In many negotiations for sale of a business, the buyer will ask to pay for the business in instalments. An initial amount will be paid at completion of the sale, and after completion, one or more further payments will be made. The element of the purchase price which is paid after completion of the sale is called the ‘deferred consideration’.
We have outlined below the issues which should be considered by the parties if deferred consideration is proposed in a business sale.
Are there circumstances in which the seller receives the deferred consideration earlier?
The period between completion of the business sale and payment of the deferred payment may be several months to a number of years. During to that period, a lot could happen to the buyer. The seller should consider providing in the sale agreement a right for it to receive immediate payment of the deferred consideration in certain circumstances. For example:
If the deferred consideration is payable by a number of instalments and a payment is missed. The seller in that circumstance should have a right to require immediate payment of all the outstanding deferred consideration.
If the buyer is approaching insolvency, the deferred consideration should automatically become immediately payable. This is so that the seller can then make an immediate claim against the buyer, rather than having to wait for the future date on which the deferred consideration is scheduled to be paid.
If the buyer’s obligation to pay the deferred consideration is guaranteed, and the guarantor is approaching insolvency. This is for the same reason as regards the buyer approaching insolvency. The seller can then make an immediate claim against the guarantor.
In a share sale, if the target company is approaching insolvency. This may indicate issues regarding creditworthiness of the buyer as well as the company.
If the buyer or any guarantor is a company and it is sold. In such a circumstance, the financial condition of the buyer or any guarantor may have changed.
In a share sale, if the target company is sold. Although that might not make any difference to the buyer’s ability to pay the deferred consideration, that sale may be an indication of a change to the financial condition of the buyer.
The buyer may require the deferred consideration to be set-off or withholding against warranty and indemnity claims
The buyer may further require that, in circumstances where it has a claim against the seller, it should not be required to pay the deferred consideration. The buyer may also argue that if it wins a claim against the seller, it will have practical difficulties in recovering damages, for example, because the seller’s assets are offshore.
The sale agreement will then provide that the deferred consideration can be set-off or retained against any warranty or indemnity claims that the buyer may make against the seller.
The contrary argument is that the buyer should have to substantiate claims before the seller makes any payment as regards claims.
Can the seller be safeguarded against spurious warranty and indemnity claims?
The buyer may make spurious claims so that it can hold on to the deferred consideration pending resolution of the claims.
If the seller accepts the right by the buyer to set-off or withholding the deferred consideration in respect of outstanding claims, it should negotiate some safeguards into the sale agreement. For example:
Determination of outstanding claims by an independent lawyer. If the parties fail to reach agreement within a specified period on the amount of an outstanding claim, the matter is referred at the request of a party, to an independent lawyer for determination. The lawyer could be required to determine, if possible, whether the outstanding claim has a reasonable prospect of success. There are, however, cost implications for the parties since the lawyer’s costs will have to be paid for by one or both parties.
Obligation on the buyer to progress claims. As the buyer will be holding on to the cash until the claim has been resolved, there is no incentive for it to progress the claim against the seller. In order to prevent the cash being held back indefinitely, the seller should insist on a provision that requires such cash to be released to it if proceedings in respect of the claim have not started within a certain period.
Payment of the deferred consideration into an escrow account. The deferred consideration could be paid into an escrow account (such as a joint account operated by the parties’ solicitors) pending resolution of an outstanding claim. Since the buyer is still required to pay the deferred consideration in full when due, the buyer has no cash flow incentive to pursue spurious claims against the seller. The escrow account also provides a ready fund from which the seller can be paid if the outstanding claim is resolved in the seller’s favour.
Are you thinking about selling or buying a business?