The NSW Court of Appeal (AMA Group Limited v ASSK Investments Pty Limited [2021] NSWCA 45) has unanimously upheld an appeal by a publicly listed company of a Supreme Court of NSW decision concerning the interpretation of a ‘binding’ heads of agreement (HOA).

In 2019, the company executed a ‘binding’ HOA to acquire a smash repair business. As is common, the HOA contained various terms indicating that, while the HOA was binding, the deal would only complete if the buyer was satisfied with its due diligence inquires and certain conditions precedent were satisfied. The relevant terms are extracted as follows:

‘The parties agree to enter into Business Sale Agreements subject to the terms and conditions set out in this Heads of Agreement’

‘Subject to [the buyer carrying out comprehensive due diligence] … the transaction will be recorded in a Business Sale Agreement’.

‘[conditions precedent include] … all necessary third party consents, authorisations and approvals being obtained (including the Purchaser’s Board approval)’.

Following execution of the HOA, the buyer’s Board formed the view that the deal ‘in its current form’ did not meet its requirements and gave notice terminating the HOA on the basis that the board approval condition precedent had not been satisfied.  In other words, exactly the commercial outcome most sellers would have expected if, for whatever reason, the buyer was not satisfied with its due diligence.

First instance decision

Somewhat surprisingly, the seller successfully sought an order for specific performance of the HOA. The primary judge did not consider that approval of the buyer board was a condition precedent to performance of the HOA, even though the HOA expressly referred to it as a ‘condition precedent’. In his view, the HOA was ‘…far more than an agreement for the provision of information coupled with an option in … [the buyer’s] favour’ and that to the extent that buyer board approval was ‘… a condition precedent to anything, it is to the entry into Business Sale Agreements, not the sale transaction to which the HOA seeks to secure’.

The appeal

On appeal, the Court of Appeal unanimously found that the primary judge erred in his construction of the HOA and that buyer board approval was a condition precedent to the buyer’s obligation to enter into the long form sale agreements. When considering the HOA language as a whole, they reasoned that the parties’ objective intention must have been that the business sale not take place unless the buyer’s board approved the purchase. This was inherent in that comprehensive due diligence had not been carried out at the time of entry into the HOA and the condition precedent would have no meaning unless interpreted in this way.

Arguably the most interesting aspect of the judgment is the discussion around whether the withholding of buyer Board approval needed to be exercised honestly and bona fide, or objectively reasonably as well. While it was ultimately not necessary for the court to reach a concluded view, it is a reminder that such a right is not absolute or unfettered and depends at least on good faith, and in some cases reasonableness too.

Thoughts

It seems extraordinary to us that this matter found itself before the courts. It would be highly unusual for a heads of agreement of this nature not to include a right for the buyer to terminate if it is not satisfied with its due diligence inquiries.

What is unusual and may have led to some of the confusion in this case is referring to the heads of agreement as a ‘binding’ heads of agreement. Usually, a heads of agreement is structured so that it is not binding in relation to the ultimate commercial terms of the transaction, but binding in relation to matters such as exclusivity periods, access to due diligence materials and confidentiality.

Our suggestion would be to speak with an experienced M&A lawyer before signing any heads of agreement – you’ll find our details below 😊 – and to think carefully about how the document is laid out and gather the terms that are intended to bind the parties from the outset into a clearly labelled ‘binding terms’ section. If commercial terms of the ultimate transaction, such as conditions precedent, have been pre-agreed by the parties at heads of agreement stage but are not intended to be binding unless and until transaction documents are signed, be sure to expressly say that. Laying it all out neatly and clearly at initial engagement stage makes for a clean parting of ways if a deal doesn’t eventuate.

WB