Case Study: Buyer buys. Seller sells. What can go wrong? Cherie Hearts & G8 (by Spore M&A Lawyer)
- Cherie Hearts was a large chain of Childcare Centres in Singapore.
- G8 Education ("G8") was an Australian listed company.
- G8 and the Founders (of Cherie Hearts) entered into a "Heads of Agreement".
- It provided that there was to be no legal obligation until subsequent documentation was signed.
- The Heads of Agreement provided:
- the Founders would sell the shares to G8 and
- G8 would pay $50m, of which:
- $21.5m was to be paid to the Founders
- $14.7m was to settle some of Cherie Heart's debts and
- $13.8m was for the Founders to remain and manage the operations for 3 years.
- About one to two months later, the Founders agreed to sell all the shares in Cherie Hearts Group to G8 and
- G8 would pay $50m, of which:
- $13.94m was to be paid to the Founders
- $18.06m was to settle some of Cherie Heart's debts and
- $13m was to be paid to the Founders if they attain certain earning targets and
- a $5m loan was to be extended to Cherie Hearts Group (guaranteed by the Founders and other security).
- At this point, it is important to note that the Share Sale Agreement is a binding agreement, i.e., G8 is bound to buy the shares and pay for them.
- Generally, we would advise the Buyer to do thorough due diligence (as thorough as possible) before signing the Agreement.
- "Assuming due diligence is completed with no major problems or concerns arising, the next step forward is executing a final contract for sale;". (underlining added)
- "The due diligence phase involves investigating, evaluating, and assessing the target company in as much detail as possible prior to finalizing the deal agreement. ….. Upon conclusion of the due diligence phase, the findings are reviewed ..., attention is given to any risks or other issues that would be considered 'show-stoppers' to going forward with the deal." (underlining added)
- "(Before writing the Agreement,) In the due diligence phase, Buyer examines Seller’s books and records to confirm everything Seller has claimed." (emphasis added)
- Another one to two months later, the parties agreed to increase the loan amount
- from $5m to $6,888,000.
- Just another week later, the parties agreed to increase the loan amount
- from $6,888,000 to $16,044,000.
- In just one to two months after agreeing to buy the shares, the Buyer finds that the loan it was to make (as part of the deal) had increased more than 3 times from the original $5m to over $16m. In a situation like this, we would certainly advise the Buyer to consider carefully whether or not to walk away from the deal.
- Generally, great caution should be exercised if the Seller, after having signed the Agreement for Sale of Shares, then says to the Buyer, "Now that you have signed, let's increase the loan amount by more than 3 times."
- However, it is possible that in this case, the Buyer was very motivated and decided to press ahead with the purchase despite the substantial increase in debt (and despite subsequent events).
- Indeed, G8's auditors, while reviewing Cherie Hearts' accounts, found that some accounts could not be verified, making it difficult for the Founders to meet the conditions for the sale of shares.
- Instead of walking away from the deal, G8 renegotiated yet another contract.
- This time, instead of buying the shares from the Founders,
- G8 contracted to buy the businesses of Cherie Hearts from 20 different entities (the Sellers). (The Founders also signed this contract.)
- Apart from this BAC, the various parties also signed numerous other agreements to cover yet other aspects, including changing the structure of the childcare chain and reducing the loan amount.
- This is an important turning point.
- Before, the Buyer had agreed to buy all the shares of various companies.
- Advantage: the Buyer takes over the various companies and usually, it is easier to get approval for change in shareholders (if there is a need).
- Disadvantage: the Buyer also takes over the liabilities of the companies.
- However, because of the difficulty verifying some accounts, the Buyer had decided to buy over the businesses from Cherie Hearts (instead of buying over the companies' shares).
- Advantage: generally, none of the liabilities of the companies will be taken over by the Buyer.
- Disadvantage: usually, the licences given to Cherie Hearts remain with them and are not transferred to the Buyer and because of this, the Buyer will have to undergo the relevant ministry's more complex and lengthier "Transfer of Ownership" process
- To effect the latest structure, the Cherie Hearts' holding company ("CHG") lodged applications for licences to be issued.
- At about that time, G8 discovered that CHG had serious cashflow difficulties and so, to protect itself, G8 wanted (a) to convert the loans that it had extended into hard assets; (b) 48 Franchise Agreements be transferred as consideration to be set off against the existing loan; and (c) to reduce the amounts that it had agreed to disburse, etc.
- CHG had to go along and had no choice because it had already reached in principle agreements with other entities to acquire the rest of their shares to effect the latest structure.
- It must have been a great blow for the Buyer, after signing the Agreement, to find out that the company it was buying had "serious cashflow difficulties".
- (This is precisely why due diligence is usually substantially done by the time the agreement is signed.)
- Naturally, we would advise our client to do his (or her) best to avoid getting into such a situation.
- CHG and the Founders were the Plaintiffs. They wanted to stop the sale and hold on to their childcare chain.
- G8 were the Defendants. They wanted to proceed with the sale and take over the childcare chain from Cherie Hearts.
The learned Judge's findings include the following:
- G8 acted in breach of the Loan Agreement when demanding repayment and taking action to enforce its security.
- However, this did not entitle the Plaintiffs to repudiate the BAC (i.e., the Plaintiff was still bound by the BAC to sell the shares to G8).
- CHG was in breach of the BAC in relation to various terms that had to be met on or before 28 February 2011
- G8's action in demanding repayment indicated that G8 wanted payment but this did not indicate that it was unwilling to complete the BAC and pay the balance of the Purchase Price in cash at Financial Close.
- Earlier, that Founder had told G8 that they had to hire six more staff but G8 had refused and that Founder had stormed out and told others office that he was cancelling the contract with G8.
- At 4.10 am the next morning, that Founder had sent an email to his staff to tell the relevant ministry “NOT” to issue certain licences and he (the said Founder) would contact the ministry to confirm the dates of issue and sent a copy of this email to G8.
- Later, that Founder sent the relevant ministry an email that said, "we would like all licences to be dated from 15 March 2011." but did not send a copy to G8.
- "It would appear … that the (Plaintiffs) were trying to delay the issue of Licences to 15 March 2011 so that they would have some time within which to persuade G8 to change certain terms of the BAC."
- The Plaintiffs’ actions were in breach of their duty under cl 11.2 of the BAC to, “do all things necessary to assist the Buyer in the transfer or the re-issuing of the Child Centre Licences”.
- G8 had earlier made five payments to Tembusu and paid about $7m to assist CHG.
- Unfortunately, before getting all the licences, the Buyer had already paid $7m to CHG. This allowed the delay in licensing to be used as a weapon against the Buyer in negotiations to vary the terms of the BAC.
- This is most unsatisfactory and again, we would advise our client to do his (or her) best to avoid getting into such a situation.
- The Plaintiffs’ claim to hold on to their childcare chain was dismissed with costs.
- G8's claim for specific performance of the BAC was granted. They got to go ahead with the purchase of the childcare chain businesses in accordance with the BAC.
- The Plaintiff appealed to the Court of Appeal but their appeal was dismissed.
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