Relying on an implied trust.
The importance of ensuring a watertight, meticulously drafted business sale agreement to protect a purchaser has never been so abundantly stark, than where the vendor subsequently entered into a liquidation.
The sale
Prior to our appointment, the company sold its business (importing and selling medical supplies) and business assets to an unrelated third party. The sale was completed within 14 days for purchase consideration and included:
- plant and equipment (P&E) assets
- inventory
- the company’s debtor book.
Despite the sale settling, the purchaser did not notify the company’s debtors of the purchase/assignment and therefore debtors continued to pay into the previous company’s trading account. The purchaser then relied on the company to forward these debtor monies as and when received!
The liquidation
At the time of liquidation, the company’s bank account had around $60,000 and the purchaser promptly alleged the company was essentially holding the post-settlement debtor recoveries on trust and requested immediate remittance as these were not a company asset. We identified that the cash at bank balance on the date of liquidation was mostly funds collected from debtors outstanding at the time of the sale; however, we could not pay the purchaser—if at all—until the following was determined:
- Whether the company and the purchaser arrangement met the “constructive trust” requirements.
- Whether a liquidator is required to seek directions from the Court prior to disbursing the available funds.
- Whether the purchaser is now an unsecured creditor, and the funds can only be distributed under the priorities outlined in section 556 of the Corporations Act 2001.
Determining the above is more complex due to:
- The sale agreement being silent on the debtor book’s collection. The sale agreement did not include any clause assigning the debtors to the purchaser, nor did it specify the vendor’s obligation to collect the debtor book and remit the funds to the purchaser.
- The debtors continuing to pay into the company’s trading account, which held other company cash assets. Although a high-level review of the bank account found available funds included debtor amounts outstanding at the time of the sale; arguably those intermingled funds represent cash at bank i.e. company assets (again, at the time of the appointment).
Clearly, solving this problem inevitably requires incurring legal costs.
As the factors above are unresolved, we cannot outline what the quantum net effect will be on the purchaser and the liquidation’s creditors (which may include the purchaser becoming an unsecured creditor). However, some key takeaway points are prevalent and pertinent to share.
The key takeaway points
Those seeking to enter a sale agreement that has either a long settlement or intends to rely on the vendor to discharge certain functions after consideration is paid, should consider:
- Seek proper legal advice on the preparation and drafting of legal documents such as sale agreements.
- Notifying relevant third parties and key stakeholders of the sale.
- Ensuring that the sale agreement clearly states the vendor’s obligations post settlement, especially in a situation where the vendor must advance monies/ property to the purchaser.
- Registering a security interest against the property that the purchaser expects to receive in the sale (if not delivered at the sale agreement completion/settlement).
Registering a security interest includes considering a clause in the sale agreement that gives the purchaser the right to register a security interest against the vendor on the Personal Property Securities Register (PPSR). Any debt or claim attaches to the specific asset and gives the purchaser a higher priority than other claims in the event of a liquidation scenario.
Related article: Transfer of business provisions and employee entitlements