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Deferred Payment Sales: Risks and Mitigation Tips for Sellers

Caveat Legal

A sale of business or shares usually follows a predictable pattern. In many cases, the seller agrees to transfer business assets or shares before receiving final payment, which is referred to as a ‘deferred payment’ or ‘deferred loan’.  A seller may agree to transfer ownership on a deferred payment basis for various reasons, including a negotiated increased amount for the assets on offer, an increase in BBBEE scorecard points for the purchaser, difficulties experienced by the purchaser in raising funds, or the earn-out model through which the seller receives higher payments on meeting certain criteria.

Sellers should, however, be wary of agreeing to such deferred payment terms, and should they agree to such terms, they should ensure that appropriate clauses are included into the sale-purchase agreement and that they hold security for their deferred payment rights.

A deferred payment could be regarded as an interest free loan, which in practice is often made without any corresponding security provided by the purchaser.  Given the loan nature of the obligations of the purchaser, it is always recommended that the seller include standard loan terms into the acquisition documents, including clauses providing for:

  1. Events of default and events that would trigger a default, allowing for acceleration of payments or enforcement of security. Such triggers could include the purchaser being placed in liquidation, business rescue or analogous proceedings, the purchaser defaulting on payment obligations to third parties or a judgement being served against the purchaser which exceeds a certain amount;
  2. Information undertakings requiring the purchaser to provide certain information to the seller until the final payment has been made. Such information would place the seller in a position to understand whether the purchaser remains able to meet its payment obligations, and could include annual financial statements, management accounts or notification of any default events, litigation or insolvency proceedings being brought against the purchaser; and
  3. Security to be provided by the purchaser. Where possible, this should be in the form of first ranking security over the asset which has been sold.  It may not be possible where the purchase is funded by senior lenders, who may then take first ranking security over the relevant asset. Other forms of suitable security which a seller could negotiate include funds in escrow, reversionary rights on the assets or the shares, suretyships and guarantees, or a pledge of shares or assets.

Most importantly, the seller should first and foremost always conduct a due diligence on any potential purchaser who is requesting a deferred payment structure to ascertain whether the purchaser has the financial means to pay the deferred payment.

It is recommended that sellers who accept deferred payment terms when selling their assets understand the loan nature of such obligations.   To address the risk that this presents, the seller should ensure that they have considered all security options available to them and include appropriate loan terminology into the sale purchase agreements in order to adequately protect their interests in the event of a default and to provide greater protection to the seller.

Robyn Bandey

Robyn has a BA LLB (Cum Laude) and was admitted as an attorney in 2011 after having completed her articles at ENS. She advanced to senior associate level in ENS’ corporate department before moving to Deloitte and then Coast to Coast Capital. Robyn joined Caveat in 2020 specialising in M&A and banking and finance work.

* For vendor finance transactions where interest is charged to the purchaser, read Robyn’s article on the effects of the National Credit Act on these transactions.

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