Sale and Purchase of Business Assets Practice Paper CC302

PRACTICE PAPER CC302 Sale and Purchase of Business Assets Edited by Ilan Kraus BBus (Banking & Finance), LLB (Mon) Barrister and Solicitor of the Supreme Court of Victoria...

PRACTICE PAPER CC302 Sale and Purchase of Business Assets Edited by Ilan Kraus BBus (Banking & Finance), LLB (Mon) Barrister and Solicitor of the Supreme Court of Victoria Revised by Saveria Dimasi BA (Hons) (Melb), LLB (Melb), LLM (Melb) Barrister and Solicitor of the Supreme Court of Victoria Adjunct Lecturer, The College of Law Victoria August 2023 © 2023 The College of Law Limited This publication is copyright. Except as permitted under the Copyright Act 1968 (Cth), no part of this publication may be reproduced by any process, electronic or otherwise, without the specific written permission of the copyright owner. Neither may information be stored electronically in any form whatsoever without such permission. Disclaimer The practice papers have been prepared as practice guides primarily for students at The College of Law and also for legal practitioners. They are not intended to be a comprehensive statement of the law or practice and should not be relied upon as such. If advice on the law or practice is required or required to be given, professional advice should be sought and practitioners should undertake their own legal research.  CC302 Sale and Purchase of Business Assets CONTENTS 1 INTRODUCTION................................................................................................................... 7 2 COMMERCIAL CONSIDERATIONS FOR A PURCHASER OF A BUSINESS..................... 7 2.1 Initial considerations.............................................................................................................. 7 2.2 Pre-purchase evaluation or due diligence............................................................................. 8 2.3 Business plan........................................................................................................................ 8 2.4 Particular businesses............................................................................................................ 8 3 TYPES AND SOURCES OF BUSINESS FINANCE............................................................. 9 3.1 Financiers.............................................................................................................................. 9 3.2 Security................................................................................................................................. 9 4 INTRODUCTION TO STANDARD SALE OF BUSINESS CONTRACTS............................ 10 4.1 Standard contract................................................................................................................ 10 4.2 Drafting the contract............................................................................................................ 11 4.3 Agent................................................................................................................................... 11 4.4 Role of the vendor’s lawyer................................................................................................. 11 4.5 Role of the purchaser’s lawyer............................................................................................ 11 4.6 Choice of entity for purchase............................................................................................... 12 4.7 Separate representation...................................................................................................... 12 4.8 Buyer beware...................................................................................................................... 12 4.9 Description of business....................................................................................................... 12 5 PURCHASE PRICE AND ITS APPORTIONMENT............................................................. 13 6 GOODWILL......................................................................................................................... 13 6.1 Legal position...................................................................................................................... 13 6.2 Economic view of goodwill.................................................................................................. 14 6.3 Goodwill from a purchaser’s perspective............................................................................ 14 6.4 Local and personal goodwill................................................................................................ 15 7 PLANT, FITTINGS AND CHATTELS.................................................................................. 15 7.1 Overview............................................................................................................................. 15 7.2 Vendor’s lawyer’s obligations.............................................................................................. 15 7.3 Purchaser’s lawyer’s obligations......................................................................................... 16 7.4 Fixtures............................................................................................................................... 17 7.5 Vendor also selling freehold................................................................................................ 17 7.6 Where business premises leased....................................................................................... 18 7.7 Leases and mortgages........................................................................................................ 18 8 STOCK-IN-TRADE.............................................................................................................. 18 8.1 Overview............................................................................................................................. 18 8.2 Valuation of stock-in-trade................................................................................................... 19 © The College of Law Limited 3  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE 9 DEPOSIT............................................................................................................................ 19 10 SETTLEMENT DATE.......................................................................................................... 19 11 NEW LEASE OR TRANSFER OF AN EXISTING LEASE.................................................. 20 11.1 General considerations....................................................................................................... 20 11.2 Negotiation for a new lease................................................................................................. 20 11.3 Consideration of an existing lease...................................................................................... 20 11.4 Liability of vendor and purchaser on and after transfer of lease.......................................... 20 11.5 Obtaining the mortgagee’s consent.................................................................................... 21 11.6 Transfer of lease................................................................................................................. 21 12 RESTRICTIONS ON VENDOR’S COMPETITION.............................................................. 22 12.1 Restraints generally............................................................................................................ 22 12.2 Trade practices and public policy considerations................................................................ 22 12.3 Key persons’ restrictions..................................................................................................... 23 13 VENDOR’S WARRANTIES AND OBLIGATIONS............................................................... 23 13.1 Overview............................................................................................................................. 23 13.2 Managing the business as a going concern........................................................................ 23 13.3 Notices affecting the business............................................................................................ 24 13.4 Lawful use of premises....................................................................................................... 24 13.5 Clear and unencumbered title............................................................................................. 24 13.6 Takings warranty................................................................................................................. 24 14 GUARANTEES................................................................................................................... 24 15 PURCHASER’S PRE-EXCHANGE SEARCHES................................................................ 25 15.1 Purchaser’s pre-exchange searches and enquiries............................................................ 25 15.2 Categories of searches....................................................................................................... 25 15.3 Inspection of books and records......................................................................................... 26 16 EXCHANGE OF CONTRACTS........................................................................................... 26 17 PURCHASER INSPECTION............................................................................................... 26 18 PRE-SETTLEMENT............................................................................................................ 26 18.1 Vendor’s obligations and default......................................................................................... 26 18.2 Purchaser’s obligations and default.................................................................................... 27 18.3 Vendor’s representations and the Competition and Consumer Act 2010............................ 27 18.4 Vendor’s tuition and assistance period............................................................................... 27 18.5 Business name transfer...................................................................................................... 28 18.6 Service of documents.......................................................................................................... 28 19 SETTLEMENT.................................................................................................................... 28 19.1 Overview............................................................................................................................. 28 19.2 Settlement instructions........................................................................................................ 28 19.3 Takeover of existing agreements........................................................................................ 29 4 © The College of Law Limited  CC302 Sale and Purchase of Business Assets 19.4 Rent and outgoings adjustments......................................................................................... 29 19.5 Lease outgoing adjustments............................................................................................... 29 19.6 Bond.................................................................................................................................... 29 19.7 Vendor’s finance and security............................................................................................. 29 19.8 Payments to outgoing mortgagee....................................................................................... 30 20 EMPLOYEE MATTERS...................................................................................................... 30 20.1 Employee entitlements........................................................................................................ 30 20.2 Annual leave....................................................................................................................... 31 20.3 Personal/carer’s leave......................................................................................................... 31 20.4 Long service leave.............................................................................................................. 31 21 POST-SETTLEMENT......................................................................................................... 32 21.1 Vendor’s lawyer’s obligations.............................................................................................. 32 21.2 Purchaser’s lawyer’s obligations......................................................................................... 32 22 DUTIES PAYABLE.............................................................................................................. 32 22.1 Duty generally..................................................................................................................... 32 22.2 Duty on the contract for sale............................................................................................... 33 22.3 Duty on a new lease or transfer/assignment of lease.......................................................... 33 23 INCOME TAX CONSIDERATIONS FOR THE VENDOR.................................................... 33 23.1 Overview............................................................................................................................. 33 23.2 Depreciable property........................................................................................................... 33 23.3 Intellectual property............................................................................................................. 34 23.4 Trading stock....................................................................................................................... 34 23.5 Work-in-progress................................................................................................................. 34 23.6 Employee entitlements........................................................................................................ 34 24 INCOME TAX CONSIDERATIONS FOR THE PURCHASER............................................. 35 24.1 Overview............................................................................................................................. 35 24.2 Goodwill.............................................................................................................................. 35 24.3 Depreciable property........................................................................................................... 35 24.4 Intellectual property............................................................................................................. 35 24.5 Trading stock....................................................................................................................... 35 24.6 Work-in-progress................................................................................................................. 35 25 CAPITAL GAINS TAX CONSIDERATIONS FOR THE VENDOR....................................... 35 25.1 Consequences of capital gains tax...................................................................................... 35 25.2 Restraint of trade................................................................................................................. 36 25.3 Lease.................................................................................................................................. 36 25.4 Date of acquisition and disposal.......................................................................................... 36 26 CAPITAL GAINS TAX CONSIDERATIONS FOR THE PURCHASER................................ 36 27 GOODS AND SERVICES TAX........................................................................................... 36 © The College of Law Limited 5  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE ABBREVIATIONS AllPAAP all present and after-acquired property ASIC Australian Securities and Investments Commission ATO Australian Taxation Office CCA Competition and Consumer Act 2010 (Cth) CGT capital gains tax FWA Fair Work Act 2009 (Cth) GC general condition GST goods and services tax GST Act A New Tax System (Goods and Services Tax) Act 1999 (Cth) ITAA 1997 Income Tax Assessment Act 1997 (Cth) PPS Act Personal Property Securities Act 2009 (Cth) PPSR Personal Property Securities Register SIT stock-in-trade standard contract Contract of Sale of Business – 2020 edition ACKNOWLEDGMENTS This practice paper was edited by Ilan Kraus BBus (Banking & Finance), LLB (Mon) and is regularly reviewed and updated (as necessary) by College of Law academic staff and other legal practitioners. Previous reviewers include Ian Angus LLB (Syd), FCIS in 2006, Elspeth McNeil BA (Hons), LLB (Melb), GradCertHigherEd (Mon) in 2007–2008, Geoff Nicholson in 2009–2011, College of Law academic staff in April and November 2012, Philip Chown LLB (UNSW), BCom (UNSW) in August 2012, Silvana Marasco LLB (Melb), BComm (Melb) in 2013–2016, Steven Lowry LLB, BA in 2017, Clare Lethlean BEc (Mon), LLB (Mon), GAICD in 2018, Mary Garson BA (Juris), LLB (Hons) in 2019–2021, and Saveria Dimasi BA (Hons) (Melb), LLB (Melb), LLM (Melb) in 2022. Current revision by Saveria Dimasi, August 2023. 6 © The College of Law Limited  CC302 Sale and Purchase of Business Assets 1 INTRODUCTION This practice paper addresses the sale and purchase of a business by way of the sale and purchase of the assets of that business. It is possible to acquire a business by acquiring the entity that owns the business assets (for example, by acquiring all the shares in a company that owns the business assets). Which option is preferred depends on the vendors’ and purchasers’ objectives and the size of the entity in question. For example, a large publicly listed company is more likely to be acquired by buying the shares rather than only the assets. On the other hand, the purchase of some or all of the business assets may be preferable for a small to medium business acquisition. Both options have advantages and disadvantages. For example, acquiring all the shares in an entity is relatively easily done, essentially needing only the transfer of share certificates. The purchaser acquires control of the business entity that way. A potentially significant disadvantage of a share acquisition is that not only are the assets acquired but so are the liabilities, including any unknown or contingent liabilities. A purchaser may consider the purchase of only the business assets of a business to be less risky because there is no passing on of the liabilities. However, the purchase of business assets may require the transfer of (unencumbered) title in each asset to the purchaser, which can be complex and time-consuming. Further, acquiring only the assets does not bring with it control of the existing business; effectively, it provides control of the “tools” to run a similar business. In both types of transactions, the purchaser should undertake a comprehensive due diligence process to understand what it is acquiring, what the risks are and whether its objectives are being met. 2 COMMERCIAL CONSIDERATIONS FOR A PURCHASER OF A BUSINESS 2.1 Initial considerations People start or purchase a business for a variety of reasons, generally believing (or hoping) it will be successful. However, many will not be particularly successful and may even fail, with severe financial consequences. Common reasons why businesses do not achieve their proprietor’s expectations include some or all of the following factors: Personnel related: Does the purchaser/operator of the business have: – sufficient qualifications, experience and skills in the particular business or industry; – adequate business management training; and – adequately trained staff to run the business? Business related: Has the purchaser/operator: – a clear understanding as to why the vendor wants to sell the business; – determined the level to which the business’s success is contingent on the vendor’s presence; – obtained an independent evaluation of the business from a professional adviser; – received a full disclosure of financial information from the vendor; – investigated whether the business has been well managed and that proper records have been kept that verify the business’s previous performance; – determined if the business’s location is conducive to maintaining or expanding the profits; – inspected and assessed the business’s assets; and – identified any external factors, such as competitors, new developments, changing patterns or legislation, that may affect the business’s viability? © The College of Law Limited 7  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE Financial related: Has the purchaser/operator: – made provision for sufficient capital to purchase and operate the business; – ensured that adequate finance is available, if needed, to complete the purchase on reasonable terms; and – ensured that the business’s revenue will be sufficient to provide a proper return on capital and service the borrowing costs? 2.2 Pre-purchase evaluation or due diligence “Due diligence” is a process of evaluating the business and can be undertaken at different stages of the acquisition process. It is putting the business “under the microscope” to confirm that it is what the vendor says it is. It is prudent to do some due diligence at the pre-purchase stage as well as after contracts are exchanged. The components of a prudent pre-purchase evaluation of a business by a professional, such as an accountant, valuer, financial adviser or management consultant, will vary considerably depending on the nature and size of the business. The following due diligence matters are considered fundamental in an evaluation of most businesses: Do the current values of the assets justify the price? Are the profits adequate for the type of business? Have the financial records been properly kept and are they available for a sufficient number of years? Are the sales and profits increasing or declining? Can the level of overheads be maintained? Do the profits include a market salary for working proprietors? Is stock readily available? Are key personnel secured to the business? Are there any existing or pending court proceedings against the business? 2.3 Business plan Most successful businesses have a considered business plan that is regularly updated, often annually. Business plans are an important management tool that potential purchasers of businesses should review. Professional help may be required to develop an understanding of the business, set appropriate goals, and prepare and implement a business plan that includes key performance indicators, a target market strategy, a corporate identity, training and management and accounting systems. 2.4 Particular businesses The commercial considerations indicated above will generally apply to all businesses, but many businesses will require particular skills, qualifications, permits, approvals or licences before they may be operated or transferred. In Victoria and other states, there are hundreds of Acts, regulations and licences governing or controlling particular businesses. In many instances, it is illegal to conduct a business without the appropriate qualification or licence. The Business Licensing Authority is an independent body established by the Business Licensing Authority Act 1998 (Vic). It administers licensing, registration and permission provisions contained in legislation, including the Conveyancers Act 2006 (Vic) and Estate Agents Act 1980 (Vic). Information about the Business Licensing Authority can be found on the Consumer Affairs Victoria website. 8 © The College of Law Limited  CC302 Sale and Purchase of Business Assets The Australian Business Licence and Information Service (ABLIS) is a national service provided by the Australian Government in partnership with state and territory governments. The ABLIS website provides useful information about many of the licences required, details of relevant authorities and the procedure for obtaining licences. 3 TYPES AND SOURCES OF BUSINESS FINANCE 3.1 Financiers The following financiers offer finance packages generally used for business dealings: banks and credit unions; finance companies; merchant banks; trade suppliers; and private client financiers (often referred to as private equity). Trading banks and credit unions are the most common source of finance for the acquisition of businesses. The most common finance products available are: from a bank: – term loan (fully drawn business loan repayable over a period of time); – line of credit or overdraft (on an existing bank account); and – personal loans; to procure funding to purchase plant/equipment: – chattel mortgage; and – equipment finance leases; and for trade finance: – letters of credit; and – bill facilities. Often, more than one form of finance product may be useful. Lenders other than banks will offer some of these finance products, and there is an increasing tendency for new financial products to be created or old products to be “repackaged” in modern terms. 3.2 Security Almost invariably, a lender, also known as a financier, will require security for the loan, which will usually involve one or a combination of: mortgage of real estate; mortgage of the lease for the business premises; security interest over personal property (regulated by the Personal Property Securities Act 2009 (Cth) (PPS Act)). Personal property under the PPS Act generally excludes land and fixtures attached to the land and some statutory licences: PPS Act s 10. The most common security interest is a general security interest over all present and after-acquired property (AllPAAP) of a business. A security interest also includes all types of security arrangements over personal property, such as a charge, pledge, chattel mortgage, finance lease or conditional sale agreement; and if the borrower is a company, a personal guarantee by its directors, which may be secured by the directors’ real estate or personal property. © The College of Law Limited 9  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE A borrower needs to be well informed about the terms of any loan and the obligations under a loan facility. Typical provisions that should be carefully considered include: term of the loan; interest rates, including: – effective rate and “default” rate; – whether the rate is fixed or variable; and – whether the option exists to convert from fixed to variable or vice versa; when interest is payable; principal repayment terms; early repayment options and penalties; break cost calculations; establishment fees; ongoing fees and charges; insurance requirements; security – whether there is a restriction on granting further encumbrances (usual); guarantee – whether it is unlimited or if there is any “cap” on the exposure of the guarantee; representations and warranties by the borrower; and default provisions. When a company is the borrower, the financier will usually require a personal guarantee from the company’s directors. Depending on the size of the business and the financial arrangements being put in place, the financier may also request that the spouse or domestic partner of a director/borrower provide a guarantee, even if they are not directly involved in the business’s day-to-day operation. This is particularly important to the financier when the company does not own sufficient assets in its own right that can be used as security for the loan. A purchaser of a business may negotiate a finance facility directly with the financier or through an intermediary, such as a broker. It is common for a loan agreement to contain the terms of the facility, often in the form of a letter of offer, which requires acceptance by the borrower and any guarantor providing security. At this time, the borrower and any security provider should seek legal advice on the terms of the offer and, particularly, financial advice on the loan terms before entering into a loan agreement. For further information on securities, refer to Practice Paper CC305 Finance and Securities and the Personal Property Securities Register (PPSR) website. 4 INTRODUCTION TO STANDARD SALE OF BUSINESS CONTRACTS 4.1 Standard contract There is one standard form contract for the sale of small business in Victoria – the “Contract of Sale of Business” endorsed by the Law Institute of Victoria and most recently amended in February 2020 (standard contract). References in this practice paper to “particulars” are to the Particulars of Sale set out in the standard contract. Similarly, references to “Schedule” and “general condition” (GC) are references to those contained in the standard contract. Although most lawyers use the standard contract (amended as necessary to suit the particular transaction), especially for the sale and purchase of a small business, it is not unusual for large law practices and some lawyers to use their own form of bespoke contract. 10 © The College of Law Limited  CC302 Sale and Purchase of Business Assets In addition, the vendor must provide certain prescribed trading and financial information to the purchaser on the sale of a “small business”: Estate Agents Act 1980 (Vic) s 52. A small business is a business in which the goodwill, plant, equipment and fittings being sold have a total price of the prescribed amount of $450,000 or less. The prescribed information must be set out in a “Statement by a Vendor of a Small Business”, signed by the vendor and acknowledged by the purchaser: see Estate Agents (General, Accounts and Audit) Regulations 2008 (Vic) reg 8. A vendor’s failure to comply with the terms of the Estate Agents Act 1980 (Vic) amounts to an offence under that Act. Any contract entered into in breach of its terms will be voidable at the option of the purchaser prior to taking possession of the business. This practice paper does not analyse the standard contract but looks at practical considerations involved in the purchase and sale of a business, with reference to the standard contract where appropriate. 4.2 Drafting the contract Typically, the contract for a sale of business is not prepared until a purchaser for the business is found. The vendor’s lawyer then prepares the draft contract after receiving instructions from the vendor or the agent on the sale. The contract is sent to the purchaser’s lawyer and amendments are commonly made to the contract after negotiation between the parties. It is good practice for the vendor’s lawyer, when sending the draft contract to the purchaser’s lawyer, to state that no legal obligations will arise until a formal exchange of contracts (that is, execution of the contract by both parties) has taken place. 4.3 Agent Businesses may be sold without the involvement of an agent or business broker. Often, the vendor and purchaser will directly arrange the sale of a business, with the purchaser responding to an advertisement. However, if an agent has introduced the purchaser, standard agency procedures will apply. 4.4 Role of the vendor’s lawyer Some of the vendor’s lawyer’s responsibilities when drafting a contract for sale of a business are to: receive clear instructions from the vendor on all aspects of the business and what will be sold; advise the vendor on the legal procedures involved in the sale; assuming that the standard contract is used, advise the vendor on the need for any special conditions (and, in particular, pre-conditions (also referred to as conditions precedent) to be fulfilled before the sale is completed) or variations to the standard contract; regardless of the vendor’s level of financial understanding, advise the client to seek financial advice from an accountant or financial adviser, particularly in relation to apportioning the purchase price between assets in the transaction or minimising the application of capital gains tax (CGT) or other taxes; and understand the need to secure the continuing obligations of the purchaser under guarantees, particularly if the purchaser is a company. 4.5 Role of the purchaser’s lawyer Upon receipt of the draft contract, the purchaser’s lawyer should check it, noting: the legal entity of the vendor (a company, sole trader, partnership, or trustee for a trust); any special conditions imposed by the vendor; and all other details relevant to the purchaser’s interest. © The College of Law Limited 11  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE The purchaser’s lawyer must provide advice to their client on the contract and the effect of any special conditions. It is important to understand the purchaser’s objectives, including their expectation regarding purchasing the business. The purchaser’s lawyer will want to understand if the purchaser has had any discussions with the vendor that may have influenced the purchaser to buy this particular business where representations have been made that are not reflected in the sale documentation. It is crucial for the purchaser to investigate and verify any representations made by the vendor regarding the business and to include these as vendor warranties in the contract. The purchaser’s lawyer should enquire how the purchaser will pay for the business and advise on the implications of obtaining finance. The lawyer should suggest to the purchaser the advantages of obtaining independent financial advice and should be careful not to provide financial advice to the purchaser. 4.6 Choice of entity for purchase The purchaser’s lawyer should advise on the nature of the legal entity most appropriate for the purchase of the business, taking into account the nature of the business, the client’s goals, liability concerns, and taxation and other revenue considerations. Usually, the choice of entity is between: sole proprietor; partnership; private (proprietary) or public company; and trust (discretionary or unit). 4.7 Separate representation It is important that both the vendor and purchaser are separately represented (unless they choose to represent themselves). Lawyers run the risk of being negligent and/or guilty of professional misconduct when acting for both parties due to the real possibility of an actual conflict of duty to act in the best interest of each client: see Farmer v McGregor (1988) Q ConvR ¶54-281; Blackwell v Barroile Pty Ltd (1994) 51 FCR 347. 4.8 Buyer beware The purchaser’s lawyer must warn the purchaser that, despite the legal protection given by legislation such as the Australian Consumer Law (Competition and Consumer Act 2010 (Cth) (CCA) Sch 2), the maxim of “let the buyer beware” applies in the purchase of a business. The purchaser’s lawyer must use their best efforts to protect the purchaser at every stage of the purchase of a business. 4.9 Description of business It is essential that the business being sold is accurately described in the contract. The contract must specify precisely what assets the vendor is selling to the purchaser in exchange for the consideration. A business may comprise: goodwill; plant and equipment (whether leased or owned); premises leased or owned; intellectual property (including patents and trade marks); licences, permits and approvals; business name; phone numbers; 12 © The College of Law Limited  CC302 Sale and Purchase of Business Assets websites, email addresses and social media accounts; know-how and customer lists; stock-in-trade (SIT); work-in-progress; debtors; and current (and significant) contracts with key customers or suppliers. A business may also have employees, some of whom will continue to be employed after the sale and others who may not. Schedule 1 of the standard contract sets out details of assets included in the sale of business. It is important that any liabilities of the business the purchaser is to take over are clearly set out. The description of the business is very important to the purchaser, who must acquire the vital components of the business, including the use of the business names and the exposure (if any) afforded by the premises, to preserve the goodwill of the business and gain full value for the purchase price. The operative part of the standard contract provides that the vendor agrees to sell and the purchaser agrees to purchase the business and stock on various terms specified in the standard contract. The standard contract defines “Business” and “Business Assets”. The parties must carefully consider these definitions because if any alteration is required to correctly record what is being sold and purchased as part of the sale it must be done by way of a special condition to the standard contract. The standard contract also provides that the parties represent and warrant to each other that they have not altered the general conditions in the contract except to the extent that a special condition expressly amends them. 5 PURCHASE PRICE AND ITS APPORTIONMENT It is important to consider how the purchase price is to be apportioned between the various assets being sold, as the apportionment will have tax implications for both parties. The price to be apportioned for the plant and equipment on which the vendor has claimed depreciation is important: see Income Tax Assessment Act 1997 (Cth) (ITAA 1997) Subdiv 40-D. Careful consideration is required of the possible application of ITAA 1997 s 40-285 in relation to the sale of equipment for which the vendor has been claiming depreciation. The vendor must also carefully consider the possible application to the sale transaction of the CGT business concessions and/or the CGT 50% discount. Both the vendor and the purchaser will need to carefully consider GC 9 of the standard contract and any special conditions as to how the goods and services tax (GST) legislation may affect the sale transaction. Generally, parties acting at arm’s length are entitled to minimise the revenue impact on the transaction, and it is vital to confer with a client’s accountant before apportioning, or agreeing to, the price. See also Sch 1 of the standard contract for the allocation of the purchase price between assets and goodwill. 6 GOODWILL 6.1 Legal position There is no definitive description of goodwill. Goodwill is “personal property” for the purposes of the PPS Act. © The College of Law Limited 13  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE In legal terms, goodwill is a type of intangible personal property similar to some forms of intellectual property: see Inland Revenue Commissioners v Muller & Co’s Margarine Ltd AC 217. Goodwill is the “drawcard” that attracts customers to the business – it is the lifeblood of the business without which there is no business. It is the reputation of the business and, accordingly, can be difficult to quantify. Generally, goodwill is sold with the business it is connected to, and it has been suggested that goodwill cannot exist independently of a business it is connected to. Despite this, it is legally possible to sell goodwill or a portion of the goodwill independently from the business it is attached to. This is particularly the case where customer patronage depends in large part upon trade marks, trade names, packaging or other separate and distinctive features of the business: see Commissioner of Taxation v Murry (1998) 193 CLR 605; G Chiert, ‘Murry: Ending the Mysteries of Goodwill or Creating New Commercial Pitfalls’ (1999) 73 Australian Law Journal 659. 6.2 Economic view of goodwill In economic terms, the “value” of goodwill can be determined only when a business is sold – it is the cost to purchase the business minus the value of the net identifiable (tangible and intangible) assets (noted in Sch 1 as Plant/Equipment and Other Assets). An accountant will view goodwill as the “premium” value attributed to the business after deducting the value of its tangible assets, the intangible assets that are identifiable and attributed a value (for example, intellectual property, such as patents or designs) and the liabilities obtained in the purchase. Goodwill can be represented (in accounting terms) as follows: Goodwill = Value of Business − Value of Net Tangible Assets (net tangible assets is calculated by deducting the total liabilities of the business from its gross tangible assets) and identifiable intangible assets. When apportioning the price, the amount applied to goodwill is often (but not always) the surplus of the price after allocating appropriate amounts to the tangible and identifiable intangible assets of the business. 6.3 Goodwill from a purchaser’s perspective Both obtaining and protecting goodwill is an essential component of a business from the purchaser’s perspective. The purchaser’s lawyer must ensure that the sale contract properly restricts the vendor’s ability to “interfere” with goodwill sold to the purchaser. The position under general law on a sale of goodwill is as follows: Unless the vendor has entered into a restraint of trade covenant, it is: – not precluded from carrying on a similar business to the one sold, even in close proximity; and. – allowed to advertise having set up or continued in business but should not represent that it is continuing with or relocating a business that has been sold. The vendor is not able to canvass the customers of the business, and an injunction may restrain it from approaching those customers. The purchaser is entitled to use the vendor’s name in conducting the business but must not hold out the vendor as the business’s present owner or expose the vendor to any personal liability. The two ways of vesting the goodwill in the purchaser are by: transferring to the purchaser all the assets and rights that constitute the goodwill, including the business name and trade marks in particular; and preventing the vendor (through appropriate contractual conditions, commonly restraint of trade clauses) from interfering with or depreciating those rights. 14 © The College of Law Limited  CC302 Sale and Purchase of Business Assets 6.4 Local and personal goodwill There is a clear distinction between “local” goodwill and “personal” goodwill. The local goodwill of a business depends on the business’s physical location, whereas personal goodwill depends on the skills, personality and reputation of the proprietors and their ability to retain existing customers and attract new ones. 7 PLANT, FITTINGS AND CHATTELS 7.1 Overview Collins Marrickville Pty Ltd v Henjo Investments Pty Ltd (1987) 72 ALR 601 interpreted “plant, fittings and chattels” as a composite phrase meaning all things, whether attached to the business premises or moveables used in the operation of the business. The standard contract refers to these components as “Plant, equipment, fittings”: see Sch 1 of the standard contract. For convenience, this practice paper refers to them as “equipment”. Equipment may include common equipment items such as mobile phones, copying and scanning machines, chairs and computers, as well as more specialised equipment used in particular businesses such as printing presses and die-casting machines or excavators, cranes and similar mobile plant. The difference between equipment and SIT lies in a distinction between durable assets used over a significant period in the conduct of a business and consumable items disposed of in the normal course of business. Equipment should not be confused with fixtures, although what constitutes a fixture can be difficult to determine. 7.2 Vendor’s lawyer’s obligations The vendor’s lawyer should obtain from the vendor or the vendor’s accountant a full list of equipment included in the sale. This list should be included in Sch 1 of the standard contract. Often, the vendor’s latest depreciation schedule is attached to identify each piece of equipment by its registration details (if applicable) or salient features and the associated price being paid for the equipment. The vendor’s lawyer should ascertain the nature of any encumbrances or security interests over the items of equipment (which is personal property under the PPS Act) being sold. They should search the PPSR to find details of registrations of any “security interest” over “personal property” and decisions made about whether the equipment will be sold subject to, or discharged from, the security interest. General condition 2.2 and Sch 6 Vendor Warranties 12 and 13 of the standard contract provide that the sale of the business (including any equipment hire contract in Sch 2) is not to be subject to any security interest or encumbrance on settlement, subject only to permitted encumbrances agreed to by the parties: see Sch 5. The vendor usually pays out security interests over equipment on settlement, but this may be a point of negotiation with the purchaser. The contract must specifically address this and afford appropriate protection to the vendor and purchaser and any vendor guarantors. The vendor may not own some items of equipment but may lease or hire them from a third party. The standard contract provides for details of equipment hire and lease contracts to be specified in Sch 2. The standard contract should also include an appropriate special condition setting this out. A lessor of goods or equipment leased for a period of 2 years or more will register a security interest on the PPSR, so a search of the PPSR should be made of all goods or equipment to be transferred with the business. © The College of Law Limited 15  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE If a security interest in equipment that is the subject of a lease is registered and is to be paid out by the vendor on settlement, the vendor must, pursuant to GC 3.9, ensure that at or before settlement, the purchaser receives: evidence in writing (acceptable to the purchaser, acting reasonably) of a release of the security; and evidence in writing that the secured party will register a financing change statement on the PPSR. General condition 2.2 obliges the vendor to inform the purchaser of: all persons or entities who have or may have any security interest in the business or any assets or stock; the vendor’s ABN; the vendor’s date of birth; and any other information the purchaser needs to conduct a search of the PPSR. If the lease on the equipment is to be transferred to the purchaser at settlement, the approval of the security interest holder (lessor) must be obtained and documented. If the equipment is being transferred subject to a continuing security interest, Sch 5 of the standard contract (relating to permitted encumbrances) will also need to be completed. When acting for a vendor transferring a lease of equipment to a purchaser, it is important to release the vendor and any vendor guarantors from any continuing legal obligations under the lease if the lender will agree to this. If the lender does not agree to this, an indemnity from the purchaser in relation to the vendor obligations under the lease should be obtained. 7.3 Purchaser’s lawyer’s obligations If the purchase of the business includes the acquisition of equipment, the purchaser’s lawyer should recommend an inspection of the equipment being offered for sale before the exchange of contracts to ensure the equipment is suitable to the purchaser’s needs and in proper working order. This should be part of the due diligence process. The standard contract provides that, at settlement, the assets of the business (which includes equipment) must be in the same state of repair and proper working order as at the day of sale: GCs 3.4 and 13 and Sch 6 Warranty 9. Therefore, a purchaser’s lawyer might require a special condition warranting that the equipment is in fact in good working order and will be maintained in that condition until settlement. The purchaser’s lawyer should ensure that the vendor has clear title to all equipment being sold with the business. It is important for the purchaser’s lawyer to undertake appropriate due diligence searches, including checking for: security interests over personal property on the PPSR – the vendor must disclose any security interests in the contract as it warrants that the business is not subject to any charge, security interest or encumbrance; bankruptcy (for individuals) – a search on the National Personal Insolvency Index maintained by the Australian Financial Security Authority (AFSA). A search can also be made at the Federal Circuit and Family Court of Australia and the Federal Court of Australia to find any bankruptcy proceedings that have been filed but not yet recorded on the National Personal Insolvency Index; insolvency (for companies) – a current company search from the Australian Securities and Investments Commission (ASIC); and court searches for causes, writs and orders. 16 © The College of Law Limited  CC302 Sale and Purchase of Business Assets If there are security interests registered on the PPSR, GC 2.2 obliges the vendor to inform the purchaser of all persons or entities who have or may have a security interest and GC 3.9 obliges the vendor to provide the purchaser, at or before settlement, with evidence in writing of the release of any security interests. The parties can extend the settlement date by agreement to enable the appropriate security interest releases. Failing agreement, the provisions of GC 16 (Default) will apply. A purchaser’s lawyer may require the addition of a special condition to the standard contract obliging the vendor to provide a “transfer number” at settlement, to enable the transfer of each registered business name so that the purchaser can become the registered name holder. To transfer a business name registered on ASIC’s business names register, the existing name holder (the vendor) must apply to transfer the business name and ASIC will issue a “transfer number”. ASIC then provides that number to the new business name owner (the purchaser), who can then register the business name in the purchaser’s name. The special condition will seek to cover the vendor’s agreement to provide such further assistance as the purchaser requires at or after settlement to ensure the business name is registered in the purchaser’s name. All relevant searches should be updated immediately prior to settlement. 7.4 Fixtures If the sale includes fixtures, the purchaser’s lawyer must establish that the vendor has title to those fixtures and can pass the title to the purchaser under the relevant lease. What constitutes a “fixture” can be difficult to determine. The PPS Act excludes fixtures attached to land as, at law, they form part of the land. If the premises is leased, the fixtures may belong to the landlord of the business premises, not to the owner of the business. If they are the tenant’s fixtures, the tenant can remove them subject to repairing any resultant damage to the premises. Careful consideration needs to be given to whether there may be a mortgage or other security over the fixtures being sold as part of a business. A lawyer will need to consider whether such fixtures are: the landlord’s property – if so, does the landlord’s mortgagee have a land mortgage which is effective security over the fixtures; or because of their method of attachment, the tenant’s fixtures and, therefore, the tenant’s personal property under the PPS Act – if so, is there any security interest over this personal property under the PPS Act? Where a landlord has expressly agreed that the tenant’s fixtures remain the tenant’s property notwithstanding that they are permanently affixed to the land, it is likely that the landlord has provided a similar acknowledgment to a lender who may have financed those fixtures. Therefore, it is possible that a lender may have registered a security interest over the fixtures, so when acting for a purchaser you should search the PPSR. 7.5 Vendor also selling freehold Where the vendor is selling both the business and the freehold title to the business premises, the normal conveyancing procedures for the sale of land will apply to the freehold business premises, and there is no restriction on the vendor’s right to sell the fixtures. A contract for the sale of the business still needs to be prepared. When both standard land and business contracts are used, it is common practice to insert a special condition into each contract referring to the other contract and any necessary inter-dependent obligations in the particular circumstances of the transaction. It is usually essential to ensure a simultaneous exchange of both contracts and, in turn, a simultaneous settlement to ensure the purchaser obtains possession of the freehold business premises at the same time as they have possession of the business itself. © The College of Law Limited 17  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE When acting on a transaction that involves both the sale of the freehold business premises and the business, it is possible a lender has a security interest in fixtures attached to the land. A search on the PPSR should be conducted to reveal any security interest in the fixtures that will need to be discharged and ensure that any mortgage over the land is discharged at settlement. It is possible that different lenders may be involved, so simply discharging the mortgage over land may not clear all encumbrances. 7.6 Where business premises leased It is more common for the vendor to lease the business premises. When a lease exists, you need to determine what items are tenant’s fixtures and if the vendor has power to sell those fixtures. There are three main questions: Is the item affixed to the premises? If not, it is a chattel that may be sold and title transferred by delivery. Is the item affixed to the premises for business purposes? If so, it is likely to belong to the tenant, with some entitlement for removal. What rights exist between the landlord and the tenant for the removal of the fixtures and repairing any damage to the premises? 7.7 Leases and mortgages The purchaser’s lawyer must exercise particular care where the freehold of leased business premises is subject to a mortgage. Whether the purchaser is taking the transfer of an existing lease or a new lease, it is important to confirm that the mortgagee of the freehold has consented to the lease or the transfer, so that the tenant’s right to use the leased premises and to remove fixtures also binds the mortgagee. General condition 8.6 of the standard contract requires the parties to do everything reasonably required to achieve written evidence of consent of any mortgagee of the freehold of the business premises to any existing or new lease. 8 STOCK-IN-TRADE 8.1 Overview Stock-in-trade refers to goods that are available for sale and that generate the business’s primary income. General condition 22.1(n) of the standard contract defines stock as “all marketable Stock of the Business appropriate for the Business in the possession of the Vendor in the ordinary course of the Business”. A key problem in defining SIT in a contract for sale of business is to determine what stock the purchaser can reject. Although the SIT may be of good quality, it may be slow-moving or out-of-fashion. It is not commercially sensible for a purchaser to pay full value for these items when there is no prospect of quick sale and recovery of full value on the market. The description of stock as good, saleable or marketable does not adequately deal with this aspect of the transaction. A special condition should be drafted to cater for the circumstances of SIT of the business being sold. If the purchaser is familiar with the relevant industry, they should examine the SIT to determine its value and saleability; otherwise, the purchaser’s lawyer should suggest engaging a valuer for this purpose. 18 © The College of Law Limited  CC302 Sale and Purchase of Business Assets 8.2 Valuation of stock-in-trade A vendor may sell a business for a price plus stock, inclusive of stock (walk-in/walk-out) or without stock. If a business is sold on a walk-in/walk-out basis, a suitable condition in the contract should prevent a vendor: purchasing large amounts of stock before settlement outside the normal course of business; and selling stock at a discount between exchange of contracts and settlement. The standard contract provides for the business to be sold for a price plus the value of stock in the business at settlement and for the value of stock to be mutually agreed or otherwise determined by an independent valuer. The parties are to jointly conduct a stocktake to mutually agree on the value of each stock item, and, in the event of a dispute, an independent valuer will decide on the value of the stock and each stock item: GC 4.3. The purchaser is to pay the vendor the value of stock up to the maximum stock value inserted in the particulars and choose which stock it will not purchase if it exceeds the maximum stock value: GC 4.4. If no maximum stock value amount is inserted, the purchaser must buy all stock. 9 DEPOSIT The deposit is generally 10% of the purchase price (excluding the SIT figure). If the deposit is less than 10%, it should be enough to show the buyer’s commitment to purchase the business. General condition 1.1 of the standard contract requires the buyer to pay the deposit to the vendor’s lawyer or the vendor’s estate agent as stakeholder at the time and on the day specified in the particulars or the date the purchaser signs the contract if no date is specified. The stakeholder must hold the deposit and any interest derived on it in their trust account as stakeholder until the contract is settled or ended. The stakeholder must then pay the deposit and any interest to the entitled party (who is also entitled to the interest): GC 1.2(a). 10 SETTLEMENT DATE A contract for sale of a business should always specify a date for settlement (also referred to as completion) and should make it clear whether time is essential. See due date for settlement in the particulars and GC 3.12. The standard contract provides as follows: The parties must perform the obligations in the standard contract by the due date of settlement unless otherwise indicated: GC 3.1. Settlement must be effected on the due date for settlement at the time and place specified by the vendor, and different parts of the settlement may occur simultaneously at different places: GC 3.12. Settlement is effected when the vendor transfers the full title, benefit and quiet possession of the business, stock and all documents free from all encumbrances (except permitted encumbrances) to the purchaser in exchange for the whole price for the business and stock as set out in the particulars: GC 3.2. The circumstances of the sale may require time to be essential. Often, the parties will want to complete the transaction as soon as possible and may request a specific date for settlement. If settlement depends on an external event, it is risky to make time an essential condition, and a special condition should be inserted to account for any delay to settlement. © The College of Law Limited 19  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE 11 NEW LEASE OR TRANSFER OF AN EXISTING LEASE 11.1 General considerations Unless the purchaser is buying the freehold where the business is conducted, security of tenure is crucial and depends on the nature of the available lease. This is particularly important where there is substantial goodwill associated with the business’s location. Purchasers and their lawyers should ensure that the term of the lease is long enough (including options for renewal) and that the other terms are commercially acceptable. The term of the lease should be sufficient for the purchaser to conduct the business for the relevant period they seek but also contain a sufficient additional period (option to renew) to enable them to sell the business in the future with an adequate lease term still to run. 11.2 Negotiation for a new lease When a new lease is required, it will involve direct negotiations between the purchaser and the landlord or via their respective lawyers, with a new lease in place at the time the purchaser takes possession of the business. In the event negotiations are not finalised before exchange of contracts, a purchaser’s lawyer must ensure the contract is conditional on the landlord agreeing to grant a new lease on the required terms within a specific time after exchange. The purchaser’s lawyer should also recommend a due diligence be undertaken of the building before entry into contract which covers the leased premises in relation to its structure, building materials and all services and utilities. 11.3 Consideration of an existing lease If the existing lease for the business premises is acceptable to the purchaser, a transfer of the lease will be arranged. The purchaser’s lawyer must obtain a copy of the lease, check it and advise the purchaser on all important aspects of it before exchange of contracts. The contract should also be conditional on obtaining the landlord’s consent to the lease transfer within a specific time after exchange: see GC 8 of the standard contract. If there is a transfer of an existing lease, there is no reason why the terms cannot be renegotiated. Where the request is reasonable and the purchaser appears to be a valuable tenant, a landlord may oblige. However, the landlord, acting reasonably, is not legally obliged to agree. Whether a lease is transferred or a new lease is obtained, the purchaser’s lawyer must search the title to ensure there is no mortgage or caveat that may prevent the transfer of the lease or the grant of a new lease. It is also important to obtain the mortgagee’s consent as a precondition to settlement. If the lease is a sublease, both the sublease and the head lease should be carefully examined. The head landlord’s consent will normally be required for a transfer of the sublease. 11.4 Liability of vendor and purchaser on and after transfer of lease The contract for sale of a business and transfer of the lease will cover the vendor’s and purchaser’s liability following the transfer of the lease: see GC 8 and Sch 4 of the standard contract. The contract should contain warranties by the vendor that: the lease is valid and subsisting; the vendor has performed all of the tenant’s obligations under the terms of the lease and will do so up to the date of settlement: see GC 8.5; the vendor is not in breach of the lease (see Sch 6 Vendor Warranty 10) or that any breach has been waived or rectified; 20 © The College of Law Limited  CC302 Sale and Purchase of Business Assets there is no litigation (past or pending) between the vendor and the landlord concerning the lease: see Sch 6 Vendor Warranty 11; the vendor has the right to use the premises for the purposes indicated in the lease and there is no dispute concerning such use: see generally Sch 6 Vendor Warranties 1 and 2; there is no dispute between the vendor and the landlord concerning any rent review or a right to exercise an option to renew the lease; and in the case of a sublease, the above warranties should cover the head lease. In addition, both parties must do everything reasonably required to achieve written evidence of consent of any mortgagee to a transfer of the lease: see GC 8.6. The transfer of lease should deal with liability after the date of transfer. The following matters are usually covered: The vendor will perform and indemnify the purchaser in relation to the lease covenants up to and including the date of settlement. The purchaser will perform and indemnify the vendor in relation to the lease covenants after the date of settlement. The purchaser usually covenants with the landlord to perform the lease covenants after the date of settlement. Under GC 8.4, the purchaser must prepare the transfer of lease unless the lease provides otherwise. 11.5 Obtaining the mortgagee’s consent Whenever a mortgage exists over leased premises, the granting of a new lease or transfer of an existing lease will usually require the lessor’s mortgagee’s consent. When the lease is registered over Torrens title land, it is not binding on the mortgagee unless the mortgagee consented in writing. If a lease is granted without the mortgagee’s consent, there are usually two consequences: the landlord mortgagor has breached the mortgage conditions which may give the mortgagee the right to call up the debt by reason of the default; and if the mortgagee exercises its powers on default, it can recover possession of the premises from the tenant. If the purchaser’s lawyer’s title search discloses a mortgage, the purchaser’s lawyer should immediately take steps to obtain the mortgagee’s consent to protect the purchaser. When obtaining a mortgagee’s consent, the purchaser’s lawyer should carefully read any attached conditions and ensure the consent covers not just the initial term of the lease but all further option terms under the lease. The condition in the sale of business contract dealing with the transfer or grant of a lease should also make the contract conditional on obtaining such mortgagee’s consent. See GC 8.6 of the standard contract. 11.6 Transfer of lease A transfer or deed of assignment of a lease is imperative to bind all parties to the transfer of the lease and ensure all rights and obligations are fully understood. The transfer may contain: adjustment of rent and outgoings; any agreed amendments to the lease covenants; and execution of a guarantee by any new guarantor of the incoming tenant. © The College of Law Limited 21  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE Under the standard contract, it is usual for the vendor to pay for the costs related to obtaining the written consent of the landlord and any mortgagee to the transfer or new lease, as well as the landlord’s reasonable legal costs relating to any transfer or new lease (unless it is subject to the Retail Leases Act 2003 (Vic)): see GC 8.11. Normally, the purchaser will pay for any duty payable on the transfer or new lease. However, parties may negotiate these matters depending on individual circumstances. The Law Institute of Victoria has prepared a form of Transfer of Lease for use by lawyers, which is available on its website. 12 RESTRICTIONS ON VENDOR’S COMPETITION 12.1 Restraints generally In practice, the most common way to protect the goodwill of a business is to require the vendor (and other “key” persons involved in running the business) to agree not to engage in specified activities (that is, compete with the business) within a particular geographic area and for a period after settlement. Such restraints need to be carefully drafted. They should be reasonable, in the interests of the vendor and the purchaser of the goodwill, and in the public interest. Restraints that are unnecessarily wide both in respect of area and time may be unenforceable and even void. See GC 14 of the standard contract. 12.2 Trade practices and public policy considerations In Australia, the common law doctrine of restraint of trade continues to operate where it does not conflict with the CCA. The doctrine renders unenforceable any provisions in a contract that impose restrictions on a person’s freedom to engage in trade or employment unless they are reasonable and in the interests of the parties and the public. It is important to distinguish restraints of trade provisions in a contract that fall within the common law doctrine and those that are merely incidental so as to regulate trade (which fall outside the scope of the doctrine). While there is no restraint of trade legislation in Victoria, the courts have on occasion been willing to test the validity of a restraint of trade condition. Recourse is also available under the CCA. This issue has led to the creation of what is known as a “cascading” or “severable restraints” condition, which can specify a range of restricted capacities, businesses, areas and periods, and the vendor or other restrained person will separately enter into each restraint. The benefit of the severable restraint is that, if a court determines that some part of the restraint is unreasonable, that part may be unenforceable while the remainder or some other part of the restraint may be enforced. General condition 14.1 of the standard contract provides for a restriction on the vendor being “involved in any way” in another business of the same type within a time and radial distance from the business premises being transferred without the purchaser’s written consent. (See GC 14.2 for a definition of “involved in any way”.) The parties should carefully set out the relevant cascading time and distance restraints in the particulars in descending order. The cascading restraints will be interpreted in accordance with GC 19, which provides that, if any cascading restraint is unenforceable, it shall be severed from the contract without affecting the rest of the contract. Any other part of the restraint not severed will then remain enforceable. There have been instances where it has been alleged that a conflict exists between restraints created in accordance with the common law and the operation of the CCA. However, CCA s 4M preserves the restraint of trade doctrine insofar as that law is capable of operating concurrently with the Act. 22 © The College of Law Limited  CC302 Sale and Purchase of Business Assets 12.3 Key persons’ restrictions A key person may be a principal or an employee of the business. If the key person is a principal of the business (generally a director of a vendor company), it is usual to join them to the contract as a covenantor to the restraint of trade condition. General condition 14.1, in general terms, extends any restraint to “any third party who signs a separate restraint agreement” under which that person agrees to be bound by GC 14. Unless named as a vendor guarantor in the particulars, a purchaser will need to turn their mind to restraining, by separate agreement, any other key persons or employees of the vendor. Unless a key employee is already subject to a restraint of trade in their existing employment contract, it may be difficult to constrain them as part of a sale and purchase of a business. They are not party to the sale contract, so privity of contract does not apply to them. They would need to voluntarily agree to separate restraint arrangements for appropriate consideration. If a key person is not a principal of the business, it may be possible for the purchaser to make a separate payment to the key person as a consideration for giving the restraint. Such a payment will usually be taxable as a capital gain by the key person resulting from an asset being created and disposed of simultaneously at the time of execution of the restraint. It potentially also increases the purchase price of the business to the purchaser unless the situation is known before the purchase price is agreed. This type of issue emphasises the importance of effective due diligence before contracts are exchanged. If a key person is an employee of the business who will be re-employed by the purchaser, a new employment agreement should be executed that contains an appropriate restraint preventing the employee using the employer’s confidential information. It is not appropriate to restrain knowledge or experience the employee acquires in the normal course of employment. A valid restraint will relate to information that is confidential and vital to the employer, such as secret formulae, special know-how, customer lists and price lists. Even if an employment agreement contains such a restraint, it may not be enforceable. 13 VENDOR’S WARRANTIES AND OBLIGATIONS 13.1 Overview Under GC 13 and Sch 6 of the standard contract, the vendor provides certain warranties and indemnities to the purchaser. The vendor must disclose to the purchaser before settlement any fact it becomes aware of that makes any warranty under the standard contract incorrect or misleading. The warranties contained in the standard contract are general in nature, so a purchaser who is aware of an issue before entering into a contract should include an appropriate special condition specifically addressing that issue. 13.2 Managing the business as a going concern A contract of sale of a business will usually contain a provision to protect the goodwill of the business by requiring the vendor to run the business “in the normal course” up to the date of settlement. A carefully drafted special condition will ensure that the vendor will maintain the assets of the business, not run down stock and not hold any closing down sales. The standard contract provides that the vendor must maintain the goodwill of the business and carry on the business in the ordinary course and in a proper and businesslike manner until settlement: GC 10.1. © The College of Law Limited 23  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE 13.3 Notices affecting the business A contract of sale of a business should provide a mechanism to deal with a notice issued by a statutory authority prior to settlement. Under GC 3.8(b) of the standard contract, the vendor must comply with any order or notice affecting the business or the business premises served before settlement. The vendor’s lawyer should provide appropriate advice in relation to the impact this general condition may have on their client. The purchaser should rely on its own searches and enquiries to establish whether an order or notice has in fact been issued on the business, although it is prudent to include a special condition to this extent. 13.4 Lawful use of premises The purchaser should require a warranty that the premises are lawfully used for the purposes of the business, as well as rely on its own enquiries: see GC 3.8(a) and Sch 6 of the standard contract. It is good practice to obtain a planning certificate under the Planning and Environment Act 1987 (Vic) or to contact the relevant local council to ascertain the zoning of the land (including permitted uses) on which the business is located. 13.5 Clear and unencumbered title The purchaser should receive clear title to all the assets being sold in the business unless there are arrangements for the transfer of equipment finance leases. The purchaser should make searches and requisitions to ascertain that the title is clear and is capable of being transferred in full and without encumbrance: see GCs 2.2 and 3.9 and Sch 6 Vendor Warranty 12 of the standard contract. They should search the PPSR to check for registered security interests, in addition to any other searches and requisitions/enquiries that should be undertaken. 13.6 Takings warranty Vendors do not readily give warranties as to takings. Takings during trial periods are difficult to predict and may not accurately reflect the average takings, particularly with a seasonal business and also because they are open to manipulation. It is difficult to accurately predict future revenue, especially on change of owners. In certain circumstances, a prudent purchaser may seek to include a special condition in the contract allowing it to check weekly sales figures for a specified period up to settlement and entitle them to terminate the contract if these sales figures do not reach pre-agreed targets or reflect representations as to takings. Assuming that no warranty is given or special condition included, purchasers should carry out their own investigations and obtain the financial records for at least the past 3 years and have their accountant assess them to advise on the business’s financial viability. A purchaser’s lawyer should ensure the purchaser has had the financial records checked by an accountant before exchange of contracts. The standard contract makes no specific reference to the takings of the business, and the purchaser would need to carefully inspect all records of the business during any due diligence period preceding the signing of the contract. 14 GUARANTEES Where the purchaser of a business is a company, the vendor usually requires the purchaser company’s directors to guarantee the purchaser’s obligations under the contract. Likewise, where the vendor is a company, the purchaser may require guarantees from the directors of the vendor company: see GC 21 of the standard contract. 24 © The College of Law Limited  CC302 Sale and Purchase of Business Assets 15 PURCHASER’S PRE-EXCHANGE SEARCHES 15.1 Purchaser’s pre-exchange searches and enquiries The results of pre-exchange searches are vital for the purchaser’s lawyer to adequately advise a client in deciding whether to proceed with the purchase of a business. When considering which searches and enquiries to undertake, the purchaser’s lawyer must consider: nature of the business; assets to be sold and their condition; entity through which the vendor is operating; and premises from which the business is conducted, from both a structural (that is, whether the building is structurally sound) and planning perspective. The vital searches to conduct pre-exchange are those that may affect the purchaser’s decision to buy (for example, financial investigations and outstanding council notices). “Mechanical” matters relating to title and the vendor’s capacity to sell the business may be carried out after exchange because the vendor’s obligations under general law and the contract protect the purchaser in case of difficulty. However, it is best practice to do as many pre-exchange searches as reasonably possible. Lawyers must use their professional judgement in determining, and obtaining instructions on, which searches and enquiries should be carried out and at what stage of the transaction. 15.2 Categories of searches There are three main categories of searches: Searches of the vendor: – if the vendor is a company, search the ASIC records and ascertain the officers of the company to ensure the person(s) carrying on the negotiations have power to bind the company; – if the vendor is a sole trader or partnership or if guarantees are being taken from directors of the vendor company, carry out a bankruptcy search against the people involved; and undertake a causes, writs and orders search against the vendor. Title and other searches and enquiries: – obtain a title search of the business premises to check if the lease is registered and for any conflicting lease, mortgage or caveat; – if there is a lease, obtain a copy from the vendor (or land titles office if the lease is registered); and – check that the local council’s zoning regulations permit the business. Search the assets being sold: – search the PPSR for any registered security interests over the assets of the business being sold, including any leased equipment; – if there is intellectual property, such as trade marks, patents, registered designs and copyright, obtain searches on the relevant IP Australia register. A schedule attached to the business sale agreement should list the intellectual property, but it is prudent to conduct those searches to check the details are correct and identify any additional registrations that might have been overlooked; – identify the domain name and email addresses and who holds their registration. There are multiple domain name registers that you can search free of charge (for example, “Whois” and “Ausregistry”); – identify key phone numbers, social media and licences that need to be transferred on sale; © The College of Law Limited 25  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE – if there is a business name and it is to be sold, search ASIC’s business names register; and – if the business uses or requires any licences or permits, check these exist and have been and are being fully complied with. This list of searches is not exhaustive but is a guide to the matters considered essential in obtaining full title to a business. 15.3 Inspection of books and records The purchaser should inspect a business’s books and financial records to ascertain the viability of the business and to check if the earnings to date justify the purchase price. A purchaser should have an accountant review the books to ascertain the business’s true financial position and viability. A thorough analysis of the vendor’s financial records will sometimes reveal debts, which need to be considered when negotiating the purchase price, particularly if they impact profitability. It may not be possible to obtain an accurate picture of a business’s viability if there is a large cash component that is not reflected in its official records. In these instances, the purchaser’s lawyer should insist on a vendor’s warranty as to actual takings in the agreement. Where a business has key (large) customers, it is prudent to request copies of these contracts to ensure that they are not due to expire soon or contain obligations that may reduce the value of the business. 16 EXCHANGE OF CONTRACTS Once preliminary negotiations have been completed, preliminary searches done and all special conditions and amendments negotiated, the client has been fully informed and advised and the contracts are signed, then a time and place is arranged for exchange of signed copies. Traditionally, exchange usually took place at the offices of the vendor’s lawyer, where the deposit cheque would be handed over to the vendor’s lawyer or the agent, who then held the deposit on trust until completion, when the purchaser authorised release of the deposit. With the increase of electronic communication and remote working, exchange can now be a virtual process. Once exchange has taken place, the contracts become legally binding. Lawyers must ensure their clients are aware of this when they obtain instructions to proceed to exchange. 17 PURCHASER INSPECTION The purchaser is entitled to inspect the business and business premises at all reasonable times within 3 business days of settlement: see GC 11.1. The vendor must allow inspection of the business premises by local or other government authorities if requested by the purchaser under GC 11.2. The parties can negotiate any additional inspection requirements and include them in the contract as a special condition. 18 PRE-SETTLEMENT 18.1 Vendor’s obligations and default Once exchange has taken place, the vendor must perform those obligations contained in the contract for sale. The vendor’s obligations commonly include: executing all necessary documents to allow full transfer of title to those assets being sold with the business: see GC 3.5 of the standard contract; conducting the business in its normal manner and not doing anything to adversely affect the goodwill or value of the business before settlement: see GC 10.1; 26 © The College of Law Limited  CC302 Sale and Purchase of Business Assets discharging any existing mortgage, security interests, charges or other encumbrances over the business: see GCs 3.9 and 13 and Sch 6 Vendor Warranty 12; obtaining any landlord’s and any mortgagee’s consent to any transfer of lease: see GCs 8.1 and 8.6; and notifying staff of the sale and attending to staff terminations as required: see GC 12. A vendor’s failure to perform its obligations may allow the purchaser to rescind the contract. General condition 16 must be carefully considered where the vendor defaults under the contract. A party (the purchaser) must first serve a written default notice on the other party (the vendor) specifying the particulars of the default; state that it is the purchaser’s intention to exercise its rights arising from the default unless the vendor remedies the default within 5 business days of service of the notice and pays reasonable costs of the default; and state the rights that the purchaser intends to exercise if the default is not remedied in time. The standard contract will end if the vendor fails to comply with the default notice by the specified date. Where a party (here, the vendor) breaches the contract, it must pay to the other party (the purchaser) on demand any compensation for reasonably foreseeable cost, loss or damages resulting from the default and interest on any overdue money without affecting the offended party’s (the purchaser’s) rights: GC 16.3. The vendor must repay any money paid by the purchaser and pay the expenses attributable to the default if the purchaser ends the contract under GC 16: see GC 16.9. 18.2 Purchaser’s obligations and default The purchaser will similarly be bound by the terms of the contract after exchange. If the purchaser defaults in the performance of its obligations under the contract, such as failing to meet time limits or to pay money due, the vendor may be able to sue the purchaser for damages for breach of contract or, in case of serious default, cancel the contract and keep the deposit money as a forfeit. General condition 16 needs to be carefully considered in the event the purchaser defaults under the contract. If the purchaser defaults in payment of the purchase price or stock, the vendor may sue for any unpaid balance of the purchase price of the business or the value of the stock (or both) immediately, without giving notice to the purchaser and without affecting any other rights of the vendor: GC 16.2. In all other cases of default by the purchaser under the standard contract, the vendor must first serve on the purchaser a written default notice: see GCs 16.4 and 16.5. 18.3 Vendor’s representations and the Competition and Consumer Act 2010 The purchaser can rely on a vendor’s contractual representations as to the business. It may be prudent to include a condition in the contract to specifically negate any warranties or representations the vendor may have made to the purchaser during the contractual negotiations but which, for whatever reason, are not also included in the final contract. Even if such a condition is included, there are statutory remedies that cannot be excluded. For example, a purchaser may have remedies under Australian Consumer Law ss 18 or 29 for any misleading statement or representation by the vendor. 18.4 Vendor’s tuition and assistance period A tuition period (both before and after settlement) is advisable for all purchasers, particularly those starting in an area of business for the first time. On exchange, the parties should arrange for a mutually convenient time to begin the tuition period after exchange of contracts. This will allow the purchaser to be introduced to clients and staff and get an understanding of business operations. The length of tuition © The College of Law Limited 27  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE will depend on the type of business, its size, the purchaser’s prior knowledge of that business and the level of goodwill attributed to the business. General condition 10.2 and the Particulars of Sale refer to an assistance period. 18.5 Business name transfer ASIC administers the business names register. The process for a transfer of a business name on the register requires the existing name holder (the vendor) to apply to transfer the business name. ASIC then issues a “consent to transfer number” which is provided to the proposed name holder (the purchaser), who can apply to register the business name. Following settlement, the purchaser must apply online on the business names register using the discrete “consent to transfer number” advised by the vendor at settlement to transfer the registration of the business name(s) to the purchaser. A special condition may have been included to cover the vendor’s agreement to provide such further assistance as required to the purchaser at or after completion to ensure registration of the business name in the purchaser’s name. Such a clause should provide that it will remain a continuing obligation notwithstanding the completion of the contract, by using the expression “and this clause shall not merge on completion” or “and this clause shall survive the completion or expiry of this agreement”. Further information about the business names register is available on the ASIC website. 18.6 Service of documents Generally, a contract of sale of a business will contain a condition stipulating modes of serving documents: see GC 17. This condition should be designed to facilitate communication and the progress of the transaction and will deal with various methods of service. Time for delivery of documents by mail or document exchange should be realistic and provisions should be made for weekends or public holidays. If disputes arise during the transaction, it is important that all documents have been served correctly to avoid technical problems caused by improper service. 19 SETTLEMENT 19.1 Overview The process of settlement should be performed with care. Settlement will generally occur at a place nominated by the vendor or may occur virtually. The vendor’s lawyer will arrange a suitable date and time and communicate this to the purchaser’s lawyer. Lawyers for both parties should ensure that they have all the relevant documents signed, that correct cheques or electronic fund transfers have been confirmed and that all necessary parties will be present, if required. See GCs 3.2 and 3.12 of the standard contract. 19.2 Settlement instructions It is useful to prepare settlement instructions before attending settlement. The instructions will set out what each party is to hand over and will help avoid any omissions or oversights that might delay or prevent settlement. If there are missing items, settlement should not be completed unless the “defaulting” party provides satisfactory written undertakings. A lawyer must take extreme care when drafting or accepting such undertakings and must always ensure they comply with their professional and ethical obligations when providing undertakings themselves. 28 © The College of Law Limited  CC302 Sale and Purchase of Business Assets 19.3 Takeover of existing agreements The parties should have obtained all necessary consents before settlement to a transfer of an existing service agreement. It is good practice to provide in the contract that the vendor will indemnify the purchaser against any claim or action arising after settlement relating to any default by the vendor before settlement. The vendor will seek a corresponding indemnity from the purchaser: see GC 3.7. 19.4 Rent and outgoings adjustments The parties must adjust all income and outgoings of the business to the date of settlement. Adjustments should always be made unless special conditions in the contract state otherwise. General condition 5 of the standard contract provides that the vendor is liable for all outgoings of the business before and on the day of settlement, excluding sales of stock included in the sale, any new stock acquired by the purchaser after settlement and employee expenses accruing after settlement. Rental adjustments are calculated when there is a lease being transferred. If a lease is being transferred, a special condition should also be included to provide that the vendor indemnifies the purchaser against any claims arising from a breach of the lease for the period prior to settlement. The purchaser will indemnify the vendor for any claims arising from a breach of the lease after settlement. The transfer of the lease will normally cover these issues. If there is a new lease, all obligations under the pre-existing lease will be the vendor’s responsibility. 19.5 Lease outgoing adjustments In addition to rent adjustment, tenants often contribute to the running costs of the building (commonly referred to as outgoings) that must be adjusted on settlement. The outgoings are usually calculated on an area percentage basis and are set out in the schedule to the lease. Before settlement, the landlord’s lawyer should confirm in writing the date to which the vendor has paid rent and outgoings. 19.6 Bond If the vendor has paid a bond or security deposit or provided a bank guarantee to the landlord, this will need to be addressed at settlement. If the purchaser is obtaining a new lease for the business premises, the purchaser would pay a bond to the landlord and the landlord would refund the vendor their bond. In the case of a transfer of an existing lease, the purchaser usually wholly adjusts the bond in the vendor’s favour and the purchaser takes the benefit of the bond. This may not be possible, however, where the vendor has provided a bond by way of a bank guarantee or where the bond is held under Retail Leases Act 2003 (Vic) s 24. In these circumstances, the vendor would request the landlord to return the original bank guarantee it supplied in exchange for one supplied by the purchaser. 19.7 Vendor’s finance and security The vendor may have agreed to provide finance to the purchaser on terms contained in the contract for sale. The terms of the finance may simply allow the purchaser to pay the balance of the purchase price by instalments, following settlement, usually subject to the payment of interest. Because title to the business will be transferred to the purchaser, the vendor will usually require security for any outstanding purchase price. The security will often take the form of a security interest over some or all of the assets of the business. If the purchaser is a company, a personal guarantee by the directors of the purchaser is also customary. In such circumstances, the purchaser must deliver to the vendor on settlement the duly executed security documents. Where the purchaser grants a security interest in personal property, the vendor’s lawyer must ensure that the requirements of the PPS Act are met and that they promptly register the © The College of Law Limited 29  THE COLLEGE OF LAW COMMERCIAL AND CORPORATE security interest on the PPSR to gain the benefit of priority and protection in the event of the purchaser’s insolvency or bankruptcy. 19.8 Payments to outgoing mort