How anti-embarrassment clauses can safeguard sellers in M&A transactions

Anti-embarrassment clauses, also known as on-sale clauses or anti-shaming clauses, and commonly referred to as cláusulas de mejor fortuna in Spain, are a mechanism that protects the seller in sale and purchase transactions.

These clauses originate in Anglo-Saxon law and stipulate that, if the buyer resells the assets acquired from the seller to a third party for a higher price within a specified period, the buyer must pay the seller an additional amount based on the originally agreed-upon price. It aims to shield the seller from potential embarrassment or disadvantage resulting from selling the assets below their actual value or due to a short-term fluctuation in value.

An example where this type of clause can be seen included in a sale and purchase agreement of a Spanish company is in the transaction which took place in 2021 between Telefónica and American Tower, where the latter purchased the telecommunications tower division for €7 billion. Specifically, if, within two years of the completion of the transaction, the US company had sold the acquired assets for a higher value (referred to as a "disposal event" in the agreement), it would have been required to compensate all the partners of Telxius (a subsidiary of Telefónica) for the agreed-upon value between the parties.

Anti-embarrassment clauses typical use

Anti-embarrassment clauses can be observed in different scenarios, such as the purchase and sale of companies, either through the purchase and sale of shares or interests or through the transfer of assets. They can also be applied in transactions involving the partial or total resale of shares, mergers, capital increases, or any other agreement that may generate capital gains for the buyer. In particular, in divestment agreements within the private equity sector, these clauses can be of special interest.

Notwithstanding this, it is most common for these clauses to be included in share or equity interest sale and purchase agreements. In such cases, and for a specified period of time, if the shares or equity interests are sold for a higher price than what was originally paid by the buyer, it will be agreed and determined what proportion of the capital gain generated by such subsequent sale will be paid back to the seller.

In this way, it ensures that, if a shareholder sells their interest and a significant fluctuation in its value occurs in the short term, the shareholder will have a contractual right to receive a proportional share of the capital gain generated. This mechanism not only protects the seller against potential opportunistic purchases at a lower price than the market value, with the buyer being aware of this, but also reduces the opportunity cost associated with selling their interest in the company.

What anti-embarrassment clauses should contain

Firstly, it is necessary to identify the legal acts that will trigger the application of the clause. Generally, these are linked to the completion of the sale and purchase agreement. However, it can also be agreed that the clause will be activated at the time of the delivery of the assets, or even that a mere offer to sell that generates a capital gain will be sufficient, allowing the seller to maintain a certain level of control over the assets they have sold.

Secondly, it is essential to define an amount from which it will be considered that an economic surplus has been generated. This amount may coincide with the sale and purchase price or be adjusted based on market expectations. For example, the amount could be higher than the sale and purchase price, if an increase in the value of the shares or interests is anticipated.

The following aspects should be considered when wording the clause.

• Duration: The clause must indicate when the seller is entitled to a share of the capital gain.
• Percentage share: The percentage of the capital gain that must be returned to the seller should be established. This percentage may vary depending on the time elapsed since the sale, decreasing as time progresses.
• Duty of information: The buyer must inform the seller about any event that activates the clause or any situation that may disrupt the agreed-upon period.
• Penalties: Consequences should be outlined if the buyer fails to meet their obligations. By way of example, such penalties could be triggered in cases of failure to notify the resale, simulation of a lower sale price than the actual price, or non-compliance in the payment of the due compensation.
• Exceptions: It is also possible to include scenarios in which, even if a capital gain has been generated, the clause will not be activated. This can occur by prior agreement between the parties or due to exceptional circumstances stipulated in the contract.

The seller has the right to be notified of any event that triggers the application of the clause and to receive the corresponding capital gain. On the other hand, the buyer has the obligation to notify the seller if the condition triggering the application of the clause is met and must deliver the corresponding capital gain.

Osborne Clarke comment

In the context of sale and purchase transactions, mergers, or acquisitions of companies, anti-embarrassment clauses are useful tools for minimising both financial and reputational risks. These clauses provide the seller with an additional guarantee, ensuring that they are not disadvantaged by a subsequent resale at a much higher price, thereby reinforcing confidence in the value of the transaction for both parties involved.