In other words, will a handshake suffice – or should you ask your lawyer to prepare a written contract for the sale of a business?
The title of this article comes from a famous quote attributed to movie mogul, Samuel Goldwyn: “A verbal contract isn’t worth the paper it’s written on”. This seems to directly point to the unreliability of a verbal contract!
Unlike real estate, there is no Documentary Title, Certificate of Title or Right to Deal in a business sale.
Additionally, there is also no requirement that a contract for the sale of business must be in writing.
Although verbal contracts are legal, they may be hard to prove, especially the specifics of its terms. To compound the problem, it will undoubtedly be many times more expensive to litigate to prove those terms than what it would have been to have a written contract prepared!
It turns out that Goldwyn’s quote was actually meant to praise the honour and integrity of a colleague: “His verbal contract (the colleague’s) is worth more than the paper it’s written on”.
There is no prescribed form for a contract for the sale of a business. Various agreements are commercially available but, unlike conveyancing, the contract of sale of a business is not required to be available before marketing commences. However – and importantly – these contracts specify an orderly process of sale and normally protect the vendor and purchaser alike.
Even where a verbal contract is decided on, certain sales and transfers contained in a contract for sale of business may require registration with authorities (vehicles, business names, trademarks, patents, models). Transfer of licenses that are required to conduct a business – or the transfer of software licences, domain names, social media accounts and certain leases that require registration and must be in writing – will require it in writing.
You may also be required to give a vendor’s statement for the sale of a small business in some Australian States (Victoria and South Australia).
Disclosure statements are required in writing in all states when assigning a retail lease. Supplier agreements, rights and obligations required for the conduct of the business, and security interest over assets will normally be evidenced by written documents and require written documents for transfer, extinguishment and/or creation when selling a business.
Importantly, remember that to qualify for the going concern exemption in terms of s 38-325 of A New Tax System (Goods and Services Tax) Act 1999, the parties to a sale of business transaction must have agreed in writing that the supply, is a supply of a going concern.
The law recognises and sees verbal contracts as enforceable – as long as the parties have the capacity to contract, there exists an offer, an acceptance, consideration is given and there is the intention between parties to create legal obligations.
Consider human nature
To prove a meeting of minds on the specific terms of a verbal contract may be much more difficult. Here one should consider human nature and what Warren Buffet so aptly said: “Honesty is a very expensive gift”.
It is not impossible that as vendor or purchaser you may have found a purchaser or vendor with exceptional integrity. But then consider that our courts are not empty, and a lack of demand is certainly not fuelling the costs involved in litigation.
Most sales of business are more complex than merely selling some plant and equipment – or just introducing a purchaser to clientele. As such, it should be ensured that all matters of importance are addressed in a contract of sale of business.
A sale of business typically involves:
- The sale of tangible assets (plant & equipment)
- The sale of intellectual property and immaterial goods (goodwill, trademarks, patents & copyright)
- The transfer of rights (assignment of a property lease, equipment leases, domain name transfers; assignment or entering into a franchise agreement and transfers of supplier agreements)
- Obtaining and/or transfer of permits and registrations (business name transfer or transfer of a liquor licence and/or gaming licence)
- Disclosure of confidential information and completing of a due diligence
- Transfer of employees
- Transfer of goodwill and protecting ongoing revenue.
As a vendor you should anticipate – and as a purchaser you should require – that all sales and transfers forming part of the sale and purchase of a business, be perfected.
Consider doing and arranging this in a verbal contract. Think about what may really be involved to effectively complete a sale or transfer. For example, who owns the plant and equipment? Are some items required for the continued conduct of the business, the property of a landlord or can a previous employee claim copyright over a recipe, manual or the like? What about security interests? One needs to understand the intricacies and limitations of intellectual property rights.
A business name may not provide any protection against the use of that exact name by a competitor. How do I protect and maintain goodwill? How do I exclude a threat to ongoing revenue? Are all important supply agreements in place and will suppliers continue with you as new owner?
- Take a step back prior to reaching an agreement as a vendor:
- You want the sale structured in the most tax advantageous manner. You want to know if you are selling a revenue or capital asset
- You want a non-disclosure (confidentiality) agreement in place
- You want to be sure that you do not inadvertently make misrepresentations and ensure that a purchaser conducts his due diligence inspection, using current information and historical reports of which you as vendor can guarantee the accuracy
- You want to be sure that you provide all relevant information to a purchaser to make your business as saleable as possible and receive the maximum return on your investment.
As a purchaser:
- You may want a call option for a limited period enabling you to conduct a due diligence investigation and giving you exclusivity for the option period
- You may want to conduct a detailed due diligence and consider statements alongside source documents, thus complete and comprehensive information
- You may want to enter into a binding sale contract providing for a due diligence period and giving you a limited window to terminate the contract of sale if you are not satisfied.
Doing a due diligence may require a substantial investment of time and money and you do not want somebody else to purchase the business in your due diligence period.
Key terms of contract
Again, imagine when agreeing on the above verbally, the likelihood for a dispute arising between the parties about the specifics, contents of, or scope of such a verbal agreement. Over and above that, consider entering into a verbal non-disclosure agreement or obtaining the right on some basis to conduct a due diligence investigation, without at least having the key terms of contract for sale of business or the contract for sale of business agreed verbally. A very daunting task, I would suggest.
In my opinion, it is not only nearly impossible to enter into a comprehensive verbal contract for the sale of business, but in doing so, it is more than likely the creation of the perfect recipe for many disputes that may very well end up in a court, where it may be found that there was no meeting of minds on specific terms and finding the contract or parts thereof that may be essential to a purchaser or vendor as unenforceable.
Get proper advice
In our fast paced world, it may just be good business to obtain proper accounting and legal advice and have a formal written contract for sale of business prepared by a competent lawyer.
Remember that your relationship with your lawyer is a special relationship – as it is fiduciary in its nature. You lawyer is required to act in your best interests, in good faith and importantly, with diligence and competence. If costs are your concern, know that your lawyer will provide you with a cost disclosure in which your lawyer will define the scope of the retainer and importantly you are entitled to negotiate the terms of cost agreement, which incidentally will be in writing.
NOT LEGAL ADVICE: Information contained in this article is provided for information purposes only and should not be considered as legal advice. You should not rely on, or take, or fail to take, action on the basis of the information provided in this article. Do not disregard taking legal, taxation or accounting advice as a result of something that you have read in this article.
Roelof Stols is a solicitor and Principal Director at Edge Business Law with more than 30 years’ experience in commercial law in several jurisdictions. To see how Edge Business Law can assist you, please email Roelof directly at [email protected].