arguing that:

The Investors will have a claim under the relevant Warranty, if any disclosure against that Warranty is inaccurate, because the disclosure will not meet the required standard of "fair" disclosure (see Drafting note, Clause 1: Disclosed). It is therefore unnecessary to warrant the accuracy of the disclosures themselves.

The main purpose of the disclosure exercise is to protect the Warrantors from Claims. The Disclosure Letter should not, therefore, be used to provide the Investors with additional grounds for a Claim.

If the Warrantors do warrant the contents of the Disclosure Letter, they should resist also warranting the contents of the disclosure bundle that accompanies the Disclosure Letter, as the bundle will contain information not produced by the Warrantors. The Warrantors may also wish to resist warranting that the Disclosure Letter is "complete", as this word may be seen as incompatible with the meaning of the term "Disclosed".

Warranty 2.3: Matters not disclosed

In most cases, the Warrantors should resist a Warranty asking for disclosure of any other information that may be relevant to an Investor's decision to invest in the Company. Warranty 2.3 is qualified by awareness and relates only to information a reasonable investor may consider influential. To that extent, Warrantors may be better able to disclose against a warranty in these terms, than against one that requires disclosure of all information that would be relevant to a specific Investor's decision to invest.

Warranty 2.4: Questionnaires

It is common for Investors to ask each Founder to complete a questionnaire in respect of his personal circumstances. Such a questionnaire will address issues such as bankruptcy, court judgments, criminal offences and, potentially, a Founder's assets. As with warranties 1.1 and 1.2, warranty 2.4 is not subject to the Warranty limitations of clause 6.

As drafted every Warrantor, including the Company, is required to give warranty 2.4 on a several basis, Consider whether it may be more appropriate for this warranty only to be given by those individual Warrantors who have completed a questionnaire and then only in respect of their own such questionnaire.

Warranty 3: Business Plan

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The Business Plan is an agreed form document and must be delivered to the Investors at Completion (see paragraph 2 of Part 1 to schedule 4). Warranty 3 sets out a series of statements asking the Warrantors to stand behind that Business Plan.

In practice, it is common for the Business Plan to be an organic document that is discussed and agreed between the Founders and the Investors in the period before Completion. Often the Investors will base their investment return projections at least in part on the contents of the Business Plan and so these Warranties will be of material importance to the Investors, who will not expect any disclosures to be made against them of information not already known to the Investors.

Warranty 4: Accounts

Under the CA 2006, a company's directors have an obligation not to approve the company's annual accounts unless they give a true and fair view of the financial position of the company and, in the case of group accounts, the group (section 393, CA 2006). As a result, where the Company is incorporated in the UK, the Warrantors will usually be expected to warrant that the Accounts show a true and fair view of the Company's financial position.

Note that a true and fair Warranty may not give the Investors comfort in respect of liabilities not shown in the accounts that were unknown to the Warrantors and undiscoverable at the time of preparation of the Accounts. For more information on the requirement for accounts to show a true and fair view, see Practice note, True and fair view.

Warranty 4.1 should be tailored to reflect the basis upon which the target group's accounts are prepared. Since 1 January 2005, any unlisted UK company or group has been able to elect to prepare its accounts in accordance with EU-adopted International Financial Reporting Standards (IFRS), instead of UK GAAP, and still comply with the requirements of UK company law. Warranty 4.1 assumes that the Company prepares its accounts in accordance with UK GAAP. However, on 1 January 2015, UK GAAP moved to a new regime which is more closely aligned with IFRS. For accounting periods beginning on or after 1 January 2015, a new set of UK accounting standards apply. For sample accounts warranties drafted to reflect new UK GAAP, see Standard clause, Warranties for accounts prepared under IFRS: share purchase agreement.

For general information on accounting standards applicable to UK companies, see Practice note, Accounting standards.

Warranty 5: Management Accounts

A management accounts warranty, when combined with the Warranty relating to post-accounts date changes (see warranty 6), is important in bringing the financial position up-to-date, particularly where the Accounts are more than a few months old.

In relation to Management Accounts, there are a few points to bear in mind:

There is no statutory requirement for companies to produce them. What they consist of and the standards to which they are prepared are internal matters, which vary from company to company.

They are normally unaudited and it is probably unreasonable to expect the Warrantors to warrant them to the same standard as the Accounts, although they should normally be prepared using the same accounting principles and practices.

Warranty 6(c): Dividends and distributions

The term "distribution" has a specific meaning for tax purposes (that differs from the CA 2006 definition). The tax definition includes, broadly:

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Any dividend paid by a company.

Any distribution out of the company's assets in respect of shares in the company except to the extent it represents repayment of capital or is for new consideration.

The issue of securities or redeemable shares in respect of shares or securities in the company otherwise than for new consideration.

Interest on non-commercial securities (being securities the interest on which exceeds a reasonable commercial return) and interest on special securities if paid to a company that is not within the charge to UK corporation tax. Special securities include bonus securities and unlisted convertible securities, and securities the interest on which is results-dependent.

Other amounts that are treated as distributions, including certain expenses incurred by a close company in providing benefits and facilities to participators (broadly shareholders).

Warranty 7.1: Tax returns

The purpose of warranty 7.1 is to ensure that the Company's tax returns have been made on time. Late returns or notices, or the failure to provide information on time, can result in penalties being imposed.

Consider widening this warranty to cover the completeness and accuracy of the returns, notices, accounts and information.

Warranty 7.2: Taxation payments

The purpose of warranty 7.2 is to establish whether the Company has paid all the tax it was obliged to pay before Completion. Otherwise, interest could accrue on the unpaid tax and penalties could be imposed.

Consider whether a warranty for deferred tax is required. Deferred tax is not a tax but is an accounting concept. It is concerned with preventing distortions in the accounts arising from tax and accounting timing differences (for example, if, in a period, taxable profits are reduced by reliefs for tax purposes but accounting profits are not reduced to the same extent). The timing difference will reverse in a future period and is reflected in the accounts as a deferred tax liability. A deferred tax liability reduces the net value of the balance sheet. If the deferred tax provision is too low, the balance sheet value may be misleading.

Warranty 7.3: Tax deductions

Warranty 7.3 seeks to establish that the Company has complied with its withholding tax obligations (for example, under PAYE and the construction industry scheme).

For information about PAYE, see Practice note, Pay as you earn (PAYE) and for information about the construction industry scheme, see Practice note, Construction Industry Scheme (CIS). For information on other withholding obligations, see Practice note, Withholding tax.

Warranty 7.5: Employment-related securities

Warranty 7.5 seeks disclosure of all employees, directors and other officers who have received employment-related securities, or interests in them, or employment-related securities options.

Part 7 of ITEPA includes provisions that can lead to income tax charges on the acquisition and disposal of employment-related securities, and on various post-acquisition events. Likewise, employment-related securities options fall within Part 7 of ITEPA, which imposes income tax

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charges on the exercise of the options, or cancellation of the options for consideration (as well as other events relating to options).

When income tax is payable in respect of employment-related securities and options, if the securities are readily convertible assets, or the individual receives cash or readily convertible assets in connection with the securities or securities options, the income tax due must be accounted for by the employer under PAYE, and Class 1 (employee and employer) NICs will be due.

Investors will want to check (among other things) that:

The employer has properly accounted for tax and NICs.

Employees/officers have properly "made good" any income tax liability so that future Class 1 NICs liabilities are avoided.

Employees/officers have agreed to suitable mechanisms to minimise and satisfy any future NICs and tax liabilities.

For an overview of the taxation of employment-related securities and options, see Practice note, Taxation of employment-related securities: Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003): overview.

Warranty 7.6: Readily convertible assets

If securities, or interests in securities, are readily convertible assets (RCAs) and an income tax charge arises in respect of them, the employer must account for tax and employee NICs through PAYE. The employer will also be liable to pay employer NICs. Given employee tax and NICs cannot be deducted directly from RCAs as they can from any cash payment, the Investors will want to be sure not only that tax and NICs were deducted and accounted for to HMRC, and class 1 employer NICs were paid (to avoid penalties), but also that no section 222 liability arose (giving rise to a further Class 1 NICs liability).

For information about readily convertible assets, see Practice note, Readily convertible assets.

Warranty 7.7: Section 431 elections

If no disclosure is made against warranty 7.5, then warranty 7.7 should also not elicit any disclosure. It seeks confirmation that section 431(1) elections have been entered into. A section 431(1) election is an election to be taxed up-front on the unrestricted market value of shares and to opt out of the restricted securities regime in Chapter 2 of Part 7. While entering into the election will bring forward and potentially increase the tax charge on acquisition of the securities, it ensures that the entire gain on the disposal of the securities is subject to CGT rather than income tax (provided that the shares are disposed of for market value). Section 431(1) elections must be in the standard HMRC form, or using a different form expressly approved by HMRC, and made within 14 days after the securities were acquired. Requiring copies of the elections ensures that these requirements can be checked.

For more information, see Practice note, Restricted securities elections: section 425, section 430 and section 431 elections.

Warranty 7.8: Close companies

Warranty 7.8 should be read with warranty 7.9. Broadly, a close company is a UK-resident company which is under the common control of five or fewer participators or of any number of participators who are also directors (section 439, CTA 2010). Where a close company makes a loan to a participator (or associate of the participator) and that loan (or part of it) is outstanding 9 months and 1 day after the end of the accounting period in which the loan is

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made, that company must pay a tax charge equivalent to 32.5% of the amount of the loan outstanding (sections 455, 459 and 460, CTA 2010). However, if and when the loan is repaid or is released or written off (in whole or in part), the company is able to reclaim the tax charge (or a proportionate part of it). If the loan is released or written off and the company suffered a corporation tax charge, the participator is treated as having received a dividend. A company that is not close will not fall within the provisions of this warranty.

The concept of a close-investment holding company was repealed from 1 April 2015. Prior to that date, companies with taxable profits of under £300,000 qualified for the small companies rate of corporation tax (20%). However, close investment holding companies were prohibited from benefiting from that rate.

For more information about the taxation of close companies, see Practice note, Close companies: tax.

Warranty 7.9: Loans and distributions

Warranty 7.9 should be read with warranty 7.8. Benefits and facilities (such as living accommodation) provided by a close company to its participators (or their associates) may be treated as distributions (section 1064, CTA 2010). If so, their provision will not be a tax deductible expense.

Warranty 7.10: Asset acquisitions and disposals

Warranty 7.10 seeks to identify any transactions which are susceptible to adjustment for tax purposes (for example, where the arm's length or market price may be substituted for the actual price).

Warranty 7.11: Value Added Tax Act 1994

Warranty 7.11 seeks confirmation that the Company is registered for VAT and has never been a member of a VAT group. The concern with VAT groups is that liability for VAT is joint and several between group members. Accordingly, a member or former member of a VAT group could become liable to pay unpaid VAT in connection with the VAT group. The company may wish to limit the warranty to a set period before Completion. Six years is generally acceptable.

Depending on the nature of the Company, it may be advisable to extend the warranty to seek confirmation that all supplies made by the Company are taxable supplies. The concern here is to establish that all input tax is recoverable.

For information about VAT and VAT groups, see Practice note, Value added tax.

Warranty 8.3: Bribery Act 2010

Warranty 8.3 sets out a relatively short form warranty in respect of offences under the Bribery Act 2010 (BA 2010). It supplements the general compliance with laws warranties set out in warranty 14.

For companies at a more developed stage of their business, the Investors may seek more extensive anti-corruption Warranties. It may also be appropriate to seek a warranty stating that the Company has adequate procedures in place to prevent bribery by their associated persons (as defined by the BA 2010). If adequate procedures are in place, this will operate as a defence to an offence under section 7 of the BA 2010. In this agreement, note the undertaking relating to adequate procedures in paragraph 10 of schedule 7.

For example longer-form warranties in the context of a share purchase, see paragraph 30 of Part 1 to schedule 4 of Standard document, Share purchase agreement: multiple individual sellers: simultaneous exchange and completion.

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Warranty 9: Properties

The Investors' due diligence exercise will include property enquiries.The extent of those enquiries will depend upon the Company's particular circumstances. Many early stage companies will have limited property interests and so it may be possible to reduce significantly the scope of the warranties in paragraph 9.

When buying commercial property, pre-contract enquiries are often raised using the Commercial Property Standard Enquiries (CPSE). These are industry-standard forms, prepared by members of the London Property Support Lawyers Group and endorsed by the British Property Federation (see Practice note, Commercial Property Standard Enquiries).

Although a venture capital investment does not involve the transfer of ownership of any asset, the Investors are likely to want to know whether there are any property issues, as they might have an adverse impact upon:

• The Company's ability to operate from the Properties.

• The investment value of the Properties.

• The Company's income stream.

Depending on the circumstances, it may be appropriate for the Investors to raise queries based on some of the matters covered by CPSE.1.

For general information on the property investigation process, see Practice note, Investigating the property. For information on pre-contract enquiries, see Practice note, Investigating the property: pre-contract enquiries.

Warranty 9: Environmental issues

As drafted, the Warranties do not include specific warranties on environmental matters, other than the CRC warranty (see warranty 9.9). In any transaction it will be important to tailor the Warranties and, depending on the nature of the Company's business, environmental matters could affect the value and viability of the Company. For example:

A history of heavy industrial use at one of the Properties could give rise to liability for contamination. Remediation, particularly of water pollution, can be very expensive. For more information, see Practice note, Contaminated land regime: overview.

Tightening environmental standards (for example, relating to carbon emissions) could require significant investment in plant or equipment.

However, as the SSA is designed for venture capital investments into early stage companies, a relatively short track record may limit the need for specific environmental protection. In such cases, it may be sufficient to rely on the general Warranties for environmental protection, in particular the Warranties on:

Compliance with law and permits (paragraph 14, Part 1, schedule 5).

Absence of litigation or regulatory investigation (paragraph 8, Part 1, schedule 5).

The physical condition and liabilities concerning any of the Properties (paragraph 9.9, Part 1, schedule 5).

If the nature of the Company's operations or other activities at the Properties (including historic activities) indicate that environmental issues could be a risk, and the size of the investment merits it, the Investors may wish to carry out environmental due diligence and consider

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appointing environmental consultants to carry out an environmental report. For more information, see Practice note, Appointing environmental consultants.

If environmental risks are identified, the subscription agreement should include specific environmental warranties. The basic environmental warranties should cover:

Compliance with environmental law and permits.

No contamination or presence of hazardous substances.

No litigation or regulatory investigations or proceedings.

Additional environmental warranties may be needed if there are specific areas of risk that fall outside those areas (for example, see Practice note, Environmental warranties: overview). Some types of activity also have a high risk of claims for industrial disease. If this is the case, then health and safety warranties should also be considered.

For further background on possible environmental issues, see Practice note, Environmental law: overview.

Warranty 9.1: Extent of the Properties

It will be important for the Investors to seek confirmation that schedule 8 (The Properties) sets out details of all the properties owned by the Company (and any other Group Companies), as the property schedule effectively defines the extent of the property-related assets and liabilities of the Company in which the Investors are acquiring an interest. Warranty 9.3 includes a further warranty that all those details are accurate.

Note that warranty 11.3 confirms that (subject to some qualifications) all assets used by the Company are at the date of Completion its absolute property. In the case of tenanted property, prima facie all fixtures attached by the tenant become the landlord's property. However, the tenant may remove them during the term of the lease (unless prevented under the lease or licence for alterations). Depending upon the circumstances, appropriate disclosure of the lease terms may need to be made.

Warranty 9.2: Good and marketable title to Properties

The aim of warranty 9.2, that the Company is the sole owner of the Properties, is to flush out the existence of any trust arrangements and to ensure that the Company has full title to its assets.

The warranty that the Company has good and marketable title is appropriate in circumstances where the Investors will carry out limited, or no, title investigation. For information on investigating title, see Practice note, Investigating the property: title investigation.

Note that, in relation to the warranty that the Company holds the title documents for the Properties and that they are in good order, the Company may well have no documents, or very few, if the relevant Property is registered. This is because the register at the Land Registry is intended to be a complete and accurate reflection of the state of the title of the land at any given time, so that it is possible to investigate title to land online, with the minimum of additional inquiries and inspections.

Warranty 9.3: Adverse rights

There may be adverse rights of which the Investors would not be aware even after making searches at the Land Registry, Land Charges department or Companies House. For example, leases of three years or less cannot be noted and (with some exceptions) is not registrable at the Land Registry. Warranty 9.3 obliges the Warrantors to set out details in schedule 8.

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Warranty 9.4: Access rights

Warranty 9.4 contains a statement that the Properties have adequate access rights. In situations where the Investors can undertake a full title investigation, they should be able to discover these matters for themselves. However, it may not be feasible, or appropriate, for the Investors to investigate the position (or, in exceptional cases, there may be too many Properties to investigate).

The Warrantors might seek to qualify this warranty in the Disclosure Letter by reference to the title investigation that the Investors have undertaken, or should have undertaken. In such cases, the Investors may only wish to accept a qualification of this nature by reference to the title investigation that they have actually undertaken.

Warranty 9.5: Lease obligations

Warranty 9.5 deals with compliance with all obligations affecting the Properties. This could potentially cover statutory obligations, as well as leasehold obligations.

In the case of leaseholder obligations, it may be unrealistic for the Investors to expect that all obligations in a lease have been fully performed and observed at all times by both the landlord and the tenant. It is inevitable that one or more of the obligations will have been broken at some stage. As an example, the tenant's repair and decoration covenant is frequently breached. It may be appropriate therefore for the Warrantors to limit this warranty to compliance "in all material respects".

From a commercial perspective, the Investors may not be concerned about absolute compliance, but rather material compliance. Although any breach of the lease terms will allow a landlord to take enforcement action, it is more likely that a material breach will result in the landlord taking enforcement action against the tenant, including forfeiture.

If the Company as tenant has committed a material breach of covenant, it could prove expensive for the Company to remedy, or the landlord might forfeit the lease. If the lease is forfeited this may affect the Company's ability to operate.

For more information, see Practice notes, Why landlords need to know whether tenant breaches are capable of remedy and Forfeiture: a practical overview.

Warranty 9.6: Outstanding liabilities

Examples of residual liability in relation to Properties include:

Tenant liability. If the Company was previously the tenant under a lease, it may retain liability even after it has assigned the lease. For more information on a tenant's liability, see Practice note, Section 17 of the Landlord and Tenant (Covenants) Act 1995.

Guarantor liability. The Company may have given a guarantee. A typical example would be where a lease is taken by a subsidiary company and the Company provides a guarantee for the performance of the tenant covenants by its subsidiary.

Landlord liability. Where the Company has been a landlord and has assigned the property, it may still remain liable in respect of the landlord covenants. For more information, see Practice note, Statutory and contractual ways to release a landlord from landlord covenants and Practice note, Transfers: when is an indemnity covenant required?.

Freehold liability. If the Company owns freehold property and has entered into covenants, as an original contracting party the Company could remain liable under those covenants.

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Warranty 9.7: Property insurance

The Company will need to consider whether any disclosure needs to be made in the Disclosure Letter in respect of warranty 9.7. For example, it may be that a Property is not insured for damage by terrorism or in respect of flood damage.

If any Property is subject to a lease, the Investors may wish to check whether rent is still payable in the event that the Property is damaged and whether the insurance covers loss of rent, as the rent may be a valuable income stream for the Company. Likewise, if a Property is itself leasehold property, the Investors may wish to check whether the Company is still obliged to pay rent if the Property is damaged.

Warranty 9.8: Local authority searches and enquiries

Raising enquiries of the local authority is one of the standard pre-exchange searches that should be carried out when acquiring a property or an interest in it (see Practice note, Investigating the property: Pre-exchange searches).

The Investors will often ask the Warrantors to warrant the accuracy of any replies to enquiries. Any such replies will most likely form part of the disclosure bundle accompanying the Disclosure Letter, so that there is a complete record of information provided to the Investors.

Warranty 9.9: Community Infrastructure Levy (CIL)

CIL is a charge on new buildings above a certain size that local planning authorities may choose to set and which is designed to help fund local and sub-regional infrastructure identified in their development plans. CIL will be paid primarily by owners or developers of land that is developed.

CIL is a local land charge and will need to be registered in the local land charges register. The local land charge register will show that CIL is due on the commencement of CIL liable development. Purchasers of affected land will therefore be aware of any CIL liabilities.

For more information, see Practice note, Community Infrastructure Levy: an overview.

Warranty 9.9: CRC Energy Efficiency Scheme

The CRC Energy Efficiency Scheme (CRC) is a mandatory emissions trading scheme for large businesses and public sector organisations in the UK. It requires participants to measure and report on their energy consumption and buy allowances for the amount of carbon dioxide emissions associated with their energy consumption. There are significant penalties for non-compliance. Landlords that are covered by the CRC may be able to pass the cost of purchasing CRC allowances on to their tenants, depending on the terms of the lease.

However, in the 2016 Budget, the government confirmed that, following its review of business energy efficiency taxes, it would abolish the CRC from the end of the 2018-19 compliance year. Businesses will be required to surrender allowances for the final time in October 2019.

For more information, see:

Practice note, CRC Energy Efficiency Scheme: overview.

CRC Survival Kit: issues for specific sectors: Private equity.

Practice note, CRC Energy Efficiency Scheme: what changes have been made to the scheme since it was launched?.

Warranty 10: Intellectual Property

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Paragraph 10 sets out detailed Warranties relating to intellectual property. If intellectual property does not play a significant role in the Company's business, it may be possible to reduce the scope of these Warranties.

The IT Warranties in paragraphs 10.16 to 10.20 are intended for use in relation to a general commercial company. More detailed warranties are likely to be needed if the Company is itself in the business of providing IT products or services.

Warranty 10.1: Protection of Intellectual Property

Warranty 10.1 states that the Company has fully protected itself with regard to intellectual property and know-how and that it has not granted any rights to third parties. If the Company has in fact licensed any of its rights (for example, the rights to use its name or its technology), this should be set out in the disclosure letter as referred to in warranty 10.4.

The Warrantors may wish to qualify the warranty by:

Limiting the warranty to provide that the Company has taken those steps to protect its Intellectual Property that the Founders reasonably consider to be necessary or desirable.

Limiting reference to Intellectual Property and know-how used by the Company to that which is used in the ordinary course of business.

Warranty 10.2: No infringement by the Company

Warranty 10.2 covers infringement by the Company of third-party rights. The Warrantors are likely to request that this warranty is qualified by reference to their knowledge and that the paragraph starts with the words "So far as the Warrantors are aware…"

Warranty 10.3: Ownership or licensing of Intellectual Property

Warranty 10.3 confirms that all material Intellectual Property is fully vested in the Company or licensed to it.

The Investors may wish to add the words "(including know how)" after Intellectual Property for the sake of completeness and certainty, if know how is particularly relevant to the business.

Warranty 10.4: Intellectual Property licences

Warranty 10.4 will prompt disclosure of all licences entered into by the Company in any capacity, such as licensor or licensee. Warranty 20.14 includes optional wording that would exclude the need for the Warrantors to disclose licences of Off-the-Shelf Software. The Investors are unlikely to be interested or concerned by any such licence and so may consider their disclosure unnecessary. If those optional words are omitted (so that disclosure of such licences is required), the corresponding definition should be omitted from clause 1.

Warranty 10.5: Infringement of Company Intellectual Property

In warranty 10.5, the Warrantors warrant that none of the Company's Intellectual Property is being infringed or misused by any third party, or is subject to any licence or similar right.

The Warrantors are likely to want to qualify this warranty by reference to their knowledge and belief.

Warranty 10.6: Validity of Intellectual Property

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Warranty 10.6 aims to elicit disclosure of all registered intellectual property rights (and applications for the same), which are warranted to be fully vested in the Company, valid, enforceable and not subject to any opposition.

The Investors should consider extending this warranty to cover all defined Intellectual Property, not just registered Intellectual Property.

Warranty 10.9: Applications to register Intellectual Property other than by the Company

Warranty 10.9 states that no third party has registered or applied to register any intellectual property right made or claimed to be owned by the Company.

The Warrantors are likely to want to qualify this warranty by reference to their knowledge and belief.

Warranty 10.10: Licences, agreements and arrangements

Under warranty 10.10, the Warrantors provide assurances about licences and other agreements entered into by the Company, which are specified to be in full force, not subject to notices to terminate, unamended, fully complied with and not subject to dispute.

The Warrantors are likely to want to qualify this warranty by reference to their knowledge and belief.

Warranty 10.11: Disclosure of confidential information

Warranty 10.11 relates to non-disclosure of the Company's know-how, confidential information and the like.

The Warrantors are likely to want to qualify this warranty by reference to their knowledge and belief.

Warranties 10.13 and 10.15: Domain names

These Warranties relate to domain names. Warranty 10.13 states that no third party has registered a domain name that is similar to the Company's domain names or trade marks. The Warrantors are likely to want to qualify this warranty by reference to their knowledge and belief.

Clause 10.15 states that there are no third-party claims that the Company's domain names infringe any third-party rights. It is qualified by reference to the Warrantors' awareness.

For more information, see Practice note, Domain names.

Warranty 10.14: Company Website

There are many types of laws and regulations and codes of practice that could apply to the contents of the Company Website, such as:

Intellectual property rights (see Practice note, Website contracts: Website content licences).

Data protection (see Practice notes, Overview of UK data protection regime, EU General Data Protection noter-up: history and background and Data Protection and the internet).

Advertising and marketing (see Practice note, Direct marketing).

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Regulation of the advertising and marketing of specific services or products, for example, financial services or medicines (see Country Q&A, Medicinal product regulation and product liability in UK (England and Wales): overview: Advertising).

Consumer law (see Practice notes, Consumer Contracts, Consumer Rights Act 2015: overview, Consumer law toolkit and Checklist: Consumer contracts).

Defamation and obscenity (see Practice note, Overview of defamation).

Trading disclosures (see Practice note, Trading disclosures).

Language requirements.

For information on linking, see Practice note, Linking and framing.

Warranties 10.16 and 10.17: Open-source software (Drafting note last reviewed August 2017)

Open-source software (OSS) is increasingly used in the development of software and systems. However, its use carries with it potentially far-reaching obligations to third parties which can significantly devalue the intellectual property rights in the affected software or system.

Specifically, OSS is provided under a licence which grants certain freedoms to the licensee. There are various OSS licences. The GPL family of licences account for over 50% of OSS. These are the most common and can require the licensee to pass those freedoms on to any person to whom he has distributed the software that incorporates the OSS code.

The ambit of the Warranties in paragraphs 10.16 and 10.17 is broad and the Warrantors may seek to limit their scope. For more information, see Practice note, Open-source software toolkit.

Warranty 10.18: Third party and shares IT assets and Computer Data (Drafting note last reviewed August 2017)

Warranty 10.18 is designed to flush out whether any elements of the Company's Computer System are owned by, or subject to arrangements with, third parties.

If elements of the Computer System are provided by third parties (for example, leased equipment, software licences or services agreements), the Investors may need to review the relevant arrangements to ensure they will not be affected by the proposed investment.

Computer System is defined to include Computer Data. Databases, such as customer and employee databases, can be extremely valuable to a business.

Warranty 10.19: Computer System Data (Drafting note last reviewed August 2017)

The Investors should ensure that the various elements of the Computer System are sufficient for the Company's business requirements.

Warranty 10.19(a) should flush out, for example, whether the Computer System is in any way dependent on any cloud computing services. If so, the Investors will need to review the identity of the cloud service providers and the location of their servers, as this could have a bearing on data protection compliance and security issues (see the Warranties in paragraph 14.6 and Practice notes, Data protection aspects of cloud computing, Cloud computing: due diligence and security assurance and Cloud computing: overview).

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Warranty 10.19(b) addresses maintenance of the Computer System. As regards the software comprised in the Computer System, it is important to flush out whether the software used by the business is currently maintained and supported. The Warrantors may seek to limit the warranty, insofar as it relates to software, to material software.

Warranty 10.19(c) is aimed at ensuring that the Company can adjust the Computer System from time to time to meet any changing foreseeable business needs. The Investors should examine the specification of the Computer System to ensure that it is sufficient to meet the Company's capacity, scalability and performance requirements.

Warranty 10.19(d), in combination with warranty 10.18, should also flush out whether relevant source code is owned by a Group Company or by a third party, in which case access to it will need to be assured by way of a source code deposit (or escrow) agreement to which an appropriate company within the group is a party.

Warranty 10.20: Disaster recovery (Drafting note last reviewed August 2017)

If the back-up procedures of personal data involve storage in the cloud, consider whether to amend this warranty to specify that the Company meets ISO/IEC 27018:2014 (Code of practice for protection of personally identifiable information (PII) in public clouds acting as PII processors).

It will be necessary to review these warranties and amend or supplement them in light of the data security requirements under the General Data Protection Regulation (GDPR) and the Network and Information Security Directive (NIS Directive) that will come into force in May 2018 (directly and by national implementing legislation respectively).

The GDPR and NIS Directive requirements are general and sector-specific (operators of essential services and digital service providers) respectively. There are mandatory requirements under each of these instruments to notify authorities "without undue delay" (capped at 72 hours in the case of the GDPR). The GDPR requirements extend not only to notifying the authority but also, in cases of high risk, the affected individuals.

Both the GDPR and NIS Directive include obligations to ensure that appropriate technical and organisational measures are taken. (The Electronic Identification Regulation (EU/910/2014) (EIR), already in effect, imposes a similar obligation on providers of "trust services" such as businesses involved in providing identification, verification or authorisation of a person's identity in electronic transactions.)

Certain GDPR breaches contemplate fines of up to EUR20 million or 4% of annual worldwide turnover (whichever is higher). Non-compliance with the UK legislation implementing the NIS Directive will have serious consequences, with potentially significant fines of between EUR10 million and EUR20 million or 2% to 4% of the organisation's global turnover. Sanctions under the EIR include liability for damage arising in relation to a breach of the EIR which is caused negligently or intentionally.

Guidance on the GDPR from the Information Commissioner's Office and consultation proposals on the UK transposition of the NIS Directive has also been published and these will also need to be reviewed. For more information, see:

EU General Data Protection Regulation: Practical Law coverage.

Standard clause, Data processing clauses (GDPR version).

Legal update, ICO consults on GDPR guidance on contracts and liabilities.

Practice note, EU cybersecurity framework: Part 2.

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Legal update, Consultation on UK transposition of Cybersecurity Directive.

Warranty 13: Employment and consultancy arrangements

Paragraph 13 includes employment Warranties covering the following key areas:

The Company's workforce (its officers, employees, workers and consultants) and the terms and conditions of their employment or engagement.

Its relationship with any trade union or other employee representative body.

The Company's compliance with immigration legislation in respect of its employees.

The Company's liabilities and obligations in relation to its workforce.

The Company's pension scheme.

Compliance with employment legislation and any employment or trade union disputes are dealt with under "Social obligations" at warranty 20 of Part 1 to this schedule.

"Worker" is defined in clause 1 of the agreement by reference to the definition in section 88(3) of the Pensions Act 2008. "Employee" is not defined in this agreement.

For more information, see Practice note, Employment: share purchases and Checklist, Employment issues on a share purchase.

Warranty 13.1: Employee details

Warranty 13.1 seeks disclosure of the terms and conditions of all of the Company's officers, employees, workers and consultants. If the Company has a large workforce, consider limiting the scope of the warranty to certain categories of personnel. One option may be to limit "employees" to "Key Employees" (see the definition in clause 1). However, exercise caution over any limitation especially if the business relies heavily on the services of individuals who are not employees. The Investors should ensure that the disclosures cover all key personnel whether they are employees or not.

Consider whether to widen the warranty to include disclosure of information about agency workers. Although section 89 of the Pensions Act 2008 treats an agency worker as a "worker", they would usually be treated as the agency's worker. They would only be treated as the Company's worker if the Company either had a contract directly with the agency worker, or paid them directly.

Consider amending this warranty to provide for the workforce information to be anonymised, in order to avoid disclosing personal data. Unless an exemption applies, the requirement of fair processing in the Data Protection Act 1998 (DPA 1998) would normally require the Company to tell any data subjects of the disclosure of their personal data, and would also require the Investors to notify the data subjects that they are in receipt of it. If this is undesirable the data should ideally be anonymised so that it falls outside the DPA when in the hands of a potential Investor.

For further information on issues relating to the DPA, see Practice note, Data protection issues on commercial transactions.

Warranty 13.2: Trade unions and other bodies

Warranty 13.2 concerns existing collective agreements or other arrangements with trade unions, works, council or other representative body and any existing or possible future industrial relations disputes.

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Arguably, warranty 13.2 does not apply to disputes with an individual employee, unless that dispute is being handled by a trade union or similar body. However, see warranties 8.1, 8.2 and 20.2 which would apply to individual employment disputes.

Warranty 13.3: Outstanding employment obligations

Warranty 13.3 is intended to ensure that there are no hidden liabilities to employees, directors or shareholders, such as arrears of salary, other payments (such as unpaid termination payments or employment tribunal awards) or other obligations, other than the current month's salary (since salary is normally paid monthly in arrears).

Warranty 13.4: Incentive schemes

If the Company has an employees' share scheme in place, this may have a number of implications for the transaction.

This document is drafted on the assumption that neither the Company (nor its corporate parent) has granted any options or other employment related securities to any employees of the Company. If there are any in existence, further more specific Warranties may be advised depending on the circumstances.

For further information, in the context of a share purchase agreement, see Standard clause, Warranties relating to employee share plans and other incentives: share purchase agreement.

Warranty 13.5: Gratuitous payments

Warranty 13.5 seeks to obtain disclosure of any gratuitous termination payments made. The Investors may wish to consider whether to delete "gratuitous" so that the warranty also covers termination payments made or pending in genuine settlement of actual or possible legal claims.

The warranty as drafted is not limited in time and would therefore cover any such termination payment whenever made or promised.

The warranty does not deal with actual or proposed terminations where no termination payment has yet been made or promised. The Investors may wish to seek a warranty that no notice to terminate the contract of any employee (or possibly just any Key Employee) is pending, outstanding or threatened, and that there are no circumstances likely to give rise to such notice.

Warranty 13.6: Immigration status

An employer that employs an individual who does not have the right to work in the United Kingdom may be liable to a substantial civil penalty under section 15 of the Immigration and Nationality Act 2006. It is also an offence under section 21 to employ such an individual if the employer has "reasonable cause to believe" they have no right to work.

The Warrantors may wish to qualify this warranty by reference to their awareness, although it should be noted that the employer will in any event have a statutory defence to the civil penalty or criminal prosecution if it has no reason to know of the illegality and has conducted the necessary checks of employees' documentation.

For further information on immigration issues, see Practice note, Prevention of illegal working and establishing the right to work in the UK.

Warranty 13.7: Pension schemes

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Investors will want to ensure that they are fully aware of all pensions commitments of the Company past and present (whether legally binding or not). This should cover any commitment to pay or provide pensions and similar benefits to the employees, including unapproved arrangements. The Company will normally disclose all such arrangements as part of the Investors' due diligence exercise.

Warranty 13.8: Pensions disputes

All ongoing pensions' disputes must be disclosed by the Warrantors. For the complainant, the Pensions Advisory Service and the Pensions Ombudsman offer a low cost route to raise issues with the Pension Scheme. The management of such claims, even if unsuccessful, can be an additional expense for the Company.

Warranty 13.9: Defined benefit schemes

When an employer ceases to participate in a defined benefit occupational pension scheme, a debt may arise under section 75A of the Pensions Act 1995. This debt is calculated by reference to the full cost of buying annuities for all affected members. The law in this area is complex and its impact has been examined in several court cases. If a Group Company has been involved with a scheme in the terms outlined in this warranty the Investors should carry out further enquiries to assess the extent of any liability. For more information, see Practice note, Statutory debt on the employer: overview.

Warranty 13.10: Relevant transfers

Occupational pension rights do not normally transfer under the Transfer of Undertakings (Protection of Employment) Regulations 2006, due to the operation of what is known as the "pensions exception", which came into effect on 30 August 1993.

The decisions in two European Court of Justice cases extended the application of TUPE to cover certain scheme benefits relating to redundancy and early retirement. These were held to pass under TUPE. Thorough due diligence and contractual protection may be needed to address this issue. If an issue does arise after due diligence has been carried out, the Investors may seek some form of indemnity protection from the Company.

For more information, see Practice note, Pensions issues on a TUPE transfer.

Warranty 14.6: Data Protection (Drafting note last reviewed September 2016)

Warranty 14.6 intends to ensure the Company's compliance with the DPA 1998. Under that Act, those responsible for the processing of personal data (Data Controller) must comply with a number of data protection principles and other procedural requirements.

Data Controllers must notify the Information Commissioner's Office (ICO) before processing personal data (section 18, DPA 1998). Failure to notify where required to do so under the DPA 1998 is a criminal offence. There is a charge for notification that is determined by the Company's annual turnover and/or number of employees. Under the terms of warranty 14.6(a), the Warrantors must disclose any failure on the part of the Company to comply with the notification requirement.

Schedule 1 to the DPA 1998 sets out a number of data protection principles. Among other things, those principles require that personal data is processed fairly and lawfully and that it must be obtained only for specified lawful purposes (and not further processed in a manner that is incompatible with these purposes). For more information, see Practice note, Data protection issues on commercial transactions and, in particular, Data protection principles.

The ICO is responsible for enforcing and overseeing the DPA 1998.Where it finds a breach of the DPA 1998, the ICO may serve data controllers with:

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Information notices, requiring data controllers to provide information about their processing operations (unless the information is self-incriminating or the subject of legal privilege).

Special information notices.

Enforcement notices, requiring data controllers to comply with the data protection principles.

It also has the power to impose a fine (up to a maximum of £500,000) for serious contraventions of the DPA 1998 (section 55A, DPA 1998).

Under the terms of the Warranties given under paragraphs 14.6(b) and (c), the Warrantors must disclose any breaches of the DPA 1998 by the Company and any sanctions imposed on it in response to those breaches. It must also disclose any breach of other Data Protection Legislation, including the Privacy and Electronic Communications (EC Directive) Regulations 2003 (as amended), the Regulation of Investigatory Powers Act 2000, the Telecommunications (Lawful Business Practice) (Interception of Communications) Regulations 2000 and all applicable laws and regulations relating to processing of personal data.

Individuals are entitled to compensation from data controllers for damage caused by any breach of the DPA 1998 (section 13(1), DPA 1998). Compensation is also available, in certain cases, where the individual suffers distress as a result of the breach (section 13(2), DPA 1998). Compensation can only be awarded by the courts and not by the Information Commissioner. Under the terms of warranty 14.6(d), the Warrantors must disclose any claims for damages the Company has received or of whose existence they are aware.

An individual can obtain a court order for the rectification, blocking, erasure or destruction of personal data the Company holds about him, which is inaccurate, and the court may also, where it considers it reasonably practicable, order the data controller to notify third parties to whom incorrect data has been passed of the rectification, blocking, erasure or destruction (section 14, DPA 1998). Under the terms of warranty 14.6(e), the Warrantors must disclose any order made against the Company for the rectification, blocking, erasure or destruction of any data under the DPA 1998.

Under certain circumstances, the Information Commissioner may (with a warrant from the court) exercise powers of entry, inspection and seizure of documents and equipment. In particular, the Commissioner has the power to require any person on the inspected premises to provide an explanation of any document or other material found on the premises (paragraph 1(3)(e), Schedule 9, DPA 1998) and to require such a person to provide information that is reasonably required to determine whether there has been any contravention of the data protection principles (paragraph 1(3)(f), Schedule 9, DPA 1998). Under the terms of warranty 14.6(f), the Warrantors must disclose any warrant the Company has received under the DPA 1998 authorising the Information Commissioner or other relevant authorities to enter any premises of the Company.

For further background information on the Data Protection Act 1998, see Practice note, Overview of UK data protection regime.

Warranty 15.1: Company records

Investors will want to ensure that the statutory registers of the Company are duly written up to the time immediately before completion. In practice, the Investors' solicitors should arrange to inspect the Company's statutory registers before Completion to ensure that they are properly written up.

For further information regarding the obligation to maintain statutory books, see Practice note, Company records.

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Section 790M of the CA 2006 requires all companies within scope (including all UK-incorporated private companies and many public companies) to produce, keep and maintain a separate register (PSC register) of individuals and certain legal entities with significant control over them. The PSC register constitutes a company record under section 1134 of the CA 2006. Failure to comply with the PSC regime (including section 790M) will generally result in criminal liability for both the company and each of its officer in default. Investors will therefore be keen to ensure that the Company has complied with its obligations under the PSC regime (see Practice note, PSC register: completing the register: Offences under the PSC regime).

For general information on the PSC regime and its scope:

Practice note, PSC register: completing the register.

Practice note, PSC register: identifying people with significant control.

Warranty 15.2: Company records: unregistered matters

While warranty 15.1 seeks confirmation that the company's records contain true, full and accurate records of all matters required to be dealt with therein, it is arguable that this would not require disclosure of an entry that has yet to be made, if the company is not in breach of an obligation to make that entry within a certain period. For example, the PSC regime requires a company to make certain entries in its PSC register on the occurrence of specified events, but no time period is specified for doing so. Optional warranty 15.2 aims to capture any such outstanding matters that the Warrantors are aware must be made, but which has not yet been completed.

Warranty 15.5: No relevant changes to PSC register

Section 790E of the CA 2006 requires a company to update its PSC register after becoming aware of a relevant change (as defined in section 790E(3)). Under paragraph 8 of Part 1 to Schedule 4, the Company must receive agreed form letters from existing PSCs or RLEs in relation to the Company whose details in the PSC register will require removal or amendment as a result of Completion (see Drafting note, Confirmation of relevant change to PSC register on Completion).

Warranty 15.5 seeks confirmation from the Warrantors that no other relevant change will occur as a result of Completion. The Warrantors may seek to limit the warranty to provide that the Company reasonably believes that Completion will not trigger any other relevant change, to more closely match the wording of the legislation.

A similar warranty is included in Part 2 to Schedule 5 in respect of the Second Completion Warranties.

Warranty 15.6: Holding information on the central register

Provisions introduced into the CA 2006 by the Small Business, Enterprise and Employment Act 2006 allow a private company to elect to keep information on the central register at Companies House, instead of entering it in the relevant register below:

The register of members (section 128B, CA 2006).

The PSC register (section 790X, CA 2006).

Register of directors and register of directors' residential addresses (section 167A, CA 2006).

Register of secretaries (section 279A, CA 2006).

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Where such an election has been made, information that would otherwise have to be registered by the Company must instead be filed with the Registrar, for inclusion on the central register. The Company does not have to make entries in its own registers although, in the case of the register of members and the PSC register, the Company must note the existence of the election and the date it took effect in its own register (then known as its historic register).

While, in each case, an election is made by giving notice of the relevant election to the Registrar, such an election does not take effect until registered by the Registrar. As such, it is possible that a search of the public register relating to the Company would not reveal that an election has been made.

If due diligence or draft disclosures reveal the existence of an election, it may be necessary also to include additional warranties relating to company obligations during the period such an election is in force (although, in many cases, those obligations will be covered by the general compliance warranties in paragraph 14).

Once made, an election may be withdrawn by giving notice of withdrawal to the Registrar but, again, this would not take effect until registered by the Registrar. Once it takes effect, the company is once again subject to the requirements to maintain the relevant register itself, in accordance with the requirements of the CA 2006.

For information on an election to hold PSC information on the central register, see Practice note, PSC register: completing the register: Alternative method of keeping PSC information.

Warranty 15.7: PSC register: warning notices and restrictions notices

Warranty 15.7 seeks to establish whether any warning or restrictions notices have been issued by the Company under the PSC regime. For further information on such notices and the circumstances in which they can be issued, see Practice note, PSC register: completing the register: Enforce the obligation to disclose.

A company is not required to issue a warning notice (which must precede the issue of a restrictions notice), but may do so if the recipient of a notice under section 790D of the CA 2006 has not responded to it within the required timeframe. Unlike a restrictions notice, a company's PSC register does not have to record the issue of a warning notice. As such, an Investor might be unlikely to learn of such an issue by inspecting the Company's PSC register.

A restrictions notice effectively disenfranchises the recipient's interest in the issuing company, and prevents any dealings in that interest while the notice continues in force (for further information, see Practice note, PSC register: completing the register: Effect of a restrictions notice). An Investor may therefore consider it important to confirm that there are no outstanding restrictions notices in respect of the Company's share capital, as such a notice could operate to prevent the transfer of the Sale Shares to the buyer.

The Warrantors may resist inclusion of reference to restrictions notices in warranty 15.7, on the basis that a company's PSC register is required to record the issue of such a notice (regulation 17(2), The Register of People with Significant Control Regulations 2016 (SI 2016/339)). As such, if the company had issued a restrictions notice not yet recorded in its PSC register, that would require disclosure under warranty 15.2 (Company records: unregistered matters).

Where due diligence or draft disclosures reveal the existence of a restrictions notice, it may be necessary also to include additional warranties relating to conduct obligations or rights to apply for court orders during the period such restrictions are in place (although, in many cases, those obligations will be covered by the general compliance warranties in warranty 14).

Warranty 17.2: PSC register: the Company as registrable relevant legal entity

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Part 21A of the CA 2006 requires all companies within scope (including all UK-incorporated private limited companies, many public companies and all UK LLPs) to create, complete and maintain a new statutory PSC register of individuals (PSCs) or legal entities (RLEs) that have control over them. For general information on the PSC regime and its scope, see:

PSC register: who must keep a PSC register: flowchart.

Practice note, PSC register: completing the register.

Practice note, PSC register: identifying people with significant control.

While the obligation to create and maintain a PSC register lies with the company or LLP that is subject to Part 21A of the CA 2006, the legislation also imposes proactive disclosure obligations on those who are registrable individuals or legal entities in relation to the company or LLP (for further details, see Practice note, PSC register: completing the register: PSC and RLE obligations).

Warranty 17.2 requires the Warrantors to disclose whether the Company (or, by virtue or clause 2.15, any other Group Company) is a registrable RLE in relation to any other company or LLP. For guidance on identifying registrable individuals and legal entities under the PSC regime, see Practice note, PSC register: identifying people with significant control and PSC register: identifying people with significant control: flowchart.

If the Warrantors make a disclosure against this warranty, indicating that a member of the group is a registrable RLE for the purposes of the PSC regime, the Investors may want to consider including specific warranties concerning the relevant company's compliance with its disclosure obligations under sections 790G and 790H of the CA 2006. Alternatively, the Investors may be content to rely on the general compliance warranties in warranties 14.1 and 14.3.

Warranty 20: Social obligations

The Warranties in paragraph 20 concern compliance with employment and health and safety laws and related obligations.

Warranty 20.1: Compliance with Social Obligations

Warranty 20.1 is qualified by awareness, which assumes that the Warrantors have made reasonable enquiries of all relevant persons (see clause 5.7).

The warranty is very wide-ranging. The Social Obligations (see the definition in clause 1) include not only legal obligations but also obligations under any "code of practice", such as those produced by Acas or the Equality and Human Rights Commission. It obliges the Warrantors to make reasonable enquiries of management concerning any breaches of those Codes of Practice and to include such breaches in the disclosures, even where no breach of the general law is thought to have occurred.

The warranty also covers compliance with any collective agreements or other arrangement with trade unions or other employee representative bodies. This may help to flush out any potential industrial relations issues, even where no dispute is thought likely to arise. For disputes that have already arisen, see warranty 20.2.

Warranty 20.2: Breaches of Social Obligations

Warranty 20.2 covers any employment or health and safety breaches notified to the Company in the last 12 months, and any ongoing disputes between the Company and its employees, or any trade union. Although the reference is to disputes with "employees" this would encompass a dispute with an individual employee (see clause 2.12).

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The Warrantors will therefore have to make disclosure of all disputes, including any grievances submitted by or on behalf of employees, ongoing disciplinary proceedings, references to Acas for conciliation or arbitration, complaints to HMRC (for example, concerning non-payment of the national minimum wage) and any court or tribunal litigation commenced or threatened.

There is an overlap here with the provision in the employment Warranties at paragraph 13.2 of Part 1 to schedule 5, which is targeted at industrial relations and disputes with unions.

There is also an overlap with the warranty in respect of litigation at warranty 8 of Part 1 of this schedule 5.

Part 2, schedule 5: Second Completion Warranties

See Drafting note, Clause 5.2: Second Completion Warranties.

Paragraph 3, Part 2, schedule 4: no relevant change to PSC register on Second Completion

See Drafting note, Warranty 15.5: No relevant changes to PSC register.

Schedule 6: Matters requiring consent

See Drafting note, Clause 10: Matters requiring consent.

Paragraph 4, Part 1, schedule 6: Treasury Shares

Under section 724 of the CA 2006, a private company may hold its own shares in treasury.

Once a company acquires treasury shares, it may:

Hold those shares, in which case the company must be included in its own register of members as a holder of its own shares (section 124(2), CA 2006).

Sell or transfer them. A transfer of Treasury Shares will not be caught by any of the pre-emption provisions of the Articles (whether applicable on an allotment of shares or a transfer of shares). As such, paragraph 3 will be an important control for the Investors where they have already consented to the acquisition of shares by the Company.

Cancel them. A cancellation of Shares reduces the Company's share capital and removes shares from the voting pool. An Investor's equity percentage may therefore change following a cancellation and so it will be important for Investors to have control over a cancellation, to avoid potential consequences of that change for the Investors.

Paragraph 4, Part 1, schedule 6: Amendments to the Articles

Section 21 of the CA 2006 allows a company's shareholders to vary its articles by special resolution. Although Investors may not, together, hold sufficient voting rights to block the passing of a shareholder resolution, a subscription and shareholders' agreement will invariably restrict changes to the Articles without Investor Majority Consent.

Historically, it was also common to include this restriction within the Articles as a specific class right attached to the Series A Shares. Any change to the Articles would then require class consent of the Investors. However, due to the uncertainty over whether such a provision would, or would not, constitute a provision for entrenchment under section 22 of the CA 2006, doubt has been cast on that practice (see BVCA Articles, Drafting note, Article 12.2: Deemed variation of class rights and provisions for entrenchment).

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Paragraph 5, Part 1, schedule 6: Dividends and distributions

The term "distribution" is confined to the meaning in sections 1000 and 1064 of the CTA 2010. Broadly, these include:

Any dividend paid by a company.

Any distribution out of the company's assets in respect of shares in the company except to the extent it represents repayment of capital or is for new consideration.

The issue of securities or redeemable shares in respect of shares or securities in the company otherwise than for new consideration.

Interest on non-commercial securities (being securities the interest on which exceeds a reasonable commercial return) and interest on special securities if paid to a company that is not within the charge to UK corporation tax. Special securities include bonus securities and unlisted convertible securities, and securities the interest on which is results-dependent.

Other amounts that are treated as distributions, including expenses incurred by a close company in providing benefits and facilities to participators. Note that sections 450, 459 and 460 of the CTA 2010 are not mentioned here (close company loans made or treated as made to participators). However, such lending is only permitted with investor director consent (see paragraph 11 of Part 2 to schedule 6).

Part 2, schedule 6: Matters requiring consent

See Drafting note, Clause 10: Matters requiring consent.

Paragraph 10, Part 2, schedule 6: Encumbrances

On the winding up of the Company, the Company's creditors will in most cases receive a return before any return is made to the Shareholders. While solvent, the creation of Encumbrances may mean that the Company has lower profits available for distribution. As such, the Investors will want to tightly control the creation of any Encumbrance after Completion which may diminish the value of their equity investment.

Paragraph 17, Part 2, schedule 6: Transactions with Directors

Paragraph 17 has a wide scope and restricts any transaction (or variation of a transaction) with any Director, Shareholder or any person connected with such a person (within the meaning of section 1122, CTA 2010), save to the extent permitted or contemplated elsewhere in the SSA or within a Director's Service Agreement.

Transactions caught by this paragraph will include (but not be limited to) those referred to in Chapter 4 of Part 10 of the CA 2006, which includes:

Approval of directors' long-term service contracts (sections 188 and 189, CA 2006).

Substantial property transactions (sections 190 to 196, CA 2006).

Loans and quasi-loans to directors (sections 197 to 214, CA 2006).

Payments for loss of office (sections 215 to 222, CA 2006).

For more on transactions with directors, see Practice note, Transactions with directors: comparison between Companies Acts 2006 and 1985.

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Schedule 7: Undertakings

The undertakings set out in schedule 7 provide the Investors with additional comfort on how the Company will run the business both during any gap between exchange and Completion, and following their investment in the Company.

The undertakings should be considered in the context of each transaction and the nature of the Company's Business.

Paragraph 9, schedule 7: Bribery Act 2010

Paragraph 9 sets out an obligation on the Company and Founders not to engage in activity that would constitute an offence under the following sections of the BA 2010:

Section 1 (Offences of bribing another person).

Section 2 (Offences relating to being bribed).

Section 6 (Bribery of foreign public officials).

Paragraph 9 also extends the restriction to equivalent laws or regulations of any other jurisdiction.

For more detail on offences under those sections of the BA 2010, see Practice note, Bribery Act 2010.

Paragraph 10, schedule 7: Bribery Act 2010: Adequate Procedures

See Drafting note, Clause 1: Adequate Procedures.

Paragraph 14, schedule 7: Section 431 elections (Company)

See Drafting note, Warranty 7.7: Section 431 elections.

Paragraph 15, schedule 7: Section 431 elections (Founders)

See Drafting note, Warranty 7.7: Section 431 elections.

Paragraph 16, schedule 7: Power of attorney

Paragraph 16 seeks to grant a power of attorney, which must be granted by deed. If the agreement is not to be executed as a deed, a separate power of attorney will be required. For more on execution requirements, see Practice note, Execution of deeds and documents.

Paragraph 17, schedule 7: Social Obligations

See Drafting note, Clause 1: Social Obligations.

Paragraph 18, schedule 7: AIFM Directive

See Drafting note, Appendix A: AIFM.

Schedule 8: The Properties

Schedule 8 should contain details of the Company's leasehold and freehold properties, any leases or licences granted by the Company, and adverse rights, in accordance with the property Warranties in paragraph 9 of Part 1 to schedule 5.

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Note that the Warrantors are required to warrant the accuracy and completeness of the information contained in schedule 8 (see paragraphs 2.2 and 9.3 of Part 1 of schedule 5).

Schedule 11: Committee terms of reference

Clause 8.10 of the SSA provides for the appointment of audit and/or remuneration and/or other committees of the Board. If the Company is at a stage of development that warrants such committees being formed, details of their terms of reference should be included in schedule 11. They are largely procedural requirements with regard to the frequency of meetings and the decision making process at them, and are unlikely to be particularly contentious.

Execution of the SSA

See Drafting note, General document notes: Simple contract or deed.

Appendix A: AIFM

Appendix A sets out wording for inclusion in the SSA to address the requirements of Part 5 of the Alternative Investment Fund Managers Regulations 2013 (SI 2013/1773) (AIFM Regulations).

The AIFM Regulations constitute the instrument under which the United Kingdom has implemented the requirements of the Alternative Investment Fund Managers Directive (2011/61/EU) (AIFM Directive).

Part 5 of the AIFM Regulations sets out the obligations of the manager (an AIFM) of a fund that meets the definition of an AIF as regards its portfolio companies. The provisions of Appendix A are not included within the main body of the SSA, as they may not be relevant to a given venture capital investment. In particular:

The Appendix will not be required if the portfolio company has its registered office outside the EU. It will also not be relevant if the portfolio company is a small or medium-sized enterprise within the meaning of Article 2(1) of the Annex to Commission Recommendation 2003/361/EC of 6 May 2003; that is, where the company employs fewer than 250 employees and either has annual turnover of EUR50 million or less or an annual balance sheet total not exceeding EUR10 million.

Part 5 of the AIFM Regulations only applies to the managers of those Investors that are AIFs, within the meaning of regulation 3 of the AIFM Regulations.

Only those managers that fall within the scope of both regulations 4 and 34 of the AIFM Regulations need to observe the provisions of Part 5.

In the context of a venture capital investor, the AIFM Regulations will not usually apply to an AIFM whose assets under management do not exceed EUR500 million. Such a Small AIFM (as defined by the AIFM Regulations) may, however, elect to comply with the AIFM Regulations, subject to meeting certain conditions.

As a result, whether to include Appendix A in the SSA must be assessed on a case-by-case basis. It is important to note that the requirements of the AIFM Regulations apply to the managers of funds that make venture capital investments, and not directly to the funds themselves. If the manager of any Investor is subject to Part 5 of the AIFM Regulations, include Appendix A. For more information, see Practice note, AIFMD: scope, authorisation and marketing.

In summary, where a venture capital fund manager is subject to Part 5 of the AIFM Regulations and it makes an investment in a non-listed company (as defined by the AIFM Regulations), such an AIFM must:

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Notify the FCA when the proportion of voting rights in a portfolio company held by a fund managed by an AIFM reaches, exceeds or falls below prescribed thresholds.

Upon an AIF managed by an AIFM acquiring control of a portfolio company, notify the fact of that acquisition and disclose certain prescribed information to, in each case, the FCA, the portfolio company and its shareholders.

Include certain information within the relevant fund's annual report after it acquires control of the portfolio company.

Use its best efforts to prevent the portfolio company from undertaking distributions, capital reductions, share redemptions or buybacks for a period of 24 months after an AIF managed by the AIFM acquires control of that company.

Where the manager(s) of one or more Investors is subject to Part 5, the question of whether control has been acquired must be considered both on an individual fund basis and on a joint basis. Regulation 35 provides that control may be acquired by a single AIF, or by two or more AIFs whether or not they are managed by the same AIFM, provided that control is acquired on the basis of an agreement aimed at acquiring such control. However, when assessing whether control has been acquired, account need not be taken of shares held by any Investor whose manager does not fall within the scope of Part 5 of the AIFM Regulations.

For further background information on the AIFM Directive, see Practice note, A guide to the AIFMD: index. For more on the requirements of Articles 26 to 30 of the AIFM Directive, the source of the AIFM Regulations, see Practice note, AIFMD: acquisition of substantial stakes in EU companies.

If Appendix A is included in the SSA and the manager of a relevant Investor is not a party to the agreement, that AIFM will not have the right to enforce the provisions of Appendix A in its own name unless the agreement grants it express rights to do so. Clause 27.2 confers power on the general partner of an Investor or a management company authorised to act on an Investor's behalf to enforce that Investor's rights under the agreement. The manager of each Investor with the scope of Appendix A should ensure that the wording of clause 27.2 is adequate for its particular needs.

Consequences of breach

A failure by a full-scope UK AIFM (defined in regulation 4 of the AIFM Regulations) to comply with the obligations set out in Part 5 of the AIFM Regulations is to be treated as a contravention of rules made under section 137A of FSMA. For a discussion of the consequences of a breach of such rules, see Practice note, FCA and PRA rule-making powers: Contravention of rules.

In certain circumstances, FSMA allows private individuals to bring a suit for a contravention of FCA rules. As the intention of Appendix A is to evidence an AIFM's compliance with its obligations under Part 5 of the AIFM Regulations, Investors (or their managers) should consider whether they would be prepared, or allowed, to disclose the terms of the SSA to such an individual as evidence. If not, it may be preferable for the undertakings set out in Appendix A to be set out in a separate letter agreement between the relevant parties (and to which the AIFM(s) in question could be party).

Appendix A: Meaning of "control"

Under regulation 36(3) of the AIFM Regulations, in the context of a non-listed company, "control" means a holding of more than 50% of the voting rights of a portfolio company. This will be relevant to paragraphs 2 to 4 (inclusive) below.

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Whether control is acquired must be considered both in relation to each relevant Investor's individual holding, but also their joint holdings (see Drafting note, Appendix A: AIFM).

Appendix A: Business undertakings

If Appendix A is included in the SSA, insert new paragraph 19 into schedule 7. Schedule 7 sets out the obligations of the Company and the Founders (see Drafting note, Clause 11: Business undertakings).

Paragraph 1, Appendix A: Notification required in relation to voting rights

Regulation 38(2) of the AIFM Regulations obliges an AIFM to notify the FCA whenever the voting rights held by an AIF managed by that AIFM reaches, exceeds or falls below 10%, 20%, 30%, 50% and 75% of all voting rights in the portfolio company. That notification must be made within 10 working days of the relevant event giving rise to a notification obligation. Paragraph 1 of Appendix A aims to ensure that the relevant Investors can call on the Company's and the Founders' assistance in order to meet the AIFM's obligation.

Paragraph 2, Appendix A: Notifications required on an AIF Investor acquiring control

Regulations 38, 39 and 40 of the AIFM Regulations set out certain obligations on an AIFM where any of its AIFs (whether alone or jointly with one or more other AIFs) acquires control of a portfolio company (see Drafting note, Appendix A: Meaning of "control"). In particular, following the acquisition of control, a relevant AIFM must:

Within 10 working days of acquiring control, notify that fact to each of the FCA, the portfolio company and, to the extent possible for the AIFM to do so, each of its shareholders. That notification must include certain prescribed information, including the resulting position in terms of voting rights (Regulation 38(2), AIFM Regulations).

Make available to each of the FCA, the portfolio company and, to the extent possible, each of its shareholders, certain information about the AIF (or AIFs) that have control, and its or their AIFM (Regulation 39, AIFM Regulations).

Within 20 working days of acquiring control, disclose to the portfolio company and, to the extent possible, its shareholders, its intentions regarding the portfolio company's future business and likely repercussions on employment by the company (Regulation 40, AIFM Regulations).

In each case, the AIFM must ask the portfolio company's board of directors to pass on the information above to the company's employee representatives (or to the employees themselves if there are no representatives). Each affected AIFM is under an obligation to use its best efforts to ensure that the relevant board complies with this request. Paragraph 2 of Appendix A aims to support evidence of an AIFM's compliance with its obligations.

Paragraph 3, Appendix A: Restrictions on distributions, capital reductions, share redemptions and buybacks

Regulation 43 of the AIFM Regulations, commonly referred to as the asset stripping provisions, places obligations on an AIFM where its AIF acquires control of a portfolio company (whether alone or jointly with one or more other AIFs) as regards certain share capital transactions by the portfolio company.

During the period of 24 months after an AIF acquires control, its AIFM must not facilitate, support, instruct or, to the extent the AIFM is able to do so on behalf of an Investor, vote in favour of:

Any distribution by the portfolio company.

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Any reduction of capital by that company.

Any redemption of shares in the company.

Any buyback of shares by that company.

Such an AIFM must also use its best efforts to prevent any such transaction during that 24 month period. Paragraph 3 aims to support the Investors' best efforts to prevent any such transaction.

Paragraph 4, Appendix A: Information to be included in the annual report of a controlled company or an AIF Controlling Investor

Regulation 42 of the AIFM Regulations requires an AIFM to include within an AIF Controlling Investor's annual report certain prescribed information, unless that information is instead included within the portfolio company's report and that report is made available to that company's employee representatives (or its employees, if there are no such representatives).

If the relevant information is set out in the portfolio company's report, the AIFM of a AIF Controlling Investor must:

Make that information available to the AIF's investors within six months of the AIF's financial year end (and possibly earlier).

Use its best efforts to ensure that the information in the portfolio company's annual report is made available to the employee representatives (or employees, where appropriate) by the company's board of directors.

Paragraph 4 is designed to cover both scenarios: where the information is contained in the AIF's annual report or the portfolio company's annual report.

For more information, see Practice note, AIFMD: acquisition of substantial stakes in EU companies: Annual reports.

Paragraph 5, Appendix A: Provisions applicable in other EEA member states

The AIFM Regulations constitute the instrument under which the United Kingdom has implemented the requirements of the Alternative Investment Fund Managers Directive (2011/61/EU) (AIFM Directive).

Similar instruments have been implemented by other EEA member states. Where the manager of an Investor is subject to equivalent rules in an EEA member state other than the United Kingdom, paragraph 5 ensures that such manager can call on the Company and the Founders to assist with that manager's compliance with the rules equivalent to those set out in the AIFM Regulations and to which the provisions of Appendix A relate.

Appendix B: US Securities law requirements and ERISA

Appendix B sets out wording for inclusion in the SSA if any Investor is a US investor, or if any future possible offer or sale of securities in the US is within the contemplation of the parties.

Appendix B: Clause 1: Disqualification Event See Drafting notes, Appendix B: Clauses 8.12 and 8.13: "Bad actors" and Clause 37(d) and (e): "Bad actors". Appendix B: Clauses 8.12 and 8.13: "Bad actors"

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The US Securities Act of 1933 (as amended) regulates the offer and sale of securities in the US. Under section 5 of the Securities Act, all offers and sales of securities in the US must be registered with the Securities and Exchange Commission (SEC) unless there is an exemption from registration that applies to such offer or sale of securities. Contravention of the Securities Act's registration requirements is a criminal offence, with the potential for severe penalties, including possible injunctions, fines and imprisonment. Contravention might also provide investors with a right of rescission in respect of any shares purchased without an applicable exemption from the registration requirements. One of the most common transactional exemptions from registration sought by issuers is the safe harbour for private placements under Rule 506 of Regulation D under the Securities Act. To qualify for the safe harbour under Rule 506, an offering must meet certain criteria, including that no felon or other "bad actor" is relying on the Rule 506 safe harbour for a particular issuance of securities (Rule 506(d)). Persons caught by Rule 506(d) will include, among others, the issuer itself and its directors and executive officers, if they were involved in a disqualifying event. Subject to exceptions, certain criminal convictions within the last ten years in relation to securities laws violations will constitute a disqualifying event, as will certain SEC disciplinary orders, final orders from specified US state and federal agencies that bar participation in certain types of activities and suspension or expulsion from membership in a self-regulatory organisation. Clauses 8.12 and 8.13 should be included if the Company may sell shares to a US investor in the future in reliance on a US private placement exemption. Optional clause 8.12 of the SSA sets out an awareness-based warranty to the Company from each person who has the right to appoint a director under clause 8 (typically the Investors) which aims to ensure that no such person appoints a person who might be a "bad actor" under Rule 506(d) and so might jeopardise any future offer or sale of securities in the US. Optional clause 8.13 provides a related covenant from each such person that they will not participate in the appointment of any person who, to their knowledge, is a "bad actor" and that, if they become aware that such person is or has become a "bad actor", they will promptly remove that person as their appointee. The purpose of the covenant is to reduce the burden on the Company in determining whether or not any "covered person" is a "bad actor". The SEC provided a Compliance and Disclosure Interpretation (Question 260.14) to provide guidance regarding the "bad actor" safe harbour which states that a company "may reasonably rely on a covered person's agreement to provide notice of a potential or actual bad actor triggering event." The SEC guidance also states that for offerings that are continuous, delayed or long-lived, the issuer of securities must update its inquiry through bring-down representations, negative consent letters or other reasonable means. In connection with the "bad actor" warranty and covenant in the SSA, it is also advisable that the Company should prepare "bad actor" questionnaires for each director and covered person which include an affirmative covenant to update the company if any Rule 506(d) Related Party becomes a “bad actor”. For more information, see Practice note, US securities laws: Introduction to US registered and unregistered offerings for non-US companies: Bad actors cannot rely on Rule 506. Appendix B: Clause 37: US securities laws requirements

Include clause 37 for any Investor that is a resident of the United States.

Any offer or sale of securities in the US must either be registered under the United States Securities Act of 1933 (Securities Act) or sold under an exemption from the registration requirements of the Securities Act. The Company will typically rely on the exemption from registration set out in Section 4(a)(2) of the Securities Act, which is a private placement

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exemption for offers of securities in the US not involving a "public offering", or the private placement safe harbour set out in Rule 506 of Regulation D under the Securities Act. For more information about Section 4(a)(2) and Rule 506 private placements, see Practice Note, US securities laws: Introduction to US registered and unregistered offerings for non-US companies, Unregistered offerings: private placements under Section 4(a)(2) or Regulation D.

All offerings of securities in the US must also comply with the securities laws of the US state in which the securities are offered. State securities laws may require registration with the state securities regulator unless an exemption from state registration is available.

Under clause 37, each Investor makes certain acknowledgements and warranties to ensure that the Company can rely on the Section 4(a)(2) exemption, or Rule 506 safe harbour, from registration under the Securities Act, and agrees to comply with any applicable state registration requirements or an exemption from state registration requirements.

Appendix B: Clause 37(a): No registration under federal or state securities laws

In Clause 37(a), each Investor acknowledges that the Shares are subject to transfer restrictions. Securities issued in a private placement under Section 4(a)(2) or Rule 506 of the Securities Act are restricted securities and cannot be re-sold or transferred unless they are registered under the Securities Act or sold under an exemption from registration. Any re-sale or transfer must also comply with the applicable state securities laws.

Appendix B: Clause 37(b): Share transfer restriction

As the Shares are subject to transfer restrictions, each Investor agrees to comply with the applicable transfer restrictions under federal and state securities laws.

Appendix B: Clause 37(d) and (e): "Bad actors" In order to qualify for the private placement safe harbour under Rule 506 of Regulation D under the Securities Act, no Company Covered Person, investor or Rule 506(d) Related Party of any such person can be a "bad actor", or the exemption will not be available in respect of the offering. Among other people an issuer, together with certain people associated with the issuer, may be "bad actors" if they have been involved in a disqualifying event. For more information, see Drafting note, Appendix B: Clauses 8.12 and 8.13: “Bad actors” and Practice note, US securities laws: Introduction to US registered and unregistered offerings for non-US companies: Bad actors cannot rely on Rule 506. Clause 37(d) sets out a warranty from each Investor that seeks to ensure that neither it nor any of its specified related parties may be a "bad actor" that could invalidate the company's ability to qualify for the private placement safe harbour in connection with the proposed offering. Under clause 37(e), each Investor covenants to notify the Company if any such person suffers a Disqualification Event (as defined in clause 1 of the SSA) which could threaten the Company’s ability to qualify for the private placement safe harbour in the future.

Appendix B: Clauses 37(f) and (g): Sophisticated investor

In order to comply with Section 4(a)(2), case law under Section 4(a)(2) requires that the purchaser in a private placement be a sophisticated investor. Clause 37(g) aims to establish that each relevant Investor is a sophisticated investor. An "accredited investor" is a type of sophisticated investor that would enable compliance with Section 4(a)(2) and Rule 506.

Appendix B: Clause 37(h): Purchases for own account

Purchasers in a US private placement must buy the securities for their own account, without a view to reselling or distributing them to others immediately. Investment intent is relevant to show that the sale does not involve a public offering.

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Appendix B: Clause 38: ERISA

Venture capital funds raise capital from a variety of sources. Traditionally, pension funds and other employee benefit plans have been significant investors in venture capital.

In the US, the assets of a pension or employee benefit plan subject to the Employee Retirement Security Act of 1974 (ERISA) must be held in trust. The persons responsible for managing those assets have significant fiduciary duties under ERISA and may not engage in certain prohibited transactions. If a plan covered by ERISA (an ERISA Plan) invests in a venture capital fund then, unless there is an exemption available, all of the fund's assets (such as its investments in portfolio companies) are treated as assets of the ERISA Plan. As a result, the managing partner of the fund is treated as an ERISA fiduciary and the fund must comply with the rules regarding prohibited transactions.

Given the strict requirements of ERISA and the consequences for breach, it will usually be important for a venture capital fund that may constitute an ERISA Plan to structure its investments in portfolio companies to qualify for an exemption from ERISA. To that end, it is common for an Investor whose fund investors may be subject to ERISA to seek specific, additional rights, either in the subscription and shareholders' agreement , more commonly, in a separate management rights letter, designed to demonstrate that the Investor is a Venture Capital Operating Company (VCOC) and therefore not deemed to hold ERISA Plan assets.

To qualify as a VCOC, an Investor must hold at least 50% of its assets in "venture capital investments". A venture capital investment is one in which the Investor has the right to participate substantially in, or substantially influence the conduct of, a portfolio company's management. Clause 38 sets out sample wording aimed at ensuring that the exemption will be available to specified Investors. Although clause 38.4 includes the right for such an Investor to require changes to the SSA if necessary to ensure the availability of the exemption, each Investor should take specialist advice on whether it requires any ERISA rights and, if so, the particular drafting required.

Note that simply having the rights necessary to qualify as a VCOC will not be sufficient to avoid regulation under ERISA. An Investor seeking to show that it is a VCOC must also actually exercise its management rights in respect of at least one portfolio company during a relevant 12 month period.