A corporate client of mine was recently searching for an investor to make a capital infusion in the 5-year-old company. They contracted with another company to receive an investment in exchange for the sale of some of my client’s company stock. Before long, however, it became apparent that the potential investor did not actually have the necessary capital to make the investment. Rather than let the deal die, the parties found a third-party investor. They wanted to amend the original buy-sell agreement for the company stock to substitute in this new third-party investor. I suggested to them that, due to the flow of contract construction under American law, an amendment to the buy-sell agreement was not the proper vehicle to “bootstrap” in an unrelated third-party investor. This led to a larger discussion of what makes a contract under American law.
Meeting of the minds
In order for a contract to exist, there must first be an agreement between two or more people regarding a particular subject matter such that the parties intend the same thing in the same way (i.e., there is a “meeting of the minds” whereby neither party is mistaken as to what they are giving or getting, and neither is being fraudulent in their intent). In the contract under consideration (the original buy-sell agreement between my client and the errant investor), the introductory paragraph and signature lines at the bottom of the agreement denote the parties to the agreement, and the body of the document spells out the rights and obligations of the parties. However, a mere agreement between definable parties regarding a particular subject matter is still not enough to constitute an enforceable agreement.
Consideration
In order for an agreement between identified parties to be an actual contract, the agreement (the meeting of the minds) must contain an exchange of legal rights, typically in the form of a promise for an act (e.g., if you do this then I promise to pay you for it), or a promise for a promise (e.g., if you promise to do this, then I promise to do that). This exchange of legal rights (either gaining one or giving one up) is the consideration that makes a contract enforceable.
Binding unrelated third parties
Importantly, the third-party investor is a stranger to that buy-sell agreement. That is, the third-party investor (who is not a party to, or an intended beneficiary of, that underlying agreement), and, for this reason, has absolutely no rights, duties or obligations under that agreement. Thus, neither my client nor the original investor can look to this new third party to perform their respective obligations under the buy-sell agreement, and the new third party cannot obtain the benefit of their respective rights under that agreement.
In order to hold the third-party investor to the rights and obligations of the parties under the original buy-sell agreement, the parties must assign all of the original investor’s rights, title and interest in the contract to the third party, and must, likewise, delegate all of the original investor’s obligations under that agreement to the new third-party investor. This new and separate assignment and assumption agreement would also contain representations and warranties that show that the new third-party investor is authorized to enter into the agreement, and that the third party is able to perform any duties or obligations delegated to it. The document will also contain indemnifications to protect the remaining party to the original buy-sell agreement, if the new third-party investor fails to perform.
With the new assignment and assumption agreement in place, the original investor was able to bow out of the deal, and my client received a cash infusion from the new third-party investor that has allowed my client to fulfill its corporate obligations and to expand its business horizon.
Shaune B. Arnold, Esq. is a practicing attorney, business strategist and coach.
