Advice and Opinion

'How To' purchase a legal entity which owns commercial property

There are two primary ways of purchasing a commercial property. The first is where a seller sells the commercial property to the purchaser and the second is where the seller sells their legal entity, such as a company, close corporation or trust to the purchaser. “The differences between these two approaches are significant and definitely worth considering,” says, Kenneth Clarkson and Janet Gannon, commercial brokers of Rawson Commercial Kloof in Durban.

Selling a commercial property to a purchaser

“When a commercial property is purchased from an individual,” says Gannon, “the services of a conveyancing attorney is required. This is a professional who not only arranges for the cancellation of the existing mortgage bond over the property, but also obtains the necessary municipal rates clearance certificate, a SARS tax certificate, an electrical compliance certificate as well as all other clearances and documentation required for the transfer to take place. The conveyancer then lodges the required documents at the Deeds Office, where the transfer of ownership over the property passes from the seller to the purchaser”.

The applicable transfer fees can be costly, and these fees must be paid prior to lodgement at the Deeds Office. Where a seller and a purchaser are both registered VAT vendors, transfer fees may not be applicable. However, such a transaction would still require VAT to be paid on the purchase price with the remote possibility of SARS refunding the full VAT three to four months after transfer has taken place.

The seller will only receive the net proceeds from the sale, two to three weeks after the bond has been lodged at the Deeds Office, assuming there were no delays during the lodgement process.

Selling a legal entity to a purchaser

“When purchasing the legal entity which owns the commercial property it is the shareholding of the shareholders,” says Clarkson, “or the interests of the members, that are ultimately transferred. The services of a reputable accounting officer or auditing firm, as well as a commercial attorney or conveyancing attorney who understands this method of sale is generally required.”

The accounting officer or auditing firm needs to ensure that the annual financial statements as well as the tax affairs of the legal entity being purchased are all up to date. In addition, Clarkson advises that it would be prudent to investigate the legal entity’s bank statements to ensure the cash flows of the legal entity are understood, as well as to ensure that there has been no misappropriation of funds, or concealed debts which could potentially adversely influence the liquidity and continued functioning of the legal entity.

The commercial attorney or conveyancing attorney’s function is also slightly different in this method. They are required to check the legalities of the transaction, the unencumbered state of the legal entity, that no other person or legal entity holds any option to purchase any interest in the legal entity, and that the property is not subject to any pledge or restraint. They must also ascertain that the entity is not engaged in any current or pending litigation proceedings, or that there are any other pending or probable claims against the legal entity. There should also be no other outstanding liabilities, other than the mortgage bond, which may require settlement once the transfer of ownership takes place.

So which option is best?

Selling a legal entity to a purchaser can be a quicker process than selling the property to the purchaser. As opposed to the transfer of the property happening in the Deeds Office, it is only the shareholding or member’s interest, as well as the directors or members of that entity, which needs to be amended in the legal entity’s registration documents. This amendment is facilitated through an application to the CIPC, which is the Companies and Intellectual Property Commission, previously referred to as “CIPRO”.

Another advantage of selling the legal entity to the purchaser, is that no VAT is payable on the purchase or transfer of shares or members’ interests. This amounts to a substantial cash flow saving of fourteen percent of the purchase price, an incentive which alone sparks the interest of many investors.

Any transaction is, however, subject to potential pitfalls, especially in the case of purchasing a legal entity.

Firstly, the various checks performed by the accounting officer, auditing firm, commercial attorney or conveyancing attorney are all complicated further if the legal entity being purchased also conducts other business activities. It is therefore advisable that this option be reserved for those situations where the only business activity conducted by the legal entity being purchased, is that of renting the relevant commercial property out to existing tenants.

Secondly, the legal entity being purchased could potentially have hidden liabilities, as well as litigation proceedings initiated against it. It would therefore be prudent to secure an indemnity from the seller, from all existing debts and litigation proceedings from date of signature of the agreement.

Thirdly, if there is a mortgage bond over the commercial property, the relevant financial institution will need to consent to the change in shareholding or members’ interest. This seems strange, as ownership of the property remains within the legal entity being purchased. However, when originally contracting with the legal entity, the financial institution’s legal agreements with that entity would have sufficiently catered for such circumstances, and this cannot be overlooked by either the seller or the purchaser. The option of selling the legal entity to the purchaser should therefore be reserved for a situation where either the purchaser is financially strong and likely to be favourably assessed by a financial institution, or where the property is bond free.

“The process whereby a seller sells their legal entity to a purchaser, as opposed to the normal method where the seller sells the commercial property to a third party,” Gannon concludes, “is not a common method of purchasing property. Nevertheless, this method is gaining popularity, especially when buyers realise the savings in costs and time. Investors should, however, approach this method of sale with a combination of caution and prudence, ensuring at all times that the sale agreement sufficiently covers the potential risks involved.”