October 28, 2020
Given the unprecedented economic turmoil caused by COVID-19, there has been a substantial uptick in distressed asset transactions (i.e. the sale of something well below its traditional market value). We have been surprised by the number of these transactions that have lacked traditional due diligence and contingency planning. Seemingly, parties have been willing to ignore traditional risks and are increasingly motivated by fear or greed. However, distressed asset transactions typically have heightened risks associated with them, which justify additional planning from a legal perspective, not less.
Risks For Buyers
Although acquiring an existing company's equity seems relatively simple, the buyer may unknowingly be required to assume most, if not all, of the target company's liabilities. For example, a buyer may become responsible for the target company's tax obligations, commercial lease payments and/or employment related responsibilities, some of which may be significantly in arrears given the difficulties caused by COVID-19. Even with an asset acquisition (as opposed to an equity purchase), the seller may require as part of the overall business arrangement that the purchaser assume certain undesirable responsibilities and liabilities. In such situations, not all risk can be avoided. Therefore, it is imperative that the buyer conduct due diligence on the target company before purchasing it. A buyer's due diligence review often requires working with third parties, such as lawyers or accountants, to assist in obtaining and reviewing critical information and documentation, such as the target company's financial statements or a list of its creditors.
Once a due diligence analysis has been completed, it is often helpful to have an attorney craft customized covenants, representations, warranties and other provisions for the purchase contract that memorialize the exact terms of the target company's acquisition. Using an online template or preparing an agreement from scratch without professional legal guidance typically results in a failure to properly address even the known risks uncovered by due diligence, so saving money today in legal and/or accounting fees often results in greater long-term costs and headaches for the buyer.
Risks For Sellers
Unfortunately, many sellers focus nearly exclusively on the purchase price received at closing, which does not take into consideration the entire picture of avoiding future liability. For example, I recently spoke with a business owner that sold her restaurant, but failed to negotiate her release from the corresponding commercial lease's personal guaranty. Therefore, if the purchaser defaults on the lease in the future, then the landlord can and likely would seek monetary damages from the former restaurant owner, which could potentially even exceed the entire purchaser price of the restaurant.
Given the desperate nature of some business owners, we have also seen a significant uptick in seller financing (i.e., the buyer "borrowers" a significant portion of the purchase price from the seller by agreeing to pay the seller in the future). Although such arrangements are often reasonable, a cost sensitive seller may waive traditional steps associated with this process, such as preparing a promissory note to memorialize the debt obligation or potentially receiving some sort of collateral (e.g., a deed of trust on the buyer's residence, a pledge of the underlying business' assets, etc.).
Without seeking adequate legal advice, a seller may find his or her debt to be uncollectable in the future.
Restructuring Commercial Leases
Regardless of whether you currently own a business or plan to acquire one in the near future, the economic challenges resulting from COVID-19 currently present a unique opportunity to attempt to restructure a business' commercial lease agreement. For example, many landlords are now granting extended rent abatement periods at the lease commencement or giving a few months of free rent in the middle of an existing lease. Even in situations where complete rent abatement is not possible, many landlords are granting partial rent abatement or rent deferment. As a business owner, failing to take advantage of the tenant friendly renters market essentially amounts to leaving money on the table.
If you are considering buying or selling a business or have an existing commercial lease agreement, please contact us to schedule a consultation, in order to ensure that your legal and financial interests are protected.
