The Purchase and Sale Contract
- Mark K. Cullen

[Note: This is the fourth installment of a series focusing on some of the essential aspects of a sale transaction. The remaining installment in the next newsletter will cover Closing the Deal.] Nothing is ever known in a business transaction until a definitive Purchase and Sale Contract has been executed between the buyer and the seller governing the terms of the proposed transaction. In fact, even when a definitive contract has been executed, there are a myriad of details and pitfalls to be navigated by the parties to reach and complete the closing. The definitive contract is the mechanism by which the parties will be governed toward the final goal of closing, but there can still be no certainty that a final purchase and sale will be concluded. The definitive contract will be the product of the bargaining, and necessarily the compromise, between the buyer and the seller. In general, a contract will state what is being bought, by whom, for how much, and when. However, there are a number of provisions which are necessary, and this article will focus on some of the more significant provisions and give some idea of the extent of negotiation necessary to create a definitive agreement. The definitive contract must address the form of the transaction - an asset purchase, a stock purchase or a merger and reorganization. There may have been significant discussions between the buyer and the seller and this concept may even have been addressed in a letter of intent, but it must be covered by the definitive contract. This issue alone can have dramatic consequences to the parties and will largely dictate many of the ancillary provisions in the agreement. Of singular importance to most clients will be the payment terms for the purchase and sale. The contract will reflect the ultimate purchase price, including any formula necessary to derive the price, any adjustments to be made at closing, cash and non-cash components of the price, any seller financing, and the allocation of the price. Seller financing is not an uncommon part of any transaction and, as is expected for almost every element of a business transaction, there are benefits and detriments for both the seller and the buyer. Sellers often appreciate some recurring income after the closing, and sometimes get a higher price for the business by carrying back a portion of the purchase price. Buyers have the advantage of having to use less capital or borrow less from an outside lender and can create leverage against the seller if other issues arise after the closing. Sellers have some risk of never receiving the full purchase price from a defaulting buyer, and often buyers do not appreciate that the seller financing is still additional debt which must be paid by the business. A significant component of seller financing will be the extent to which the seller is given security for the remainder of the purchase price to be paid and the rights of the seller on a default (for example, whether the seller can “reacquire” the business). The purchase price allocation is another essential element of the asset purchase agreement, but it is also relevant in a stock purchase where the parties agree to elect for tax purposes to treat the transaction as an asset acquisition. The allocation will set out the portion of the purchase price for each asset purchased in a transaction. While it is not necessary to itemize each asset down to the desk, screw, pencil, and computer, the parties will want to reflect the allocation to basic categories of assets so that the necessary accounting can be completed for basis, capital gain, and depreciation on future tax returns and business financial statements. This is also important for sellers because there can be significant impact to a seller, such as the difference in tax rates applied to gain on the sale of land, building, equipment, inventory, and goodwill. Since the allocation represents the very essence of compromise between the seller and the buyer, it should be detailed in the agreement and not left to finish prior to closing. Specifying the assets to be purchased with detail is quite obvious in an asset purchase agreement, but it also can be relevant to a stock purchase agreement, since a large factor in the value of the business is the assets, and the buyer will want to preserve this value. In addition, in the case of either a stock or an asset purchase, the agreement will cover adjustments to be made in the event that the assets change (such as the level of inventory or amount of receivables) between the date of execution of the agreement and the date of closing. The agreement will also reflect the extent to which a buyer can conduct due diligence as a condition to the buyer’s obligation to close the transaction (and can also be relevant to the seller who receives stock as a portion of the purchase price). This topic was the subject of the third installment of this series and can be referenced through the firm’s website. Another item of significance to most agreements is the seller’s non-compete provision. It is typically integral to the value of the business to any prospective buyer that the seller will not continue to compete against the buyer after completion of the transaction. While in most cases a seller is willing to give up this right, any non-compete must be specific and reasonable as to term and geographic area, and it will benefit the parties to provide a specific allocation of the price to the value of the non-compete agreement. Also of significant value in many transactions is the seller’s agreement to help in the transition of the business to the buyer. This can be in the form of the seller being required to perform certain activities after the closing and sometimes becomes a consulting agreement for which a portion of the purchase price or additional compensation is paid to the seller. Employee matters must be given consideration in the definitive contract. If there are employment contracts or collective bargaining agreements, these can be both significant liabilities which are in effect assumed by the buyer as well as valuable assets necessary to the proper functioning of the business. It is also important to document the extent to which there are key personnel who need to be included in the transaction or otherwise assured to be part of the business after the closing. Finally, the contract will include a number of other provisions, including environmental matters, representations and warranties of each of the parties, covenants of the parties both before and after the closing, the specific mechanics of the closing, matters which constitute a default by the parties and indemnities, remedies, and damages for a default by one of the parties. The purchase and sale contract is often the most difficult part of the transaction because of the level of detail necessary to protect both the seller and the buyer, but a properly drafted agreement can also give more security and peace of mind so that both parties understand how the final transaction will be completed. For more information regarding this article, please contact the author or any Sorling attorney who practices business advising law by clicking: Mark K. Cullen www.sorlinglaw.com/practice-business.htm Click here to review the Sorling disclaimer: http://www.sorlinglaw.com/About-Disclaimers.htm

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