The purchase and sale of a business can be complicated. The interests of purchasers and sellers are usually on opposite ends of the spectrum. Even if the parties have agreed upon a purchase price, the terms and mode of purchase and sale must be considered carefully by each party. Purchasers will want to ensure that in exchange for the purchase price they are receiving shares of a company or assets without any surprises after closing. Vendors will want to ensure that upon the closing of a transaction, a purchaser will have as little recourse as possible against the Vendor and that the Purchaser has assumed all or as much of the risk as possible which is inherent in a business. The purchase and sale of a business takes place in two common forms: share purchases and asset purchases.
Share Purchases
Share purchases occur when one purchases the share capital of a corporation. In most cases, vendors would prefer a share sale over a sale of assets due to the tax treatment of the sale of shares. In addition, once the shares of a corporation have been transferred, the vendor will not have to determine how to wind-up or dissolve the corporation or to determine how monies will be distributed to the shareholders once the assets of a corporation are sold. This may not be the case however, if the shareholders wish to use the corporate entity to embark on a new business.
In negotiating a share sale one can picture the transaction as the transfer of a box filled with various items. Some of those items will be desirable such as valuable contracts, bank accounts, and accounts receivable, while other items will pose a concern for a purchaser such as debts, liabilities for tax, employees, environmental issues, obligations to a landlord, and regulatory liability to name a few. Accordingly, a purchaser will always want to negotiate a share purchase agreement that will allow the purchaser to determine exactly what is in the box and what risks are present. A purchaser will want to negotiate some assurances that the purchase price could be amended downward if certain risks turn into actual liabilities. If a purchaser does not negotiate adjustments or safeguards against potential liability and conduct thorough due diligence, the purchaser may be inheriting a business that is worth much less than the agreed upon purchase price without any recourse. A vendor, on the other hand, will want to sell the box in an “as is” condition or as close to it as possible.
A share purchase agreement consists, primarily, of five key sections:
i. Purchase Price. The share purchase agreement will set out the purchase price as well as how and when it will be paid. In addition, if there are any adjustments to the purchase price, how and when such adjustments will be determined and made.
ii. Representations and Warranties. The vendor and purchaser will make representations and warranties about various matters. Representations and warranties are statements of fact by one party upon which the other party can rely and act upon if it proves to be untrue. Typically, the purchaser’s representations and warranties are centered around the purchaser’s ability to enter into the agreement of purchase and sale and be bound by its terms. The vendor’s representations and warranties are usually much more onerous as they pertain not only to the ability to enter into and be bound by the agreement of purchase and sale but also extend to key factors such as confirming that there are no hidden debts, liabilities, or other problems of which the purchaser has not been advised. If a purchaser does not bargain or negotiate for such representations and warranties, they will have no recourse against the vendor if a debt, liability, or other issue arises after closing that was not intended to be assumed by the purchaser. In some cases vendors will want to refrain from making a specific representation or warranty because the vendor does not have the information required to make a representation and warranty with certainty, is not aware of a potential outcome of an issue, or presumed that the risk associated with such matter was to be assumed by a purchaser without recourse.
iii. Covenants. Covenants are promises made by the parties to perform certain acts or to refrain from committing certain acts during the course of the transaction and after it is closed.
Covenants might include matters such as the vendor agreeing to provide certain documents on closing, agreeing to terminate employees, to pay accounts, to provide consents from third parties, or to refrain from making any large purchases or paying monies out to current shareholders thereby depleting the corporate bank accounts. The purchaser might covenant to refrain from speaking to employees, disclose elements of the transaction to third parties or suppliers or to deliver certain documents on closing. It is incumbent on both parties to negotiate these matters in the course of finalizing the terms of their agreement.
iv. Indemnities. An indemnity is a promise by one party to the other to be responsible for certain matter. An example is a vendor agreeing to indemnify a purchaser against any representation and warranty that proves to be untrue and has an adverse effect on the corporation such as a tax representation and warranty. If a vendor represents and warrants that the Corporation has made all tax remittances for employee deductions and that there are no reassessments on such matters and that representation and warranty proves to be untrue causing an undisclosed tax liability, the purchaser would have recourse against the vendor for breach of the representation and warranty through the indemnity. Indemnities are crucial for such recoveries. Indemnities can be limited or wide ranging.
v. General Terms. General terms are commonly known as “boiler plate” terms. They will include the choice of jurisdiction, set out where official notices can be sent by any party to any one or all of the other parties, include language that binds the parties to the agreement but also the parties’ heirs, executors, successors and assigns as applicable. While these terms are general, they are critical elements of an agreement of purchase and sale.
Asset Purchases
Asset purchases differ from share purchases. They provide the purchaser a greater ability to remove the undesirable portions of a business from the transaction to purchase only those items that the purchaser considers desirable. In the box analogy used above, a purchase of shares leaves the purchaser with the entire box. In contrast, in an asset purchase transaction, the purchaser can select what it wishes to purchase, such as the receivables of a company, customer lists, equipment, inventory, goodwill, or intellectual property.
The most important aspect of an asset purchase transaction for a purchaser is to ensure that the assets being purchased are going to be free and clear of any external claims. For example, if the vendor has a lease for a location where it operates its business then the purchaser will want to ensure that the vendor’s lease is in good standing and that the landlord cannot seize the assets the purchaser is buying to satisfy the vendor’s obligations under the lease. If the landlord does prove an interest and the transaction is not disclosed to the landlord, the landlord may trace the assets and seize them from the purchaser to satisfy the debts or obligations of the vendor to the landlord. In addition, it is important to determine whether the vendor has the right to transfer an asset. If an asset is leased or financed, the vendor typically will have to obtain a consent from the lessor or financier to transfer the asset to the purchaser and the purchaser will likely have to be financially approved to take over such leases.
One of the more complicated issues in an asset transfer when a purchaser is buying all or substantially all of the assets of a vendor is dealing with employees. The parties must decide whether the employees of the vendor will have to be terminated outright by the vendor, terminated by the vendor and rehired by the purchaser, or whether some will be terminated by the vendor but not rehired by the purchaser. This issue is significant because of the cost of severance or termination pay in lieu of notice that may arise from the terminations. If there are employees of significant tenure and pay involved, these costs can be significant if such matters are not dealt with appropriately.
An asset purchase agreement generally consists of five key sections:
i. Purchase Price. The share purchase agreement will usually set out the purchase price as well as how and when it will be paid and how the parties will allocate the purchase price between each asset for tax purposes. These allocations are important to determine the adjusted cost base of assets for the purchaser and to crystallize the vendor’s tax obligations. Certain assets will also attract harmonized sales tax (HST) immediately payable or deferred if an HST election form may be filed with the Canada Revenue Agency.
ii. Representations and Warranties. The vendor and purchaser will make representations and warranties about various matters. Representations and warranties are statements of fact by one party upon which the other party can rely and act upon if it proves to be untrue. In an asset purchase transaction, many of the representations and warranties will be similar to those in a share purchase, however, some will differ. A critical difference is that a purchaser in an asset purchase will want to know that the assets being transferred are being delivered free and clear of all liens, encumbrances or other interests. This is to ensure that if the assets are not delivered with clean title, the purchaser will have recourse against the vendor.
iii. Covenants. Covenants form a critical part of asset purchase transactions. Covenants are promises of one party to the other that such party will perform or refrain from committing certain acts during the course of the transaction and after the transaction is closed. The covenants offered and negotiated are similar to those offered and negotiated in a share purchase transaction and will differ based on the specific issues arising from each transaction.
iv. Indemnities. Parties to an asset purchase will negotiate for indemnities as discussed above. The key difference is that the purchaser will often want to obtain a specific indemnity for liabilities of the vendor that are excluded from the transaction but are not discharged by the vendor. Indemnities in an asset transaction can also be limited or wide ranging.
v. General Terms. General terms in an asset purchase transaction are often the same terms that appear in a share purchase agreement as described above.
The foregoing attempts to address very broad and common considerations in relation to the purchase and sale of a business. It is only intended to provide general information. For a detailed discussion and advice specific to your needs, please contact a member of the Business Law team.
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