So far in this ten-part series on how to sell a business, our blogs have focussed on the lead-up to an exit and the sale process itself. This week, we look at the problems that can arise after completion of a sale. This article will assess why disputes arise after an exit, and the steps sellers can take to reduce the chances of a post-completion dispute. We will also consider what sellers can do if something does go wrong.
Common areas of dispute
The seller of a business will generally be required to provide warranties in the sale agreement. Warranties are contractual promises as to the condition of the business and if they turn out to be untrue, the seller may face a claim for any loss suffered by the buyer as a result.
The likelihood of a breach and resulting claim depends on the drafting of the warranties. In the first instance, a seller should be working with their legal advisers to reduce the scope of the warranties; the wider they are drawn, the greater the chance of an issue arising that could give rise to a breach.
In part 4 of the series, we discussed the importance of using the disclosure exercise to qualify and limit your liability under warranties. The wording of the matters disclosed should be given careful consideration to maximise scope for arguing that any post-completion allegations of breach of warranty are issues which the buyer was already aware of, and cannot subsequently complain about.
You should also seek to negotiate provisions which limit the buyer’s ability to claim for breach of warranty. Clauses that restrict the types of claim which can be brought, agreeing a minimum financial value of the claim and time limits, can provide sellers with protection from speculative post-completion warranty claims.
The purchase price and any subsequent uplift or reduction may be decided using completion accounts. They are a useful way of showing the true value of the business at the date of sale, but completion accounts can cause uncertainty for sellers. A buyer may attempt to interpret the accounts to their advantage, and seek a downwards adjustment of the price, and this is a common source of disputes.
It is therefore important to set out a clear framework for drawing up the accounts, and an appropriate adjustment mechanism. In addition, the parties should agree early on the accounting methods to be used.
A well drafted sale agreement should provide a procedure for dealing with completion accounts disputes. One option is to include a clause referring the dispute to an independent accountant to make a binding determination on the figures. This could achieve a quicker and cheaper outcome than litigation.
Part of the purchase price may be retained by the buyer to provide security for the seller’s post-completion obligations. A retention can also be agreed to allow the buyer to verify the warranties provided, until completion accounts have been agreed, or to allow the buyer to generate profits to pay the full purchase price.
To provide sellers with security, retentions are often held in an escrow account on terms recorded in the sale agreement. Payments can then only be made from the account in specified circumstances. It is important to ensure that the agreement terms are balanced, and not weighted in the buyer’s favour, to provide an easy opportunity for them to avoid paying all or a part of any retention due, by raising speculative claims.
A seller commonly agrees not to establish a competing business, poach employees or to solicit customers from the business they have sold. Breach of these sorts of covenants enables the buyer to seek remedies, including injunctions to restrain the seller, and damages.
Sellers who are planning new ventures should carefully negotiate the scope of such covenants and remain aware of the limits they place on future trading. If a claim is made by the buyer for breach of covenant, the seller should check that the covenant is actually enforceable. A covenant must go no further than necessary to protect the buyer’s legitimate business interests. If wider than this, the restriction may be unenforceable.
What can a seller do if the wording of the sale agreement does not reflect their understanding of what had been agreed? The courts have the ability to interpret a contract in a way that might not have been anticipated by one or other of the parties. The court can also correct mistakes by retrospectively amending the wording of a contract, in appropriate cases.
However, the law on interpretation and mistake is complex and uncertain, and cannot be used to relieve a party of a bad bargain. The parties to a contract are usually held to the terms and conditions they signed up to, even if they operate unfairly or not as expected.
It may be possible to negotiate revised wording with the purchaser, but otherwise, a careful analysis of the legal position will be required, to assess the merits of bringing a claim.
What to do if a dispute arises
(1) Clarify the area of dispute
Establish the nature of the dispute and gather together all of the information and available evidence relating to the disputed matters.
(2) Consider the relevant sections of the sale agreement
Understand the scope of the parties’ obligations in relation to the dispute.
(3) Check any procedure to be followed
The agreement may provide for procedural requirements to be followed in the event of a dispute, including notice provisions, time for investigation and dispute resolution clauses. Have these been followed and if not, what are the consequences?
(4) Assess any limitations on bringing a claim
The agreement may limit the buyer’s ability to bring of a claim dependent on time frame, the nature of the claim or its value.
(5) Seek legal advice
Dispute resolution lawyers regularly deal with disputes involving the sale of a business. A solicitor can offer advice and assist you with negotiating the resolution of a dispute, invoking or responding to dispute resolution clauses, expert determinations, and starting or defending litigation.
Prevention is always better than cure, so investing the time and effort in negotiating the terms of sale is the best way to provide post-completion certainty for a seller. Next week, we will be taking a more positive look at success stories, and what happens when a sale proceeds smoothly.