A recent decision of the Ontario Superior Court of Justice highlights the importance of a well-drafted asset purchase agreement. 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 dispute arose between two business owners. Jonathan’s – Aluminum & Steel Supply Inc. (the “Seller”) entered into a one-page asset purchase agreement with Mrs. Tharumarasa, who signed the agreement in trust for a corporation to be incorporated, whereby the Seller would sell its chattels and inventory (the “Purchase Agreement”). Soon after the signing of the Purchase Agreement, Mrs. Tharumarasa incorporated a new corporation – Retail Alloy Metal & Plastic Plus Limited (the “Purchaser”).
While the Purchaser paid the purchase price for the chattels on closing as required by the Purchase Agreement, the Purchaser refused to pay for the inventory as it disputed the assessment of the purchase price of the inventory. The Seller claimed that the purchase price was fair and reasonable and that Mrs. Tharumarasa, in addition to the Purchaser, is personally liable for the unpaid amount.
The parties had also entered into a non-competition agreement two months after signing the Purchase Agreement. The Purchaser argued that any amount owing to the Seller should be set-off against their loss of business and income caused by the Seller’s breach of the non-competition agreement.
The Court identified four main issues in the case: (1) the personal liability of Mrs. Tharumarasa; (2) the assets being purchased; (3) the reasonableness of the inventory count and the inventory price; and (4) the non-competition agreement.
(1) The Personal Liability of Mrs. Tharumarasa
The Court reiterated 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 was the intention of the parties that Mrs. Tharumarasa would only be bound by the Purchase Agreement until the new corporation comes into existence. In reaching its decision that she was not personally liable, the Court relied on several factors, including the following: (a) the Purchase Agreement indicated that she 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.
(2) The assets being purchased
The Purchaser argued that it purchased the entire business of the Seller (except its name) and that the purchase included the customer list, the phone number, and goodwill of the Seller, as well as training by the Seller. The Court stated that the Purchase Agreement clearly provided that the purchase was for chattels (being certain specified equipment) and inventory. The Purchase Agreement did not mention the customer list, the phone number, the training, or the goodwill. Although the Purchaser’s principal assumed that these additional items were also being sold, the Court held that the Seller was not told about these additional items and had not agreed to their sale and, as such, was not bound to sell them.
(3) The reasonableness of the inventory count and the 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”. The parties disagreed on what the appropriate invoice price was. The Purchase Agreement did not provide for a particular formula to be utilized in reaching 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.
(4) The non-competition agreement
The Court stated that the Purchase Agreement did not contain a non-competition clause and that the Seller’s principal signed a separate non-competition agreement under economic duress, for fear of not getting paid for the inventory. Given that the Seller’s principal signed the non-competition agreement while voicing his protest, the Court found that the requirement to promptly disavow his promise not to compete did not apply. Moreover, the Court added that launching a legal action 8 months after the signing of the non-competition agreement met the requirement to disavow the promise as soon as possible. The Court held that the non-competition agreement was not a variance of the Purchase Agreement and there was no fresh consideration for entering into it. As such, the Seller’s principal was not bound by the non-competition agreement.
What are some lessons that can be learned from this case? Consider the following:
- 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:
- Ensure that the asset purchase agreement states that you are signing the agreement “in trust for a corporation to be incorporated”;
- Arrange for a corporation to be incorporated as soon as possible after the asset purchase agreement is signed; and
- As soon as possible after the incorporation of the new company, notify the seller (preferably in writing) of the incorporation and the new corporation’s intention to assume the asset purchase agreement.
- Specify exactly which assets are being sold.
- Set out a clear formula for determining the price of inventory.
- If you want a non-competition agreement to be enforceable, include a non-compete clause in the asset purchase agreement itself and/or ensure that a separate non-competition agreement provides for adequate consideration and is not signed under circumstances that can be interpreted as economic duress.
- Put everything into writing. How you understand the transaction and how the other party understands it may not, in fact, be the same.
Contact Our Ottawa Law Firm – Merovitz Potechin LLP
Lastly, it is recommended that you hire a lawyer to draft or review the asset purchase agreement to avoid misunderstandings, disputes, and costly litigation in the future. If you require assistance with drafting or reviewing a purchase agreement, or with any of your other business needs, we would be happy to assist you.