Managing historical liabilities in business sales and restructures

Sales and restructures of businesses have many moving parts, and during the negotiation and settlement process the parties commonly overlook management of historical liabilities. The parties may not be aware of facts leading to these liabilities until they come to light after settlement, which can have serious consequences for both parties and lead to drawn out disputes.

It is therefore integral that parties to a business restructure or transfer are cognisant of these liabilities and manage them effectively.

In this article, we examine five common types of historical liabilities, and summarise some ways in which both parties may seek to protect themselves.

Superannuation

Most employers are aware of their general obligation to pay superannuation to their employees. In addition, the business may engage contractors who could be entitled to superannuation payments under the Superannuation Guarantee Scheme. This is dependent on the nature of the relationship and contractor agreements, which should be reviewed thoroughly.

In the event of inadvertent underpayments, claims may arise against the Buyer who in turn seeks a remedy against the Seller.

It is common that the parties will include an indemnity in the Buyer’s favour for any underpayment of superannuation up to the Settlement Date, along with warranties that all superannuation has been paid correctly. The Buyer should also conduct a thorough due diligence with respect to prior payments.

Sellers can protect themselves from surprises after settlement by uncovering any potential underpayments via thorough due diligence during the preparation for the sale. They may also seek to limit the contractual warranties and indemnities to mitigate against the Buyer commencing actions for small claims which may be uncommercial to defend.

Employee entitlements

The general position is that employees who accept new employment with the Buyer from settlement will be the responsibility of the Buyer, and those who do not accept new employment will be the responsibility of the Seller. It is common to adjust employee entitlements in the Buyer’s favour at settlement.

Depending on the contract terms, the Buyer may elect not to recognise an employees’ prior service for the purpose of calculating certain service-related entitlements. Other service-related entitlements of transferring employees must be recognised by law.

In the event of underpayments, the Buyer is usually protected with warranties and indemnities relating to the period before settlement. The Buyer should always conduct a thorough due diligence, including to identify applicable industrial instruments, and seek appropriate adjustments and protective contract clauses.

The Seller should seek advice as to appropriate adjustments for transferring employee entitlements and with respect to managing non-transferring employees, as well as in relation to the proposed indemnities and warranties. If employee underpayments are identified in connection with the sale of business due diligence, it will be imperative to seek advice taking into account wage theft laws.

Tax

Unpaid tax liabilities are mostly a concern within a share sale context, where the Buyer purchases shares in the company along with existing liabilities. The Buyer should seek advice as to appropriate contractual warranties and indemnities to protect from any historical non-payment or underpayment, and retention mechanisms for paying known future tax liabilities.

Litigation and claims

Ongoing or pending litigation and claims affecting the business may not be discoverable before settlement, but can prove costly to defend.

The parties should carry out searches of court and tribunal records in order to ascertain any current litigation against the Seller and determine likely effects on the business. Liability for those claims should be addressed in the contract of sale. The Buyer will commonly insist upon the Seller giving a warranty that there is no pending litigation or claim against the Seller which would materially affect the business.

The Seller may wish to be better protected by limiting that indemnity or warranty – for example, excluding loss or damage caused or contributed to by the Buyer, or for small value claims.

Lease liabilities

Where the Seller occupies the premises under a lease, the parties may agree either to negotiate a new lease, or to assign the existing lease. Entering into a new lease can be negotiated directly with the landlord and may be a condition precedent to the purchase of the business.

Where an existing lease is assigned to the Buyer, there is usually considerable documentation including the transfer of lease and a deed of assignment or deed of consent to assignment to which the landlord is party . The aim is generally to limit the parties’ liabilities to the period under which they are in occupation of the premises – i.e. the Seller’s liability is limited to before settlement, and the Buyer’s liability is limited to matters after settlement.

A major source of uncertainty for Buyers is liabilities relating to the Seller’s breach of the lease prior to settlement. Existing breaches of the lease may be unknown at the time of the sale, and may have serious consequences if the Landlord requires the Buyer to rectify the breach. The Buyer can request a release from the landlord for all breaches of the leases before the date of assignment.

Equally, Sellers may be concerned about their liability for the Buyer’s breach after the Settlement of the business. The Seller remaining “on the hook” to the Landlord for breaches of the lease after settlement is a common commercial term of leases. This can be mitigated by inclusion of a contractual release in favour of the Seller on and from the date of assignment.

The parties should be aware of:

1. guarantees and arrangements for security under the lease;
2. warranties and indemnities in respect to breaches of the lease during the parties’ respective periods of occupation;
3. the state of the premises and likely existing breaches under the lease; and
4. the Buyer’s liability for the make good obligations under the lease.

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