Conditions Precedent are clauses or conditions in a Business Succession Agreement or legal agreement that prevent a Contract of Sale of the Equity being created until the Conditions have been satisfied.

They postpone the date of disposal of the Equity for CGT purposes until the date of satisfaction of the Conditions.

This avoids the risk that CGT will be payable on a disposal of the Equity from the date of the legal agreement, even though the sale has not occurred yet.

Framework Agreement

The fact that there is no binding Contract of Sale yet does not mean that there is no binding Business Succession Agreement.

The parties will still sign a Business Succession Agreement that is binding.

However, in a sense, the Agreement is a Framework Agreement that sets out the terms upon which a binding Contract of Sale might be created subsequently when the Conditions have been satisfied.

Example

The best way to understand the concept of a Framework Agreement is to consider an example.

If the Proprietors of the Business were Michael and Wendy, then there would be two alternative outcomes, depending on who died first.

If Michael died first, then the desired outcome would be a Contract of Sale pursuant to which Michael would sell to Wendy.

If Wendy died first, then the desired outcome would be a Contract of Sale pursuant to which Wendy would sell to Michael.

The problem is that nobody knows who will be the first Proprietor to die.

Because of this uncertainty, there is no point in having a binding Contract of Sale pursuant to which one Proprietor would have to sell to the other.

Equally, there is no point in having two binding Contracts of Sale.

In a sense, we have to wait until one Proprietor dies in order to know which Proprietor will be the Vendor and which Proprietor will be the Purchaser.

In effect, the Business Succession Agreement sits over the top of two "possible" Contracts of Sale, until we know who dies first.

The terms of the Contract are pre-agreed and certain.

The only thing that needs to occur is to insert the details of the Vendor and the Purchaser, which we can't do until we know who has died first.

When we know who has died first, we can insert the details of the Vendor and Purchaser.

At this point, one of the alternative "possible" Contracts of Sale becomes "real" and binding.

It is no longer just "possible".

It is now "actual".

If Michael died first, then there will now be a binding Contract of Sale pursuant to which he has to sell to Wendy.

However, just as one possible Contract of Sale has become "real" or "actual", the other "possible" Contract of Sale ceases to be a possiblility.

There can now be no possibility of a Contract of Sale pursuant to which Wendy must sell to Michael.

Michael has died and cannot be a Purchaser.

In summary, the Business Succession Agreement creates a framework that sits over the top of the alternative "possible" Contracts of Sale.

It sets out the terms of the "possible" Contracts of Sale.

However, there is no "actual" Contract of Sale, until the Conditions Precedent have been satisfied.

Conditions Precedent vs. Conditions Subsequent

The "actual" Contract of Sale only comes into existence when the Conditions Precedent have been satisfied.

In effect, the Conditions precede the formation or creation of the Contract of Sale.

Conditions Subsequent

Another method of drafting Conditions in a Contract is to use Conditions Subsequent.

This method of drafting works the opposite to Conditions Precedent.

When Conditions Subsequent are used, there is a binding Contract of Sale from the outset.

However, if the Conditions Subsequent are not satisfied, the binding Contract of Sale ceases to be binding.

It comes to an end or is terminated.

Adverse CGT Implications

However, because there has been a binding Contract of Sale from the outset, there has been a Contract of Sale of an asset for CGT purposes.

There has also been a disposal for CGT purposes.

The date of disposal is the date of the Contract of Sale, even though there is a possibility that it might cease to be binding or it might be terminated.

Thus, Conditions Subsequent do not postpone the date of disposal for CGT purposes.

As a result, Conditions Subsequent are not an appropriate method of drafting Business Succession Agreements.

Postponing the Date of Disposal

There are two alternative methods of drafting that effectively postpone the date of disposal for CGT purposes:

Put and Call Options; and
Conditions Precedent.

Click here to read about Put and Call Options.

The ATO has accepted that both methods work, as long as they are drafted properly.

CGT Issues

Both alternatives require careful drafting to avoid CGT liabilities.

Click here to read about the potential CGT liabilities.

This drafting is often not in standard Shareholders Agreements and Partnership Agreements.

Comparing the Alternatives

Put and Call Options require a party to know it has an Option and then to exercise it within the required time.

The Contract of Sale will only be created when the Option has been exercised.

However, in the case of a Death or Disability, there can be delays in locating a valid Will, identifying the Executor (or Trustee or Attorney in the case of a Disability), becoming aware of the existence of the Option and exercising it.

This can frustrate the intention of the Option and prejudice the interests of the parties.

In the case of Conditions Precedent, the Contract of Sale will be created automatically upon the occurrence of the Insured Event.

There is no need to exercise an Option.

Therefore, a party cannot be prejudiced by their ignorance of the existence of the Option.

IGS Drafting Preferences

IGS prefers Conditions Precedent where possible, because it is not necessary for one of the parties to physically exercise an Option.

However, the use of Conditions Precedent will incur stamp duty in NSW, SA, WA and NT.

IGS uses Put and Call Options in these jurisdictions.

Adviser Tip

"Conditions Precedent" and "Put and Call Options" are just methods of legal drafting that postpone the date of disposal of the Equity in the Business from the date of the Business Succession Agreement to after the date of occurrence of the Insured Event.

If correctly drafted, both methods are acceptable to the ATO.

See more Adviser Tips

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