1. Introduction
1.1. A sale transaction can expose sellers to significant legal and commercial risks both before and after implementation. A properly drafted sale agreement plays an important role in identifying and mitigating such risks.
1.2. This article briefly considers some of the key legal protections commonly used to protect sellers in South African sale transactions.
1.3. This article has been prepared on the basis that the Consumer Protection Act 68 of 2008 (“CPA”), does not apply to the transaction. To the extent that the CPA applies, different legal considerations may arise and certain protections discussed in this article may be limited or unavailable. Accordingly, specific legal advice should be obtained in relation to the application of the CPA to any particular transaction.
2. Valid Contract
2.1. Although it may seem obvious, the seller must first ensure that there is a valid and binding contract. If the agreement is invalid or unenforceable, the seller may not be able to rely on the protections contained in it.
2.2. In simple terms, a sale may be defined as a contract in which one party undertakes to deliver an asset to another, who in turn undertakes to pay a purchase price.
2.3. The following elements must be met to satisfy a valid sale:
2.3.1. the parties must be capable of entering into the agreement of sale;
2.3.2. the asset or subject matter being sold must be identified or capable of being identified;
2.3.3. the purchase price must be determined or capable of being determined in monetary terms;
2.3.4. there must be mutual consent between the parties to conclude the transaction.
2.4. A contract will generally become binding once the parties have agreed not only on the essential elements above, but also on all other material terms which either party regards as important to the agreement. For example, parties may agree on the purchase price for an asset, but if aspects such as the payment terms, security for payment, warranties or due diligence requirements remain outstanding, there may not yet be a binding agreement in place.
3. Suspensive Conditions and Resolutive Conditions
3.1. Sale agreements often contain conditions that must either be satisfied before the transaction can proceed or which may bring the transaction to an end if certain events occur.
3.2. A suspensive condition is a condition that must be fulfilled before the transaction becomes operative. Common examples include the purchaser obtaining funding approval, completing a satisfactory due diligence investigation or obtaining a required third-party consent.
3.3. A resolutive condition, on the other hand, is a condition which, if triggered, will result in the agreement terminating. For example, the parties may agree that the agreement becomes binding on signature, but will automatically terminate if a key licence is revoked before transfer or delivery of the asset.
3.4. From a seller’s perspective, these provisions are important because they allow key risks to be identified and addressed before the transaction proceeds and, where appropriate, provide a mechanism for the agreement to terminate if material events occur which the parties have agreed should affect the continuation of the transaction.
4. Purchase Price and Payment
4.1. One of the most important considerations for any seller is ensuring that the purchase price is paid in full and on time. Whilst the ideal position is often payment in cash against transfer of the asset, this is not always commercially possible.
4.2. Where payment of the purchase price is deferred, whether in whole or in part, the seller should ensure that adequate security is provided for the purchaser’s payment obligations.
4.3. Broadly speaking, security can be divided into two categories. Personal security involves a third party undertaking liability for the purchaser’s obligations, whilst real security involves a specific asset being made available as security for payment.
4.4. By way of example, a suretyship signed by a director constitutes personal security, whilst a mortgage bond over immovable property constitutes real security.
4.5. Real security is generally regarded as the stronger form of security because it gives the seller direct recourse against a specific asset. In insolvency proceedings, the holder of real security will often rank ahead of other creditors.
4.6. Where payment of the purchase price is deferred, sellers should, before concluding the transaction, carefully consider whether adequate security is available and whether it will provide meaningful protection if the purchaser defaults. This includes assessing the value of the security and whether it is sufficient to cover the purchaser’s payment obligations under the agreement.
4.7. Sellers should also carefully consider the tax implications of any deferred payment structure. Depending on the nature of the transaction, tax may become payable before the seller has received the full purchase price. This can create significant cash-flow challenges where the purchase price is payable by way of instalments over an extended period, leaving the seller with a tax liability before it has received sufficient funds to satisfy that liability. Appropriate tax advice should therefore be obtained before the transaction is concluded and the payment structure should, where possible, be designed to minimise this risk.
5. Delivery, Ownership, Risks and Benefits
5.1. Sale agreements should clearly regulate when delivery takes place and when ownership, risk and benefits pass from the seller to the purchaser. These concepts do not necessarily pass at the same time and can be regulated differently by agreement between the parties.
5.2. Written sale agreements often provide that ownership of, risk in and benefit to the asset will pass to the purchaser upon delivery of the asset once the sale has become perfected, namely once the sale is unconditional. However, parties are generally free to regulate these aspects differently in their agreement.
5.3. From a seller’s perspective, it is important to ensure that the provisions dealing with delivery, ownership, risk and benefits are aligned and do not produce unintended consequences. For example, a seller may agree that ownership and the benefits of an asset pass to the purchaser on delivery, whilst the risk of loss or damage remains with the seller for a further period. In such circumstances, the purchaser may enjoy the use and benefit of the asset whilst the seller remains exposed if the asset is damaged, destroyed or loses value.
5.4. Sellers should therefore carefully consider when delivery, ownership, risk and benefits pass to the purchaser and ensure that the allocation of risk remains commercially sensible in the context of the transaction.
6. Warranties and Representations
6.1. Warranties and representations are commonly used to allocate risk between the parties. Broadly speaking, a representation is a statement of fact made by one party to induce the other party to enter into the transaction, whilst a warranty is a contractual undertaking that a particular fact or state of affairs is true and which forms part of the agreement between the parties.
6.2. In most sale transactions, it is the purchaser who requires extensive warranties from the seller regarding the asset being acquired. Sellers, however, should also consider obtaining warranties from the purchaser, particularly regarding its legal capacity, financial ability to perform and authority to conclude the transaction.
6.3. One particularly important protection for sellers is a warranty that the purchaser has obtained all necessary approvals and that the person signing the agreement is duly authorised to bind the purchaser. A director, trustee or representative does not automatically have unlimited authority to conclude transactions on behalf of a company, trust or other entity.
6.4. An agreement concluded without the necessary authority may be void and unenforceable. Sellers should therefore carefully verify that the purchaser has obtained all required approvals before signing the transaction documents.
6.5. Sellers should ensure that the purchaser’s constitutional documents or trust deed permit the transaction, all necessary resolutions have been properly passed, and the relevant resolutions specifically authorise the conclusion of the transaction and related agreements.
7. Disclosures
7.1. Disclosure provisions allow a seller to disclose information relating to the asset which may qualify or limit a warranty or representation given by the seller. The agreement should expressly provide that matters properly disclosed to the purchaser before signature of the agreement will not give rise to a claim for breach of the relevant warranty or representation.
7.2. By way of example, a seller of a business may warrant that the company which houses the business is not involved in any litigation, but disclose that the company is involved in a pending labour dispute with a former employee. Provided that the dispute has been properly disclosed and the agreement regulates the consequences of such disclosure, the purchaser should generally not be entitled to pursue a warranty claim arising from that issue.
7.3. Disclosure provisions promote transparency between the parties and allow identified risks to be addressed before implementation of the transaction. Using the above example, the parties may agree to reduce the purchase price, retain a portion thereof pending resolution of the dispute, provide a specific indemnity, or exclude the disclosed matter from the relevant warranty.
7.4. The disclosure process should ideally be completed before the agreement is signed. In transactions involving a due diligence investigation, sellers should also seek to provide that information contained in the due diligence documents, including annual financial statements, management accounts and other information made available to the purchaser, constitutes disclosure for purposes of the warranties.
7.5. From a seller’s perspective, the agreement should expressly provide that any matter properly disclosed to the purchaser before signature, whether through a disclosure schedule or the due diligence process, will not entitle the purchaser to pursue a claim for breach of the relevant warranty or representation.
8. Indemnities
8.1. An indemnity is a contractual undertaking by one party to compensate or hold the other party harmless against specified losses, liabilities or claims. In sale transactions, sellers may require indemnities from purchasers to protect themselves against risks arising after implementation of the transaction.
8.2. For example, if the purchaser assumes control of a business after implementation and incurs liabilities, penalties or claims attributable to the purchaser’s conduct, but a third party seeks to hold the seller liable for those liabilities, the seller may require the purchaser to indemnify the seller against such losses.
8.3. From a seller’s perspective, indemnities are important because they allocate specified risks to the purchaser and provide the seller with protection against liabilities, losses or claims arising after control of the asset has passed to the purchaser.
9. Limitation of Liability
9.1. Limitation of liability provisions are among the most important seller protections in a sale agreement. Their purpose is to limit the extent to which a seller may be exposed to claims by the purchaser after implementation of the transaction.
9.2. These provisions commonly regulate matters such as the seller’s maximum liability, the period within which claims must be brought, minimum claim thresholds and the types of losses for which the seller may be liable.
9.3. By way of example, if a purchaser seeks to recover losses from the seller after implementation of the transaction, the agreement may provide that the seller’s total liability will not exceed a specified portion of the purchase price and that any claim must be brought within a defined period.
9.4. From a seller’s perspective, limitation of liability provisions create certainty and allow the seller to quantify and manage its potential post-sale exposure.
10. Third-Party Claims Procedure
10.1. Following implementation of a transaction, a third party may institute a claim against the purchaser. The purchaser may then allege that the circumstances giving rise to that claim constitute a breach of warranty by the seller and seek to recover its resulting losses from the seller.
10.2. Sellers should ensure that the agreement contains a properly regulated third-party claims procedure. A purchaser should not be entitled to concede, settle or inadequately defend a claim and thereafter seek to recover the resulting loss from the seller.
10.3. The agreement should therefore provide the seller with the right to be notified of the claim and, where appropriate, to participate in or assume the defence thereof before any liability is imposed on the seller.
11. Breach Provisions
11.1. Breach provisions regulate the parties’ rights and remedies if one of them fails to comply with its obligations under the agreement.
11.2. From a seller’s perspective, these provisions are particularly important where the purchaser fails to pay the purchase price, provide agreed security or otherwise perform its obligations under the transaction.
11.3. A properly drafted breach clause will typically regulate the notice to be given to the defaulting party, the period within which the breach must be remedied and the remedies available if the breach is not remedied.
11.4. These remedies may include specific performance and damages or cancellation of the agreement and damages.
12. Conclusion
12.1. Every sale transaction is unique and the protections required will depend on the particular circumstances of the deal. Sellers should therefore seek appropriate legal advice before concluding any sale transaction.
12.2. A properly drafted sale agreement can significantly reduce risk, minimise disputes and provide sellers with greater certainty both before and after implementation of the transaction.
12.3. At Lanham-Love Inc., we regularly advise clients on the structuring, negotiation and implementation of sale transactions. Should you require assistance in relation to a proposed sale transaction, we would be pleased to assist.
By: Darren Anderson
