Commercial Business and Lease Purchases: Beware of Companies

by Ambigesh Sivapatham LLB (Hons), LLM, Solicitor

25 May 2023

Companies are important considerations in any lease or business purchase, and play an important role in the compartmentalisation of liability. While having a corporate seller increases the safety of the shareholders, they create new risks for purchasers.

It is well known that a company is only worth value of the net assets owned by that company. Except in limited circumstances, a purchaser cannot sue the directors or shareholders directly.

Purchasers will rely on contractual protections given from the seller, e.g. assurances as to the quality of fixtures and fittings, compliance with lease terms, and ownership of assets. Where a contract is made with a company, the law considers that the company is a separate legal entity. You are contracting only with that company and not with any real human being operating that company. This means that, where the company holds little to no assets, there is a risk that the human being controlling the seller can breach any part of the contract, and when you go to sue them, they will simply let the company be sued, made insolvent, and dissolved without any real consequence.

Let's take a hypothetical example. Say there is someone, Amanda, who runs many businesses. She wants to start a new business but it is a risky venture, so she starts to trade via a company, called "A Ltd". She also takes on a lease in the name of A Ltd. Amanda makes sure that the company has a low cash flow, and that all cash is quickly extracted from the company in the form of salary or dividends.

Now say that a second person, Betty, wants to buy Amanda's business and lease together. Amanda and Betty instruct their solicitors to go ahead with the purchase of the business and lease, with Amanda selling via her company "A Ltd", and Betty buying the business and lease in her personal name. The terms of the sale contract are agreed, and the sale goes ahead.

Let's carry on the example. It is one month later and it turns out that A Ltd has not kept its word. The stock and fixtures supplied by A Ltd are defective and in dire need of replacement. There have also been discrepancies identified in the accounts of A Ltd, which represented that the business was doing better than it actually was. Betty's solicitors made sure that protections were drafted in the contract which stated that all stock and fixtures should be of a high quality, fit for purposes, in a good state of repair, and that any accounts provided to Betty were accurate. It should be a straightforward case of suing Amanda, right!?

Well unfortunately that is not the case. Betty would most likely have to sue A Ltd, not Amanda directly, but when she goes to do so she finds out that A Ltd has no assets held in it. This means, that although she could go to court and sue A Ltd she won't get any compensation for the defective stock, fixtures or accounts, because A Ltd is worthless and is now an empty "shell". Betty could not sue Amanda under the contract, and Amanda could carry on her other successful businesses without a loss to those businesses, and without having to pay compensation.

So even though Betty went through all the correct motions in getting protections under her contract, the contract itself was made against a party who was not worth suing.

The above example oversimplifies things a little, but gets the basic point across.

If you taking nothing else away from this this piece, remember this, corporate sellers with a low net asset value should always raise red flags.

If you are thinking of buying a commercial lease or business, get is touch with us on 020 88 666 333. The opinions expressed in this article should not be construed as legal or financial advice, and should not be relied upon. If you require legal or financial advice, you should seek the assistance from a professional.

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