Susan Hopcraft, professional negligence solicitor with Wright Hassall, runs through what can go wrong when you’re buying or selling a business and how you can fix it.
You have worked hard to build up your business and finally ‘cash in your chips’ by selling. Or possibly you are still on the ‘escalator’ and buy another business to add to your burgeoning empire. Or, and say this quietly, getting rid of a part of the business that just doesn’t work for you.
These can be exciting times, but whether you sell/buy shares or assets, things can go wrong. Often deals are hammered out late into the night with last minute changes to sale and purchase agreements; hardly the ideal environment in which to negotiate the fine detail of the sale of your life’s work or an acquisition of the key to your future!
Avoiding pitfalls is best, but there are ways to put things right if the ball is dropped. This article highlights some of the things that must be dealt with carefully when buying and selling businesses and explains how to address problems if they result.
How to sell or buy businesses
You can either trade the whole company by selling the shares, or acquire or sell a particular part of the business by an asset sale. They are different, notably in relation to the liabilities that pass with the shares but which are excluded from an asset sale, but the issues that need to be dealt with are broadly similar.
1. Due diligence
Sale and purchase agreements usually result from lengthy investigations into the target business. This ‘due diligence’ should lead to the discovery of all of the warts, and these are usually dealt with in warranties and indemnities set out in the sale and purchase agreement.
If any particular hole in the accounts or liability is missed then it obviously cannot be part of a reduced price or indemnity. The due diligence must therefore be done carefully and often solicitors or accountants carry this out. Failing to identify an issue in due diligence can cause a purchaser to fall at the first hurdle and that is why, with larger businesses in particular, it is often the professionals that carry out the due diligence.
2. Drafting warranties
Solicitors then draft the contractual clauses that reflect the way in which the particular wart is to be treated between the parties. Once aware of an issue, if is not set out totally clearly then there can be a problem when, for example, the purchaser calls on an indemnity seeking repayment of a claim from the seller, but the seller argues back that the issue does not fall within the terms of the indemnity.
Some of the other key issues are to ensure an effective transfer of employees under the Transfer of Undertakings regulations, or of any pension liabilities, and to advise on any competition implications. Here any failure to consider the issues could leave one party or another with a higher cost than intended.
4. Change of ownership clauses
Sometimes a change of ownership of a business can put it in breach of some of its key contracts. If there is a ‘change of control’ clause in a key contract then that must be addressed in advance to ensure that the sale does not cause termination of the relationship with a vital supplier or customer.
Various policies can be affected. If the liabilities within your existing business are affected, do you need additional insurance cover immediately on the completion of the deal?
6. Tax/earn outs
Does the company or any director need advice on any tax provisions such as entrepreneurs relief? Are there any ‘earn out’ provisions from a previous deal that might trigger an accelerated payment clause? These need to be identified and dealt with before the agreement is signed, otherwise unexpected liabilities might arise.
7. Foreign acquisitions
A more unusual type of claim, but one that recently ended up in court was the example of solicitors who failed to advise on the voting rights when a foreign company was acquired. Assuming that 94% of the shares gave effective control over a Slovakian ice cream company was incorrect. The buyers were frozen out by the director and 6% shareholder and their solicitors faced a £10m negligence claim.
What if an unintended liability comes back to bite?
All professionals acting on the sale and purchase of businesses owe duties of care to the company (and possibly shareholders) to carry out their due diligence, advice and drafting with reasonable skill and care. If they do not then they are negligent, and if that causes loss then a claim for damages can be brought.
The loss might be the unexpected sum that needs to be paid, or it might be the difference in price that you would have paid/accepted at the time with proper advice. But you cannot assess that with hindsight. Your assessment of loss must be a true reflection of what you would have done then, without hindsight!
Both accountants and solicitors carry insurance to pay claims as a result of negligence so a legal claim is often a good method to make good the damage.
Any of the examples above could be the result of an accountant or solicitor failing in the investigation of the business, the contracts review, or a failure to appreciate and advise on the implications for employees and tax liabilities. Solicitors bear a heavy burden when drafting the agreement and the warranties and indemnities but, without proper drafting, the contract will not reflect the deal that was intended and loss can arise.
The first step, if a loss has occurred, is to complain to the professional, but if that fails then legal advice should be sought. Time limits apply to negligence actions – usually six years from the breach of duty, although this can be longer depending on when loss accrued, or three years from when the right to claim was known about. These are inflexible limits and if in doubt about whether you have a claim you need to take advice as soon as possible to make sure you do not miss a time limit to obtain redress.
So, whether you’re cashing in, up-sizing, or even just getting rid of a part of the business you just don’t like any more, it is vital that you choose your professional team carefully. The risk of a liability coming back to bite is best avoided, but if things do not go to plan there is still a route available.