The global COVID outbreak is unprecedented. The long-term impact on the economy is unknown and unpredictable. Buyers under contract may be wondering if they should, from a business standpoint, proceed with the transaction. They may also be wondering if they are legally required to proceed, and if they nonetheless opt not to, what the consequences would be.
Many business purchase contracts have a clause allowing the buyer to terminate the agreement if there is a material change in the value of the business after signing the contract. (In reviewing a number of contracts in my files from recent transactions, it appears these are used in attorney written purchase contracts but absent in many broker form contracts.) There seems little doubt that this pandemic has caused a material change on most businesses and their annual revenues. Unless there is a non-refundable deposit, most contracts will permit the return of the full deposit in this circumstance.
If there is no contingency for material changes, the buyer can also review the other contingency clauses in the contract. There may be one or more that cannot be satisfied for one reason or another given the quarantine chaos and virtual shut down of much of the country. Unless there is a non-refundable deposit, most contracts will permit the return of the full deposit where an express contingency to proceed to closing is not removed.
The pandemic would probably qualify as a force majeure and allow a party to terminate the contract without losing their deposit (unless it was nonrefundable). Unfortunately, unless the seller agrees that the pandemic is a force majeure event, this could end up in litigation. If there is a dispute, this is an ideal case for mediation or arbitration to find an equitable resolution.
The buyer can always elect not to proceed and forfeit the deposit. However, given the unusual circumstances, the parties may mutually agree to split the deposit. Thus, they both are sharing the risk and losses created by the pandemic. This might be particularly appropriate if there is a disagreement or when the seller has expended substantial sums toward closing. Recovering some of the deposit toward those losses may be equitable.
There are mitigating steps the parties might take to keep the transaction moving forward such as negotiating rent forbearance or reduction agreements during the shut-down. The seller may also apply for the PPP program, a loan that is forgiven as long as the employees are employed for 8 weeks post-loan funding.
If you are not certain you want to terminate the agreement and want a “wait and see approach,” you may ask for a contract extension until after the shut-down ends. This can give a buyer time to assess the situation and post-pandemic impact on the business value, revenue forecasts and local economy. Another option might be renegotiating the purchase price to account for the new risk and potential change in business valuation. An earn-out agreement may be a way to share the risk between buyer and seller and keep the business sale on track. There are other modifications of the transaction structure that can be used in this situation. For example, there may be a benefit to a stock transfer agreement where the buyer an benefit from the federal stimulus program and the SBA loans available for small businesses. The interest rates are 3-4% and can be a source of operating capital for the business for the new owner of an existing entity. While there are risks in a stock transfer, this unique situation can outweigh the risks if there are contractual indemnities or seller financing with a right of offset for any expense attributable to seller.
While there may be a right to terminate a contract, there may also be opportunities for the parties to adjust the contract to address the unanticipated pandemic situation. There may also be unanticipated opportunities created by the situation. At the time of closing, the buyer may be getting a business with a stronger infrastructure and improved procedures in place. For example, a restaurant or liquor store may have adapted and created a significant take-out or delivery program and increased the customer base as a result of the shut-down. These assets will benefit the buyer in the long run.
If you are considering buying a business, and especially if you need to renegotiating the deal, please contact Tracy Jong right away to set up a consultation and allow us to analyze the potential advantages and disadvantages of doing so in your unique situation. If this is a good option for you, we can assist in drafting an effective contract amendment that protects your interests in the purchase of a business so you face a more certain outcome.