ABOUT THIS SERIES
- This is the final edition of McCullough Robertson's six part Commercial Law Masterclass series.
ABOUT THIS ARTICLE
- In this our final Commercial Law Masterclass article for 2018, we discuss some of the key items you need to monitor after you've negotiated and signed the sale document for your business. From pre-emptive rights to pre-completion covenants, staying on top of your business (and your obligations) is key to a smooth completion and reducing the risk of disputes.
- We'll wrap up the series with a Masterclass in Brisbane in early 2019 where you can ask our expert panel any questions.
Successfully negotiating the sale of your business and signing the sale document can be a long and complicated process. However, once you've signed on the dotted line it's important to understand your obligations leading up to, and the steps necessary for, completion to occur.
Three of the key areas to focus on in the pre-completion period are:
- pre-emptive rights – arrangements which give another party the last right or option to acquire the relevant interest being sold;
- pre-completion covenants – also known as restrictive covenants, limit what you can do following signing; and
- third party consents and releases – obtaining any necessary third party consents and releases for the transaction, such as change of control, assignment or relating to security interests.
Pre-emptive rights, or rights of first refusal, are arrangements which give another party the right or option to acquire the relevant interest being sold, be it shares in the entity being sold or the relevant assets. They can arise under any number of documents such as a company's constitution or a shareholders' agreement and can be triggered:
- on receipt of an offer to acquire the relevant interest;
- on agreement to sell the relevant interest; or
- where there is a control transaction in relation to a shareholding entity.
Most commonly, they will allow the other party (often another shareholder) to acquire the relevant interest at the same price and on the same terms as you have negotiated with the third party.
If your interest in the business is subject to another party's pre-emptive right, you will need to ensure you follow the relevant procedures and notice requirements and communicate these requirements to the buyer. Critically, if the entity being sold is a controlling entity of the business itself and you have co-investors or owners who will be remaining with the business, you should understand any pre-emptive rights they may hold and ascertain their appetite for exercising them.
Timing considerations should be discussed with your advisors at the beginning of the process so that a clear timetable can be established. This is particularly important where the pre-emptive rights stipulate a particular time period in which you must complete the sale to the third party once a waiver of the pre-emptive rights has been obtained. If this time period is too restrictive, you should ensure that you receive an appropriate extension of time as part of the waiver, particularly if you are expecting a lengthy period leading up to completion or anticipate delays in satisfying any other conditions precedent.
Where completion of the transaction is not expected to occur for a significant period of time following signing, it's common for buyers to require the seller to provide certain pre-completion covenants which will restrict what they and the business can do prior to completion. The purpose of these covenants is to ensure that the business being acquired at completion is substantially the same as the business the buyer expects to acquire and understands from their due diligence leading up to signing.
Common covenants include:
- carrying on the business as a going concern and following its usual or ordinary course;
- exercising due care;
- maintaining assets and insurance;
- limits on incurring any expenditure or liabilities above set thresholds; and
- prohibiting entry into new agreements or varying the terms of existing agreements.
One of the most common ways in which a covenant can be breached is through a failure to adequately communicate the covenants to key employees and management. A seller should ensure that they effectively communicate to relevant employees how the agreement may restrict the current operations of the business or otherwise limit employees' authority to enter into new agreements or vary existing arrangements.
If you do have concerns that a covenant may be breached due to factors beyond your control, such as a key customer exercising a right to renegotiate terms of a current contract with you or unanticipated capital expenditure being required to repair or replace a critical asset, it's always best practice to communicate these issues to your advisors and involve the buyer as early as possible so that you can obtain their consent and avoid a claim for breach of contract.
Third party consents and releases
Whether you're selling a business or a controlling interest in a company, it's highly likely that the consent of, or release by, certain third parties will be required prior to completion. Other than regulatory consents, these third party consents usually take the form of:
- change of control consents;
- consents to assignment; or
- security releases.
Change of control provisions and consents to assignment are common in key agreements and leases where the counterparty wants to maintain control over who they will be doing business with following assignment of a contract or a change of control of an entity. In both circumstances, it's important to begin this process early and involve the buyer as it will be their capacity to fulfil the obligations of the relevant agreement that the counterparty will be most concerned with. If you are party to a large number of agreements requiring these sorts of consent, the factors you should consider are:
- does the counterparty have absolute discretion in providing their consent;
- are there stipulated notice and consent periods in the agreement; and
- are there any issues in the current relationship with the counterparty?
Where the counterparty has discretion, the consent process can often become a bargaining chip for them to renegotiate the agreement on better terms which may impact on your pre-completion covenants.
Most sale documents require the release of any encumbrances, including security interests, other than those held by suppliers in relation to goods supplied on retention of title terms. The most common security interests requiring release are mortgages and registrations on the Personal Property Securities Register (PPSR). While you'll be aware of an existing mortgage over land which forms part of the interest being sold, the sheer number of registrations which may exist over the company or assets being sold, or registered against you personally in respect of your shares in that company, can be significant.
In approaching these PPSR registrations it's important to first of all identify any incorrect or outdated registrations and ask the relevant secured party to remove the registration. If the secured party doesn't respond to your requests for release within five business days you can approach the PPSR Registrar or apply to a court for the registration to be released. This process can be quite lengthy so you should ensure it's commenced as early as possible.
For valid registrations, match these against your existing agreements such as general and specific security agreements and hire purchase agreements to ensure you understand the outstanding liabilities relating to the security interest and the actions necessary to secure its release.
If the purchase price to be received on completion is needed to pay off any debts relating to the security interest, it's common practice to obtain a copy of a signed but undated 'release and undertaking to amend registration' from the secured party which is only effective on completion subject to receipt of the payment.
After the high of negotiating and signing the sale document, it's important to begin work in earnest on negotiating the waiver of pre-emptive rights, complying with your obligations under the sale document, and negotiating consents and releases with relevant third parties.
This process can be overwhelming and difficult to manage, particularly with the number of moving parts involved in a business, but communicating the expectations with your key employees and working with your advisors to develop a structured approach to these issues should help streamline the process.
Our team has been involved in countless deals from small business sales to major transactions for ASX listed companies and we're always happy to discuss how we can help you achieve your objectives.
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.