Buying & Selling Businesses Blog Series - Part 5C - What can go Wrong after the Sale has Been Completed

Posted by Malcolm Campbell, Luke Mitchell on 16 March 2016
Buying & Selling Businesses Blog Series - Part 5C - What can go Wrong after the Sale has Been Completed

In addition to financial performance and taxation complication which can arise, there can sometimes be critical issues with fundamental elements of the business and the terms agreed to in the contract.

Waiver of Conditions Precedent Conditions precedent provide basic preliminary safeguards for a purchaser and typically cover the elements of the transaction that are critical for the purchaser to obtain a full benefit of the business.

A purchaser may waive the conditions precedent in their haste to have the transaction completed or without fully understanding their relevance to the business. Where this occurs, the purchaser may be effectively waiving the right to void an agreement where certain key requirements have not been achieved. In circumstances where a purchaser has waived, or has not had the benefit of, certain conditions precedent, a purchaser may be obliged to proceed with a transaction which is of detriment to the purchaser and which may mean that the purchaser is not getting the deal they originally bargained for.

Employees If there are certain employees that are crucial to the business and need to be retained, it is important that there be a condition precedent to the contract that they be retained for the benefit of the purchaser. If the key employees do not join the business after the sale, existing relationships of the business with customers and suppliers may be lost. In addition, if the key employees are not subject to a suitable restraint of trade, those key employees may establish a business that is in competition with the business acquired by the purchaser.

Intellectual Property It is not uncommon, particularly with small businesses, for the vendor to have failed to:

  1. appropriately protect the intellectual property;
  2. ensure that any intellectual property created by contractors is assigned to the business; or
  3. properly document intellectual property licences.

Where this has happened, the vendor may not own all rights and title to the intellectual property and may not have the right to transfer or assign such intellectual property. In this situation, a purchaser may discover after completion that the vendor does not own the intellectual property it has purported to transfer or that a third party has an interest in the asset.

Leases Often, when negotiating a sale of business agreement, the lease of the premises at which the business is conducted will form part of the transaction. In circumstances where the vendor has failed to secure the assignment of the lease prior to completion, the lessor may not grant to the purchaser the benefit of the lease. When this occurs;

  1. the purchaser may be required to re-negotiate a new lease on terms that are substantially less favourable than those previously provided to the vendor;
  2. the purchaser may have to leave the location. This can  result in the loss of a significant proportion of the customer bases and, consequently, the good will of the business; or
  3. the purchaser may incur significant costs in moving to another location and negotiating a lease with a new landlord.

As a matter of law the vendor/lessee remains liable to the lessor in the event of a default of the purchaser, unless released by the lessor on assignment. If the purchaser lacks the financial capacity to maintain the lease, or if the purchaser causes damage to the premises, the vendor could be liable for significant amounts of money.

Inadequate Due Diligence Due diligence in relation to the business may be inadequate for a number of reasons including if:

  1. the vendor does not fully co-operate with the due diligence requests and endeavours of the purchaser;
  2. the vendor and purchaser agree to a short timeframe for the conduct of due diligence;
  3. the due diligence is limited in its scope, for example, limited to the financial affairs of the business only; or
  4. the purchaser waives the opportunity to conduct a due diligence.

If the due diligence relating to a business is inadequate, the purchaser may not be made aware of something that could materially affect the business and assets it is purchasing prior to completion. In those cases, the purchaser's only recourse may  be the warranties provided in the contract and the pre-contractual representations and warranties of the vendor.

Breaches of Warranty Where there has been a breach of warranty, then in a properly drafted agreement, proceedings are to be commenced within a defined period of time. In addition to imposing a defined period of time in which to bring warranty claims, a vendor may also seek to limit its exposure to a certain monetary amount. As a practical matter, and to stop vexatious warranty claims, it is not unusual to include a minimum claim amount. Unless there is a minimum claim amount on a "per claim" basis, the vendor may be burdened by multiple possible claims.

Enforceability of Restraints of Trade This is a recurring area of post sale of business litigation. The decided cases  focus upon the wording  of the particular agreement and the reasonableness of the restraints. Getting the restraints right in terms of the activity they cover, the geographical area and time frames within which they operate is critical. However, who they cover is often glossed over. It is critical to ensure that all key persons, whether they be employees, directors or simply relatives of the vendors, are properly signed up to appropriate restraints.

Misleading & Deceptive conduct allegations regarding Pre-Contract Representations and Warranties - A number of judicial decisions demonstrate that purchasers are entitled to rely on pre-contractual representations and warranties made by the vendor and it is no longer sufficient just to look to the contract as the source of a party's rights and obligations.

The pre-contract period, being the period that precedes formation of the contract for sale of a business, is of particular legal significance as it is during this period that the vendor may make certain representations to the purchaser which could amount to misleading and/or deceptive conduct.  While an actionable misrepresentation may provide substantial common law and equitable remedies including rescission and/or damages, misrepresentations made in the pre-contract period may also attract liability under the Competition and Consumer Act 2010 (Cth).