A recent case in the South Australian Supreme Court provides a timely reminder to all businesses about the traps that lurk in business sale contracts and provides a useful overview of the potential dangers that need to be managed when dealing with earn-outs in a sale.
The matter* involved the sale of an accounting practice 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 the former owner of the firm, Mr Robinson, attempted to terminate the agreement on the basis of the breach. Crucially, Mr Robinson aimed to reverse Restraint of Trade clauses that had formed part of the initial transaction so that he could deal with his clients again, following the buyer’s breach of the Sale Agreement.
Whilst the Court found that the buyer was in breach of the agreement as a result of having failed to pay interest as agreed, they maintained that 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 business sales:
- The Importance of using properly drafted earn-out clauses
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 result in costly disputes later on.
- 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…what the parties had agreed to”.
This suggests one of two alternatives: Either he didn’t get his own legal advice on the sale contract – an incredibly risky move, particularly when dealing with a transaction involving difficult legal considerations such as earn-outs and restraints; 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 commonly dealing in this area of law. The issues relating to sales and acquisitions are specific and unique to this area of law. Often, a general practice lawyer will not understand the nuances of a particular drafting approach to, for example an earn-out provision, or they might ‘kill a deal’ by taking an uncommercial approach.
- The cost of litigation
Finally, this case illustrates the huge cost of litigation.
Mr Robinson would have been likely to lose hundreds of thousands of dollars in legal fees, on top of the losses he had already suffered through lost interest payments and the lost opportunity to re-establish a revenue base from his clients. His choice of phrase regarding his devastation at the outcome of the dispute highlights an oft forgotten cost of litigation: the emotional toll.
Litigation can be incredibly time consuming, exhausting and, as Mr Robinson learnt, devastating. The value of getting reliable advice from the outset to help avoid the likelihood of disputes down the line, isn’t just quantified in dollar terms, but also in the sleepless nights it might save.
This is a timely reminder for all business owners who may be involved in negotiating the contract for the sale of a business, 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 or another business that you know of are considering the future sale of a business, or purchase of a target business, we are happy to meet with you to discuss the approach. Our first meeting is free. And our aim is to ensure that we help you 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 discussion with us in relation to your situation, or to discuss how we can help provide you with tools and resources to assist you in preparing for these types of transactions.
* Richmond v Moore Stephens Adelaide Pty Ltd  SASCFC 147