Key Laws Related to the Sale of a Business: What Owners Need to Know

Business Sale Agreements 101

One of the key components to selling a business is a clear and thorough business sale agreement. Such an agreement is critical for the protection of both the buyer and the seller. Regardless of the size of the business, a solid agreement is essential in laying out key terms such as purchase price, terms of payment, contingencies, limitations and warranties. An agreement provides protection against misunderstanding and dishonest representation of the facts about the company, its goods and services . A clearly written agreement helps both parties recall essential details during the course of the negotiations process and the subsequent transaction. Many issues need to be prioritized before drafting the agreement. As a final point, taxes related to the sale of a business can be complicated and should be carefully considered. Always consult with a business attorney for any important legal issues you may face.

How Contract Law Impacts Business Sales

Contract law governs business sale transactions in the same manner that it governs all other transactions. That is, contracts control the relationship between the parties to the contract, and the contract’s terms govern what the parties are required to do relative to issues covered by the contract’s language.
Certain contract provisions are present in every business sale to protect the parties and ensure compliance. In addition to selling price, which requires a written purchase agreement, other provisions typically address sales or installment payments of the purchase price; liabilities being assumed (if any); an allowance for lease payments; and guarantees.
Contracts also typically specify what happens when one party is in default. Will there be a grace period? An opportunity to cure the default? Will the default result in termination of the contract, and if so, will the buyer’s deposit be returned or the seller’s vehicle be repossessed? What remedies exist for the damaged party?
The agreement should also establish a time frame for performance. What are the start and stop dates for each party’s obligations? Will extensions be allowed?
In addition, the contract probably requires that the seller assign the lease. Are additional payments necessary to permit an assignment, such as rent escalations or transfer fees? It is helpful to have the concurrence of the lessor in advance of the closing.
Laws governing contract interpretation will often impact how the contract will be read and interpreted by a court. For example, statutes of frauds require that particular agreements be in writing to be enforceable. In Texas, for instance, an agreement for the sale of real estate must be in writing. Whether paper or electronic, a contract that is properly executed as required by the statute will be binding on both parties to the contract.
When a contract is violated or breached, the injured party has a few options. A breach may be declared a default. If a default exists, is it an incurable default? Can the injured party terminate the contract, or enforce it?
Without a mutually-agreed-upon dispute resolution clause or a statute requiring mediation, you are likely headed to the courthouse. When you find yourself in this position, Texas rules of civil procedure (and those of most states) will guide you on the deadlines for pleadings and responses.
You may also consider relief available through alternative dispute resolution. One example is mediation, in which a neutral third party meets with both you and the opposing party and attempts to reach an agreement. Alternatively, you may pursue arbitration, another form of dispute resolution in which a neutral third party hears the evidence from both sides to the dispute and makes a decision that is usually binding.
Your contract is your best ally in resolving a business ownership dispute. It will guide you through contract interpretation, enforcement and compliance, or it will guide you through the legal process.

The Implications of Employment Law When Selling a Business

One area of employment law that you absolutely cannot ignore when selling a business are the obligations you have to your employees. For most retail businesses, employee costs will represent the largest single expense item on the profit and loss statement. Although there are some exceptions, most buyers will expect the seller to retain its employees after close.
Although it’s tempting to try and get away with just sending your employees home, not only does this not represent best practice but also it likely goes against the contractual obligations you have with your employees and could mean exposing yourself to legal risks. Employees have a right to reasonable notice of termination in the absence of just cause. How much notice is reasonable will depend on a number of factors including the employee’s salary, length of service, age, position and the availability of similar employment. By selling a business, you are not reducing your obligation to provide reasonable notice in the absence of just cause. Even if the buyer is going to offer a new employment contract with a new terms to the employees, you may still be liable to pay out your prior obligations to the employee.
Additional liability can be created if you have an unfavourable contractual provision in your standard employment agreement. For instance, if the agreement has a termination clause that limits the liability of the employer to a maximum equal to the lesser of one week or the statutory minimum notice, but greater than a week, this clause may not be enforceable at law. This means what would have been a prescribed amount under the contract will now be an amount determined by the courts to be the appropriate amount of reasonable notice. These assessments of reasonable notice can be made by looking at the employee’s age, length of service, position and what other employment is available. This means that in certain situations, your diagnosed liability under the law could be significantly higher than anticipated. In these cases, it might also be worthwhile to ask the buyer to indemnify you for any such liability.
Most businesses have obligations to make payments to employees for vacation not taken by the time employment is terminated. Make sure you account for those amounts as well. If you have a business where you give your employees equity or opt in bonus plans, or you plan to sell your business subject to some form of earn-out, then you may want to consider the implications of the sale from a tax perspective. There can be additional tax savings associated with the sale of a business where the seller receives capital gains treatment on their sale. However, if the employees are going to receive any form of equity or bonus, then the nature of the payment may be re-characterized as employment income from capital gains. The tax rate for income may be significantly higher than the capital gains rate, in which case it is desirable to ensure the seller is compensated for the difference between the two rates. Tax advice should be obtained in all circumstances.

Tax Law and Business Sales

Enough can’t be said about the tax considerations in selling a business. Do you think your sale price is the only thing you have to worry about? What about the 20% Capital Gains Tax? Did you properly allocate the goodwill between your ‘C’ and ‘S’ Corporation? What about that self-employment tax? So on and so forth.
There are potential deductions you may have on the sale of a business. First, there is a deduction for the sale of certain principal residence. If this is your principal residence and you have occupied it for 2 out of the last 5 years, then you don’t have to treat any profit from the sale of your residence as taxable income. This doesn’t apply to the sale of real property your business used. Nevertheless, if you took title to the real property your business is using, then you may also have a deduction for the sale of this property. Of course, the home sale tax exemption does not apply to the sale of a rental house, vacation home or vacation timeshare unit. One major difference between the home sale tax exemption and rental property is that the capital gains tax is imposed on the sale of a rental and the depreciation recapture is ordinary income. That home sale tax exemption will not apply to this sale.
There could be hefty penalties for not having proper tax planning in business transactions. For example, if you sold a C Corp and received a 25% capital gain, then you have to pay tax on 23.8% of it. A regular C Corp will incur double taxation if it was taxed at 21%. A C Corp will not have "Flow through" taxation like an "S" corporation where the gain has already been taxed at the individual level. So if you sold a pass-through entity, then you only pay 23.8% on the gain. Those taxes are also generally lower than ordinary income tax rates because capital gains are either taxed at 15 or 20 percent. This, however, doesn’t mean not to be taxed at the ordinary income rate. For example, if you were a senior corporate executive and also sold stock options, then you have to pay capital gains at regular rate on your capital gains from the sale of an assets. For example, you are taxed at a 39.6% rate on your 50% capital gains. It is important to have a tax advisor before the sale of your business to take advantage of such deductions, otherwise you can end up paying a lot more in taxes.
You still need to have tax considerations even if your business was sold as an asset. You want to make sure that you receive proper allocations of the sale to minimize the taxes you will have to pay. You may be taxed at ordinary income rates on anything over $120k. Also, don’t forget that self-employment tax is also applied to those who have a high business income and a substantial amount of income from a pass-through entity.

Intellectual Property Laws

A sale of a business often includes the rights to valuable intellectual property assets such as trademarks, copyrights and patented inventions. Intellectual property laws are statutory rights granted on a country by country basis. The most valuable right for a U.S. business that wants to expand internationally may be trademark rights. The U.S. protects trademarks through state level registrations and federal registrations with the U.S. Patent & Trademark Office. But many, many foreign countries require registration with that particular country’s government for a trademark to be protected. If your business has registered with the U.S. Patent & Trademark Office, it can file on the form for a federal trademark registration with the U.S. Patent & Trademark Office a request for an "International Registration." The form is called an "Madrid Application." This is a relatively inexpensive way to extend protection to trademarks in other countries. However, you must designate the countries in which you want protection.
The records of Intellectual Property registrations by U.S. government agencies and those of many foreign countries can be inspected on the internet. Businesses wanting to acquire your business almost always would search the records of the U.S . Patent & Trademark Office to see if you have registrations, and they would also search the records of the Intellectual Property Office in their country or countries, looking for any registrations you might have in those countries. Likewise, you should search those countries from which the business you are acquiring has filed International Registrations.
A good idea is to take stock of the trademarks, copyrights and patents of your business before putting it on the market. You may have additional trademark rights even if you don’t have a registration. For example, you may have extensively used your trademarks in commerce so as to have "common law" trademark rights. You may have other intellectual property rights such as nondisclosure rights and nondisparagement agreements with employees. If you have employment contracts that require assigning inventions that were conceived during employment, those can also be valuable assets which should be assigned properly or acknowledged by the new owners. Having a good inventory can make your business more valuable.
For example, if you have filed a number of International Registrations for trademarks, those are assets of your business. It will be important that the new owner’s lawyer know which country’s offices you are designating for each mark, or whether you are designating the entire world. A number of expensive filing fees can accrue if the new owner designates too many countries for each application.

Antitrust Laws Regarding Business Sales

Antitrust laws are a set of regulations aimed at maintaining fair competition within a market. These laws prevent businesses from engaging in anti-competitive practices such as monopolistic behaviors, restraining trade, and other unfair methods of competition. These restrictions also extend to the sale of a business. Depending on the size and nature of a sale, antitrust laws might affect how it is conducted, if not outright prevent it from occurring at all.
Antitrust laws are enforced at the state and federal levels. The Federal Trade Commission enforces federal antitrust laws through investigations and fines. In general, the larger the business undergoing a sale, the greater the regulation it will be subject to, whether state or federal. In these situations, government approval might be necessary for the transaction to occur.
Companies with large market shares usually fall under the purview of antitrust law. The market share necessary to trigger antitrust restrictions varies from state to state and federally. For instance, in California, antitrust restrictions are triggered when two companies seek to merge and their combined market share will exceed 10 percent.
Antitrust law restrictions can take the form of criminal prosecution as well as fines and injunctions. A defendant found in violation of antitrust laws can face criminal prosecution and up to 10 years in prison. Antitrust law violations usually carry civil penalties of $350 million or up to three times the value of the benefit, whichever is higher. Civil penalties are capped at $100 million for individuals and $10 million for companies.

Business Sale Due Diligence: Legal Factors to Consider

The due diligence process is a vital mechanism for disclosing facts about the seller’s business, enabling the buyer to make an informed purchase decision. For this reason, an earnest buyer will want a provision in the purchase agreement that defines the period in which it will have access to the seller’s legal records. But what does the buyer get to see during due diligence?
A seller is obligated to turn over certain written and electronic materials in its possession. In addition, at times, a seller will also permit a buyer to inspect certain physical properties with respect to asset purchases. The objective of the review process is to confirm facts that can be gleaned from looking at the seller’s paper trail. Sellers are not obligated to voluntarily disclose materials that are protected by attorney-client privilege or the attorney work-product doctrine, so sellers may utilize a confidentiality and works-product privilege agreement in connection with the review process.
No two transactions are alike, so the scope of documents reviewed and any property inspections are tailored to the particular facts of the deal. However, in most transactions, a buyer will request reviewing the seller’s articles of incorporation, bylaws, organizational minutes, federal and state tax returns, customer and supplier contracts and correspondence , intellectual property documentation, real estate-related documentation, government and other licenses, litigation documents, financial statements and disclosures, employee contracts, work environment issues and insurance policies.
Relevant legal contract provisions are also closely examined. Not only might privileged contracts impact the time and manner in which a sale takes place, but also key contracts, such as supply and employment agreements, are especially important because they may be in effect on the closing date. In addition, the material contracts should not only be analyzed in terms of its current value to the seller but also in terms of whether they can be accessed after the sale is completed.
For a buyer, the due diligence process is a useful negotiating tool because upon learning specific details about legal aspects of the target, it then has the option of increasing the purchase price, reducing the purchase price or renegotiating the terms and obligations of the purchase agreement based on changed circumstances. Such due diligence findings may or may not affect the valuation of the target. As a practical matter, while information gained through the due diligence review is valuable to the purchasing company, the buyer’s ability to gain access to see the necessary records and conduct inspections is usually stipulated in the purchase agreement.