Recent Sale of Business

I was asked in mid-October to act for the owners of a registered training organisation (RTO) to assist with its sale. A basic term sheet had been signed with the buyer and they both wanted to complete before the end of the month. Due diligence was underway, but unfortunately there was not a confidentiality deed in place. That was the first item to address.

Next was preparing the share sale agreement (SSA). The broker had a version of a SSA that was tailored to the peculiar RTO regulatory environment. That needed just a bit of a shift to be a little more in the seller’s favour, a tad (!) of tightening, including adding some warranties from the buyer and addition of a buyer’s guarantor. It also required a mechanism to calculate and adjust for the net position vis-à-vis receivables and payables, provision for a tax estimate for trading up to completion and otherwise allowing the seller to dividend to itself the net cash/profit out of the company.

The buyer didn’t appoint a solicitor until 3 days before scheduled completion (not so helpful). Those solicitors then sought a range of changes (many of which were agreed), but also a $50,000 holdback to address a variety of issues and also sought a range of liquidated damages based on perceived technical compliance issues in the RTO regulatory framework. This broad hold back was resisted, although a 10k holdback was agreed for 30 days just to cover if there were additional debtors than were adjusted for. We also resisted the request for liquidated damages, principally because the seller was very on the ball and could quickly address the technical issues raised or could demonstrate that the perceived issues really had no merit and that not hold back was appropriate.

The share sale agreement was signed on 30 October with completion following later in the day (but critically, before the end of month). The buyer and its solicitor were located in Melbourne and the seller in Brisbane (and me on the Gold Coast). Completion occurred by the exchange of a scan of the share transfer and other documents, with original documents to be exchanged in due course.

Besides successfully completing a transaction within a compressed timeline, there is one other very gratifying aspect to assisting the sellers. The sale was for a generous six-figure sum. I have never met the sellers face to face, but they are a husband and wife team. I am not privy to their financial position but receiving a generous six-figure sum has to help them and their family get ahead in life. Of course, that payday was for many years of hard work and running a successful and profitable business.

Total legal fees will be south of $10k, and roughly 1.5% of the transaction value.

Funding your global expansion

Many businesses, at some stage in their life, need funds from external sources.  That is, their cash flow is insufficient to allow them to grow at the desired rate or to take a quantum leap into an entirely new level of operations or to expand globally.  For any business, poor or negative cash-flow creates strain and is not sustainable, and for some a failure to obtain additional funding may mean the end of their business.  This may be particularly acute when a business has a relatively mature position in Australia but is seeking to expand overseas.

If your global expansion is occurring by way of appointing a distributor for your products then it may be possible to obtain healthy deposits from them when they place an order, which can in turn pay or contribute to paying the required deposit likely required by the business’ suppliers/manufacturers.  There may still be a cash flow gap.  Clearly, this is not available if the business is seeking to grow organically and set up its own operations overseas.

 

The principal sources of funding available to businesses are bank loan, factoring, an angel investor, private equity/venture capital, crowd funding (either in exchange for product or for shares in the entity) and/or going public (that is, a full blown initial public offering of the entity’s shares on the Australian or other stock exchange).

 

Besides the traditional avenues listed above, support may be available from the Australian government via Export Finance Australia.  For example, EFA may be able to provide either a direct government loan or a government guarantee of your existing or proposed finance facility (which guarantee may increase the amount your financier may be willing to lend to you).  It is not a requirement that your products are manufactured in Australia or are imported into Australia before being exported overseas for the government support to be available.

 

This is not a free kick.  Commercial terms apply.  For example, the loans are unsecured, but do require a director’s guarantee, and interest is payable (current indicative rate is 12% p.a.).

 

EFA has eligibility criteria, but it is a potential avenue definitely worth investigating (www.exportfinance.gov.au).

Trading account guarantees are like zombies

Most businesses trade with the benefit of a corporate structure. The key benefit is that a company is a separate entity and the liability of the shareholders is limited to their capital contribution (typically a nominal amount). That is, if the underlying business fails then the debts remain those of the company, not the directors or shareholders (exceptions for failure to pay super, PAYG, etc).

In theory, that sounds almost too good to be true! The reality is a little different. So, if the business seeks a bank overdraft, then the bank will insist on personal guarantees from the shareholders and directors to support the loan to the company. If the company defaults on the loan, then the bank can seek repayment from the directors/shareholders.

Many companies/businesses also obtain goods on credit from other traders. Typically, the company/business receives the goods and only needs to pay the invoice 30 days later. The terms of trade for those other traders often also seek a personal guarantee from the directors/shareholders of the company. Sometimes the request for a guarantee can be resisted, but often it can’t. For example, if you are a house painter then likely Resene or Dulux or the local trade centre will not supply their products on credit without a personal guarantee, and without paint a painter does not have a business.

Personal guarantees do not have a use by date. So long as the company has a trading account with that trader, if the company defaults the individual guarantors are personally responsible for the company’s debt to that trader. A guarantor can’t just write to the trader and say my guarantee is cancelled. The trader holds the benefit of a guarantee and it cannot be unilaterally withdrawn. That is, the guarantee lives on in some zombie like after-life and is difficult to kill off.

If a company is set up with two directors/shareholders, sometimes one decides to buy the other one out, either amicably or because of a falling out. If this occurs, often there will be a refinancing, so any guarantee to the bank will be released.

But for trading account guarantees, this can be more problematic. Perhaps the business hasn’t kept track of what guarantees have been given. Perhaps the trader is approached but refuses to release the guarantee. If this occurs, the business could continue to trade for a couple of years, rack up significant trading account debts to these traders, go bankrupt and then the trader claims against all guarantors. The person who exited the business two years earlier gets a rude surprise; he or she thinks they are long out of the business but then discover that they remain personally responsible for the company’s debts for trading when they had no interest in, or control over, the business. This issue can also arise on a sale of the whole business to a third-party buyer if it occurs by way of selling the company itself (less common) rather than all the assets comprising the business (more common).
One recommendation to deal with this is to put a use by date on the guarantee. If it is an ongoing trading account, it is a bit artificial to state that it expires in a set time (say in a year). The credit department of the trader is very unlikely to want to have to deal with ensuring that personal guarantees are regularly renewed. An alternative is to seek an amendment to the guarantee to the effect that the guarantee expires if the person ceases to be appointed as a director. A suitable clause would be:

• “This guarantee ceases to operate regarding any debts incurred after the time the guarantor ceases to be appointed as a director of the customer.”
Under this formulation, the director would be responsible for any debts incurred by the company prior to their resignation.

A broader clause, more beneficial to the guarantor but likely less palatable to the trader, is:
• “This guarantee ceases to operate after the time the guarantor ceases to be appointed as a director of the customer, including regarding debts incurred by the customer prior to that time.”

You can simply hand-write one of the above clauses into the guarantee section of the credit application and initial the change. Be sure to retain a copy.

Absent something peculiar in the company’s constitution, and assuming it is not a single director company, the resignation of the outgoing director is effective upon the resigning director giving written notice to the company. The resignation does not require acceptance by the company.

Be sure to inform ASIC of your resignation. If the exiting director does not have the corporate key for the company (allowing the lodgement of electronic notices with ASIC), the director should lodge a paper form 484 with ASIC notifying ASIC of their resignation accompanied by their letter of resignation (as permitted by Corporations Act s205A).

As a final tip, try to keep track of the guarantees that have been provided. Then their release, absent a clause as suggested above, can be sought in an orderly manner, upon a resignation or sale situation.
Failing all else, and whilst not necessarily effective, the resigning director should write to all traders who hold his or her guarantee and inform them of their resignation and saying the guarantee is withdrawn for all trading by the company with that trader from that time forward (asserting that any goods supplied after that time is done so without the benefit of that person’s guarantee).

Use of trademarks in a corporate group: risks of non-use

 

Wow, a higher court makes a commercially sensible decision, even in the face of technical legal arguments (and overturns the lower court’s decision)!

There is the principle in trademark law of “use it or lose it”.  If a mark is simply languishing on the trademark register, an alert opportunist may apply for the same mark and seek to have the earlier mark de-registered on the grounds of non-use.  If the mark has simply not been used for 3 years, then the opportunist is likely to be successful.

That is a sensible policy position to adopt.  If a mark is not being used, let another trader have a crack.  This position holds even if historically the first trader built up over a long period of time significant goodwill in the mark if it hasn’t been used for at least 3 years.

The person who is registered as the owner of the mark must be the person who is using the mark to avoid a non-use application. Once again, a simple and uncontroversial proposition.

But what of corporate groups?  Some groups are deliberately structured so that there are separate operating entities from the entity that holds the trademarks.  Operating entities, being the entities that sell products or offer services, carry the risk of commercial failure.  If that unfortunately occurs, this may not cause the group as a whole to fail and the valuable trademarks are insulated from this risk.  That is sound risk planning.

But, within that sound planning, does use by the operating entity constitute use by the separate trademark owner?  Or can an opportunist seek to de-register the trademarks of the separate trademark owner because that entity has not used it?

This is precisely what Trident Seafoods Corporation recently tried to do.  Trident Foods Pty Ltd owned the trademark “Trident” in class 29 for seafood and had done so since the 1970s.  Its parent company Manassen Foods Australia Pty Ltd was the operating entity and undertook all sales of Trident seafood products.

A different company, Trident Seafoods, applied to register “Trident” in class 29 for seafood and to clear the path sought to de-register Trident Food’s marks on the basis that Trident Foods had not used it (although its parent company Manassen had).

Notably there was not a written licence agreement between Trident Foods and Manassen, at least not until Trident Seafoods came on the scene (at which time a written licence was put in place between Trident Foods and Manassen).  That lack of a written licence was a mistake and was partly the reason for the problems.  Trident Foods and Manassen, as is common in corporate groups, had the same directors.

Under the Trademarks Act (s7(3)), a use by a trader that is authorised by the trademark owner is taken to be use by the trademark owner.  A use is authorised by the trademark owner if the use occurs under the “control” of the trademark owner (s8(1)), which is certainly the case if there is quality control (s8(3)) or financial control (s8(4)) by the trademark owner.  This concept of authorised users recognises the widespread practice of licensing trademarks.  So, for example, in a franchise situation, the franchisor and trademark owner will typically license use of its trademarks to the franchisee and will tightly control the quality of products offered. The use by the franchisee is recognised as use by the franchisor/trademark owner.

In a corporate group, often the structure is set up and thereafter there is no active control by the trademark owner of the operating entity.  That is, a set and forget strategy.  But usually there are common directors, all of whom are rowing in the same direction.

Initially, a single judge of the Federal Court held that Manassen’s use of the Trident mark was not use by the trademark owner, Trident Foods.  The lack of a licence agreement didn’t help.  Being part of the same corporate group and having common directors wasn’t enough.  There needed to be “actual control” or “control as a matter of substance”.

Trident Foods appealed.  It really wanted to keep its marks and it wanted to block its competitor from registering the trident mark.

Fortunately, the Full Federal Court ([2019] FCAFC 100) in June 2019 took a much more commercial, pragmatic view to the control test.  The judges made much of the two entities being in the same corporate group with the same directors (at [45]):

“…it significant that at all relevant times the two companies had the same directors. It must be inferred from the evidence that the two companies operated with a unity of purpose. Trident Foods held the trade marks. Manassen sold the products under the TRIDENT brand and thereby used the trade marks …. As directors of Trident Foods, the directors had obligations to ensure the maintenance of the value in the marks. To that end Trident Foods necessarily controlled Manassen’s use of the marks by reason of the simple fact that it owned the marks and its directors, who were also Manassen’s directors, must have had one common purpose, being to maximise sales and to enhance the value of the brand…. it is commercially unrealistic in the circumstances of the present case not to infer that the owner of the marks controlled the use of the marks because the common directors necessarily wished to ensure the maintenance and enhancement of the value of the brand. The fact that this must also have been Manassen’s purpose simply confirms the unity of purpose between the corporate entities. But unity of purpose is not inconsistent with the existence of control in a case such as the present.”

Actual, factual control was not necessary (at [46]):

“it is not surprising given the corporate relationship, the commonality of directors and the shared processes between the owner and the user of the marks that there is no particular illustration of actual control by Trident Foods of Manassen in respect of the marks. The natural and ordinary inference given the relationship between the companies would be of unity of purpose, rendering redundant any particular illustration of the actual control Trident Foods must have had as the owner of the marks. Unity of purpose is indicative of the existence of actual control vested in Trident Foods as the entity owning the marks over Manassen as the entity using the marks.”

Given that the Full Federal Court held that there was control by the trademark owner it also held that therefore the use by Manassen was in effect use by Trident Foods and so its marks were not to be de-registered upon the application of its competitor.  Common, commercial sense prevailed!

Key takeaways:

·       If a corporate group is established with an operating entity different from the entity holding the trademarks, then ensure that there is a written licence agreement between the two which makes it clear that the TM owner authorises and controls the use of the marks by the operating entity;

·       Preferably do not have the TM entity as a subsidiary of the operating entity; it is better if they are both a subsidiary of an inactive holding company (although there remains the risk of the potential liability of holding companies for the insolvent trading of its subsidiaries Corporations Act s588); and

·       Ensure that there are common directors between the two entities; or

·       If there are not common directors (or if the TM owner sits outside the corporate group), then ensure there is practical, actual control by the TM owner of the use of the TMs by the operating entity.

An off the cliff risk of 3PL

An off the cliff risk of 3PL

Risk of trading on Credit

Any trader who supplies product on credit and has been in business for a decent length of time will know the pain of a customer going bankrupt and the consequent inability to be paid for products delivered (and typically the loss of that stock).  The bigger the customer, the bigger the pain.  A very large customer going bankrupt can even put the ongoing viability of the trader at risk.

Terms of Trade and retention of title clauses

Traditionally traders have sought to cover this risk by means of a retention of title clause in their terms of trade.  Upon bankruptcy of the customer, the trader could seek to enforce the clause and recover its goods (or so much of it as had not been on-sold during the normal course of the customer’s business) to reduce the pain incurred.

PPSA

That position was complicated in Australia during 2009 by the introduction of the Personal Property Securities Act (PPSA).  Unless the security interest created by the retention of title clause was registered under the PPSA then the retention of title clause in effect became unenforceable.  Under the PPSA, the old adage of “possession is 9/10ths of the law” became the law of the Australian land.  The trader needs to register its interest (and quickly after being created) under the PPSA so that its interest took priority relative to other creditors and so was in effect unenforceable.

Warehousing function and 3PL

Under a traditional business model, a trader would operate its own warehousing function and when its customers placed an order for products the trader’s warehouse would pick the stock and dispatch the order.  For wholesale customers, orders would be aggregated (and often with minimum quantities stipulated).  With a limited number of wholesale customers, this was an entirely manageable function.  With many traders now also operating on-line retail stores with direct to consumer sales, the size of orders has decreased (to perhaps one sku) but the volume of orders has dramatically increased.  Many traders recognise that warehousing/dispatch is not a core competency of their business and have sought to outsource this function to a 3PL provider (3rd party logistics).  Good 3PL providers have the systems and resources to operate a very efficient service, often undertaking this function far better than the trader was doing itself.  Appointing a 3PL provider leaves the trader better positioned to focus on the core aspects of their business.

Whilst it can make good commercial sense, there is one massive risk to entering into a 3PL contract.  The 3PL provider is not just one customer who takes delivery of some stock on a promise to pay.  The 3PL provider takes custody of ALL the trader’s stock, and not with a promise to pay but with a promise to provide services.  This makes it even harder for the trader to have line of sight on any potential financial difficulties the 3PL provider may be having (unlike customers, who may over time become more and more delinquent when it pays for products).  If the 3PL provider goes bankrupt, the trader will lose all its stock unless the trader has a security interest drafted into the services contract with the 3PL provider and promptly registers that security interest under the PPSA. 

Is it worth ensuring a trader gets this right?

In the law of civil wrongs, in assessing if someone has been negligent and therefore liable to compensate another person who was harmed by that negligence, there is the negligence calculus involving 3 elements: (1) what is the probability that the harm may arise; (2) what is the gravity of the resulting injury; (3) how difficult or easy are adequate precautions?  Using this as a guide to assess whether traders should bother with this:

(1)    Risk of 3PL provider’s bankruptcy: Difficult to assess the risk of a 3PL provider going bankrupt, but perhaps let’s say small;

(2)    The gravity of the resulting injury to the trader: potentially very significant.  If a trader loses all their stock, then this will be at the least a significant set-back and a huge strain on cash-flow, but may have a domino effect, leading to the trader’s bankruptcy; and

(3)    Precautions to guard against the harm: relatively simple.  Some 3PL providers are setting up from overseas using a template warehouse service agreement that makes no reference to Australia’s (or New Zealand’s) PPSA regime.  They don’t need to; it is not their risk.  But it is relatively easy for an appropriate professional to review the 3PL contract, insert appropriate clauses and promptly register the trader’s interest in its own stock under the PPSA.

Copyright – ownership of key designs

Copyright – ownership of key designs

Many businesses will have key copyright works that are central to their operations. Perhaps the most central is a logo that identifies their brand or is otherwise a key part of their business.  Think the Nike swoosh logo or the coca-cola stylised name.

A very large amount of these business’ marketing expenditure and brand awareness are built around these key pieces of intellectual property.

It is critical that the business owns, and can demonstrate that it owns, copyright in these logos.  The key logos may also get registered as trademarks, but at the beginning, if they are an original artistic work, then copyright will subsist first.

Initially, the copyright in any artistic work will be owned by the artist/designer who created the work.

If an employee creates the copyright work in the usual course of their duties, then the employer automatically becomes the owner of the copyright (Copyright Act s35(6)).  For employees who create copyright, it is prudent to have a term in their employment contract recognising this too.  The business should track which employees created what copyright and when.  If this is a common part of their business, such as a fashion brand, then it is recommended that a register of copyright be maintained.

However, if a business engages an outsider person, a contractor, to create the artistic work, copyright is not automatically transferred to the business.  That sounds counter-intuitive, because that is what the outside person is being engaged, and paid, to do.  But to transfer copyright a written assignment is required.[1]  It is therefore critical that whenever a business engages a contractor who is involved in developing IP, for the business to enter into a written and signed agreement with the contractor which provides that all IP developed by the contractor is the contractor’s own original work and is transferred to the business.[2]

Two recent cases demonstrate the necessity to do this (but in the second case saved ay an ironic twist.

In the first, the Hells Angels motorcycle club in San Francisco engaged a tattoo artist known as “Sundown” in 1954 to create a skull image used on membership cards. The tattoo artist apparently frequented the pool hall where the San Francisco chapter met.  The tattoo artist came up with the death head design.

Pool halls and characters like the Hells Angels and Sundown are not the type of people who worry about the niceties of a legal assignment in writing.  Indeed, there was none.  So when the Hells Angels sought to sue Redbubble who allowed people to print various images onto various products (such as coffee mugs), the Hells Angels could not establish that they owned copyright in the death head logo and lost their case on this basis (but succeeded based on trademarks).

In the second case, Racing Victoria wanted commemorative medals based on famous jockeys or trainers struck for annual awards.  Racing Victoria provided historical photographs of the jockeys and trainers and a Melbourne jeweller provided sketches of proposed medals.  Mr Douglas was engaged to make the medals and was paid accordingly.  Mr Douglas then engaged a die maker Mr Forwood to create the actual medals based on Mr Douglas’ sketch, but gave to the die maker the original photographs.  Over time, Racing Victoria moved away from Mr Douglas in providing the medals and appointed a new supplier.  Mr Douglas claimed that he was the owner of the copyright in the medals, that his copyright had not been assigned to Racing Victoria and that Racing Victoria was breaching his copyright by continuing to strike the commemorative medals.  Although Douglas had been paid for his work, arguably he was being opportunistic and was just seeking another pay day.  It was true that there was no assignment from Douglas to Racing Victoria.  But in an ironic twist, the person who ultimately created the medals, Mr Forwood, had not assigned his copyright to Mr Douglas.  So, the court held Mr Douglas did not own the copyright which he alleged Racing Victoria had breached!

The bottom line is that, particularly if a business engages a graphic designer to create their key logo, ensure that the contract with the graphic designer includes an express assignment of copyright in the work created.  But the same principle applies to a business engaging:

  • photographers, whether for an advertising shoot or a model/action/athlete shoot;
  • filmmakers;
  • designers for products;
  • graphic design studios who design point of sale catalogues, etc.; and
  • IT software writers.

 In all situations, written contracts with appropriate IP assignment and indemnity clauses should always be used.



[1] Robin Ray v Classic FM (1998) 41 IPR 235; Douglas v Racing Victoria [2019] FCCA 49 at [116].

[2] Copyright Act s196(3).