A recent case in the South Australian Supreme Court illustrates many examples of the traps that lurk in business sale contracts and forms a double barrelled lesson for accountants both in relation to dealings with their clients who might be grappling with earn-outs in a sale, and in relation to a possible future sale of their own practice.
The case* revolved around the sale of an accounting business by an accountant (Mr Robinson) to a larger practice, part of which included an earn-out component. The earn-out payment was dependent on fees achieved after the sale.
As is often the case in earn-out environments, arguments emerged after the sale. The buyer refused to pay interest under the agreement, and Mr Robinson then attempted to terminate the agreement on the basis of the breach. Crucially, Mr Robinson’s aim was to reverse restraints of trade that had formed part of the initial sale transaction so that he could deal with his clients again, given the breach of the sale agreement by the buyer.
The Court found that even though the buyer was in breach of the agreement by failing to pay interest, the restraints should be upheld.
Mr Robinson admitted to being “bewildered” and “devastated by the outcome”.
“I think I have been totally hard done by” he said.
Mr Robinson’s comments throw an interesting light on a number of key aspects of this case:
- The Importance of getting earn-out clauses drafted right
Earn-out clauses are complex. Simplicity and clarity are key to making sure the parties are clear on how results will be determined and agreed between the parties. When not drafted correctly, these clauses can form the fodder for costly disputes down the track.
If you are involved in any way in the preparation of formulas or any other accounting aspects of an earn-out approach, you are at risk of becoming involved in the dispute yourself if an argument emerges.
Even though you might feel that this is the domain of your client’s legal representative, be aware that you are also exposed if something goes wrong: Clients will often look to all advisers who have been involved. Therefore it is in your best interests to ensure that your client is getting the best advice possible!
- The importance of getting the RIGHT advice
After the judgement was handed down, Mr Robinson lamented that “the [sale] contract was drawn up by the other party’s solicitors and it didn’t reflect, in [his] opinion, what the parties had agreed to”.
This suggests one of two alternatives: Either he didn’t get its own legal advice on the sale contract, an incredibly risky move, particularly when dealing with a sale environment that included difficult legal considerations such as how an earn-out arrangement and restraints should work.
Or, he didn’t get the right advice. We often see the fall out from sale and acquisition matters that have been dealt with by solicitors not used to dealing in this area of law. The issues relating to sales and acquisitions are specific and often unique to this area of law. Often a general practice lawyer will not understand the nuances of a particular drafting approach to an earn-out provision, or might simply kill a deal by taking an uncommercial approach.
- The cost of litigation
Finally, this case illustrates the many costs of litigation.
Mr Robinson would have been the likely loser of hundreds of thousands of dollars in lost interest payments, a lost ability to re-establish a revenue base from his clients, and in an exorbitant amount of legal fees. However, his choice of phrase about his devastation at the outcome points to something more – the emotional toll of litigation.
Litigation can be incredibly time consuming, exhausting and, as Mr Robinson learnt, devastating. The value of getting the right advice at the beginning, to help avoid the likelihood of disputes down the line, isn’t just quantified by the hundreds of thousands of dollars in loss and costs that might be avoided, but also by the sleepless nights it might save.
Your take-away
This is a timely reminder for accountants who may be involved in helping to create or negotiate the formula to be used for earn-out provisions for their clients, or any other aspect of a business sale or purchase, to ensure that they are seeking the right legal advice from the beginning.
If you have clients that are considering the future sale of their business, or purchase of a target business, we are happy to meet with you and them to discuss the approach together. Our first meeting is free. And our aim is to ensure that we help you, and your clients, to be aware of the areas of risk in these transactions from the start – and get a handle on how best to deal with those risks.
Click here now to book in a time for a free telephone discussion with us in relation to your client’s situation, or to discuss how we can help provide you with tools and resources to assist your clients preparing for these types of transactions. Or email us here if you would like us to directly contact one of your clients, or if you would like to arrange a face to face meeting.
* Richmond v Moore Stephens Adelaide Pty Ltd [2015] SASCFC 147
