“Sign and Close” Sale Transactions – Understanding Completion Risk

Most sale of business transactions are now structured on a “sign and close” basis. This practice has some consequences that business owners who are involved in the purchase or sale of a business should understand.

A sign and close deal is one where the comprehensive Agreement of Purchase and Sale is not signed until the closing, which means that if there is no closing, there is no binding agreement between the buyer and the seller. This is to be contrasted with a deal where the comprehensive P & S Agreement is signed on one day and the closing occurs some time later.

Typically, the major terms of a transaction are set out and agreed to in a letter of intent that is for the most part, non-binding. After due diligence is completed, and the buyer confirms that financing is in place, the parties negotiate an Agreement of Purchase and Sale.

In years past, P & S Agreements were most often structured much like a real estate transaction with a delayed closing. An agreement is drafted and signed that sets out a formal closing date sometime in the future at which time shares, or business assets, are transferred and the purchase price is paid provided that the conditions specified in the agreement are satisfied or waived. Often the satisfaction of the conditions and the completion of the closing documents involve much effort, so sellers usually insisted on a deposit being paid which helps to confirm that the buyer is serious about completing the transaction. The deposit also helps offset the seller’s wasted expenses if the buyer does not close for good reason and simply changes his mind.

Sometime ago, this structure changed for most business sale transactions. In most transactions today, the P & S Agreement is signed on closing. Since, for the most part, the letter of intent is non-binding, the buyer and seller do not have a legal obligation to close. There is no certainty that the deal will close, or the final terms of the deal, until the closing has occurred – it isn’t over until it’s over!

This practice probably became prominent because public companies do not want to have to announce acquisition or sale transactions until they have complete certainty that the deal will close. Also, in some cases, provisions in Canada’s Income Tax Act may cause the signing of an agreement to trigger tax consequences such as a loss of Canadian-controlled private corporation status and a deemed year end.

Sign and close structures create risks for buyers and sellers.

Once a letter of intent is signed, the buyer doesn’t want the seller to sell the business to someone else, and the seller, once it has accepted the buyer’s offer, doesn’t want the buyer to walk from the deal.

Sometimes it takes substantial time to satisfy conditions such as governmental approvals or contractual consents. If the parties do not enter into a binding P&S Agreement until the closing, then they are both at risk of the other side walking from the deal during the period from signing the letter of intent and the closing.

Since the letter of intent is non-binding, where a sign and close is contemplated, neither side has any recourse if the other side decides not to close, even if it so decides for no good reason.

The seller also faces other risks of meeting the buyer’s requirements in order to close. The buyer’s due diligence activities are difficult to keep confidential and may result in third parties finding out that the seller’s business is in play. This can negatively impact the seller’s relationship with customers, suppliers and employees. If the buyer requires access to the seller’s key customers and employees as a condition to closing, this issue is even more acute. The seller will want to be very satisfied that the closing will occur before he allows this to happen. Signing a binding P & S Agreement before putting itself in such a risky position may be the smart thing for a buyer to insist upon.

If the buyer or seller decides not to proceed just before closing, the other party is left with wasted legal and accounting fees which may be substantial.

For these reasons, buyers and sellers have to assess how likely the other side is to close the deal early in the process. Both are well advised to make sure that the letter of intent covers all terms which might be deal breakers. Finally, in some cases, it may make sense to insist that your deal not be structured as a sign and close deal, but rather on a delayed closing basis.

Most business owners will sell his or her business some day. You should seek tax and legal advice in advance in order to structure the sale in the most effective way from a business and tax perspective. We would be pleased to assist you in this respect.

Our Lawyers

Mihkel Holmberg Kate Watson Peter Math
mihkel@holmbergwatson.ca kate@holmbergwatson.ca peter@holmbergwatson.ca
416.648.8499 647.500.0844 416.274.4752

Need advice? If you need help understanding your responsibilities, contact Mihkel Holmberg or Kate Watson for expert legal advice concerning your business.

This newsletter is produced by the estate lawyers at Holmberg Watson Business & Estate Lawyers. The information in this newsletter is general information only and should not be considered exhaustive or treated by readers as legal advice and ought not be relied upon without further, detailed legal counsel being sought.

© Holmberg Watson Professional Corporation. All rights reserved. 2014

by on December 2, 2014