Selling the family business: Hidden contractual liabilities

For many family-owned enterprises, the sale or succession of the business marks both the culmination of generations of effort and the start of a new chapter. Yet amid the focus on valuation, tax planning, and succession structures, one area often underestimated is the presence of any ongoing contractual obligations that may accompany the business into its next phase.

Any undisclosed or misunderstood contractual liabilities can significantly affect sale value, future exposure, and the validity of warranties and indemnities under the sale agreement. Sellers and buyers alike must therefore carry out detailed due diligence to uncover and manage these risks.

Share sale vs asset sale

When a family business is sold, whether by share sale or asset sale, the allocation of contractual liabilities will depend on the structure of the transaction.

• Share sale: The company itself remains the contracting party to all existing agreements. The buyer acquires both assets and liabilities, including historic and ongoing contractual obligations, unless released by counterparty consent
• Asset sale: Only the specific assets and contracts transferred are acquired.

However, many commercial contracts contain non-assignment clauses or change of control provisions that may restrict transfer without consent.

Regardless of structure, the due diligence process must uncover all potential obligations, both express and implied, that could materially affect the business’s ongoing viability or value.

Common sources of hidden contractual liabilities

Long-term supply and distribution agreements

Family businesses often operate on handshake arrangements later formalised into contracts that roll over automatically. Clauses to scrutinise include:

• Auto-renewal and minimum purchase commitments
• Exclusivity obligations limiting future flexibility
• Price review or indexation mechanisms that escalate costs over time
• Termination for convenience rights (or lack thereof)
• Indemnities, guarantees, warranties and liability.

Change of control clauses

These are particularly significant in share sales. Many commercial contracts (including key customer or supplier agreements) allow the counterparty to terminate or renegotiate terms upon a change of ownership. Failure to identify such clauses can lead to immediate loss of major contracts post-completion.

Warranties, indemnities and guarantees

Family shareholders may have given personal guarantees or cross-company indemnities to support business obligations. These can survive the sale unless expressly released. Key areas include:

• Bank facilities and finance leases
• Property leases (landlord guarantees, authorised guarantee agreements – AGAs)
• Equipment or vehicle hire-purchase agreements.

Employee and consultancy contracts

Inherited liabilities under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) must not be overlooked. Hidden obligations may often arise from:

• Enhanced redundancy or pension promises made informally over time
• Commission, bonus or profit-share arrangements
• Restrictive covenants enforceable post-sale.

Intellectual Property (IP) and licensing

Informal arrangements regarding trademarks, domain names or proprietary software may conceal ongoing royalty or licence fees, restrictions on sublicensing or assignment and IP created by contractors where ownership was never properly assigned

Prior to a sale, you will want to ensure that all relevant company IP required for the business to operate is either properly assigned to the company or appropriately licensed. It is also important to ensure that all relevant terms are clearly documented. This is particularly significant, as share purchase agreements often include such provisions as warranties, and for most companies, the purchase price may be directly linked to the value of the IP they own.

Due diligence

Thorough contractual due diligence is essential. Sellers should prepare a contracts schedule identifying all ongoing agreements, obligations, and contingent liabilities. Buyers will want to:

• Review not only principal contracts but also historic side letters, variations, and informal correspondence
• Confirm whether key consents (e.g., landlord, regulator, counterparty) are required
• Assess whether any undisclosed liabilities could trigger warranty claims post-completion.

In relation to a share sale, a comprehensive disclosure letter is crucial for the seller to limit future warranty exposure.

Corporate and succession considerations

In family business contexts, ownership is often intertwined with personal and trust structures. Practitioners should ensure:

• Shareholders’ agreements do not impose continuing obligations post-sale
• Pre-emption rights or drag/tag-along provisions are properly triggered
• Minority shareholders are not left with residual exposure under historic agreements.

Succession planning may involve transferring shares to family members or a family trust. Even where the business remains ‘in the family,’ the same principles apply, hidden liabilities can undermine the next generation’s success if not uncovered and managed.

Managing and mitigating risk

To mitigate exposure, you will want to think about:

• Conducting early-stage legal due diligence before marketing the business
• Preparing an internal audit of contracts, guarantees, and liabilities
• Seeking third-party consents well ahead of completion
• Using indemnities and retention mechanisms in the SPA to allocate risk appropriately
• Considering warranty and indemnity (W&I) insurance for significant deals.

Conclusion

Selling or passing on a family business is as much about uncovering what lies beneath the surface as it is about negotiating price or structure. Hidden contractual liabilities, if ignored, can erode value and expose both parties to avoidable disputes. Early legal review, detailed due diligence, and clear contractual drafting remain the best safeguards for ensuring a clean transition from one generation (or owner) to the next.

If you have any queries please contact our Commercial Team.