Typical due diligence issues

In the United Kingdom, it is customary to finalize the due diligence exercise before the execution of the acquisition agreement. There are no particular issues that a foreign investor should be aware of when undertaking a due diligence review of a UK-incorporated entity or group of assets other than those usually reviewed. The main areas of review in the due diligence process vary from transaction to transaction but generally include corporate, commercial, employment, real estate, environmental, regulatory and tax matters. Based on the due diligence findings, the parties may negotiate special closing conditions and/or specific indemnities and/or tailor specific representations and warranties.

In a share sale transaction, reviewing material contracts (shareholder agreements, customer contracts, banking contracts) for change of control provisions is key to the due diligence exercise. In an asset sale, restrictions on the seller's ability to assign or otherwise transfer its rights or interests in the assets to the buyer are the most relevant.

Based on the outcome of the due diligence exercise, the parties may negotiate tailored conditions precedent and/or specific indemnities and/or specific warranties.

Pricing and payment

The payment of deposits is not common practice in the UK.

The most common form of consideration is cash, though sellers may prefer to receive loan notes or equity from a tax-planning perspective. It is common for the initial purchase price to be stated on a " cash-free, debt-free " basis either on the basis of a "locked box" or with the inclusion of a purchase price adjustment mechanism determined be reference to the working capital or net assets, of the target company or business at closing by reference to completion accounts. The completion balance sheet is usually prepared by the buyer (or an audit firm on its behalf) but is not formally audited.

While it is not common to provide for deposits or break fees, an escrow arrangement is relatively standard in respect of warranty claims. Earn-out arrangements are also relatively common, allowing the buyer to defer the payment of some of the consideration, conditional on agreed milestones or thresholds being achieved.

Electronic transfers of funds, including through the SWIFT Code international system, are the most common way of paying cash consideration.

Signing/closing

Pre-contractual obligations

Under English law, there is no general obligation on the parties to a transaction (including a sale and purchase of shares, assets, or a business) to conduct the negotiations in good faith.

Simultaneous signing and closing/conditions precedent

Subject to the detailed procedure for completion that is set out in the acquisition agreement, the shares or assets being sold are formally transferred to the buyer upon closing of the transaction. Usually, the purchase price is paid on closing.

In smaller deals, and otherwise, where possible, simultaneous signing and closing is common. Whether signing and closing is simultaneous or non-simultaneous will depend on whether there are conditions precedent that must be satisfied, including regulatory approvals (e.g., merger control), the carve-out of certain parts of the target entity, third-party consents or waivers, or the resolution of problems discovered during the due diligence exercise.

Warranty and indemnity insurance

In recent years, there has been an increase in the uptake of warranty and indemnity (W&I) insurance by corporate and private equity parties in M&A transactions. There are two main types of W&I insurance: a buyer-side policy and a seller-side policy.

The most popular type of W&I insurance is the buyer-side policy, where the buyer is insured for any losses as a result of a breach of warranty (subject to the agreed limitations) in the sale agreement.

The seller-side policy insures the seller for claims by the buyer with respect to financial loss arising from a breach of warranties given by the seller (subject to the agreed limitations). In the event of breach of an insured warranty, the buyer brings the claim under the sale agreement and the seller makes a claim against the insurance policy.

A W&I policy will usually cover warranties (e.g., title and capacity warranties, general business or operation warranties, and tax warranties) and general indemnities (e.g., tax indemnity covering unknown tax risks) provided under the sale agreement.

Foreign investment restrictions

The UK has a mandatory and suspensory foreign investment screening procedure, which means that transactions that meet the relevant criteria need to be notified to the relevant authority and cleared before they can be completed.

The UK’s mandatory foreign investment review (FIR) regime is targeted at share acquisitions taking place in certain specified sectors. The UK government also has the power to proactively review a broader range of transactions (including asset deals) on “national security” grounds. For further information, see the more detailed section on "Foreign investment restrictions".

Antitrust/merger control

The UK has a voluntary, non-suspensory merger control regime which means that there is no legal requirement to notify transactions that meet the relevant criteria to the competition authority for approval. However, in practice the authority routinely follows up on transactions that have not been notified in order to assess whether it has jurisdiction over the transaction. The authority has the power to impose interim measures, which enable it to prevent or unwind action that might prejudice the outcome of a reference for a Phase 2 investigation or impede remedial action. It frequently imposes such interim measures, and imposes financial penalties for failure to comply with these.

Other regulatory or government approvals

Approval by the relevant regulator may be required for the acquisition of a target that is subject to specific regulatory supervision, such as financial and credit institutions, infrastructure operators, telecoms providers, healthcare and life sciences companies, etc.

Acquisition of shares

An acquisition of shares is not considered a transfer of an undertaking for employment law purposes. It will therefore not involve the transfer of employees, but simply a change in the ownership of the employer (not a change in the employer per se). As such, all rights, duties and liabilities owed by, or to, the employees of the target company continue to be owed by, or to, the target company and the buyer therefore inherits all those rights, duties and liabilities by virtue of being the new owner of the target company.

However, if there is a post-acquisition integration of the target company's business with the buyer's business, this is likely to constitute an acquisition of assets or a business transfer, and the considerations set out in the next section will be relevant.

Acquisition of assets

The automatic transfer of employees on an asset sale takes effect pursuant to the Transfer of Undertakings (Protection of Employment) Regulations 2006 ("TUPE"), provided that the asset sale comprises the sale of an undertaking (for example, a sale of a business (or an identifiable part of a business)).

Where there is a relevant transfer, the employment contracts of those employees who are assigned to the business being transferred transfer automatically to the transferee on their existing terms and conditions of employment (with the exception of old age, invalidity and survivors' benefits under occupational pension schemes). The transferee effectively steps into the transferor's shoes with regard to the transferring employees such that all of the transferor's rights, powers, duties and liabilities under or in connection with the transferring employees' contracts pass to the transferee, and any acts or omissions of the transferor before the transfer are treated as having been done by the transferee.

Employees of the seller's business have the right to refuse to transfer to the buyer, but they are treated as having resigned without entitlement to severance compensation if they exercise this right and, consequently, will have no remedy against either the seller or the buyer. There are two exceptions to this rule:

• Where employees resign in response to a repudiatory breach of contract by the employer
• Where the transfer involves or would involve a substantial change in working conditions to the material detriment of the transferring employees

In these circumstances, employees will be regarded as dismissed and may have claims for unfair dismissal. Assuming that employees do not exercise their right to object to the transfer, the buyer stands in the place of the seller with regards to the employees' contracts of employment.

Acquisition of shares

A buyer will generally be responsible for the stamp duty (a transfer tax) payable on the acquisition of shares, calculated at the rate of 0.5% of the stampable consideration (which will include amounts satisfied by the payment of cash or the allotment of shares or marketable securities, together with the value of certain liabilities assumed or released). Relief is available (on making a claim) for transfers of shares between associated companies provided the necessary conditions are met.

Acquisition of assets

While stamp duty is not payable on the acquisition of assets, stamp duty land tax (SDLT) — a tax on land transactions — is payable on the acquisition of a chargeable interest in land in England and Northern Ireland. It is calculated at a sliding rate of up to 5% on commercial property and up to 12% of the chargeable consideration on residential property. A 15% rate applies to the whole of the consideration for the acquisition of residential property by a non-natural person. An additional 3% charge for "additional" residential properties where applicable, such as buy-to-let or second homes. An extra 2% charge applies to acquisitions of residential property by non-UK residents. Unlike stamp duty, any land transaction in England or Northern Ireland is liable to SDLT wherever and however the relevant transfer instrument is executed, regardless of the tax residence of the buyer of the land interest or whether the transaction is effected by an instrument. Different systems (with slightly different rates) apply in Scotland (land and buildings transactions tax) and Wales (land transaction tax).

Value added tax (VAT)

VAT is generally not payable on the purchase of shares. VAT may be payable on the purchase of taxable assets (e.g., inventory and goodwill). However, to the extent that the transfer meets certain requirements in order to be categorized as a "transfer of a going concern," it will not constitute a taxable supply and no VAT will be payable.

OECD's Two Pillar Solution

The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting has put forward a so-called Two-Pillar Solution to address the tax challenges arising from the digitalization of the economy. Pillar Two is intended to introduce a global minimum effective rate of tax of 15% for large businesses in each jurisdiction where they operate and will lead to fundamental changes in the international tax system. It is currently being implemented in a large number of jurisdictions. The UK enacted legislation to implement the Pillar Two income inclusion rule and qualifying domestic minimum top-up tax in the UK with effect for accounting periods beginning on or after 31 December 2023. The UK government will introduce the Under Taxed Profits Rule in the UK for accounting periods beginning on or after 31 December 2024.

Groups will need to consider how the Pillar Two rules could impact on the life cycle of M&A transactions from the pre-acquisition phase (including transaction planning (such as the choice of acquisition structure and financing) and due diligence of the target group), the acquisition phase (such as contractual risk allocation around Pillar Two) to the post-acquisition phase and the impact of Pillar Two on any post-acquisition integration.

For information on post-acquisition integration matters, please see our Post-Acquisition Integration Handbook.