LexisNexis Practical Guidance®

When buying or selling a business, the selection of the vendor party and the purchaser parties and the possible requirement to involve third parties raises unique issues.

A purchaser should make a very careful selection of the appropriate entities which will be operating the business. In making this judgment, the following factors are relevant:

Where the business carries substantial risk, purchasing the business in the name of a company (whether a trading company or a trustee of a trust) will insulate the client’s other assets from those risks.

Individuals generally pay the least tax on capital gains. Accordingly, where the client’s main aim is to make a capital gain from building up and selling the business, the best structure for minimising tax is generally for the business to be purchased in the name of an individual, or in the name of the trust, with individual beneficiaries.

Companies generally pay less tax than individuals on large profits. Purchasing a business in the name of a company or in the name of a trust with a corporate beneficiary may minimise income tax.

In purchasing a business, the principal’s plans for the future ownership of equity in the business should be discussed. Succession planning may be a factor in choosing the entity purchased the business. If the entity running the business is changed later this may incur CGT or stamp duty.

See Choosing the purchaser entity.

When selling a business, it is often necessary to add parties to a contract on the vendor side, in addition to the obvious party operating the business. This can occur in the following circumstances:

Important business assets may be owned by entities other than the party operating the business including:

• •Copyright owners. Software, advertising materials or other copyright works may be used as part of a business and the copyright may remain under the ownership of the original authors, including directors of a vendor company.
• •Vendor related entities. Other entities controlled by the vendor parties may own assets. For example, a business may be operated by a company, while the business premises are owned by another entity such as a superannuation fund.

In most cases, the purchaser will require covenants preventing the vendor from competing with the business after the sale. If such covenants are to be effective, the controllers of the vendor should also be parties to the contract and personally agree to be bound by these provisions.

Where the vendor is a company (other than a large corporation) the purchaser should require that the controllers be joined as parties to the contract and give personal guarantees to the vendor's obligations. The same applies if the vendor is a company operating as the trustee of a trust.

See Identifying the vendor.

Many businesses are conducted by trusts. In these cases, the purchaser’s solicitor must ensure that the business is purchased from the trustee, free from any rights of the beneficiaries of the trust.

A purchaser which acts reasonably in purchasing a business from the trustee will be able to obtain good title, free from any equities, under the doctrine of being a bona fide purchaser for value without notice. Acting reasonably in purchasing the business requires the following:

• •An enquiry as to whether the vendor is acting as a trustee. A contractual warranty that there is no trust should give a purchaser sufficient protection.
• •If the purchaser becomes aware of the existence of a trust, the trust deed should be checked, to confirm that the vendor is acting within the powers under the deed.
• •The Personal Property Security Register. The purchaser will generally take title to the business free from any security interests of which it is not aware, which are not registered on the Personal Property Security Register.

If there is no reason to suspect that the sale would breach the rights of any beneficiary, the purchaser should not be required to take its enquiries any further.

See Buying from a trust.

When purchasing from a company, it is necessary to ensure that:

• •the company has a right to sell the business;
• •the directors are acting in accordance with the company’s constitution; and
• •any registered charges are discharged in full or at least as far as they affect the business.

However, the purchaser can rely upon legal presumptions including:

• •The common law. There is a presumption that the acts of an organization have been carried out correctly.
• •Corporations Act. Sections 128, 129 and 1322 of the Corporations Act 2001 (Cth) entitle third parties to assume that officers have been duly appointed, and are acting with the authority of the company.

See Buying from a company.

A franchise business is based on an agreement with a franchisor. Accordingly, selling a franchise requires action on behalf of the franchisor including:

• •Consent. The franchisor must give consent, pursuant to s 24–25 of the Franchising Code of Conduct.
• •Disclosure. The franchisor must give disclosure pursuant to ss 13–17 of the Franchising Code of Conduct.
• •Franchise Agreement. In most cases, the franchisor will require the purchaser of the business to sign a new franchise agreement.

See Buying and selling a franchise.

The main role of a solicitor in acting on a sale or purchase of a business is preparing and/ or negotiating the contract for sale. The way the contract is drafted may save or cost the client a large amount of money.

In recent years, business clients have sought to limit the expense and complication of transactions by preparing and negotiating their own documents, then bringing them to the solicitors to finalise or “fatten up”. These documents are referred to as heads of agreement, memoranda of understanding or terms sheets. Ideally, they should set out the understanding between the parties in their own words, without any legal jargon. If so, the documents are a useful way of simplifying the solicitor’s role.

However, problems occur when clients take on the role of the lawyer. This often occurs when clients cut and paste clauses from other agreements, or from standard agreements found on the internet.

It is important that these documents should be used only for the purpose of clarifying the understanding between the parties. Problems occur when they are allowed to take on the greater role constituting legally binding agreements.

It is preferable for heads of agreement to be clearly stated as being intended not to create a legal relationship between the parties, other than for supplemental obligations like confidentiality. Rather than devoting efforts towards negotiating legally binding heads of agreement, it is usually preferable for solicitors to expend that effort on reaching agreement on the formal documentation.

See Heads of agreement.

Once you have determined how the transaction should be structured, you should choose a suitable precedent for the contract. For a simple sale, such as a shop, a standard Law Society precedent is usually ideal. If the sale is more complex, then a more detailed precedent is required.

After the first draft of the contract has been submitted, there is usually a series of negotiations between the solicitors for the parties as to the terms of the contract.

Exchanging marked-up and annotated versions of the agreement is useful and may lead to final agreement on the documentation. If not, it should at least narrow the issues. However, this process should not be allowed to drag on, as this wastes your time and the client’s money. It may also lead to bad blood between the parties and the parties walking away from the deal.

If agreement on the form of the contracts cannot be finalized reasonably quickly by email and there are just a few outstanding issues, a teleconference can usually be arranged quickly to finalise agreement on the document. Even though it may be a teleconference with the other side, it is best to have your client with you, as you are at a disadvantage trying to negotiate when you can only communicate with your client by telephone.

The most effective way to finalise the terms of an agreement is a conference attended by all parties and their solicitors. If there are a several technical issues, as well as some commercial issues, it may be useful to have a preliminary conference between the solicitors, to iron out the technical issues, and identify the issues requiring commercial resolution. If the parties and their lawyers meet together, and all genuinely try to resolve the outstanding issues, this is almost always successful. By the time the parties reach this point, it is unlikely that either party wishes to walk away from the deal.

See Preparation of contract.

It is common for a vendor to agree to defer payment of part of the purchase price. The main reasons for this are that the purchaser cannot afford to pay the whole purchase price immediately, or that part of the purchase price is agreed to be calculated on how the business performs, during an agreed period after settlement.

In this case, the vendor will usually require security for the unpaid balance. When the vendor takes security over the business, there are technical issues including the following:

If the security granted by the purchaser includes a charge over shares in the company operating the business, this is usually documented by the purchaser providing a blank transfer of the shares back to the vendor.

This requires a security interest document (formerly known as "bill of sale") to be registered.

This Act exclusively covers security over almost everything other than real property. It has a central, federal registry of all such securities. This includes securities which were registered on the numerous state registries and other federal registries prior to the act coming into force in 2012. Solicitors acting the purchasers and must now carry out a search of the PPS register.

See Vendor finance and earnouts.

The usual procedure for the sale of a business is to exchange contracts, carry out due diligence and other enquiries during the next four to six weeks, then settle.

However, in some circumstances, it is better to exchange contracts and settle the transaction at the same time. The main advantages are:

Many provisions of a normal contract will be unnecessary, such as provisions relating to the deposit and to the conduct of the business pending completion.

The purchaser knows what they are getting and is not exposed to the business being run down by the vendor between exchange and settlement.

The stock take can be carried out immediately before settlement. Accordingly, there will be no need to include or implement contractual provisions for independent valuation of the stock.

By postponing exchange, you postpone the vendor’s obligation to pay CGT, and the purchaser’s obligation to pay duty (if any).

However, there are disadvantages:

Neither party knows that they have a definite deal until settlement. This means that a vendor will reveal information, and the purchaser will incur expenditure, without the other side being bound to go ahead with the transaction.

It may not fit in with the requirements of a lender. The lender may wish to view an exchanged contract before approving a loan and to see a stamped contract on settlement.

See Simultaneous exchange and settlement.

Taxation is the most technically difficult part of buying or selling a business. The Australian taxation system is immensely complex and continually becoming more complex. Even for accountants, for whom tax work is a full time occupation, no one person could claim to be an expert on the whole of the Australian taxation system.

Accordingly, a solicitor cannot be required to be a tax expert in order to act on a sale or purchase of a business. However, some understanding of the basic principles is essential, at least to identify the issues. Otherwise, you risk putting your client into a tax trap, or allowing the solicitor for the other party to take advantage of your client.

This topic is an outline of practical taxation aspects of sales and purchases of business. However, it does not examine taxation issues in depth, and should not be relied upon as a substitute for a detailed consideration of the relevant taxation laws as applied to particular circumstances.

When a business is sold, a number of types of taxation are triggered, including the following:

This is the most important tax triggered by the sale of a business. It is of vital concern to the vendor who will be liable to pay any CGT. It is also important to the purchaser, as the transaction will provide the purchaser’s cost base. When the purchaser later disposes of its interest of the business, this cost base will be the starting point for the calculation of any CGT payable on the disposition.

See Capital gains tax.

There are very generous concessions available on the sale of small businesses, which greatly reduce or eliminate Capital Gains Tax payable. These are covered by ss 152-1 to 152-430 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). To qualify for the concessions, a series of tests must be passed. Each is surrounded by complex rules.

The concessions are:

• •15 year exemption. A business operating for more than 15 years can be sold free of CGT.
• •50% reduction. CGT is paid on only 50% of the capital gain. This is in addition to the 50% discount on CGT for individuals selling assets they have owned for more than 12 months.
• •Retirement Exemption. There is an exemption for capital gains of up to $500,000 per person, if either the exempt amount is rolled into superannuation, or the person is already over 55 years of age.
• •Small Business Roll-Over. If, within 1 year before or 2 years after the sale of a business, the sale proceeds are used to buy another business, no CGT is payable on the sale of the first business.

See Small business relief.

The sale of a business is a taxable supply under Div 9 of A New Tax System (Goods and Services Tax) Act 1999 (Cth). Accordingly, it exposes the vendor to a GST liability on virtually all the assets of the business. The GST may be avoided by using the going concern exemption under s 38-325 of that Act. However, there are many situations where the exemption is not available, or where the parties may not wish to apply it.

See GST.

Duty (referred to in some states as “stamp duty”) is covered by state legislation. Queensland, Western Australia, and the Northern Territory still impose duty on sales of businesses. In all other states, sales of businesses are exempt from duty, unless the sale includes a transfer of real property or other dutiable property.

As a business is a collection of different assets and rights, duty is imposed on defined business assets. These are different in different states. Duty on sales of shares has been abolished throughout Australia.

Some assets comprised in a sale of business attract duty anyway, such as goods that are dutiable under the general provisions, sales of real property or transfers of shares in land-rich companies or unit trusts. For example, in Victoria, duty may be imposed where the shares being transferred have a land use entitlement (or an entitlement to occupy land in Victoria): ss 10(1)(v) and 103A of the Duties Act 2000 (Vic).

See Duty.

Selling a business may trigger ordinary income tax as follows:

A sale of stock included in a sale of business will attract income tax, just like the ordinary sale of stock in the course of the operation of a business.

Where plant and equipment are sold for more than their written down value, the difference is subject to income tax. Similarly, any sale for less than the written down value will create a deductible tax loss.

CGT is generally less than income tax. Accordingly, a vendor will try to structure the breakdown of the sale price to maximise the component for goodwill, and minimise the components for plant and equipment. A purchaser will try to do the opposite.

Taxation legislation imposes limits on the manipulation of value of assets included in a sale of business. This includes the following:

Assets will be deemed to be sold at market value, rather than at their stated prices, if the sale is not at arm’s length. This is covered by s 70-90 of the ITAA 1997 in respect of the sale of trading stock, and s 112-20 (market value substitution rule) of the ITAA 1997 for the cost base of a capital item.

Part IVA of the Income Tax Assessment Act 1936 (Cth) states, in effect, that any scheme to reduce tax will be void as against the ATO.

The client’s accountant is responsible for the client’s overall tax planning. Accordingly, it is important that the accountant should be consulted as to any tax strategies suggested by the solicitors acting on a sale or purchase of business.

See Income tax.

Due diligence is the term to describe the investigations into a business carried out by a purchaser before buying a business.

The process revolves around the vendor providing a large number of documents relating to the business and (when required) access to management and premises. The documents are inspected by the purchaser and its advisors. Much of the documentation is usually legal documents, such as leases and contracts, and these are inspected by the purchaser's solicitors. The due diligence documents may also include financial documents, which are usually inspected by the purchaser's chief financial officer and/ or external accountants.

Where the sale proceeds by way of sale of shares in a company, due diligence involves investigation both of the company and of the business.

Due diligence also includes carrying out searches of publicly available records, such as the Personal Property Security Register, the records held by ASIC for any relevant company or business name, or records relating to the registration of any relevant trade marks.

Due diligence before exchange of contracts can have different purposes, as follows:

The contract will contain warranties that matters with the business are generally in order and certain minimum standards are satisfied. This is subject to anything disclosed before exchange of contracts. The vendor will wish to disclose any matters which would otherwise be a breach of a warranty. Otherwise, the purchaser could terminate or claim damages if those matters are discovered after exchange of contracts.

The vendor may also be required by law to provide information to a prospective purchaser before the contracts are signed. For example, a vendor of a small business in Victoria must give a statement to a purchaser before signing a contract or accepting a deposit, and the vendor of a franchise is required to give disclosure under the Franchising Code of Conduct.

The purchaser and its advisers search and inspect documents to enable them to decide whether to proceed with the purchase, including whether the price is fair.

See Due diligence before exchange.

When due diligence is carried out after exchange of the contract, the purchaser's solicitor will confer with the client and other advisers to determine a list of the matters that need to be investigated, to ensure that the purchaser is getting what they bargained for. This list will be the basis of the documents which the purchaser's solicitor will require from the vendor.

The process is then that the advisers go through the documents to check that they are in accordance with the contractual warranties. For example:

• •check that the important contracts have been properly executed, are enforceable and any duty on them has been paid; and
• •if the transaction is the sale of shares, the purchaser’s accountant will need to check that the financial records have been property kept, that the tax returns, BAS documents and other returns have been properly prepared and lodged.

The enquiries the purchaser’s solicitor is required to carry out will differ from business to business. The main point of the enquiries is to determine that the assets being sold are not subject to any registered encumbrance. It is also necessary to check the registration of any property which requires registration, such as trade marks, business names, patents or real property leases, in states where they are registered.

Due diligence requires the vendor to provide documents to the purchaser. These will often be commercially sensitive, which could help the purchaser to compete with the vendor, if the sale does not proceed. For this reason, the vendor will require the purchaser to sign a non-disclosure agreement. This requires the purchaser not to disclose any of the information provided, nor to make any use of it, otherwise than for the purpose of the proposed purchase.

Issues may also arise if the documents themselves have provisions preventing disclosure to third parties — the consent of the parties to the agreement may be required before disclosure.

See Due diligence after exchange.

Due diligence has traditionally been carried out by the vendor collating the relevant documents and placing them in a room, to be inspected by the purchaser and its advisors.

In recent times, these physical data rooms have largely been replaced by online data rooms. The documents are scanned and loaded onto a website, with the purchaser and its advisors having access by use of a password.

There is a tendency to load too much data into the data room. Supplying too much data can be as uninformative as not supplying enough.

See Due diligence after exchange/signing.

Goodwill is what makes a business more than just a collection of assets.

Goodwill has a number of related meanings, including:

• •the ability of the business to make a profit;
• •the additional value a business has, beyond the individual property assets of the business;
• •the reputation of the business or staff; and
• •the likelihood of continuing customer support of the business.

Goodwill, in this context, is best defined as the value of a business, so far as that value exceeds the value of the independent assets. However, it is not an item of property in the usual sense of that term, as it does not exist and cannot be owned, bought or sold otherwise than as part of the other property that makes up the business.

A contract for sale of business always states that what is sold includes goodwill. However, as goodwill is not property in the usual sense of the term, when a contract says that it is selling goodwill, what it really means is that it is providing the purchaser with the means to use the collection of other assets being sold to make a profit.

This is achieved by transferring title to the assets of the business to the purchaser, along with contractual covenants not to interfere with the purchasers’ ability to use those assets to run the business.

These covenants are restraint provisions, which state that the vendor shall not directly or indirectly be involved in competing with the business. Restraint provisions typically prevent a vendor from:

• •providing competing goods or services to customers;
• •poaching staff; and
• •dealing with key suppliers.

A restraint clause which is an unreasonable restraint on the ability of the vendor to trade will be unenforceable. Accordingly, the clauses should be drafted so that they:

• •are broad enough to protect the goodwill of the business;
• •are not so broad as to be unenforceable;
• •they are drafted so as to prevent the vendor from running a competing business through any other entity; and
• •they are clear enough to be able to be enforced, without arguments as to precisely what conduct is prohibited, in what geographical location and for what period of time.

The courts will strike out any restraints that are too wide, but will leave the remaining provisions, if they still make sense and are not too wide. For this reason, it is common to have cascading restraints, whereby there are several alternative time periods and geographical areas. For example, a vendor of a business based in Sydney may be restrained from operating a competing business:

• •in Australia;
• •in NSW; and
• •within 50 km of the head office of the business.

If the first and second alternatives were too wide to be enforced, the third provision would still be binding.

Having cascading provisions for time, geographical area, and the types of business restrained can lead to multiple combinations of prohibitions. This is acceptable and enforceable, provided that the number of combinations is not so great as to make the provisions void for uncertainty.

See Goodwill and restraint clauses.

The fact that goodwill is not property as that term is generally used does not cause the taxation legislation any hesitation in taxing it. However, it is excluded from the depreciation provisions, which means that a business owner can claim no deduction in respect of depreciation of goodwill. There can be a difference of treatment of taxation of goodwill compared with tax on consideration for a restraint, especially if goodwill is pre-CGT. The relevant provisions are as follows:

Goodwill is included as a “CGT asset” under s 108-5 of the Income Tax Assessment Act 1997 (Cth).

Section 9-10 of A New Tax System (Goods and Services Tax) Act 1999 (Cth) defines “supply” so as to include goodwill.

Section 40-30 of the Income Tax Assessment Act 1997 (Cth) defines “depreciable asset” in such a way as to exclude goodwill.

See Tax considerations.

Almost all sales of business include sale or transfer of plant and equipment. This may appear to be a simple aspect of the transaction. However, some complex and important issues can arise.

Most plant and equipment is subject to depreciation, where the owner can claim a tax deduction for a certain percentage of its value each year. Plant and equipment is not subject to Capital Gains Tax, as it is “otherwise assessable” under s 118.20 of the Income Tax Assessment Act 1997 (Cth) (ITAA).

The sale of plant and equipment as part of a sale of business is a “balancing adjustment event” within the meaning of ss 40-280 to 40-370 of the ITAA. Under these provisions, the vendor is liable for income tax if the plant and equipment is sold for more than its depreciated or written down value. Similarly, the vendor will be entitled to a tax deduction for the difference between the written down value of an asset and its sale price, if it is sold for less than the written down value.

Even though the overall contract price has been agreed, there is often debate as to how much should be allocated to goodwill, as opposed to plant and equipment. The vendor will usually try to minimize the figure for plant and equipment, to minimize income tax, as this is usually higher than the capital gains tax applying to goodwill. Small businesses, with annual turnover under $10 million, can claim a tax deduction by instantly writing off the whole of the purchase price of any plant and equipment for less than $20,000. Accordingly, vendors will pay income tax on the whole of the value of any such equipment included in the subsequent sale. This gives vendors a strong incentive to minimise the value of plant and equipment in sale of business contracts.

The contract for sale of business will usually divide the agreed purchase price into:

• •goodwill;
• •plant and equipment; and
• •stock.

However, careful examination of the balancing adjustment provisions of the ITAA shows that it is the value of the assets, not the expressed purchase price that should be taken into account in calculating any balancing adjustments to the vendor’s tax.

A purchaser will be able to claim a tax deduction for depreciation for plant and equipment, but not goodwill, which cannot be depreciated, for tax purposes. Accordingly, the purchaser will try to reduce the amount expressed to be paid for goodwill with a corresponding increase in the amount allocated for plant and equipment.

This can lead to arguments between the vendor and purchaser. However, the ITAA states that, where several assets are bought together, it is the value of the relevant asset which counts in calculating future tax deductions for depreciation, not the stated price breakdown.

The same considerations and the same laws apply to other assets sold as part of the business including:

• •improvements to land;
• •fixtures forming part of real property, even if they are not removable;
• •computer software; and
• •intellectual property, including copyright, registered design and patent (but not goodwill).

This is pursuant to s 40.30 of the ITAA.

See Tax considerations.

The plant and equipment included in the sale of business are often subject to an equipment lease, or similar finance arrangement.

On a sale of business, the use of this equipment can be transferred to the purchaser by paying out the finance company on settlement or by novating or transferring the existing equipment lease.

If the lease is to be novated or transferred, this needs to be covered by careful provisions in the contract, including provisions to the following effect:

• •each of the parties shall take all steps reasonably necessary to obtain the consent of the finance company to such novation or transfer; and
• •if such consent cannot be obtained, or if such consent can only be obtained on unreasonable terms, then:
• • ◦either party may rescind the purchase and sale agreement; or
• • ◦if the lease is not a pivotal part of the sale, the vendor is required to pay out the lease, with the purchase price increased accordingly.

If the lease is paid out, the purchaser’s solicitor should ensure that any registration of the finance company’s interest over the plant and equipment is discharged.

Practice Tip: The plant and equipment needs to be precisely specified in the contract. The “good enough” listing in the “big picture” rush to sign up a deal, may not withstand the cooling of ardour of the parties. Both parties need to audit the plant and equipment list at both contract and settlement. If you choose to use templates or example lists, used in other matters, it is important to ensure they are amended to cater for the matter at hand.

See Leased equipment.

The term “stock” is mainly used to refer to the goods held by a business for sale. However, it can also refer to the following:

Consumables

This includes fuel and spare parts for plant and equipment, and the printed stationery of a business.

Raw materials

This includes stock, such as the paper held by a printing business. In the sale of a manufacturing business, raw materials may form a considerable component of the price.

Work in progress

This can include products in the course of manufacture. It can also include intangible products, such as an advertising agency’s partly completed artwork, or a solicitor’s work on an uncompleted probate application.

The contract should make it clear what is included in the term “stock”, and whether this is to include consumables, raw materials and work in progress.

In general, what a business pays to acquire its stock is a tax deduction, and what it receives for sale of stock is part of its taxable income. When stock is sold as part of a sale of business, it is taxed in the same way as if it had been sold in the ordinary course of business. This also applies to consumables, raw materials and work in progress. Capital gains tax (CGT) does not apply because stock is “otherwise assessable” within the meaning of s 118-20 of the Income Tax Assessment Act 1997 (Cth).

As income tax is generally higher than CGT, the vendor will try to minimize the value of the stock and increase the value of goodwill, which is subject to CGT.

The purchaser will try to do the opposite, as the purchaser receives an immediate tax deduction for purchasing the stock. However, the purchaser gains no deduction for purchasing goodwill, other than as a deduction from the capital gain it may eventually make on a subsequent sale of the business.

Where there is a sale of shares in a company conducting a business the stock automatically comes under the control of the new shareholder. However, the price to be paid for the shares will include an amount for the stock.

Accordingly, the same issues arise:

• •determining what is stock;
• •determining how the stock should be valued; and
• •determining whether the company has good title to the stock.

Some of the stock of a business may have been purchased from a supplier under a contract containing a Romalpa clause, also known as a retention of title clause. Under a Romalpa clause the supplier requires that title to the stock shall pass to the business owner only when the stock is paid for.

Businesses generally do not keep track of what stock is subject to such provisions. Accordingly, the mixture of assets making up the stock may well include items not owned by the vendor.

A search of the Personal Property Security Register should be conducted, to see if any retention of title claims are registered.

See General principles.

The unique challenge of dealing with stock included in a sale of business comes from the fact that it is constantly changing. Accordingly, a fixed figure for stock cannot generally be included in the contract. Rather, a stocktake needs to be conducted.

A contract for sale of business should clearly set out the manner of conducting a stock take including:

Ideally, the stock take should be conducted in time for the price to be determined, and included in the settlement figures. However, if a dispute arises, this may not be possible. In that event, there are several possibilities:

• •delaying the settlement until after the dispute is resolved;
• •delaying the payment until dispute is resolved; or
• •setting money aside. This is usually the best alternative.

There are various ways to value stock. It could be valued at invoice price, wholesale price, retail price, or in some other way. To avoid any arguments, the contract should clearly state how the stock is to be valued.

Work in progress (WIP) generally has no value on the open market, until the work is completed. This applies both to manufactured products and to intangibles. This can lead to arguments about how the WIP is valued. As usual, the solution is to include a clear provision in the contract, stating how to determine the value of the WIP, such as an agreed hourly rate for the work expended on creating it.

A purchaser’s solicitor should insist that the purchaser is not required to pay for stock beyond what is needed to conduct the business. Accordingly, the contract should exclude:

• •stock exceeding a total aggregate amount; and
• •stock which is not good and saleable.

See Valuation.

Disputes over stock can easily arise in relation to:

• •what is included in “stock”;
• •whether the stock is “good and saleable”; and
• •how the stock should be valued.

Clear provisions should be included in the contract for dispute resolution.

See Resolving disputes.

There is potentially a long list of what comprises the assets of a business. One of these is likely to be a business’ intellectual property. It is very important that all intellectual property of a business is included in any inventory attached to the relevant contract. The below need to be considered when determining what intellectual property the relevant business has.

This refers to the name under which a business is conducted.

The relevant legislation is as follows:

There is a single federal system to cover the registration of business names throughout Australia. The registration and transfer of business names is now entirely covered by the Business Names Registration Act 2011 (Cth).

Unlike a trade mark, a business name registration is not an item of property but rather a government regulatory licence. A business name registration cannot be bought and sold. The only way of transferring a business name is for it to be transferred to a new person or company who will be running a business under that name (see ASIC — How to transfer a business name).

A business may be conducted under the proprietor's own name. Accordingly, where a business is conducted by a company, it can be run in the company's complete name (ie with “Ltd” or “Pty Ltd” included) without registering a separate business name s 18, Business Names Registration Act 2011 (Cth).

Company names are governed by Pt 2B.6 of the Corporations Act 2001 (Cth), and r 2B.6.01 and Sch 6 of the Corporations Regulations 2001 (Cth). These allow extremely similar company names to be registered. This is based on the idea that companies are required to show their Australia Company Numbers (ACN) or Australia Business Numbers (ABN) on almost all documents, and that these distinguish between different companies with nearly identical names. Although company names cannot be literally sold, they can be transferred as follows:

• •a vendor registering a business name which is the same as the company name, without “Pty Limited”, and transferring that business name on settlement.
• •the vendor changing its name to enable the purchaser to adopt that name on settlement; or
• •the purchaser registering an almost identical company name.

Use of similar company or business names (though not items of property) may contravene general law protections in certain circumstances (eg amount to misleading or deceptive conduct or the tort of passing off).

See Business names.

A trade mark is a name and/or sign to distinguish goods and services and is an item of property. Trade marks are registered under the Trade Marks Act 1995 (Cth), and the registration is administered by IP Australia, a Commonwealth Government authority. Unregistered trade marks are given some protection by the general law.

Each trade mark is registered in one or more classes, and the benefits of registering a trade mark only applies to goods and services in those classes.

Trade marks can be assigned simply, under s 106 of the Trade Marks Act 1995 (Cth).

These cover the unique shape and appearance of original products. They are subject to the Designs Act 2003 (Cth). A search of registered designs may be carried out at IP Australia or via its website.

Assigning a registered design requires only a simple assignment, completion of a form and lodgment with IP Australia or via its website. See s 11 of the Designs Act 2003 (Cth).

A patent is how a product works. Registrations are covered by the Patents Act 1990 (Cth) and, again, this is administered by IP Australia.

Patent registrations are highly technical. A solicitor acting for a purchaser of a business which includes patents should obtain specialist advice from a patent attorney.

Patents may be assigned to another party by lodging a request to amend ownership form through IP Australia. See s 14 of the Patents Act 1990 (Cth).

Passwords are an important part of running almost any business. Businesses may also have dongles, which are the electronic equivalent to a key, to operate part of their computer system. A purchaser’s solicitor should require these to be handed over on settlement.

Information, such as client lists, may be a valuable part of a business. Confidential information is often described as intellectual property. However, it is not property at all.

The only way for a vendor of a business to “sell” confidential information is to provide it, together with covenants not to use or disclose it to any third party.

See Trade marks and other intellectual property.

Information technology, or IT, is the term for computers and everything that allows them to function, including computer hardware and software. The term also encompasses web sites.

Most businesses rely on computer software to function. Accordingly, in acting for a purchaser of a business, it is important to secure the legal rights to use, adapt and maintain the software used in the business.

The main legal right associated with software is copyright. This is covered by the Copyright Act 1968 (Cth).

When purchasing a business, including the copyright to software, issues can arise, including the following.

• •ownership and sale of copyright;
• •software licence terms;
• •software support; and
• •software patents.

A website is often a core component of a value of a business. To secure for the purchaser all of the relevant legal rights to use a website of a business, the purchaser’s solicitor should give attention to the following:

• •domain names;
• •web hosting;
• •website software; and
• •text images and other materials (eg audiovisual) displayed on the website.

See Information technology.

There are taxation considerations in relation to intellectual property for both the purchaser and vendor when purchasing or selling a business and the practitioner must be aware of this. For example, the location of the intellectual property may impact on the amount of duty payable.

See Tax factors.

Protection of trade secrets, know-how and confidential information is an important issue for consideration in the sale of a business. The purchaser in particular will want to ensure to have the knowledge transferred to it effectively, e.g. through a knowledge transfer agreement.

See Protection of trade secrets.

Contracts are at the heart of any business. Transferring to the purchaser the benefit of the contracts under which the business operates is a fundamental part of a sale of business. These contracts include:

• •contracts with suppliers;
• •contracts with customers; and
• •leases of business premises.

On a sale of business, the benefits of contracts are passed on to the purchaser by:

• •assignment;
• •novation; or
• •sale of shares in the contracting company.

If the other party to the contract agrees, there is no problem in assigning the contract to the purchaser.

In many cases, it is not practical to obtain the consent of the other parties to the assignment of each contract to which the business owner is a party for the following reasons:

• •there maybe thousands of contracts, especially customer contracts;
• •it may take too long to obtain the formal consent of each relevant party; or
• •the other party to the contract may not agree.

However, some contracts can be assigned without the other party’s consent:

• •contracts which are not for personal services may be assigned without the consent of the other party, and
• •a contract may have specific terms, allowing assignment.

Novation occurs pursuant to an agreement between the vendor, the purchaser and the other party to the contract, whereby the old contract is replaced by a new one. The advantages of novation are:

• •from the vendor’s point of view, there is no liability for anything arising after settlement, under the new contract; and
• •from the purchaser’s point of view, there is no liability for anything that occurred under the old contract, before settlement.

Generally, a contract with a company will remain on foot, and will automatically come under the control of the purchaser of the shares in the company. However, the following issues may arise:

Some contracts state that a transfer of the control of a company will be deemed to be an assignment of the contract. This is usually in contracts which state that the contract cannot be assigned without the other party’s consent.

Many contracts between suppliers and companies are personally guaranteed by directors, who are usually also the shareholders. In that case, the vendor shareholders will wish to avoid being called on later to make payment under the guarantees. This raises the following issues:

• •A supplier may agree to release vendor guarantees if the purchaser provides a substitute guarantee.
• •The contract for sale of business should provide that the purchaser shall indemnify the vendor’s guarantors for liabilities arising after settlement, until those guarantors are released.
• •It is often difficult for directors of a company to know what guarantees they have signed over the years. A purchaser is unlikely to give a blanket indemnity for any guarantee which is not specifically nominated. The only solution may be for the vendor’s directors to carry out the detailed searches of their records.

See Contracts.

A sale of business often includes a transfer of the lease of the business premises. All of the considerations set out above in relation to the transfer of contracts apply to transfer of leases. However, some additional factors need to be considered.

Almost all leases contain provisions covering transfers of the lease by the lessee. They usually state that the lessor’s consent is required, and often state that such consent shall not be unreasonably withheld.

In New South Wales, Victoria, Queensland and Western Australia, provisions to this effect are included in leases by statute, and in New South Wales and Queensland, the statutory provisions override any express provisions to the contrary.

In Tasmania, there is no statutory provision to this effect, except for retail leases.

In South Australia, a lessee can only seek to apply to the court for relief against forfeiture, where the lessor vexatiously or capriciously withholds its consent to a transfer: s 12(4), Landlord and Tenant Act 1936 (SA).

All states and territories have provisions facilitating the lessee’s right to assign a shop lease. In all states but Queensland, a lessor must consent to an assignment, except on very limited grounds set out in the relevant statutes.

Queensland gives no help to a lessee wishing to transfer a lease, other than invoking a dispute resolution procedure if the lessor refuses to consent.

At common law, the assignor of a lease remains liable, even for liability arising after assignment. The solutions are:

• •seek an indemnity from the purchaser;
• •seek a release from the lessor; and
• •negotiate to terminate the existing lease, and replace it with a new lease.

On a sale of business, the transfer of a lease does not automatically release the guarantors, or effect a refund of the bank guarantees or bond provided by the original lessee. This must be negotiated with the lessor, who has no legal obligation to agree.

All states and territories but Tasmania have provisions to the effect that assignment of a retail lease will release the assignor and the vendor’s guarantors.

See Commercial leases.

Employees can be a very valuable part of a business. However, the vendor does not own the staff, so, unlike other assets of a business, they cannot be sold.

On settlement, the obligations of the vendor to its staff, for which the purchaser will become responsible, must be adjusted, by being deducted from the purchase price. See Adjusting employee entitlements.

The relationship between a business owner and its employees is governed by a contract. These contracts may be partly or entirely:

• •written;
• •oral; or
• •implied.

It is important for a purchaser to check the records of the business relating to the employees, including the original employment contracts, and any subsequent variations. This process should also include requiring records showing:

• •details of the employee;
• •duties;
• •salary and benefits;
• •accrued entitlements;
• •any applicable industrial instruments, such as awards, determinations or agreements; and
• •any contracts of employment, including any variations.

A contract of employment is a contract of personal service, which means that it cannot be assigned, novated or "transferred" from a vendor to a purchaser. The employee is always free to decide for whom they want to work.

A business acquisition will either take place by way of a purchase of shares or a purchase of assets.

Technically, transferring shares in the employer company does not require the employee’s consent because there is no change to the legal identity of the employer. However, from a practical point of view, an employee can choose to terminate their contract of employment at any time. Accordingly, the employee must be persuaded to work under the control of the new business owner.

In a sale of assets, the purchaser will need to offer employment to any of the vendor’s employees it wishes to retain. Any employees who are not required by the purchaser (or who decline an offer of employment) will remain employed by the vendor, who will need to decide about their ongoing employment. If the vendor has no remaining work for the employees to perform, usually it will be necessary to terminate their employment on the ground of redundancy.

Both workers and business owners often claim that the workers are contractors, not employees.

Employees believe it may give them tax benefits while employers believe that it avoids employment-related laws, such as the Fair Work Act 2009 (Cth).

On a purchase of business, the purchaser must be sure that those described as contractors are not disguised employees. If they are, then all of the laws relating to employees will apply. These include benefits such as long service leave, accrued while working for the vendor, passing through to burden the purchaser.

If there are any staff whose services are vital to the business, the purchaser should ensure that the contract for purchase of business is conditional upon securing their services. Also, particular attention should be paid to the restraint provisions in their contracts and the enforceability of those restraints, should they leave the business.

See Employee contracts.

The Fair Work Act 2009 (Cth) (FWA) became law on 1 January 2010. It phased out Australian Workplace Agreements and old awards, and has introduced a series of "modern awards". It also applies the National Employment Standards to all employees. These provide ten minimum standards of conditions for employees.

When buying a business, the purchaser may become bound by a variety of awards, agreements and determinations including:

Section 313 of the FWA provides that the purchaser of a business is bound by “transferrable instruments”, defined in s 312 of the Act to be either an enterprise agreement that has been approved by the Fair Work Commission, a workplace determination or a named employer award. Similarly, s 768AM of the FWA provides that the purchaser of a State employer will be bound by a “copied State award” or a “copied State agreement”, defined in s 768AF of the FWA. These are agreements, determinations and awards, specific to the vendor.

Awards apply according to the type of industry the business is in, and according to the type of work the employees perform. For example, if you buy a business which fits fire sprinklers, the Plumbing and Fire Sprinklers Award 2010, will automatically apply to each of your workers carrying out work as referred to in that award.

Individual arrangements under the FWA include:

• •individual flexibility arrangements; and
• •guarantees of annual earnings.

To find what instruments apply to a business you can conduct a search, but this may not give the true picture:

• •it does not include all of the employer specific instruments; and
• •it may be difficult to determine which awards apply to each of the vendor’s employees.

The purchaser’s solicitor should include provisions in the contract for sale of business to force the vendor to disclose any applicable award, determination or agreement. There should then be the subject of a careful examination during the due diligence process.

Under s 535 of the FWA, and under the Pt 3-6 Div 3 of Fair Work Regulations 2009 (Cth), detailed employment records must be kept. The regulations provide that, on a sale of business, these records must be handed to the purchaser and the purchaser must keep them as if they were their own records.

See Industrial relations law.

Each state has long service leave (LSL) legislation. The entitlements vary but are usually between 10–13 weeks' LSL once 10–15 years' service have been completed. Pro rata entitlements are generally available once employees reach 5–10 years' service (or 7 years in Victoria, South Australia and the ACT). Some industrial instruments also provide for LSL, in similar terms to the state legislation.

On a transfer of employees as part of a sale of business, the time spent working for the vendor automatically transfers across. Accordingly, employees are entitled to LSL from the purchaser as if the purchaser had always been the owner of the business.

On settlement, there is usually an adjustment, whereby the purchase price is reduced by the liabilities for LSL taken on by the purchaser. For employees with less than 10 years of service (or 7 years in Victoria, South Australia and the ACT), there can be issues between the vendor and purchaser as to what adjustment should be made. This is because there may be no LSL entitlement if the employee leaves voluntarily before achieving a minimum period of service.

This covers:

• •sick leave; and
• •carer’s leave.

On a purchase of a business, any entitlements accrued with the vendor automatically pass to the purchaser under s 22(5), FWA. However, the purchaser may never have to pay such liability if the employee leaves without using up their leave entitlements accrued while working for the vendor. In practice, the entitlement of transferring employees to personal/carer’s leave is ignored, and not included in standard templates for contracts for sale of business.

See Long service and personal/carer’s leave.

If a vendor and purchaser are associated entities within the meaning of the Corporations Act 2001 (Cth), the purchaser will be obliged to recognise annual leave entitlements accrued by employees while working for the vendor. This obligation does not apply if the vendor and purchaser are non-associated entities but can be agreed as part of the sale. In practice, annual leave is almost always transferred to the purchaser, rather than paid out on settlement, as employees generally prefer holiday entitlements rather than to receive cash and go without holidays. In that event, the purchaser will almost always seek an adjustment to the purchase price to reflect the liabilities it takes over.

After contracts are exchanged, the focus of the parties and their solicitors is on taking the steps required for settlement.

Settlement should usually be arranged as soon as possible after exchange of contracts, to minimize the chances of problems arising from the vendor’s continuing conduct of the business.

An action plan should be prepared, showing what steps are required to be taken and by whom, in order to bring about the settlement. The solicitors for the parties should then work through those steps to achieve the settlement.

In some states and territories, there may be pre-settlement steps, such as a requirement for the vendor to provide certain forms or notices to the purchaser.

Most businesses are subject to security interests registered under the PPSR system. The purchaser will require that these be discharged on or before settlement. If the vendor needs the money from settlement to discharge the securities, this can be handled like the discharge of any other mortgage, where part of the payment of the purchase price is directed to the secured party in return for discharging the security. As the PPSR system is online, and does not rely on paper, the discharge takes the form of the secured party providing the password, known as a “token”, to enable the charge to be removed from the register. However, for securities already registered prior to the PPSR system coming into force in 2012, there is no token, so the secured party generally provides a deed of release and an undertaking to register the release with the PPSR.

The settlement will usually take place at the vendor's solicitor's office, although there is no strict rule about this. Some jurisdictions follow the old conveyancing convention that settlement must take place at the site of the deeds, which is often the vendor's bank. In some cases, it may be best to settle at the business premises, because the relevant documents are usually available there.

The convention has been that the purchase price is paid on settlement by bank cheques. However, many purchasers prefer the more modern procedure of paying by bank transfer. This applies especially if the money is coming from overseas. The legal profession has not caught up to this, and using bank cheques is often still the only way to settle, unless arrangements can be made with banks to arrange instant transfer of funds.

Where the transaction is a sale of shares in a company conducting the business, the settlement will usually include:

• •transfer of vendor’s shares; and
• •replacement of the directors and secretary.

These steps require preparation of documentation including:

• •consent of the new directors and secretary;
• •minutes of meetings of directors and, possibly, shareholders; and
• •ASIC Form 484.

See Arranging settlement.

There may be many adjustments required on settlement relating to:

• •vendor’s liabilities, which the purchaser will be assuming, such as rent and employee entitlements; and
• •vendor’s assets, from which the purchaser will be benefiting, such as stock and work in progress.

Where the purchaser will be paying a liability to which the vendor should contribute, there is an adjustment on settlement. In effect, the purchase price is reduced by the amount of that contribution.

The purchaser will receive a tax deduction for the whole of that liability, but will not be taxed on the benefit it receives by way of the allowance on settlement. In those circumstances, the vendor may seek to have the amount to be paid to the purchaser reduced to the after-tax amount of the purchaser’s liability.

Many adjustments cannot be calculated on settlement, as the amount of the relevant liability is not known at that time. This should be covered by clear contractual provisions, stating that any such adjustment should be made as soon as possible after it is able to be calculated.

It is almost universal for contracts for sale of business to state that the debts of the business continue to belong to the vendor after settlement. In the period following settlement, as those debts are paid, the vendor may issue invoices to the same customers in respect of goods or services provided after settlement. This can raise the following issues:

• •If a debtor who owes money for both pre and post settlement invoices and makes a part payment, which invoices should this be applied to? The solution is for a contractual provision stating that any payments are applied to the oldest invoices first.
• •If both the vendor and the purchaser are chasing the same customers for payment, this can cause ill-will and confusion. This issue may be solved by a contractual provision stating that the purchaser is to collect all of the payments, and then account to the vendor for the vendor’s entitlements upon receipt.

See Adjustments on settlement.

On settlement, the purchaser should be credited for any entitlements of the transferring employees. This includes:

This is where employees may be entitled to payment after settlement, for a period commencing before settlement.

Any unpaid superannuation accrued prior to settlement should be adjusted, like any other outgoing of the business.

The purchaser is only liable for annual leave accrued before settlement if it “recognises” the employees’ service with a vendor. This is covered by ss 22(5) and 91 of the Fair Work Act 2009 (Cth) (FWA). Otherwise, the vendor has to pay out the accrued annual leave on settlement.

Financially, this makes no difference to the vendor. If it does not pay the employees, it will have to allow the same amount to the purchaser as an adjustment on settlement.

However, it is better for the purchaser to recognise and assume liabilities for these entitlements. It means that the purchaser will receive a cash adjustment on settlement, but only has to pay the liabilities as the employees take holidays or leave their employment. The employees will also generally be happier, taking holidays in the usual way, rather than having them cashed out on settlement.

Businesses with more than 15 fulltime employees are exposed to paying employees who are made redundant, based on their years of service. Under ss 22(5) and 122 of the FWA, if the purchaser “recognises” the employees’ services with the vendor:

• •the employees who continue with the business are not considered to be redundant; and
• •the calculation of any redundancy pay the purchaser may have to pay in the future will include the period of service with the vendor.

In most cases, the contract should provide as follows:

• •The purchaser recognises the transferring employees’ service with the vendor. This avoids the vendor having to pay redundancy pay for those employees on the sale of the business.
• •There is no adjustment on settlement because the entitlement to redundancy pay may never eventuate.

Entitlements to long service leave (generally arising under state legislation) require careful review and apportionment. The purchaser is likely to be liable for long service leave accrued before settlement under the employees’ service with a vendor. The vendor generally cannot cash out the accrued long service leave on settlement.

See Adjustment of employee entitlements.

Because of the complexity involved in the sale and purchase of a business, there is the potential for many causes of disputes. To ensure that as far as possible disputes are avoided the practitioner must make it clear to their client what such a transaction involves. Some common causes of disputes and ways to minimise such are:

Many clients believe that a sale or purchase of a business should be quick, easy and cheap. When they realise this is not the case, the client may blame the other side or their advisors. To short-circuit this, clients should be given realistic advice at the outset to, among others, be cognisant of the steps involved in such a transaction, timing and costs (direct and indirect).

Where communication between the parties is via a business agent, misunderstanding may arise. Direct discussions between the vendor and the purchaser can often overcome these problems.

While this should be encouraged, the practitioner should ensure that their client does not inadvertently agree to something without first considering the implications of such an agreement or referring back to their legal adviser.

Once contracts are exchanged, disputes which cannot be resolved may end up in court. This possibility can be reduced by minimizing the period between exchange and settlement.

This can also be avoided if the purchaser conducts a pre-purchase evaluation, also known as a due diligence possibly with the assistance of professionals such as accountants. While this may delay the purchase and sale, it could avoid later delays, costs and potential litigation. See Due diligence.

The problem may also be avoided by having simultaneous exchange and settlement. See Simultaneous exchange and settlement.

Expert determination

It is a good idea to include provisions in contracts to refer to specified types of disputes for determination by an independent person with expertise in that field. This often involves submitting documents to the expert, who makes a decision without any meetings or hearings. This provides a relatively quick, inexpensive resolution of such disputes. However, while such clauses in a contract may be expressed to be “final and binding”, the decision may be challenged in the courts if the decision has not been made in accordance with the terms of the contract.

Conferences

Clauses in some precedent documents require the parties to follow a procedure, including meetings of executives, prior to taking any other step to resolve a dispute. If a party will not attend a meeting without contractual compulsion, the meeting is probably doomed to failure. Accordingly, such provisions are usually a waste of time and money except as a guide to parties to adopt sound process.

This is a process in which the parties to a dispute, with the assistance of an impartial third party, the mediator, identify the issues in disputes, develop and consider some alternatives and strive to reach agreement. For a mediation to be successful, the parties to it must genuinely wish to resolve the dispute as the mediator has no advisory or determinative role but will facilitate the mediation process. If there is this genuine intent from both parties a settlement will usually emerge. The outcome of this settlement is usually documented and an agreement signed. If the parties are unable to reach agreement they may look at other forms of resolution, but these will often have a binding outcome like an arbitration or a court determination.

In an arbitration, the parties to the dispute present arguments and evidence to the arbitrator. This is a more formal process than a mediation. At its core is the confidential, private judicial determination of a dispute by an independent third party. The arbitrator’s decision is final.

Litigation is often seen as a last resort when there is a dispute and as the more adversarial option. Depending on the extent and amount being claimed, it can be a relatively slow and expensive alternative to dispute resolution. The litigants are subject to the formal court procedures and rules of evidence and the proceedings take place in public.

One of the greatest benefits of arbitration over litigation is speed. It may take a significant period for the dispute to get into court, but the process may be fast -tracked when the parties decide to go to arbitration. Other benefits may include the following:

• •parties can choose the arbitrator or agree who can choose the arbitrator if they are cannot agree;
• •the process is not bound by formal court procedures and parties can agree on the procedures to be adopted;
• •the process is confidential and private; and
• •arbitrators are not bound by the rules of evidence but the rules of natural justice.

However, it should be noted that in an arbitration the decision is final and rarely can there be an appeal from an arbitrator’s decision.

See Avoiding and resolving disputes.

If the parties cannot agree as to who should act as mediator or arbitrator, there are several organizations which provide this service including:

• •Australian Commercial Dispute Centre;
• •Resolution Institute (merger between IAMA and LEADR); and
• •Law Societies of a state.

See Mediation and arbitration.

This Guidance Note provides an overview of Australia’s foreign investment regime, which is primarily governed by the Foreign Acquisitions and Takeovers Act 1975 (Cth) (FATA) and the Foreign Acquisitions and Takeovers Regulation 2015 (Cth) (FATR).

See General introduction to Australia’s foreign investment approval regime.

This Guidance Note provides an overview of the role of the Foreign Investment Review Board (FIRB) in Australia’s foreign investment regime.

See The role of the Foreign Investment Review Board.

This Guidance Note provides an overview of the powers of the Treasurer in relation to foreign investment proposals that have been notified to the Foreign Investment Review Board (FIRB), and foreign investments which were undertaken without providing notice to FIRB.

See Decision making — an overview of the Treasurer’s powers.