Those Hidden Clauses Can Bite You Bad.

Toni is selling his Barber Shop in a shopping center located next to a very popular Peruvian chicken restaurant and carry-out.  Toni is nearing retirement and wants to sell.  Toni knows that he has to have a lease for his shop as a condition of any buyer of a hair cut business, which will only draw customers in the area close to the shop.  Without the location, the business disappears. The owner of the restaurant makes Toni an all-cash offer for $100,000 to buy out his Barber Shop and hands Toni a check for $10,000 with a two-page simple contract.

Toni does not see why he needs a lawyer to go over such a simple contract, but Joe, Toni’s CPA, convinces him he needs to have a lawyer review the contract.

I am in the conference room with Toni, his wife, and CPA Joe.  The $100,000 price is reasonable based upon the gross sales and net income of the Barber Shop.  A key fact is that Toni’s lease runs out in three months, but Toni has sent a written request that it be extended.  This means Toni has a right to keep the store lease for the Barber Shop for the next five years, a requirement for any buyer of his business. The buyer says his sister will operate it as a beauty salon.

Since the amount involved is $100,000, the sale cannot support thousands of dollars in legal fees that usually derive from drafting tailor-made contracts and all of the attachments having to do with accounts receivables, inventory, leasehold rights, representations and myriad other details that are part of a smooth and efficient sale of a business. Instead, with a $100,000 transaction, it is possible to save fees and time by working with the short business sale contract proposed by the buyer.

As we are going through the contract together line by line, making revisions, accepting some provisions and rejecting others, we come to a seemingly innocent and obscure clause: “In order to discourage litigation, in the event of a contract breach by any party, the liquidated damages will be $10,000.”  Toni has no idea what that means.

Toni’s intuition tells him that what the buyer really wants is not the Barber Shop, but Toni’s lease. Toni’s gut tells him that the restaurant owner can then expand his restaurant to accommodate more customer seating and storage. As part of the sale, the buyer will take over Toni’s rights under the lease.  What Toni does not want is for the buyer to take over the lease and then drop buying Toni’s business.  Toni’s business would then not have a location and selling the business without a location would be nearly impossible.

What the liquidated damages clause says is that once the buyer gives Toni the $10,000 for the deposit on the contract and takes over Toni’s lease, and then fails to buy the business and pay the remaining $90,000, Toni has no real way to recover his remaining $90,000.

Sure, Toni can sue and say that he has a signed contract for $100,000. The Judge is likely to rule that the buyer broke his contract and then award Toni $10,000 and not $100,000 under the liquidated damages clause.  Toni gets nothing more because he already has the $10,000 deposit, which is the limit of the damages he can claim. .  Worse yet, it cost Toni more than $10,000 to sue, and the Judge does not order the buyer pay Toni’s attorney fees.

Why? Because in the contract, Toni agreed to limit his ability to sue and recover what he lost by the buyer walking out on the contract to only $10,000 in “liquidated” damages. We change the liquidated damages clause from $10,000 to $100,000. Now, the buyer is motivated to pay Toni the remaining $90,000 because Toni could get a court order to be paid $100,000.  

By spending a few moments with a lawyer, Toni saw through the buyer’s scheme and protected the equity in his business.

Selling or buying a business? Avoid having a hidden clause bite you bad. Consult us at roger@wealthcounsellors.com or call.