Why Your Asset Purchase Agreement Should Be Well-Drafted
I am often reminded of the importance of having a well-drafted asset purchase agreement. A few years ago, 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, highlighted why it is so crucial to invest in preparing a proper asset purchase agreement.
In the above-mentioned case, 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 first two issues.
The Purchaser argued that it purchased the entire business of the Seller (other than its name) and that the purchase included the customer list, phone number, goodwill of the Seller, as well as training by the Seller. The Court held that the Purchase Agreement clearly provided that the purchase was for chattels (being certain specified equipment) and inventory. Although the Purchaser’s principal assumed that the above-listed additional items were also being sold, the Court found that the Seller did not address these items in the Purchase Agreement, had not agreed to their sale and, as such, was not bound to sell them.
Inventory Count and Inventory Price
The Purchase Agreement stated that the inventory would be physically counted on the closing date and that the inventory would be sold “at invoice price”. Unfortunately, the Seller and the Purchaser disagreed on the appropriate invoice price. The Purchase Agreement did not provide for a particular formula to be utilized in calculating the purchase price for the inventory. In assigning a price to the inventory, the Seller’s principal relied on the current market value, prior prices taken from his purchase book, and on his experience in the industry. The Court held that this formula was fair and reasonable.
This case provides some important guidance in the event that you are considering entering into an asset purchase agreement. The asset purchase agreement should specify exactly which assets are being sold and set out a clear formula for determining the price of inventory.
Put everything that was agreed upon between the parties into writing. How you understand the transaction and how the other party understands it may not, in fact, be the same.
It is recommend 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.