Tina: I own a small grocery store. I am in the process of selling my business and I have a buyer. However, a customer slipped and fell at my store and is now suing me for her injuries. What affect will this have on the sale of my business? Can I still proceed with the sale, or will it have to be postponed until after the lawsuit?
Ekaterina: Pending litigation is not necessarily a legal obstacle in this type of transaction.
If a business is organized as a legal entity (corporation, LLC or other), then it is separate from its owners and the business can be transferred in spite of pending litigation. In this instance, the owner is not the subject of the litigation, the company is. An easy way to understand this is to think about a company that is publicly traded (i.e. Apple, Microsoft or IBM). Each person that owns stock in that company is an owner of the company. Each owner can then sell their stock regardless of what litigation is pending.
This does not mean that it will not affect the transaction. A savvy buyer will ask about any pending litigation at the “due process” phase of the acquisition. The seller has a legal obligation to disclose, and not doing so can cause further litigation. The most common way it affects an acquisition is in reducing the value of the business. It will be viewed as an extra risk and potential expense that will impact the ROI (Return of Investment). Or the potential buyer may request to structure a transaction in a way that the seller remains responsible for all legal claims that emerged before the interest in the company was transferred to a new person. To avoid speculation one should try to settle the claim, if at all possible.
Tina: As a business owner preparing to sell my business, what precautions can I take to avoid being sued by the buyer?
Ekaterina: The most common cause in such transactions is breach of contract. This can be caused by two factors: misunderstanding the terms of the contract or failure to disclose. Let’s start with the latter. Failure to disclose can cause a contract to be declared null and void, plus it exposes the seller to being liable for damages. After signing a Non-Disclosure Agreement (NDA) with an interested buyer, the seller should open up the financial books, disclose all contractual obligations that the company is subject to and report any pending litigation or incidents that may cause litigation in the future. Misunderstanding the terms of the contract can also cause legal issues. These types of the contracts are very complex and most of the terms come from centuries of litigation. A simple word can change the meaning of a whole paragraph. The best way to prepare for this is to consult with a business attorney before signing a contract.
The role of the Attorney is to assure that the client makes an informed decision and to look out for the client’s best interest.
Tina: In your experience, what are the most common reasons buyers do not go through with the sale of a business?
Ekaterina: The most common reason for buyers to back out of a deal is bad bookkeeping. As an attorney, I am performing due diligence by when finding that a certain financial statement is not reliable, I advise my client that there is higher risk in the acquisition than anticipated. The transaction can still go through, but we would have to rely on external resources to assess the value of the business and the risks involved for the future owner.
Tina: What advice do you give to entrepreneurs who want to use standardized legal forms or contracts to save on attorney’s fees?
Ekaterina: Standardized legal forms can be used for the simplest transactions, and when the parties know exactly what they need. The forms are standardized and pretty cheap for a reason. They do not contemplate various specifics of the transaction, the desire of the parties, their personal circumstances and many other factors which may be significant for a deal. In most cases, a legal form will not be sufficient to replace the protection that comes from consulting with an attorney.
Furthermore, the savings that a party might get from using the form can end up costing more in case of litigation than the original Attorney Fees. If the parties decide to use the standardized forms nevertheless, the most reliable forms are the ones that are provided by the Bar Association of the State. For example, in Florida the Bar Association created a standard leasing agreement for real property. However, even if a person is using the form obtained from a good source, he/she should make sure he/she understands all of the terms precisely.
Tina: I am selling my business, at what point do you recommend hiring an attorney and what role do they play in the process?
Ekaterina: The first thing that my clients go through when they are buying or selling a business is disclosure. I highly suggest to all my clients to sign a Non-Disclosure Agreement (NDA) before providing any information for the protection of both parties. As a buyer, you do not want the seller to disclose the details of your negotiations to avoid any interference in the transaction. As a seller you do not want the information that is being disclosed to be transferred to the third parties in case the transaction does not go through. I would recommend consulting with an attorney as soon as a decision to put a business for sale is made or a proposal to purchase has been made since there may be necessary precautions to be implemented before the negotiations between the parties progress.
I would recommend consulting with an attorney as soon as a decision to put a business for sale is made or a proposal to purchase has been made since there may be necessary precautions to be implemented before the negotiations between the parties progress.
Tina: I am purchasing a business and I want to make the seller sign a non-compete agreement. I do not want the seller to open up a similar business in the same state for at least 10 years. Legally, can I do this?
Ekaterina: The short version of this answer is, yes, you can legally do this. With that said, the courts will not sustain a Non-Compete Agreement (NCA) if it is unreasonably overbroad in the geographical or durational term. What kinds of restrictions are considered to be reasonable depends on many factors like industry, time, market, price paid and many others. If competition is a concern, then it would be best to discuss with an attorney the best approach to protect the investment of the buyer.
Tina: I am selling my business and I already hired a CPA and a Business Broker. Do I still need to hire an attorney? How can an attorney, CPA and business broker work together as a team to ensure a successful transaction?
Ekaterina: Each one of these professionals have a different role and purpose when it comes to this type of transaction. While the Broker will focus his energy and skills on providing a ready, willing and able buyer, the CPA will make sure that the financials are properly organized and disclosed. The role of the attorney cannot be easily replaced as his/her concern is reducing the liability and exposure of the parties in the transaction and making sure that the seller (client) is well informed of the implications of the transaction. The role of the Attorney is to assure that the client makes an informed decision and to look out for the client’s best interest. This will be done using the information received from both the CPA and the Business Broker.
It is important to note that a contract may alter the way that a law applies to a specific situation.
Tina: What disclosure obligations do I have to a buyer when selling my business? Am I legally required to tell him all the bad things about my business?
Ekaterina: Yes, full disclosure is essential for a valid transaction. The seller must provide organizational documents to the company, any agreements that are in place and that may affect the business or the freedom of operations by a new owner, a list of assets with valuation, financial statements, tax documents, a list of interested parties, legal complaints, court procedures and liens if any, inventory, and other significant factors relevant to a particular business. Failure to disclose may be deemed as misleading or fraud, which may result in protracted and expensive litigation.
Tina: What is the bulk sales law and, as a seller, do I need to comply with these laws?
Ekaterina: The Uniform Commercial Code (UCC) is a group of laws that regulate different aspects of commercial transactions. This code has been adopted by almost every state but with some variations. UCC2 has been adopted by the State of New York and it regulates the sale of goods (tangible movable property) among parties (merchant-merchant, merchant-non merchant). UCC6 deals specifically with bulk sales, when it is defined as “a sale not in the ordinary course of the seller's business of more than half the seller's inventory” but this article has not been adopted by the State of New York.
It is important to note that a contract may alter the way that a law applies to a specific situation. For instance, a law may dictate: “the seller must pay at time of the delivery of goods, unless otherwise agreed upon.” The purpose of this type of regulation is to provide guidance when there is absence of direction coming from the contract. The best way to find out what rules and regulations apply to a specific transaction is to consult with an attorney.
Tina: Do you have any other tips or advice for anyone buying, selling or appraising a business?
Ekaterina: First, determine exactly what you want to buy or to sell – a business as an ongoing operation, just particular part of the business, but not the rest, or assets of the business such as inventory, intellectual property and other, but not the company itself. Based on that determination, discuss with an attorney what would be the most efficient way for you to structure the transaction (for example, to do a merger and acquisition, a reverse merger, asset acquisition or something else).
Second, do your market research and obtain an evaluation of the business. If you are a buyer, do your comprehensive due diligence on the business at stake. Third, know exactly what you are buying or selling – define all assets of the business, negotiate which rights and liabilities transfer to the buyer and which ones remain with the seller, the scope of each party’s responsibility in possible future events and other details of the transaction.
Your business attorney should be a part of your negotiating team and you should not agree to something without first privately consulting with your attorney. Preliminary agreements may be enforced in the same way as the final ones. An experienced attorney may identify some issues or concerns, which parties to the transaction may not initially anticipate, will advise you on the consequences of various offers, propose the best possible solutions and practical tips for structuring the transaction and accomplishing your goals and otherwise it will guide you through the whole process making sure that your rights and interests are well-represented and protected.