In Brief: Selling a business requires careful consideration and planning. Once you have sold your business, the last thing you want as a vendor is to find yourself involved in litigation. Often, if a business doesn't perform as expected, the purchaser will look to the vendor to compensate them for the poor performance of the business.
Set out below are five danger areas and tips to help minimise the risk of being sued when selling your business.
- Misleading and deceptive conduct
PA claim for misleading and deceptive conduct is where a purchaser says they relied on representation made by the vendor (or their agent) which induced them to purchase the business which they claim was false.
As a Vendor, be very careful to ensure that information you provide and statements you make during the lead up to the sale of business are accurate and not open to interpretation. This may seem obvious, but even informal conversations can be relied upon and used as the basis for Court proceedings after the sale of the business.
The Courts have found the following statements to be misleading and deceptive:
- Implying the relationship with a customer is greater than it is and downplaying the customer's other supplier relationships.
- Inflating sales figures of the business.
- Providing projections of potential sales and orally stating that they would be achieved.
- Make sure that all verbal conversations with the purchaser are followed up in writing and are very clear as to their meaning. Sending an email after a conversation confirming what was discussed is the most common way of recording the conversation.
- Do not provide any information which is not 100% factual and cannot be supported by documents.
- Do not provide projections for sales or reduction in expenses which have not yet been achieved, even if you believe they are achievable.
- Breach of warranties
A warranty is where the contract says that the vendor warrants (or promises) that a particular fact is true.
The Courts have found the following things to be a breach of warranty:
- Providing a warranty that the goods sold by a business comply with government regulations, when in fact they don't.
- Providing a warranty that the information provided with regards to the earnings of a business were accurate, when in fact they were not.
- Providing a warranty that there were no pending legal claims against the business, when in fact there were.
- Ensure that any warranty is carefully drafted so that it is not too wide.
- Ensure that all products and services sold comply with all regulatory requirements.
- Ensure that all warranties provided can be supported by documentary evidence.
- Where warranties are broad, look to qualify them by reference to your knowledge or belief.
- Restraint of trade clauses
A restraint of trade clause is one where the vendor is restrained from opening (or sometimes working in) a similar or competing business for a specific timeframe in a specific geographical area after the deal completes.
The Courts have found the following instances to breach restraint of trade clauses:
- Diverting work to the vendor's wife's business and then working in that business once the vendor had ceased working in the sold business.
- Where the vendor sets up in competition in circumstances where the full purchase price had not been paid – the purchase price was payable in installments and one of the installments was not paid.
- Ensure that it is clear in the contract of sale what type of activity would breach the clause – be very clear about what type of business would be considered to be in breach.
- If the purchase price is payable in installments, ensure that the contract specifically considers whether a default in the payment of the purchase price invalidates the restraint.
- If you have plans to open another business (similar or otherwise), specifically write into the contract that the type of business which will operate in a specific location will not breach the restraint of trade clause.
- Insufficient disclosure
Often it is claimed that there had been insufficient disclosure of financial information. This is particularly relevant where a competing business is considering purchasing the business.
The Courts have found the following things to be insufficient disclosure:
- Where the Vendor enclosed inaccurate trading statements in the Disclosure Statement – a Purchaser has the right to assume that any information in the Disclosure Statement is true and accurate.*
- Where the Vendor entered into a side agreement which impacted on the business, but did not disclose this side agreement to the Purchaser.
* Disclosure Statements are only required in sales of small businesses but disclosures made during purchaser due diligence would attract the same consequences.
- Ensure that the Disclosure Statement accompanying the Contract of Sale (or information provided in due diligence) complies with the statutory requirements. Where the Disclosure Statement is sufficient, the onus then falls on the Purchaser to conduct his or her own enquiries as to the suitability of the business for their needs.
- Confidentiality clauses
Confidentiality clauses are designed to protect the business's confidential information from the competition.
The following instances are likely to be considered a breach of confidentiality clauses by the Courts:
- Where the vendor works in the industry after the sale and uses the customer mailing list to solicit clients.
- Where the vendor assists another person to set up in competition using confidential information gained from the business.
- Do not take copies of any of the business's documents (other than those required for regulatory compliance) with you when you leave the business.
It is important that all dealings prior to and post the sale of business are handled keeping in mind the common areas of litigation outlined above.
The top ways to minimise the risk of litigation are as follows:
- Ensure that the contract of sale of business is well drafted and clear. It is important that it clearly states in plain English (not legal jargon) what you understand to be the agreement.
- Document everything in writing, even informal conversations with a prospective purchaser, preferably as soon as possible after the conversations.
- Do not say or provide any information which cannot be supported by facts and existing documentation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Madgwicks is a member of Meritas, one of the world's largest law firm alliances.