Business Law – Negotiating Warranties when Buying or Selling a Business
BUSINESS LAW – NEGOTIATING WARRANTIES
WHEN BUYING OR SELLING A BUSINESS
There are great risks for both buyers and sellers when considering the purchase of a business as a going concern.
The risks are greater if the purchaser is considering buying the company through which the business is operated. This is because the purchaser will acquire not just liabilities relating to the business but also liabilities relating to the company which can be far more extensive and include such things as unpaid loan accounts, debtors and liabilities which are incurred but have not yet been reported to the company. When a purchaser buys a company, the purchaser cannot later defend a claim brought by a creditor or litigant upon the basis that the liability had not been disclosed by the former vendor. The purchaser becomes the company.
Even when the purchaser buys a business as opposed to the corporate vehicle through which that business is run, the purchaser still acquires considerable risk.
Sellers of companies and sellers of businesses also face considerable risk. Properly advised purchasers will insist on extremely wide warranties and indemnities so that if unforeseen liabilities emerge later on, the purchaser can seek redress from sellers.
This means that, when buying a business, each party will have to rely on expert lawyers and other advisers such as accountants to carefully draft and negotiate warranties in an asset purchase agreement or in the sale of business agreement.
Even though the principle as been amended by statute, the doctrine of “caveatemptor” or “let the buyer beware” still applies when the buying the assets of a business.
Nevertheless, most business acquisitions are structured so that purchasers can have the opportunity to obtain a greater degree of comfort about what they are buying and assurances from the seller.
Sometimes, sellers of businesses will attempt to make unpleasant disclosures about a business or about its stock or about potential future liabilities only a short time before settlement in the hope that the purchaser will have insufficient time to pull out. To guard against this, the buyer needs to be well advised so that it has made wide enquiries into the company or into its assets as early as possible. Obviously, it is preferable for both parties to discover problems before signing any agreement so that it can be dealt with on an open and frank basis. This will also minimize the prospect of expensive litigation.
Sellers also need to be properly advised so as to limit the scope of any warranties they are obliged to give. The ideal warranty from a seller’s perspective is one that limits the seller’s liability to material matters about which the seller actually knows. Sellers would be unwise to rely upon the absence of express warranties and assume that they getting off otherwise scot-free. Sellers need to develop a strategy in conjunction with their legal and accounting advisers on how and when to disclose difficult issues to an interested purchaser.
A well advised purchaser should consider the following:
Exactly which assets is the buyer purchasing?
What are the material contracts?
With whom will the risks and liabilities lie?
Are there any pending legal claims?
What is the intellectual property relating to the deal?
What are the personal property security aspects and considerations of the deal?
What searches of the PPSA Register need to be made?
What contracts relating to the business or the company operate which will need either to be cancelled, transferred, deferred or otherwise dealt with?
What is the situation relating to continuing employees?
What are their annual and long service leave obligations?
What other liabilities does the former employer owe to them which the purchaser may have to inherit?
Are there indispensible employees who are likely to leave and set up in competition?
Are there any applicable restraints of trade?
How will employees be transferred to the purchaser?
What are the applicable award conditions or what is in any applicable contractual terms and conditions of employment?
Are there any collective agreements that apply to this workplace or enterprise bargaining agreements?
Are there any pending disciplinary claims against employees?
Have any employees brought any discrimination or malpractice complaint against any director or officer of the company or business who will be taken over by the purchaser?
Are there any pending workers’ compensation claims from any employees?
At a minimum, a purchaser should inspect copies of all applicable employment contracts and awards as well as any collective or enterprise bargaining agreements. The purchaser will also need to identify if there are any pending industrial action being contemplated against the vendor employer.
From the seller’s perspective, all facts and circumstances will need to be disclosed which, if not, would otherwise breach a warranty.
Essentially, courts will only give sellers protections in relation to claims of breach of warranty provided their disclosure is fair and reasonable in the circumstances. This means that sellers should always try to give as much detail as possible in disclosure to maximize the protection afforded by the contractual warranties. This means bringing matters to the attention of a purchaser relevant to the acquisition even if the seller otherwise believes that the purchaser is already aware of those issues or facts.
For the purchaser, the benefit of full and adequate disclosure is obvious. If this has been made in advance, purchasers can exercise a variety of potential rights including:
Accepting the current deal;
Walking away from the transaction altogether;
Negotiating an appropriate adjustment to the sale price; or
Insisting that the vendor indemnify the purchaser against any future potential risk.
Well advised purchasers may incorporate a variety of these rights into an overall revamped deal.
Buyers and sellers of companies operating businesses are invited to contact our expert solicitors in the area of commercial and business law.
This article is intended only to provide a summary of the subject matter covered. It does not purport to be comprehensive or to render legal advice. No reader should act on the basis of any matter contained in this article without first obtaining specific professional advice.
For any further information concerning this article, please contact Michael Pickering, Principal, Judicate Lawyers – Barristers and Solicitors of Unit 11 / 233 Cardigan Street, Carlton, Victoria, 3053. His contact details are as follows: