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Selling a business: prepare for sale, avoid jail

I was taking a client through the first draft share purchase agreement the buyer had prepared to buy his business. He stopped me and got straight to the point:

“What’s my number one risk to the cash I receive under this agreement?”

“The warranties,” I answered. “If anything is not true under the warranties, the buyer will be looking for his money back.”

I explained that the way we (the seller team) get comfortable with the warranties is by making sure they are true. If they are not, we make a disclosure in a disclosure letter. We went through the warranties, topic by topic. Most of the warranties were easy to give, or easy to qualify. We eventually got to the difficult things, the skeletons in the closet. We faced the old question: if there’s a problem in the business you are selling, should you tell the buyer about it?

Should we mention it?

If your client knows there is a problem with the business and that problem contradicts a specific warranty in the share purchase agreement, then yes. Why?

  1. Failure to disclose means that the warranty is not qualified. The seller is open to be sued under the warranty when the problem comes to light; and
  1. If you are selling shares, making an untrue statement (i.e., leaving a warranty unqualified by disclosure) could be a crime under the Financial Services Act 2012. That carries a maximum penalty of 7 years in jail and an unlimited fine.

In every case?

A sale and purchase agreement will typically define a threshold for a warranty claim, say £5,000. If the value of the problem is less than £5,000, it won’t trigger a warranty claim. Also, if the problem is worth less than £5,000, it is arguably not material, as the parties have agreed what is material in the contract. But if it is close to £5,000 it is best to disclose.

What if you know there’s a problem but there is no warranty covering it? There is no general duty to disclose. But in share deals, section 89(1)(c) of the Financial Services Act 2012 says that if a person “dishonestly conceals any material facts whether in connection with a statement by [that person] or otherwise” that person could be guilty of an offence. No deal is worth seven years in jail, so unless the matter is truly immaterial, it is best to disclose. Criminal law aside, a buyer will look carefully at stretching the warranties to found a claim.

What’s more, an instruction from a client not to disclose a material matter in a disclosure exercise can result in the solicitor’s withdrawing from acting.

How should we tell the buyer?

Fairly and accurately, so that the buyer can properly ascertain the scope and value of the issue being disclosed – and, generally, the earlier the better. You are more likely to lose a deal with a late material disclosure than an early one: trust can be shattered by late disclosure.

That is not to say you should tell the buyer immediately you detect a potential issue. It is critical that the issue is properly explored, valued and understood by the seller team first before setting hares running. Most issues can be managed. There are often ways to sort problems before they become deal issues. The pre-sale period is frequently a busy time of tying up loose ends.

What might the buyer do?

The buyer has a number of responses to a material disclosure:

(a)        walk –the buyer doesn’t do the deal;

(b)        chip – reduce the price the buyer is willing to pay;

(c)        insure – the buyer might look to get insurance (with the seller paying);

(d)        indemnify – ask the seller to indemnify the buyer if the problem materialises. The buyer might need security or a price retention for this.

All of these outcomes are better than being sued later or, in the worst case, jail time.

If you would like further information on the topic discussed in this blog, please contact Andrew Fleetwood by email: afleetwood@gilsongray.co.uk or by phone: 0131 516 5365 / 07841 920 101. You can also view Andrew’s profile by clicking here.

The information and opinions contained in this blog are for information only. They are not intended to constitute advice and should not be relied upon or considered as a replacement for advice. Before acting on any of the information contained in this blog, please seek specific advice from Gilson Gray.

 

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