Selling a legal entity to a purchaser is gaining popularity

© Yuliya Tsyhun – 123RF.com

"The differences between these two approaches are significant and definitely worth considering," says, Kenneth Clarkson and Janet Gannon, commercial brokers of Rawson Commercial Kloof in Durban.

“When a commercial property is purchased from an individual, the services of a conveyancing attorney is required. The conveyancer lodges the required documents at the Deeds Office, where the transfer of ownership over the property passes from the seller to the purchaser,” says Gannon.

The applicable transfer fees can be costly, and these fees must be paid prior to lodgement at the Deeds Office. Where a seller and a purchaser are both registered VAT vendors, transfer fees may not be applicable. However, such a transaction would still require VAT to be paid on the purchase price with the remote possibility of SARS refunding the full VAT three to four months after transfer has taken place.

Interests are transferred

“When purchasing the legal entity which owns the commercial property it is the shareholding of the shareholders, or the interests of the members, that are ultimately transferred. The services of a reputable accounting officer or auditing firm, as well as a commercial attorney or conveyancing attorney who understands this method of sale is generally required.”

The accounting officer or auditing firm needs to ensure that the annual financial statements as well as the tax affairs of the legal entity being purchased are all up to date. In addition, it would be prudent to investigate the legal entity’s bank statements to ensure the cash flows of the legal entity are understood, as well as to ensure that there has been no misappropriation of funds, or concealed debts which could potentially adversely influence the liquidity and continued functioning of the legal entity.

The commercial attorney or conveyancing attorney’s function is also slightly different in this method. They are required to check the legalities of the transaction, the unencumbered state of the legal entity, that no other person or legal entity holds any option to purchase any interest in the legal entity, and that the property is not subject to any pledge or restraint.

Selling a legal entity to a purchaser can be a quicker process than selling the property to the purchaser. As opposed to the transfer of the property happening in the Deeds Office, it is only the shareholding or member’s interest, as well as the directors or members of that entity, which needs to be amended in the legal entity’s registration documents. This amendment is facilitated through an application to the CIPC, which is the Companies and Intellectual Property Commission, previously referred to as CIPRO.

Another advantage of selling the legal entity to the purchaser, is that no VAT is payable on the purchase or transfer of shares or members’ interests.

Potential pitfalls

Any transaction is, however, subject to potential pitfalls, especially in the case of purchasing a legal entity. Firstly, the various checks performed by the accounting officer, auditing firm, commercial attorney or conveyancing attorney are all complicated further if the legal entity being purchased also conducts other business activities. It is therefore advisable that this option be reserved for those situations where the only business activity conducted by the legal entity being purchased, is that of renting the relevant commercial property out to existing tenants.

Secondly, the legal entity being purchased could potentially have hidden liabilities, as well as litigation proceedings initiated against it. It would therefore be prudent to secure an indemnity from the seller, from all existing debts and litigation proceedings from date of signature of the agreement.

Thirdly, if there is a mortgage bond over the commercial property, the relevant financial institution will need to consent to the change in shareholding or members’ interest. This seems strange, as ownership of the property remains within the legal entity being purchased. However, when originally contracting with the legal entity, the financial institution’s legal agreements with that entity would have sufficiently catered for such circumstances, and this cannot be overlooked by either the seller or the purchaser.

The option of selling the legal entity to the purchaser should therefore be reserved for a situation where either the purchaser is financially strong and likely to be favourably assessed by a financial institution, or where the property is bond free.