Sellers beware

17 January 2018

At a recent forum held on the Gold Coast and attended by most of the leading management rights lawyers, accountants, real estate agents and finance brokers, overwhelming support was shown towards including in management rights sale contracts a clawback provision to protect a buyer from a drop in the numbers of units in the letting pool between the time the contract is signed and settlement.

Many attendees at the forum told of experiences of their clients when buying businesses and finding that there had been a reduction, and in some cases a dramatic reduction, in the letting pool between contract date and settlement. It is also the case that some financiers have been imposing conditions on finance approvals that there must not be a reduction in letting pool numbers beyond a certain figure prior to settlement.

Whilst it may have been a valid argument in the past that fluctuations in letting pool number are common and was a business risk covered in the multiplier paid for such businesses, that argument is hard to sustain today with record multipliers and a number of complexes moving towards predominant owner occupation.

There was much discussion around including a claw forward condition also but the consensus was that a claw forward presented too many obstacles for a buyer and a financier because any increase in the purchase price may mean that the buyer does not have the additional funds to complete the purchase at the higher price.

The other point which was extensively discussed was whether or not a clawback condition was really suitable for holiday complexes as the loss of a small percentage of units from the pool would only have a financial impact during any period of very high occupancy approaching 100%.

At subsequent industry breakfasts which Mahoneys have hosted there has also been wide support for the general concept. There has been an understandable reluctance on the part of some brokers, who after all represent the interests of sellers, to embrace contract provisions which can work to the detriment of their clients and to further complicate a sale process.

However as pointed out by attendees at the forum and the breakfasts, the sale process is still a relatively simple one when compared to motel sales where 3 years of financials are required by buyers and financiers and to rent roll sales where not only are clawbacks the norm but so too are lengthy retentions of substantial parts of the sale price.

The forum endorsed the concept of a clawback for permanent complexes and the specialist lawyers at the forum have drafted and agreed on an appropriate special condition which has been circulated to the specialist real estate agents and other lawyers who work in the area. The general principles are:

  • The condition is expected to become the norm in sales in permanent complexes;
  • The contract will disclose how many current letting appointments the seller holds at the contract date and the seller warrants the accuracy of that number;
  • The parties will have to agree on and include in the contract the clawback value of each appointment;
  • If the seller receives a notice of termination after the contract date the seller must notify the buyer of that;
  • The seller must on the day before settlement advise the buyer of, and warrant, the number of current appointments then held;
  • The buyer or buyer’s accountant can attend the complex to verify that number;
  • If the number of current appointments at settlement is less than the number at the contract date, the sale price is reduced accordingly.

Like anything new, it will take time for these changes to settle in and receive broad acceptance by all industry participants. There are also likely to be some transaction specific modifications to the basic condition.