Contracts and Sellers Warranties
Business sales contracts usually contain warranties by a Seller on a wide range of matters concerning the business sold, including as clear title to all of the assets sold and to the truth and accuracy of financial records. It is frequently the case that buyers and sellers will negotiate on the terms of such warranties. A buyer will want all encompassing broad warranties, while a seller will want to confine and narrow the warranty terms to matters that they absolutely know to be true and correct.
Careful drafting of business sales contracts reduces risk
Careful consideration must be given to the drafting of a sale of business agreement. For vendors in particular, there are a number of contractual terms and conditions by which potential liability can be reduced, (but not fully eliminated) including:
• Avoiding representations about the future performance of the business;
• Limiting warranties to matters that the vendor knows to be true and correct and can control;
• Capping any amount that can be claimed as damages;
• Providing a minimum threshold of damages before a warranty claim can proceed;
• Impose responsibility on the buyer to do their own feasibility on future performance;
• If there is a due diligence period, the buyer should confirm full satisfaction with their enquiries on giving notice to proceed.
For a buyer, any clauses which try to restrict or reduce the Seller’s liability are undesirable. Care should be taken to ensure that there will be appropriate recourse against the vendor for undisclosed issues arising post-completion.
A buyer has a number of remedies available to them if they subsequently find that the warranties are breached, including an action for breach of warranty and action under the Australian Consumer Law (ACL).
Usually, an action for damages will rely on both causes of action, and the making of misleading and deceptive representations which is prohibited by s18 of the Australian Consumer Law (ACL), cannot be excluded by contract. Vendors should be aware that s4(2) of the ACL deems a representation about any future matter to be misleading, where there were no reasonable grounds for making the representation.
Sellers should also be aware that failing to disclose any significant facts or information may well be in itself misleading and deceptive conduct, even in a due diligence process where the buyer will conduct its own investigations. Silence on any material issue can give rise to a liability in damages, or allow a rescission of the contract.
A recent example of these issues was in the decision of Evolution Traffic Control v Skerratt
[2018] NSWSC 49 (ETC).
The key facts of that case were:
• The buyer entered into a share purchase agreement for business for $10 million.
• The price was based on a multiple of 5 times the EBIT of the business.
• The seller provided future financial forecasts upon which the buyer relied in
determining the price paid.
• In calculating the EBIT, reliance was placed by the purchaser on financial forecasts
provided by the vendors.
• The financial forecasts relied upon a specific government funding program, which was
provided based upon the achievement of conditions which were in fact, unachievable
in the future.
• The sellers did not disclose that specific condition during negotiations.
On discovery of the conditions of funding, after completion, the purchaser issued proceedings
to recover the difference between the purchase price and the actual value of the business at
the time of the sale, and pleaded a case based on:
1. misleading and deceptive conduct under the ACL, and
2. for breach of the warranties.
The share purchase agreement contained two specific broad warranties:
(i) the accuracy and completeness of all information disclosed in due diligence
materials during the course of negotiations leading up to the sale; and
(ii) that all information that would be material for disclosure to a prudent purchaser had
been disclosed.
The vendors failed to show that they had a reasonable basis for making representations about the business’ future financial performance. The Court ordered damages of around $4 million representing the loss suffered on a re-sale of the business for $6 million.
The key facts of the ETC case are not unusual in the sale and purchase of businesses, and illustrates the risk of a seller making representations about the business sold based on inaccurate and incomplete information.
Selling a business can be a rewarding and profitable experience, and the reward for many years of hard work, capital and effort. Don’t risk losing that with a poorly drafted or inappropriate contract.
Consult an experienced and knowledgeable lawyer on the terms and conditions of a contract before signing. It can make a huge difference to the outcome.
For further information and assistance on any matters relating to the sale and purchase of a business, call us. Our knowledge and experience will help you make good decisions.
