Buying or selling a business: contract clauses that can maximise your interests and minimise risk (Part four of our business sales series)

Note: several broadly similar versions of business sale and purchase agreements are used in New Zealand. This article refers to the most commonly used agreement: the Agreement for Sale and Purchase of a Business prepared by the Auckland District Law Society Inc.

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What is a business sale and purchase agreement?

An Agreement for Sale and Purchase of a Business is a legally binding contract that sets out the price negotiated by the parties and the conditions of purchase.

Generally, the agreement is prepared by a lawyer or drafted by a business broker. In most cases, the buyer’s lawyer handles this work, as this allows them to propose or include additional conditions favourable to the buyer. 

What essential information does the agreement contain?

The agreement contains basic information about the business being sold, such as the names of the buyer and seller and a detailed description of the business. Some details are particularly important:

    a. Purchase price

The agreement includes the purchase price of the business, which usually comprises the following:

1. Tangible assets: fixtures, equipment, instruments and similar items;
2. Intangible assets: goodwill, customers, intellectual property, trade marks, the business name and similar assets;
3. Stock value: the value of the goods held as stock that will be transferred to the buyer at settlement. The buyer and seller can negotiate an adjustment range for the stock level, such as an increase or decrease of 20%. Once this range is specified in the agreement, the buyer can refuse to accept stock above that range.

We recommend that buyers consider more than the total offer price before making an offer. Consult an accountant or lawyer beforehand and carefully consider the price allocated to each component.

     b. Turnover warranty

The seller must warrant that the business’s historical turnover stated in the agreement is accurate. This generally includes turnover for the past year. In a future article, we will discuss how buyers can seek redress for losses if the amount stated in this clause proves inaccurate. 

    c. The seller’s assistance period after settlement

After the sale is completed, the seller must provide assistance for the period specified in this clause. Either the seller or a suitable, experienced person approved by the buyer will share knowledge and experience relating to the business to help the buyer run it.

    d. Restrictions on the seller’s future business activities and their duration

The second page of the agreement contains a clause specifying the period and geographical radius, in kilometres, within which the seller cannot compete with the buyer, directly or indirectly. This clause imposes a restraint of trade on the seller for similar businesses within a defined period and area, preventing the seller from running a competing business after settlement.

If the seller is a company, the buyer can also nominate its legal representative or a particular shareholder to be bound by this clause, and require the seller’s lawyer to prepare a formal document recording this. Particular attention must be paid to reasonableness and other relevant factors when setting this clause, because if a dispute arises, the court will consider:

1. Whether the duration is reasonable;
2. Whether the geographical area is reasonable;
3. Whether the nature of the restriction is reasonable.

If these aspects are unreasonable, the clause may be ruled unlawful and therefore unenforceable. For example, if you buy a restaurant, it would be very unreasonable to prohibit the seller’s chef from operating a similar business anywhere in New Zealand for 25 years, or from working as a chef.

    e. Deposit clause

The agreement must clearly state when the deposit is payable. It is generally paid when the agreement is signed or confirmed unconditional, and does not exceed 10% of the purchase price.

    f. The list of assets included in the business sale

Usually set out in Schedule 1 of the agreement, this lists the business assets and all other assets being transferred. The buyer should check the list to ensure all important assets are included. At settlement, the seller generally needs to ensure these assets are free of security interests.

Beyond these essential terms, the purchase conditions are among the most important parts of the agreement. Whether the business sale ultimately proceeds depends on whether these conditions can be satisfied. Common examples include:

    g. Buyer’s due diligence condition;

    h. Landlord’s approval condition;

    i. Buyer’s approval of the lease; and
    j. Other important conditions required by the buyer. 

What additional conditions are commonly included?

Business sale and purchase agreements usually include additional purchase conditions requested by the buyer. The parties must confirm within a specified period whether these conditions have been satisfied. If any condition is not satisfied, the agreement can be cancelled on that basis. Common additional conditions include:

• Buyer’s approval of the lease

The agreement provides that the buyer is entitled to review the lease after signing. If the buyer does not approve its terms, they have the right to cancel the sale and purchase agreement.

• Landlord’s consent to assignment of the lease

If the business involves leased office premises, obtaining the landlord’s consent to assign the lease becomes an essential condition of the transaction. The usual timeframe for satisfying this condition is 10 to 20 working days.

Through their lawyer, the buyer must provide evidence of their credentials and financial position, such as identification and information about their background and finances. The landlord will review this material. Neither party needs to be overly anxious; they simply need to comply with the landlord’s reasonable requests. Generally, a landlord cannot refuse an assignment without good reason.

• Buyer’s due diligence

This condition allows the buyer to investigate all aspects of the business within a specified period before deciding whether to proceed. The usual timeframe is 10 to 15 working days.

This process is very important for buyers, who need a thorough understanding of the business. The following points can serve as a guide:

1. The business’s financial statements and GST filing records, to be reviewed by your accountant;
2. Employees, including whether any particularly important staff will stay after settlement;
3. Important contracts and customers, including whether the business depends heavily on a particular customer and whether the associated paperwork and contracts are complete;
4. Any ongoing disputes, such as intellectual property litigation or proceedings involving the government;
5. Observing the premises to understand how the business operates and its daily turnover;
6. Having a lawyer review the business premises lease, including the rent, term, any associated charges and special conditions, to determine whether any amendments should be requested from the landlord;
7. For a franchise business, having a lawyer review the Franchise Agreement and investigating matters such as required dealings with head office and the associated fees.

• Finance condition

This condition allows the buyer a specified period to confirm that they have sufficient funds to complete settlement. If a loan from a bank or finance company is required, the buyer needs to establish when the relevant approval letter can be obtained.

The usual timeframe for this condition is 5 to 10 working days. Buyers can decide whether they need this condition and, if so, an appropriate timeframe based on their circumstances.

What happens if either party breaches the agreement?

Once the agreement becomes unconditional, the buyer is committed to purchasing the business. If either party subsequently breaches the agreement and prevents settlement from being completed, the party not at fault can serve a settlement notice on the party responsible. If that party still cannot resolve the issue and complete settlement within 12 working days, the party not at fault can choose to:

1. Cancel the agreement and forfeit the deposit; and/or
2. Sue the party responsible for damages.

Sellers should understand that all risks relating to the business remain their responsibility until settlement. Risk transfers to the buyer only when settlement occurs and possession is handed over. Sellers therefore need to keep relevant insurance in force until settlement. For example, if the premises are burgled two days before settlement and all the equipment and instruments included in the sale are lost or damaged, you must replace or repair them before settlement. If you cannot do so, and the lost or damaged equipment is assessed under clause 4.2 as preventing the business from operating normally, the buyer may be able to cancel the agreement under that clause.

Whether you are buying or selling a business, seeking professional advice from a lawyer and accountant beforehand will help the process run more smoothly, maximise your interests and avoid unnecessary risks and potential disputes. As a party to the transaction, however, it remains essential to understand the process and the key points of the agreement yourself.

About the authors:

Joy Yuan is a lawyer admitted to the High Court of New Zealand and a principal at Turner Hopkins. She holds degrees in law and management, and an MBA specialising in entrepreneurship from Babson College in Boston. Her expertise covers commercial law, including company structures, shareholder agreements and establishing trusts, as well as property law, including subdivisions and property transactions.

Elaine Li is a legal executive in Turner Hopkins’ commercial property department. Her work covers commercial lending, business sales and purchases, shareholding changes, commercial leases, sales and purchases of houses, apartments and commercial properties, subdivisions, and changes to easements and title registrations. She also assists the firm’s partners with employment matters and commercial disputes.