Why Your Asset Purchase Agreement Should Be Well-Drafted – Part II
This is the second blog addressing the decision of the Ontario Superior Court of Justice in Jonathan’s – Aluminum & Steel Supply Inc. v. Retail Alloy Metal & Plastic Plus Ltd. (Oct. 20, 2015), 259 A.C.W.S. (3d) 471, a case that highlights the importance of a well-drafted asset purchase agreement.
Jonathan’s – Aluminum & Steel Supply Inc. (the “Seller”) entered into a one-page asset purchase agreement with an individual (“Mrs. T”), who signed the agreement in trust for a corporation to be incorporated, pursuant to which the Seller agreed to sell its chattels and inventory (the “Purchase Agreement”). Promptly after signing the Purchase Agreement, Mrs. T incorporated a new corporation (the “Purchaser”).
While the Purchaser paid for the chattels on closing, it refused to pay for the inventory as it disputed the assessment of the purchase price with respect to the inventory. The Seller claimed that the purchase price for the inventory was fair and reasonable and that Mrs. T, in addition to the Purchaser, was personally liable for the unpaid amount. The Purchaser argued that any amount owing to the Seller for the inventory should be set-off against its loss of business and income caused by the Seller’s breach of a non-competition agreement, which was entered into by the parties two months after the execution of the Purchase Agreement.
The Court identified the following key issues in the case: (1) the assets being purchased; (2) the reasonableness of the inventory count and the inventory price; (3) the personal liability of Mrs. T; and (4) the enforceability of the non-competition agreement. In this blog, I will address the last two issues. For a discussion of the first two issues, please click here.
The Court stipulated that all that is required in deciding whether a corporation has adopted a pre-incorporation agreement is a simple notification of intent.The Court found that the new corporation adopted the Purchase Agreement, and that it had been the intention of the parties that Mrs. T would only be bound by the Purchase Agreement until the new corporation came into existence. In reaching its decision that she was not personally liable, the Court relied on the following factors:
(a) the Purchase Agreement indicated that Mrs. T signed it in trust for a corporation to be incorporated;
(b) the new corporation was incorporated within 8 days of the Purchase Agreement being executed;
(c) the Seller was immediately notified of the incorporation; and
(d) the addressee on the invoice for the inventory generated by the Seller was the newly-incorporated corporation.
The Purchase Agreement itself did not contain a non-competition clause. The Seller’s principal did, however, sign a separate non-competition agreement months after the Purchase Agreement was executed. The Court found that the non-competition agreement was signed by the Seller’s principal under economic duress, for fear of not getting paid for the inventory. Given that the Seller’s principal signed this agreement while voicing his protest, the Court determined that the requirement to promptly disavow one’s promise not to compete was not applicable. The Court added that launching a legal action eight months after the signing of the non-competition agreement met the requirement to disavow the promise as soon as possible if said requirement were applicable. It was held that the non-competition agreement was not an amendment to the Purchase Agreement and that there was no fresh consideration for entering into the non-competition agreement. As such, the Seller’s principal was not bound by that agreement.
If you are an individual purchasing assets in trust for a corporation that has yet to be incorporated, consider doing the following in order to minimize your personal liability: (i) ensure that the asset purchase agreement states that you are signing the agreement “in trust for a corporation to be incorporated”; (ii) arrange for a corporation to be incorporated as soon as possible after the asset purchase agreement is signed; and (iii) as soon as possible after the incorporation of the new company, notify the seller in writing about the incorporation and the new corporation’s intention to assume the asset purchase agreement.
If a non-competition covenant is to be included as part of the transaction, you may want to include a non-compete clause in the asset purchase agreement itself. If a stand-alone non-competition agreement is to be signed, ensure that it provides for adequate consideration, is signed contemporaneously with the purchase agreement, and is not signed under circumstances that can be interpreted as economic duress.
It is recommended that you hire a lawyer to draft or review the asset purchase agreement to avoid misunderstandings and costly litigation in the future. We would be happy to assist you in drafting or reviewing your purchase agreement.