In Heads of Agreement to purchase a business, purchasers like to insert a subject to board approval clause, to give them the flexibility to walk away from the purchase. This clause is known as a ‘weasel clause’, because it permits a purchaser to ‘weasel out’ of the agreement.
The validity of a subject to board approval clause which was inserted into a Heads of Agreement as a condition precedent to the entry of a formal Business Sale Agreement was examined in a recent decision of the Court of Appeal, Supreme Court of New South Wales.
The decision is AMA Group Limited v ASSK Investments Pty Limited  NSWCA 45 (26 March 2021) (Bell P, Leeming JA and Emmett AJA agreeing).
AMA is a publicly-listed company which has businesses in the panel shop and car repair industry. It approached ASSK Investments to purchase the ASSK smash repairs businesses.
On 31 October 2019, following a period of negotiations extending over 18 months, AMA entered into a Binding Heads of Agreement (HOA) with ASSK Investments to purchase its smash repairs businesses for a price of $6 million.
These clauses of the HOA are relevant to the issues in this case –
2(b) The parties agree to enter into Business Sale Agreements subject to the terms and conditions set out in this Heads of Agreement.
6(a) The Vendor and Covenantor must make available to the Purchaser all things necessary for Purchaser to carry out a comprehensive due diligence on the Vendor, Business, Assets and the premises.
6(b) Subject to the above, the transaction will be recorded in a Business Sale Agreement.
7(b) All necessary third party consents, authorisations and approvals being obtained (including the Purchaser’s Board approval).
A full copy of the HOA is attached to the judgment. The Court labelled it “an infelicitous instrument” because of its drafting ambiguities.
Following the entry of the HOA, ASSK sent a Mutual Confidentiality Agreement to AMA for approval, AMA sent ASSK a “Due Diligence Checklist”, and the due diligence process was undertaken. Draft Business Sale Agreements were exchanged between solicitors.
After due diligence, the Chief Financial Officer of AMA decided not to submit the acquisition for Board approval. He was concerned that ASSK’s profit margins were not sustainable, and that the business would not be making the required EBITDA amount to make the purchase financially viable.
On 10 January 2020, the solicitors for AMA sent the solicitors for ASSK a letter which concluded:
“We further note that the HOA is subject to certain conditions precedent. In particular, clause 7(b) states that the approval of the Purchaser’s Board is to be obtained.
We are now instructed that our client’s Board has not approved the purchase …
Our client accordingly terminates the HOA, and the matter is at an end.”
ASSK was unhappy to lose the sale and decided to sue AMA for specific performance of the HOA.
The primary judge
The primary judge decided that on proper construction of the HOA, AMA as purchaser could not use the subject to board approval clause to terminate the HOA. He said it was ‘capricious, unreasonable, inconvenient and unjust’ for AMA to rely upon its own Board Approval as condition precedent which enabled it to terminate the HOA. He added: “Objectively viewed, I do not think that the parties intended this to be the case.”
Consequently, he ordered that AMA specifically perform the HOA. In doing so, the primary judge found that the HOA was a concluded contract capable of specific performance.
The Court of Appeal
The Court of Appeal upheld the appeal by AMA, holding that –
- Clause 7(b) of the HOA was valid as a condition precedent to AMA’s entry of the Business Sale Agreements
- The HOA could not be treated as a contract for sale of business because the HOA contemplated that Business Sale Agreements were required to be entered into
- The Court found that the parties’ objective intention was that a sale of the businesses would not take place unless AMA’s Board approved the purchase
- Consequently, as AMA’s Board did not approve the purchase, the HOA was validly terminated by AMA
The Court made these observations concerning the subject to board approval clause (7(b)) -
- ‘all necessary’ means that Board approval was a precondition to entry of the Business Sale Agreements
- ‘third party’ governs ‘consents’ and possibly authorisations, but not ‘approvals’ such as Purchaser’s Board approval
- Clause 7(b) is a condition precedent to the performance of the obligations contained in the HOA, the principal obligation being the entry into of the Business Sale Agreements
- The AMA’s promise to enter into Business Sale Agreements was conditional upon Board approval
- This interpretation is reinforced by clause 6(a) which states that “comprehensive due diligence” was still to be undertaken at the time of entry into the HOA
The Court made these observations concerning specific performance of the HOA:
- The HOA was conditional upon the entry of the Business Sale Agreements (see clause 2(b))
- The HOA was not comprehensive – no Material Contracts or Key Personnel had been identified, and there was the possibility of additional warranties included as a result of the due diligence; it was therefore not specifically enforceable
- The fundamental purpose of the due diligence was to ascertain whether the ASSK businesses were worth the amount of $6 million contained in the HOA
- The withholding of Board approval under the subject to board approval clause was not capricious: the requirement was that “any withholding of Board approval as referred to in cl 7(b) had to be simply honest and bona fide”; it may also need to be “objectively reasonable as well”. But this “was not an issue [to be decided] in the present case”.
A costs decision followed: AMA Group Limited v ASSK Investments Pty Limited (No 2)  NSWCA 116. The Court of Appeal decided to award AMA 50% of its costs on appeal “because of the shift in argument at first instance which appears to have contributed to the primary judge’s [faulty] reasoning”. The shift was an oral submission that the Board’s approval could be withheld capriciously, which was contrary to AMA’s written submissions.
The Court of Appeal has found that a subject to board approval clause can be effective so long as it is not exercised capriciously. In summary, the Court of Appeal:
- Upheld the validity of a subject to board approval clause in a Heads of Agreement for the purchase of a business as the basis for termination of the HOA by the purchaser.
- Held that to rely upon the clause, the purchaser’s board must have an ‘honest and bona fide’ reason to withhold approval, without deciding whether it must be ‘objectively reasonable as well’. The clause does not give an unfettered right to withhold approval.
- Decided that uncertainty about the future financial performance of the business, as a result of due diligence enquiry, was valid reason for the board to withhold approval.