It is common to see in almost all contracts for pharmacy business sales a clause making the sale conditional upon a satisfactory financial due diligence exercise being carried out by the purchaser’s accountant. As a consequence, prospective pharmacist vendors focus on ensuring that the appropriate accountancy work is organised in readiness for the purchaser’s financial due diligence inquiries.

However, both purchasers and vendors are mistaken if they assume that simply carrying out a financial due diligence constitutes a thorough due diligence exercise, especially in the absence of arranging for all relevant agreements to be checked from a legal perspective.

From the Vendor’s Perspective
To avoid any unforeseen complications with a subsequent sale, a prudent pharmacist vendor should involve his lawyer as soon as he decides to proceed to market his business for sale. This will allow the lawyer to assist in properly assembling the information required for the preparation of any formal sale contract including a complete list of assets, fixtures and fittings including details and copies of all leasing, hiring or rental agreements and other contractual documents which an astute purchaser (or their experienced legal adviser) will request for inspection.

Some examples to illustrate the value in this timely exercise include the following:

  • the vendor’s lease for his business premises may require formal renewal or renegotiation to ensure continued or improved security of tenure;
  • applicable leasing, hiring or rental agreements need to be carefully checked to confirm whether the vendor has the ability to transfer such agreements or whether penalties apply if they are terminated prior to their contracted expiry date;
  • has the vendor granted security over his pharmacy business (and/or the premises lease) and, if so, has the security documentation created a first and/or last right of refusal to purchase the pharmacy business in favour of the financier (or its nominee)?
  • is the vendor subject to a current franchise agreement with a banner group and, if so, what are the requirements regarding terminating such agreement or transferring the agreement to a prospective buyer?
  • in relation to the premises lease, what obligations does the vendor have in relation to obtaining the landlord’s formal consent to a transfer of such lease?
  • has the vendor got in place formal employment contracts with each of its employees and, if so, is the vendor aware of all of the consequences associated with such employees transferring to the purchaser as part of a sale of the business?
  • does the vendor operate a business structure incorporating a service company or service trust and, if so, are the appropriate service agreements in place?

From the Purchaser’s Perspective
A legal due diligence exercise, carried out either before agreeing to purchase a pharmacy business or where a purchase is conditional upon a satisfactory legal due diligence is considered a must for any prudent buyer of a pharmacy business. It is simply inadequate for a purchaser to rely on a financial due diligence carried out by his accountant as this financial exercise principally focuses on the trading figures and performance of the business and does not extend to the key contractual documentation.

For example, a pharmacy may have a high percentage of its turnover associated with nursing homes, special accommodation facilities and other similar establishments pursuant to fixed term contractual arrangements. These contractual arrangements need to be carefully reviewed by the purchaser’s lawyer so that the purchaser is in the best position to assess the certainty of such nursing home related turnover continuing after the purchaser takes over the business. This due diligence exercise would include focussing on clauses dealing with:

  • the vendor’s ability to transfer the arrangements and, if so, whether each establishment must not unreasonably withhold its consent;
  • the remaining length or duration of each agreement and whether the institutional establishment has the ability to terminate the agreement prematurely; and
  • whether each agreement gives the vendor pharmacist exclusivity or is that pharmacist merely appointed as a preferred supplier?

With all pharmacies, the business premises is a critical component. Accordingly, the legal due diligence exercise should incorporate a full review of the current premises lease by the purchaser’s lawyer, to enable the purchaser to independently verify important matters such as:

  • the current remaining term of the lease;
  • the length and number of any option terms remaining including the basis upon which the tenant may exercise such options;
  • the method and frequency of rent reviews during each lease term and at the commencement of each option term;
  • whether or not GST is chargeable in addition to the rent;
  • the provisions which must be satisfied by the vendor and purchaser (eg. the number of references that a purchaser must provide) in order to obtain the landlord’s consent to a transfer and whether the landlord has any ability to effectively seek changes to the lease as part of the consent process (eg. has the landlord got the right to require the incoming purchaser to provide an increased security deposit, or has the landlord got the ability to review the rent payable as from the transfer date?);
  • does the lease specify a specific permitted use which is too narrow and does not extend to all of the ancillary business activities being conducted by the pharmacy business being purchased;
  • does the lease impose minimum trading hours which the tenant is required to be opened, which clearly exceed the current trading hours of the business being purchased.

Conclusion
It is vital that both sellers and buyers ensure that their respective lawyers undertake a detailed legal due diligence exercise in connection with all of the relevant contractual agreements at the earliest opportunity. In the case of a seller, it is recommended that this legal due diligence is carried out before the seller places the business on the market. From the buyer’s perspective, it is recommended that the legal due diligence exercise is carried out preferably before negotiations for the sale terms have been completed.

Prepared by
Anthony Cannizzo
Partner
Robert James Lawyers
Level 10, 200 Queen Street
Melbourne Vic 3000

E-mail: anthony@robertjames.com.au
Web site: www.robertjames.com.au
Tel (03) 8628 2000
Fax (03) 8628 2050