When you sell your business the buyer and their advisers may well insist that it is a condition of the contract that completion accounts are prepared.  That way they get to do a (post completion) check on the net asset value. The Court of Appeal case of Shafi –v- Rutherford shows the danger inherent in these arrangements.

Background

The parties to this litigation had been 50/50 shareholders in a dental practice.  A parting of the ways was agreed and a price was struck: there was an upfront payment and then a further payment was to be paid, based on the net asset value in a set of completion accounts.

The agreement contained a usual provision: if the buyer and the seller could not agree on any matter this was to be referred to an independent accountant to act as an expert.  Here, though, a major problem arose after the referral.  The business had bought a lot of capital equipment using external finance.  The question arose whether the relevant agreements under which this funding was required were operating leases or financial leases.

If the agreements were finance leases then under the appropriate Accounting Standard for Small Entities all future rental payments (not just those up to completion) were to be included in the balance sheet.

The company’s accountant had not previously seen copies of the leases.  Having seen them he agreed with the expert.  The leases were finance leases.

So was the expert required to ignore the Accounting Standard and proper status of the leases? The High Court judge and the Court of Appeal thought not.  An unhappy result for the seller as she got a much reduced final payment (and a costs order against her).

Comment

The buyer and seller had attached to the Share Purchase Agreement a draft balance sheet prepared on the “incorrect basis” but which reflected how previous statutory accounts had been prepared.  The seller had a clear expectation of the sum she was to be paid.  Neither seller nor buyer seemed aware of the potential problems.

The moral of the story

The requirement for completion accounts can lead to unexpected risks for the seller.  A “horse trade” over the draft accounts will often be the best solution for the seller. If this is not possible then great care must be taken.  The seller needs his lawyer to work hand in hand with an accountant acting for the seller.  All the “what ifs” must be considered. This may lead to significant drafting changes as the Share Purchase Agreement is negotiated.