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M&A Seller Financing: Handling a Buyer Default

Introduction

In the world of business transactions, the best-laid plans can sometimes veer off course. Buyers, with all their good intentions, may find themselves in over their heads when it comes time to meet their financial commitments. Handling a buyer default can indeed be disheartening for a seller.

As a seller, your readiness for such situations can make all the difference. Being well-informed about your available options can help you steer clear of unnecessary conflicts should issues arise.

In the event of a buyer default, your available courses of action typically fall into two broad categories:

Mutual Agreement Options:

  • Contractual Solutions
  • Negotiation
  • Mediation
  • Dispute Resolution Options:
  • Arbitration
  • Small Claims Court
  • Litigation in Superior Courts

This article aims to address crucial questions, including:

  • Which option should you prioritize if faced with a buyer default?
  • Is it possible to reclaim the business, and if so, what steps are necessary to regain control?
  • When is the right time to enlist the services of an attorney?
  • What if you need to regain possession of the lease, especially if your name is no longer on it?
  • Are the procedures different for asset sales compared to stock sales?
  • How can you take proactive measures to prevent defaults from happening in the first place?

While we sincerely hope you never find yourself in a situation requiring you to tackle a buyer default, remember that readiness is your greatest asset. To begin your journey of preparedness, delve into the insights shared in the following article.

Mutual Agreement Options

In the face of a buyer default, your initial step should always be to engage in open communication and seek a mutual agreement with the buyer. Surprisingly, many buyer defaults can be swiftly and amicably resolved through constructive dialogue.

Prioritizing this approach is key. It not only provides a potential remedy but also emphasizes the importance of preserving a cooperative relationship with the buyer throughout the transaction. When a strong working relationship is nurtured, most buyers are inclined to cooperate even when issues arise, allowing for the swift and cost-effective resolution of challenges.

Option #1) Contractual Solutions

In the event of a dispute with your buyer, the first port of call should always be the contract itself. Contracts typically include a defined procedure for addressing conflicts, serving as a navigational tool for both parties when issues arise.

For instance, if the buyer defaults on rental payments for the business premises, the contract may grant the seller the authority to assume control of the business and manage rental payments. This contractual provision often comes into play when the lessor necessitates the seller’s guarantee for the continuous rental payments as a prerequisite for lease transfer to the buyer.

When both parties agree to abide by the contract’s terms, a simple reference to the contractual provisions is usually sufficient to steer the resolution process.

Option #2) Negotiation

In the event of a contractual dispute or if the disagreement extends beyond the contract’s provisions, the most advisable course of action is to seek an amicable resolution through negotiation.

This approach is particularly pertinent when the buyer holds physical control of the business. In our extensive experience, most buyers are inclined to cooperate, facilitating a peaceful resolution. This can entail relinquishing control of the business, devising alternative payment arrangements, or offering additional collateral.

It’s vital to remember that, regardless of the circumstances, the use of force to compel compliance is not an option. For example, forcefully entering premises under the buyer’s control, no matter how strong your conviction in your rights, is not permissible. Typically, the only legally recognized means to enforce compliance is through an order issued by a competent government authority. However, it’s worth noting that this process can be time-consuming.

Option #3) Mediation

Mediation, as a voluntary process, brings disputing parties together under the guidance of a neutral third party to seek resolution. These sessions are strictly confidential and not open to the public. While technically classified as a dispute-resolution option, we view mediation as a practical avenue for mutual agreement.

It’s important to note that a mediator does not serve as a judge but rather as a communication facilitator. They can provide suggestions, address questions, and clarify various perspectives presented during discussions. However, the ultimate decision to settle or explore alternative resolutions rests with the parties themselves, a key principle shared with other mutual agreement methods.

Typically, after gathering both parties to hear their respective viewpoints, the mediator holds private meetings with each side. They then shuttle back and forth with settlement offers in an attempt to reach a resolution.

In terms of costs and time, mediation institutions often charge filing fees ranging from $100 to $500. Additionally, the parties usually share the cost of the mediator’s time, which can vary from $100 to $300 per hour depending on the complexity of the dispute and the mediator’s expertise. Based on our experience, mediating a dispute involving a small to medium-sized business can incur costs between $5,000 and $20,000 and may take one to two months to complete. These estimates are subject to various influencing factors.

Dispute Resolution Options

Issues can surface when a buyer deviates from the contract or holds a conflicting interpretation of its terms. In such situations, it becomes essential to consider the following dispute resolution strategies.

Option #4) Arbitration

Arbitration entails appointing a private individual to serve as a judge for your dispute. The arbitrator reaches a decision on the case’s merits after conducting a hearing where both parties can present testimony and evidence. Following opening statements, testimony, and closing arguments, the arbitrator(s) renders a decision on the case’s merits.

Arbitration can be the chosen method of dispute resolution as outlined in the parties’ contract, or it can be agreed upon even without a prior stipulation.

This approach is particularly useful when parties seek a swift, cost-effective hearing compared to traditional litigation, leading to a decision on the case’s merits. Arbitration procedures are generally less formal and bureaucratic than court processes.

The arbitrator’s decision is binding on the parties only if they have agreed to this in advance, either within their contract or through their submission to the arbitration institution.

Costs and Time: Filing fees for arbitration institutions typically range from $100 to $500. Parties generally share the cost of the arbitrator’s time, which can vary between $100 and $400 per hour, contingent on the dispute’s complexity and the selected arbitrator. In our experience, arbitration expenses can range from $10,000 to $50,000 when resolving disputes involving small to medium-sized businesses. The arbitration process typically takes three to five months to conclude. However, these are approximate figures that can fluctuate based on factors like the arbitration location, the contentiousness of the dispute, the number of witnesses, and the claim’s size.

Arbitration generally presents higher initial costs compared to other forms of dispute resolution. Unlike court judges, who are publicly funded, arbitrators’ fees are the responsibility of the involved parties. The fees for arbitrators tend to increase with their experience and technical expertise.

In contrast, while litigation may seem more cost-effective upfront, the extended and intricate nature of most court proceedings often results in greater overall expenses than arbitration. Overburdened court schedules can lead to significant delays between hearing dates. Moreover, the substantial time invested by the parties in attending court hearings and navigating the complex phases of discovery, pre-trial activities, and the trial itself represents a concealed cost that is frequently overlooked.

Option #5) Small Claims Court

Small claims courts offer a streamlined approach to resolving legal disputes without the complexities and time investment of a full trial. These proceedings typically maintain an informal atmosphere, allowing litigants to directly present evidence and arguments to the judge. The judge then issues a verdict based on the case’s merits.

Each state sets an upper limit on the monetary claims allowed in small claims court, with the typical maximum around $10,000, although it varies by jurisdiction.

In many states, representation by lawyers is not permitted in small claims court. This limitation is in line with the informality and affordability that small claims cases aim to provide. Some states, however, do allow attorney representation, often subject to additional rules. Regardless of legal representation, parties are generally free to consult with an attorney outside of court as long as they handle the case themselves. Furthermore, many counties offer the assistance of small claims advisors on a pro bono basis.

Costs and Time: Initiating a lawsuit in small claims court involves a filing fee, which varies from approximately $15 to $200 depending on the state and the claimed amount. If external attorney consultation is sought, small claims litigation costs typically range from $500 to $2,000 for resolving disputes related to small to medium-sized businesses. The process may take anywhere from four to eight months, although these are approximate estimates subject to variability.

Small claims courts offer an accessible alternative, especially for parties seeking to avoid the expenses associated with mediators or arbitrators. However, it’s important to note the limitation on the maximum claim amount in these courts.

Option #6) Superior Court Litigation

For claims exceeding $10,000, the appropriate venue for legal action is typically the state’s general trial court. These courts might go by different names in various states, such as “superior court,” “district court,” or “court of common pleas.”

It’s essential to note that court jurisdiction intricacies can vary significantly among states, with rules of evidence and litigation procedure playing a substantial role in these proceedings. Navigating such complexities often requires the expertise of an experienced trial lawyer.

Costs and Time: Initiating a lawsuit in this setting involves a filing fee, typically ranging from $100 to $500, contingent on the state and claimed amount. Additionally, you’ll need to budget for attorney fees, which could span from $250 to $500 per hour. Litigation costs, especially for small to medium-sized business disputes, may fall within the range of $10,000 to $50,000. However, it’s crucial to recognize that the costs can escalate considerably for contentious disputes or those involving intricate matters. As for the timeframe, expect the litigation process to extend from one to three years. These figures are approximate and subject to considerable variability.

Frequently Asked Questions

At what point should I involve an attorney?

While having legal counsel to guide you is ideal, the reality often involves a consideration of costs and benefits. Attorneys can be expensive, and it’s crucial to strike a balance. As a practical guideline, consider involving an attorney when you believe your case has a strong chance of success and when their fees are less than 30% of the value at stake. Ethical and proficient attorneys will provide honest assessments of your prospects and can provide ballpark estimates of their expected costs.

However, it’s important to note that when dealing with litigation at the superior court level, the technicalities involved virtually mandate the involvement of an attorney.

Can I simply take the business back if the buyer defaults?

Taking back control of the business after a sale requires careful consideration and adherence to legal processes. Once the bill of sale is signed, ownership is transferred to the buyer, granting them exclusive rights to the business. Even if the buyer falls behind on payments, you cannot unilaterally reclaim the business without their explicit consent or legal intervention.

To determine if you can repossess the business, consider the following:

  • Can you regain access to the business premises without resorting to force or unlawful entry?
  • If the buyer were physically present, would they willingly allow you to assume control?

If the answer to either of these questions is “no,” it’s essential to pursue a mutually agreeable solution or engage in a formal dispute resolution process to regain ownership of the business.

How do I take back the lease or franchise if my name is no longer on the agreement?

Leases and franchises often involve the crucial element of third-party approval. Even if the buyer consents to return the business, you may still face hurdles in operating it under your name until the lessor or franchisor grants their approval.

One effective solution is to consider an irrevocable power of attorney. This legal arrangement allows the buyer, in case of default, to appoint you as their agent with irrevocable authority to manage and operate the business in their name. While they retain the legal title to the lease or franchise, you gain the ability to oversee business operations and collect income. This approach allows you to step in and manage the business temporarily, ensuring its continuity.

Is the process different for a stock sale?

In the context of a stock sale, the dispute resolution process follows a similar framework. Rather than seeking the return of business assets or the completion of payment for them, the focus shifts to the stock shares. However, it’s worth noting that the same considerations regarding third-party approval may arise. Leases and franchises, for instance, often necessitate the lessor’s or franchisor’s approval when there’s a change of control within a business entity.

Is the process different if I still own a percentage of the business?

If you retain partial ownership of the business, the dispute resolution process typically remains consistent. Instead of regaining possession of business assets, your objective may shift towards reclaiming majority control within the company. As previously mentioned, third parties often treat this change of control as akin to altering the lessee or franchisee. Consequently, it may trigger the necessity for third-party approval, even if the underlying business entity maintaining the lease or franchise remains unchanged.

Can I prevent a default in the first place?

From our extensive experience, we’ve identified two effective strategies to prevent defaults:

  • Diligent Buyer Evaluation: Thorough due diligence on the buyer is paramount. It’s not just about financial checks; it’s also about trustworthiness. Meeting the buyer in person, observing their demeanor, and assessing their negotiation approach can reveal vital insights. Don’t dismiss your gut feeling – it often signals potential issues that merit further investigation.
  • Nurturing Positive Relations: Maintaining a respectful and cordial relationship with the buyer post-closing is invaluable. Clear and emotion-free communication fosters an environment where parties can openly discuss concerns and explore solutions. This approach significantly expedites the resolution of any issues that may arise.

Conclusion

When faced with a buyer’s default, a structured approach can help resolve the situation effectively:

  • Pursue Mutual Agreement: Start by engaging with the buyer to explore options. This could involve completing outstanding payments or regaining control of the business. Open communication is key at this stage.
  • Consider Dispute Resolution: If reaching an agreement seems unlikely, turn to the dispute resolution methods mentioned earlier. The choice will hinge on factors like available resources and the financial scale of the issue.
  • Assess the Ideal Path: The best course of action depends on your specific circumstances, including financial resources and the amount at stake. Keep in mind that maintaining a composed and respectful demeanor throughout the process greatly enhances your chances of success.

Remember, clear and rational communication consistently outperforms anger or hostility when resolving disputes.

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