Lessons in the importance of obtaining professional advice and documenting business transactions.
Background
We were recently appointed to a Company that previously traded a Pet Supplies store in Regional Queensland. Approximately 4 months prior to our appointment, the business was sold to a third party and whilst the terms appear to have been verbally agreed between the parties, there was no documented signed contract of sale.
Based on the information currently available, it appears that the sale occurred on the following salient terms:
Purchase price - $1,000,000 ex GST plus stock of $2.3m (i.e. total of approx. $3.3m).
Initial payment upon settlement - $500,000 – goodwill and plant & equipment.
Balance on vendor finance terms – 12 months.
Adjustments for employee entitlements, contra-accounts and miscellaneous supplier payments.
Settlement / Handover – May 2024 (approx. 4 months prior to Administration)
At the time of the appointment (i.e. 4 months after the fact), the purchaser had already paid:
$500,000 towards goodwill, plant & equipment.
$520,000 towards the stock on hand.
This left an amount of approximately $2.3m owing but subject to adjustments for contra accounts and employee entitlements which were still being negotiated.
Questions to consider included:
Was the sale was binding and enforceable given there was no signed contract, and
What was the effect of the sale on suppliers who held enforceable security interests over stock at the time of the sale.
Was the sale binding and enforceable?
Having met with the purchasers who were keen to document the agreement since they had been successfully trading the business for 4 months. Accordingly, we sought advice, which determined that the sale of the business was, for the most part, binding and enforceable. Unlike real estate, there is no requirement in Queensland for the transfer of business assets to be in writing.
Based on the information available:
The agreement was negotiated and agreed upon between the directors of the respective parties and, therefore, between individuals with requisite authority to bind each of the companies to an agreement.
There was no dispute about the agreement between the individuals and the in principle terms upon which it was formed.
The verbal agreement was supported by evidence (text messages and emails).
The primary obligations of each party have been effectively performed as:
a. Possession of the business had exchanged hands; and
b. Part payment of the purchase price had been received.
There remained issues not considered, such as:
Transfer duty under the Duties Act 2001
GST treatment of the sale
Allocations of risk, warranties, etc
Quantification of the adjustments for entitlements, supplier payments and contra-accounts
These issues are still being resolved through the process of documenting the sale.
What about the security interests?
A quick refresher on purchase money security interest (PMSI). This registration receives a super priority under the Personal Property Securities Act Cth 2009 (PPSA) when properly perfected (i.e. the registration is made in time, is properly described, supported by agreement, and relates to inventory, personal property or its proceeds).
Generally, purchasers of stock sold in the ordinary course (i.e. normal customers) of business will benefit from section 46(1) of the PPSA, which provides that:
A buyer or lessee of personal property takes the personal property free of a security interest given by the seller or lessor, or that arises under section 32 (proceeds-attachment), if the personal property was sold or leased in the ordinary course of the seller's or lessor's business of selling or leasing personal property of that kind.
So what happened with the sale of the business?
Advice obtained by our office as Administrator considered that the sale of stock as part of a sale of business was not made in the ordinary course and therefore those suppliers holding perfected PMSI security interests held in the stock on hand at the time of sale remained enforceable.
Upon review of a stocktake conducted for the purposes of the sale there were 10 PMSI holders with an estimated $1.3m of secured stock included in the sale.
Whilst the matter is ongoing we expect that upon final documentation of the sale of business, we will seek that holders of PMSIs release their security interests in exchange for the value of the stock included in the sale that was subject to their respective security interests.
What ought to have been a documented and orderly business sale has now turned into threats of litigation, business disruption and an extremely costly process. An important lesson for both purchasers and sellers in obtaining proper advice and properly documenting their business transactions to avoid these kinds of issues.
