This is the third in our series of short papers looking at the effects of the COVID-19 pandemic on different aspects of mergers and acquisitions.  In our last paper we looked at the impact of COVID-19 on share sale and purchase transactions.

In this paper, we consider how COVID-19 is affecting another (perhaps less common) type of M&A transaction; that is, asset and business sale agreements.  Asset sales are highly relevant at present:  a recent Deloitte study found that 58% of the 60 top-200 ASX-listed M&A heads were considering or preparing a divestiture.

What is an asset sale?

In an asset sale, an entity (the seller) transfers selected assets, for example plant and equipment, personal property, lease(s), brand names and trade marks, other intellectual property, to the buyer.

These assets do not usually include the entity’s cash, and the seller typically retains any financial debt e.g. bank loans.  Typically, the asset sale will include adjustments for normalized net working capital, which consists of items such as inventory, accounts receivable and accounts payable.

The buyer may acquire some liabilities of the seller, for example, liabilities under customer contracts.  However, unlike a share sale agreement, only those liabilities selected by the buyer are transferred.

What is a business sale?

A variant of an asset sale is a ‘business sale’ agreement, which typically involves the sale of all assets of the business, including goodwill, as well as most or all of its liabilities.

Some characteristics of an asset or business sale[1]

As above, a particular advantage of an asset sale is the buyer can determine what, if any, liabilities it will take on.  By contrast, in a share sale, the buyer purchases all the liabilities of the target entity, including the company’s tax position, any litigation or disputes and other items such as product liability claims.

Another characteristic of an asset sale is that the buyer can select which employees it wishes to take on.   Because the buyer only takes on staff to whom it makes an offer of employment, it is not obliged to take on any particular employee.  Similarly, a buyer can select which customer and supplier contracts it wants to take on.

For these reasons:

  • the buyer’s due diligence in an asset sale can require less time, effort and therefore money, when compared to a share sale;
  • asset sale documentation can be ‘covenant light’. While any properly documented business sale transaction will include at least some warranties and indemnities, generally these are more comprehensive in a share sale transaction.  This is because if, in due diligence, the buyer identifies a legal risk or other liability, the buyer will simply not acquire it.  Therefore, the asset sale agreement typically includes fewer contractual protections (e.g. warranties and indemnities) against these risks.
  • On the other hand, completion of asset or business sale transactions can involve more moving parts and complexity i.e. documentation. Generally, each class of asset has its own legal requirements for an effective transfer or assignment; these can vary quite widely depending on the asset type and can require filings with or approvals from government agencies and commercial counterparties.

Finally, reluctant minority shareholders do not ordinarily have any ability to prevent an asset sale.[2]

Potential effects of COVID-19 on the legal and business environment for asset and business sales[3]

The table below compares and contrasts some of the effects of the COVID-19 pandemic on shares sales, assets sales, and business sales.

Share Sale Asset Sale Business Sale Impact of COVID-19
Transaction Overview The seller sells some/all of its shares in the target company to the buyer. The seller sells some/all of its assets and liabilities in the target company to the buyer. The seller sells all of its business (including assets, goodwill, and most or all liabilities) to the buyer. See commentary above.
Transaction Documents The sale can be documented very simply, by signing a share transfer form.  (However, in practice, share sale and purchase transactions tend to contain extensive warranties and indemnities for identified risks.) The company then records the buyer as the new owner of shares and issues a share certificate to it. Each class of asset must be transferred.  In some cases there are particular formalities which must be followed to transfer some assets, e.g. intellectual property.

Also, transfer of creditors and other contractual obligations requires consent of the business’ creditors/other counterparties.

 Refer to Asset Sale. As above, while an asset or business sale agreement may be quicker to document, it may take longer to complete due to these formalities.

During the period of volatility induced by COVID-19, an asset sale may have some structural advantages to the buyer, when compared to a share sale.  For example:

·         many companies are suffering financial stress at present.  By limiting due diligence to specific targeted assets, buyers may save considerable time, effort and money, when compared to the many complex issues requiring careful due diligence in a share sale (discussed in our previous paper).

·         in a volatile market such as this one, differences of opinion on business valuation are almost inevitable.  An asset sale can be a way of achieving a sale without unanimous shareholder agreement.[4]

The flip side of the above is that the seller may not be able to achieve a ‘clean exit’ in an asset/business sale, unlike a share sale transaction.  The seller retains any liabilities which are not transferred to the buyer.
Customer Contracts These are automatically transferred in a share sale. [5] These can only be transferred with customers’ consent. Refer to asset sale The buyer does not require customer consent in a share sale, compared to in a business or asset sale.[6]

However, for both a share sale and an asset sale, the buyer needs to conduct careful due diligence on key contracts.  In either case, the buyer may require the seller to obtain the counterparty’s confirmation that no material adverse change or force majeure event has occurred e.g. as a result of COVID-19.

However, in the case of an asset sale, the buyer may simply choose not to purchase a particular contract if it appears to be problematic (e.g. because a force majeure event has occurred, triggering a right to terminate the contract).[7]
Supplier Contracts As per customer contracts.  In practice, supplier contracts are often easier to transfer, provided the buyer is creditworthy.
Employee Contracts Contracts remain in place with the target company and continue unaffected; all entitlements remain. Employment contracts must be terminated and benefits (e.g. salary) paid out on completion.

New contracts are then entered into between the employee and buyer, although it is often accepted that accrued leave entitlements will be assumed by the buyer, i.e. the employee is treated as having continuity of service.  In this case, the tax-adjusted value of these entitlements should be adjusted for in the sale price.

 More careful employment law due diligence is typically required for share sale transactions, because the buyer purchases all workplace liabilities and employee entitlements of the target company.

Some commentators predict COVID-19 will lead to a swathe of workplace claims (for example, in relation to prohibited workplace restructures) in the aftermath of the pandemic. For this purpose, an asset sale may be more attractive to a buyer, because the buyer has control over whether to accept specific types of employment liabilities.[8]

Some other employment issues to consider include:

1.       Upon completion in an asset sale, existing employment contracts are terminated, and new employment contracts issued by the buyer (if the buyer so chooses).  Employees’ eligibility for JobKeeper may be affected, and the buyer should check the employees’ eligibility, particularly for casual employees.[9]

2.       As above, a seller may not be able to achieve a clean exit if some employees do not wish to transfer their employment to the buyer of the seller’s business.  While this allows the buyer to downsize the business with minimal workplace risk, non-transferring employees remain the responsibility of the seller.
Intellectual Property Registration e.g. trade marks are transferred automatically. A formal transfer document needs to be executed and registered with a relevant government agency, e.g. IP Australia.
Regulatory approvals and completion In the current regulatory environment, regulatory approvals may take longer in both share and asset/business sale transactions.[10]  However the type and number of approvals will vary depending on how the transaction is structured.

As above, generally (all other things being equal) an asset or business/sale agreement can involve more complexity (paperwork) on completion, as typically each class of asset requires a specific form of transfer documentation.
 

Keypoint’s M&A team is presently advising clients on the effect of these issues in the current business and regulatory environment.  For more information, contact James Halliday.

[1] There are some significantly different tax outcomes between share and asset/business sale transactions.  We do not consider these tax issues in this paper.  Accounting and taxation advice should be obtained.

[2] Note: if the company is party to a shareholders agreement, this may restrict the company’s ability to dispose of material assets without certain shareholder approvals.  Listed companies are also subject to ASX listing rules, which limit their ability to dispose of the company’s main undertaking.

[3] Please refer to our earlier paper on share sale transactions for a comprehensive analysis of the effect of COVID-19 on M&A transactions generally.

[4] Please refer to note (2) above.

[5] Due diligence must include review for change of control clauses in key contracts.  Although it is literally true to say these contracts are transferred with the company in a share sale, some types of contracts commonly include a ‘change of control’ clause, e.g. in commercial lease agreements.   These clauses typically give the counterparty (e.g.  the landlord) the right to terminate the contract (e.g. the lease), if the seller (i.e. the lessee) changes ownership.

[6] See note above.

[7] Transfer of contracts can occur by way of a transfer of rights (assignment) or obligations (novation).  There are some important differences in outcome between these methods.  Also, the transfer documentation should always state whether and how the transfer affects existing contractual rights e.g. whether a present right to terminate is retained or lost.

[8] Note in some cases workplace conditions can be transferred to the buyer.  Refer to https://www.fairwork.gov.au/how-we-will-help/templates-and-guides/fact-sheets/rights-and-obligations/when-businesses-change-hands

[9] Refer to the Treasurer’s Coronavirus Economic Response Package (Payments and Benefits) Rules 2020.

[10] For example, the Treasurer has recently announced that all business sale transactions involving foreign persons that are otherwise notifiable now have a $0 notification threshold.

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This article is for general information purposes only and does not constitute legal or professional advice.  It should not be used as a substitute for legal advice relating to your particular circumstances.  Please also note that the law may have changed since the date of this article.