Warranties, Representations & Indemnities Of Buying a Business

Presenter: Steve Brown

B.Ec, LL.B (Syd), M.App.Fin (Mac), A.Bus, FAICD
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Topics
Issues to Consider  Pre-contractual representations  Specific Contractual Terms & Conditions  Negotiation of Contract warranties etc


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Formalities and terms

Terms of a contract express implied conditions warranties

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Taking Instructions
Find out what it is that the client wants. It is trite just to say a vendor wants a sale and a purchaser to purchase a business  Lawyers role is to facilitate the successful achievement of our clients goals in other words to ensure performance but of what!  Of what is the aim of taking instructions.

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Taking Instructions
Checklists are a useful tool to obtaining proper instructions  Checklists minimise a lawyers exposure to professional negligence claims  Only every act for one party  Work with clients accountant regarding tax structure issues on sales and purchases

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Issues to Consider - Vendors



Should the vendor obtain a guarantee for performance of a corporate purchaser(Swept-Up Marketing Pty Ltd v Voltrant No. 282 Ltd (NSW)
Supreme Court, 26 April 1989, )

Indemnity

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Issues to consider - Purchaser

1. 2.

3.

Does the purchaser have the finance Does the purchaser have the capacity to run the business Determine the legal structure for the purchaser by considering:

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the simplicity of the vehicle and its cost of establishment; ii. the nature and size of the business; iii. the potential for the growth of the business and the need for additional capital for growth; iv. the taxation consequences of each vehicle; v. the manner in which the business is to be managed and the degree of owner involvement; vi. the cost and complexity of terminating the vehicle on the owner exiting the business or passing it on to their family; vii. the structure of the purchasers family; and viii.the potential for the business to fail and the implications if it does fail.
i.
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Negotiation Issues Precontractual representations

 

Negotiating What to Look Out ForStatutory Impact on Contract Law Misleading or deceptive conduct
Trade practices act (Cth) ss 52 & 53 Fair trading act (NSW) s. 42

Unconscionable conduct
Trade practices act (Cth) pt IVA Fair trading act s. 43

Contracts Review Act (NSW only)

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Misleading or Deceptive Conduct

 Strict

liability  Actual deception  Overall impression  Product puff

 Silence  Ambiguity  Erroneous

assumption  Half truths

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Misleading conduct - s 52 Example

Four principles were established in the case of Taco Co of Australia v Taco Bell Pty Ltd (1982) ATPR 40-303 as assisting to determine whether conduct is misleading or deceptive. The relevant section of the public must be identified. All people within that section must be considered including the intelligent and not so intelligent, the educated and uneducated. Evidence that someone was misled is helpful, but is neither conclusive nor essential. When a misconception has arisen it is important to determine why, in order to see if it was the business' conduct that caused it.
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1. 2.

3. 4.

Misleading conduct - s 52
A SECOND PRINCIPLE: It's the overall impression on the target audience that counts
  silence can be misleading - if there is a duty to speak  a prediction can be misleading if there's no reasonable ground to make it

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The Difference Between Agreements and Contracts? Agreements are not as a general rule: Legally enforceable Courts will not involve themselves.
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The Difference Between Agreements and Contracts? Contracts are ALWAYS: Legally enforceable Courts will enforce as the law dictates
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Non Enforceable Agreement

If you wash my car Ill give you $10

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Non Enforceable Agreement

Ill pick you up for dinner at 8 oclock

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Contracts & Agreements what are they?

Practical Answer they are both Risk Minimization tools that operate as
Checklists or Rule Books by applying Performance standards

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Contracts & Agreements How Are They Risk Tools

Agreement to meet and discuss a form of long term supply arrangement  Contract to supply an apple  Contract or agreement to sell a toll manufacturing business

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Contracts & Agreement - As Checklists or Rule Books



Who is to do what who is to sell; Who is purchase (whatever it is that is being sold). When are the services\goods to be supplied by vendor when are they to be paid for by purchaser. How are the services\goods to be supplied. Consequences of good or poor performance.
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Why have a Contract instead of an Agreement

Risk

Formality & Legality

least formal form of Agreement to oral contract most formal form of written contract

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Contracts as risk tools are used to minimise the inherent risks of the contract
Risks with a contract to supply an APPLE Risks with a sale of business contract

HIGH RISK LOW RISK

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How courts interpret contracts

Courts use rules of construction as pointers to discover the presumed intention of the parties to a contract.  The rules are not slavishly applied.  The rules are used to produce as reasonable and just result as possible.


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Rules of Contract Construction



The object of construing a contract is to ascertain what the mutual intentions of the parties were as to who is to do what, how and when from the words they used to express the obligations each assumed by entering into the contract. The intention of the parties is the meaning of the words they have used. There is at common law no intention independent of that meaning. The intention of the parties must be ascertained from the words used, in light of the surrounding circumstances and the object of the contract, in so far as the object has been agreed or proved. Courts construe the objective intention of the parties not the parties actual intention.

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Rules of Contract Construction



 

Business common sense is sometimes used in addition to the words chosen by the parties. Here the courts look at the purpose of the contract, whether the form of the contract was a standard form or negotiated by the parties, and the commercial experience of the judge who is to construe the meaning of the words used. Where the words used are clear, the court must give effect to them even if they have no discernible commercial purpose. Although not overtly recognised, courts sometime manipulate the construction of a contract to achieve a fair result on the facts as ascertained by the court. In construing a contract clauses must not be considered in isolation, but must be considered in the context of the whole of the contract.

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Rules of Contract Construction



The words of a contract should be construed in their grammatical and ordinary sense, except to the extent that some modification is necessary to avoid absurdity, inconsistency or repugnancy. The ordinary meaning of a word is its meaning in its plain, ordinary and popular sense, although that sense may be a sense among a particular group of persons. Where a contract contains technical terms the court may discover the meaning of those terms using a dictionary, or where the technical terms are in dispute the court may only proceed upon calling expert evidence as to what the terms mean.

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Rules of Contract Construction

Implied terms Special situations  Courts may imply terms where a contract is silent upon a  Standard form contracts point but only if all of the next Any special conditions are 5 conditions are able to be given greater weight to the satisfied: standard conditions in the  it is reasonable ; case of conflict  it is necessary to give business efficacy to the contract;  it is so obvious a term it goes without saying;  it is able to be expressed clearly;  it is not contrary to an express term. www.etiennelaw.com

Drafting the Contract

Use standard form or not eg Law Society or own  The need to ensure that what the parties are seeking to achieve will be achieved the contract being a checklist to achieve this  Performance is the key

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Specific Contractual Terms & Conditions

Goodwill  Lease issues  Employees  Reduced Deposit Clauses  Exclusion Clauses  Early Access


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Goodwill


is incorporeal personal property The Commissioners of Inland Revenue v Muller & Cs Margarine Ltd (1901) AC 217 has no value independent of the business to which it attaches In Commissioner of Taxation v Murray (1998) 72 ALJR 1065, Therefore is its crucial to identify the bundle of assets and source of goodwill to capture it for a purchaser:
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Goodwill examples


A company which operates a business distributing high value medical equipment in Australia has developed important commercial and personal relationships with the German manufacturer of the equipment. The purchaser will need to ensure that it takes an assignment of the exclusive distribution agreements and to work on the relationship with the German manufacturer. It would be prudent for the purchaser to meet the management of the supplier in Germany and perhaps to retain the vendor as a consultant for a period of time to massage the transfer.
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Goodwill examples


The vendor is selling a well known convenience store which is located in a particularly busy area, with lots of passing traffic and good parking. The residual term of the lease is relatively short. The purchaser will have to ensure that it renegotiates the lease term to ensure that its rights to the premises are secured.

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Goodwill


If there is a risk of customers walking after the vendor leaves, it may be necessary to maintain a retention fund from the sale proceeds from which money can be repaid to you as purchaser if customers are lost through no fault of the purchaser. Retention funds are often coupled with clawback provisions of various levels of sophistication.

The other ways of protecting from a loss of goodwill is to require the vendor to grant a restraint of trade. Besides penalties for loss purchasers negotiation earnout provisions which increase the payment for the sale to a vendor upon successfully maintaining profitability

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Goodwill example


An electrical contractor servicing domestic customers has had considerable success from advertisements placed in the Yellow Pages over a number of years. The company also has easy to remember telephone numbers. The company name contains the name of the vendor that the vendor wishes to retain.

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Lease of Premises
New lease or assignment  If a real property lease is being assigned remember to advise vendors that he assignment does not extinguish their liability under the lease: Only a new lease will do this  Is term of existing lease sufficient to secure value of business for purchaser.

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Employee Issues
 

Both vendor and purchaser need to be aware of employee issues. Four types of employees
Key employees who must be retained if goodwill is to be secured Those offered employment Those not offered employment Those offered employment but decline to be employed

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Terms & Conditions Reduced Deposit Clauses

Iannello & Anor v Sharpe [2007] NSWCA 61  5% paid on exchange  No Completion  Need to consider if balance of unpaid money penalty  In this case held to be a penalty

14. Reduced Deposit Notwithstanding anything else herein contained, the Vendor shall accept, on exchange of this Agreement, payment of $225,000.00 being part of the deposit. The parties expressly agree that if the Purchaser defaults in the observance or performance of any obligation hereunder which is or has become essential the balance of the deposit, namely $225,000.00, shall become immediately due and payable and the Purchaser shall forfeit the whole of the sum of $450,000.00 pursuant to Clause 9 hereof to the Vendor.

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Reduced Deposit Clauses

To minimise penalty issue never reduce deposit  But how to negotiate this with purchaser


Be firm Be innovative take balance by promissory note or bill of exchange or bank guarantee

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Exclusion Clauses & S 52



You cannot contract out of s 52. In entering into this agreement the purchaser acknowledges that it has not relied on any statement, representation or warranty by or on behalf of the vendor whether express or implied as to ...
Clarke equipment Australia ltd v Covcat Pty ltd felling machine, exclusion clause in contract no effect. Collins Marrickville Pty Ltd v Henjo investments Pty ltd.
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Tenders & S 52
Representations that a project will take a stated period of time and it does not or the start is delayed beyond the time it is represented to commence may amount to misleading and deceptive conduct.  Section 51A shifts onus of proof for predictions. A representations as to future action must be made upon reasonable grounds.

OConnor & sons Pty ltdwww.etiennelaw.com v Entact clough Pty ltd.

Tenders & s 52
A RFT that does not indicate that strict compliance with the terms of the tender is essential gives to a tenderer not shortlisted a right to injunct the tender process (MacMillans case)  A tender that is not evaluated in accordance with how tenders were represented to be evaluated may be misleading (Hughes Aircraft v Airservices Australia)

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Early access
To premises  To executed documents that can facilitate completion  To staff, key personnel or clients/customers


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Early Access
Do not permit early access  Do not have documents held in escrow  Rather than early access provide supervised training  Rather than early access allow due diligence


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Overview
 What

is due diligence?  What is the purpose behind due diligence?  Who Conducts due diligence?  What is the due diligence process?  Where is information obtained?  Lessons from the cases.
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Contracts as risk minimisation tools?

Risk 5 year HDPE Supply contract

Acquisitions

More Formality & Legality

Less risk least formal form of Agreement as level of risk increases to most formal form oral contract of written contract
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LEGAL RISK MANAGEMENT

1. 2. 3.


Understand the legal aspects. Identify potential risks. Take practical steps to eliminate/minimise those risks.
Reduce the likelihood of an event; Reduce the consequences of an event; Transfer in full or in part the consequences of an event (Negotiate a price to accept the risk); and/or Avoid the event.
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By taking actions that:

Reduce the likelihood of an event



Due Diligence

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Reduce the consequences of an event

Warranties  Liquidated Damages  Restraints of Trade  Post employment of key personnel  Exclusion clauses


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Transfer in full or in part the consequences of an event

Firm Price Fixed Price A price which is not variable for any reason A price, the final value of which is fixed by reference to some variable parameter such as inflation, currency exchange rate, or maintainable profits of the businesses A price based on the post acquisition profits of the business so that the seller shares in the on going growth of the businesses
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Earnout/ Workout Price

Avoid the event



Dont proceed with the purchase or sale

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Questions?

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