02 Oct 2013
Words Tim Admin

Contract Dates and Stress Reduction Tips

Generally I try and write these articles from an industry commentator point of view. Otherwise it’s too easy to start thinking like a banker and generally that makes for pretty boring reading. Having said that, recent events have caused me to reflect on the lender’s plight when dealing with management rights purchase contracts. While I acknowledge that the chances of anyone feeling sorry for the banks is remote we really need to have a think about current practice in respect of critical contract dates. I’m sure most readers are familiar with the general contractual arrangements and time lines for management rights purchases. Essentially there’s two contracts, one for the business and one for the manager’s unit. The contracts are signed and dated and the clock starts ticking. From then on, to use the legal jargon, time is of the essence. Other than the contract date there are four other dates which are critical. The verification date, the finance date, the due diligence date and the settlement date. The relationship between all of these dates tends to determine the stress levels and probability of heart attacks among all of the parties involved in the purchase. The first comment I would make is that occasionally contracts get signed and dated by the purchaser prior to signing by the vendor. If the vendor takes a couple of days to sign then those days are immediately lost in the process. Once the contracts are signed the purchaser will instruct his solicitor, accountant and banker to get cracking. Discussions with industry professionals combined with my own stats indicate that the verification report and the legal diligence will take 14 days on average. These time frames are achievable provided everything goes to plan and there are no hitches along the way. A recent emerging trend around lack of preparation by vendors in terms of financial records concerns me somewhat but I digress. And so, to the poor old bank manager. He needs all these reports in order to assess the deal and make a decision. If a valuation is required to support the finance application then the valuer will want a copy of the accountant’s verification report. Let’s assume that the purchaser instructs all parties as soon as the contract is signed and dated by the vendor. This rarely happens in reality but for the sake of the exercise let’s pretend it’s a perfect world ! The lender will then request a copy of the verification report from the accountant. On average this will turn up in 14 days. At the same time the lender will also request that the purchaser’s solicitor provide confirmation that all is well with the legal due diligence. Again, this process will take about 14 days. So, in a perfect world the bank will have copies of verification and due diligence reports in 14 days from the date of contract. Provided no valuation of the management rights business is required the lender can then complete assessment of the deal, document the proposal, make a final approval decision and provide the purchaser with a letter of offer. This shouldn’t take more than 5 days dependant on business volumes at the time. Having said that it’s important to understand that time frames between finance approval and production of Letters of Offer can vary greatly between lenders. No one will go to unconditional status without a physical Letter of Offer to hand so we commonly see lenders confirming approval but then needing 3 to 5 business days to produce the Letter of Offer. So, in a perfect world the entire process has taken 19 days. If the contracts have 21 day finance clauses this leaves 2 days leeway. During this time the purchaser and their solicitor need to consider the bank’s offer, formally accept the terms and conditions and notify the vendor’s solicitors accordingly. Based on these timeframes it would seem that a 21 day finance clause in a management rights contract leaves no room for delays, public holidays, transaction complexity or work volume impacts at any point in the process. Now, let’s consider the same scenario with the added impact of a management rights valuation. The valuer simply can’t complete the report without the accountant’s verification report. It’s true that a substantial amount of work and research can be completed by the valuer pending receipt of the verification report. In the real world that’s exactly what happens. However, the valuer will still require time the study the report and incorporate the outcomes into the valuation assumptions. The final formal valuation report is then completed and provided to the lender. In that theoretical perfect world this will add at least 5 to 7 on to the process. Suddenly that 21 day finance clause is looking a bit shaky. As these scenarios demonstrate, the actual finance approval process takes about 5 days maximum. However, the bank relies on a number of other parties completing their jobs before a final approval can be achieved. And here’s the rub. When an over enthusiastic vendor pressures the agent or his lawyer to put a short finance clause in a contract guess who takes the rap. No matter where in the process the time frames blow out inevitably the net result is a finance date extension request. In fact I’ve even seen other service providers in the process request finance extensions to give them more time to complete their part of the overall job. This reflects poorly on the lender when in fact the ball has been dropped further up the line. So, what to do ? It’s pretty simple. Management rights sale contracts should have a minimum 28 day finance clause. Anything less is simply inviting stress, conflict and ill will. An acknowledgment of the commercial realities and timeframes by all parties would solve most of the problems. Oh, and don’t think you’ve dodged a bullet if you are selling a motel. Similar time frames apply given current lender guidelines for the same sort of financial due diligence reports we have traditionally see in management rights. Motel valuations in regional areas also seem to taking longer than usual these days.