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Many everyday contracts are finalised as soon as both parties sign. Some more complicated types of transactions, however, are broken down into different stages. This is often the case in contracts for the sale of a business. On a practical level, this can help to ensure that parties have enough time to fulfil their obligations under the contract. Typically, these transactions are broken down into:

  • exchange of contracts; and
  • settlement, which is also known as completion. 

It is important to understand this process and what will be required at each stage in order to finalise the agreement as easily and smoothly as possible. This article will outline the difference between exchange and settlement. It will also explain what happens at each stage of selling a business. 

Exchange

Exchange is the stage of the transaction at which the vendor and the purchaser both sign contracts. Each party then receives a copy of the other’s signed contract. Before signing, you should have a lawyer draft or review the contracts to make sure that you fully understand the terms and consequences of entering into the contract. Once you have both signed and exchanged contracts, the agreement becomes legally binding.

Exchange can take place in a number of ways. Generally, parties exchange contracts by either:

  • swapping hardcopy documents and having both parties physically sign the contracts; or
  • electronically exchanging and signing documents. Exchanging digitally may be a much more convenient process.

Sometimes, a contract requires that the purchaser pays a deposit at exchange. These requirements vary depending on the nature of the agreement. 

Settlement/Completion

‘Settlement’ and ‘completion’ are interchangeable terms that refer to when the sale of the business is finalised. Settlement takes place after each party has completed their obligations under the contract.

The settlement date (also known as the completion date) may be set a few weeks after both parties sign their contracts. The period between exchange and settlement gives each party enough time to prepare for when the business changes hands. Settlement should always take place after exchange. This is because prior to exchange there is no legally binding agreement to sell the business. It would be unfair to expect either party to begin undertaking their obligations under the contract without the guarantee that the other party will also perform their obligations under the contract.

As an example, Paul wants to sell his bookshop to his friend Jessica. Despite being good friends, both parties seek the assistance of lawyers.

Paul’s lawyer drafts the sale of business agreement and sends it to Jessica’s lawyer. After some negotiation, both parties agree on a finalised version of the contract. They sign and exchange contracts and Jessica pays Paul a 10% deposit on the total purchase price. The settlement date is four weeks after Paul and Jessica exchange contracts. Some of each party’s obligations before settlement include:

  • Paul carrying out a stocktake of the inventory in his bookshop;
  • Paul organising the transfer of assets, such as supply contracts and the business name;
  • Jessica organising finance for the outstanding payment amount;
  • Jessica offering employment to Paul’s employees who work in the bookshop;
  • Paul addressing any questions from Jessica about the bookshop and its business operations; and
  • assigning the lease for the bookshop premises to Jessica.

At settlement, Jessica pays Paul the outstanding amount and becomes the legal owner of the bookshop.

Key Takeaways

For practical reasons, some types of complicated contracts allow a set amount of time between exchange and settlement of the contract. In the context of a business sale, this process gives the parties enough time to complete:

  • their obligations under the contract; and 
  • all of the practical steps they must take to transfer a business.

If you need help in exchanging or settling a contract, contact LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.

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