New York Trying to Impose Sales Tax on Acquisition of Equity of LLC

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Buyer acquires all equity of the target, an LLC, and a disregarded entity. NY Division of Tax Appeals upholds NY’s $125K sales tax assessment on target’s tangible personal property.

M&A Stories

February 26, 2021

Introduction

M&A lawyers know that there will be no sales tax in a stock acquisition because sales tax only applies to an asset acquisition, the acquisition of tangible personal property. Why? Because sales and use tax only applies to the sale of tangible personal property, and stock is intangible personal property. Same when buying the equity (that is membership interests) in a limited liability company. LLC membership interests are also intangible property. But maybe not in New York.

The deal

The New York based buyer, provides online business and investment information to its customers through numerous subscription products.

It became interested in acquiring a New York based target in 2012. The target is a media company that publishes sophisticated coverage of the mergers and acquisitions environment, primarily through a leading digital provider of transactional information services.  The target provides its products and services through print, online, and in-person platforms.

The buyer offered to purchase the target’s assets. The target countered with an offer to sell its equity. The target was a single member limited liability company and a disregarded entity for federal and state income tax purposes.

On September 11, 2012, the buyer purchased all of the target’s membership interests from the seller for $5.8 million, pursuant to the terms of an “Equity Interest Purchase Agreement”. The target continued business operations after the closing as a single member LLC and as a disregarded entity for federal and state income taxation purposes.

The tax controversy

New York’s Division of Taxation performed a sales tax audit of buyer and target in 2014. Based upon the audit New York proposed a $125K sales tax assessment on the target’s tangible personal property. The taxpayer, to no avail, protested that it purchased the target’s equity not the target’s assets.

The dispute ended up before an administrative law judge of New York’s Division of Tax Appeals. After a hearing the Administrative Law Judge upheld the $125K sales tax assessment.

The judge said that the transaction was an acquisition of assets. It pointed to the fact that there was an allocation of purchase price in the purchase agreement, and that the buyer commingled the target assets on its balance sheet.

This case is referred to as In the Matter of the Petition of Thestreet.Com, Inc. (a/k/a The Streete, Inc.) DTA NO. 828467, State of New York, Division of Tax Appeals, (February 4, 2021); https://www.dta.ny.gov/pdf/determinations/828467.det.pdf 

Comment

This decision can’t be right. The auditor and administrative law judge were persuaded by facts that do not establish that the target sold its assets to the buyer.

The purchase agreement’s requirement for a purchase price allocation did not change this equity acquisition into an asset acquisition. It was used because the target was a disregarded entity for federal and state income tax purposes and thus (for federal and state income tax purposes) the deal was a sale of assets by the target to the buyer and not a sale of the target equity by the target’s owner to the buyer.

New York could have passed a law saying that a disregarded entity in New York is disregarded not only for New York income taxes but also New York sales and use tax. No such law was mentioned in the administrative law judge’s decision.

The other fact that New York latched on to was that the target assets were included in the buyer’s balance sheet, post-closing. I don’t know if post-closing commingling target assets on the buyer’s balance sheet is consistent with generally accepted accounting principles, but that does not convert an equity acquisition into a asset acquisition.

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in sales tax imposed on equity sale of DRE Tagged with: ,

Business Seller Faces $600K Broker Claim on Deal That Didn’t Close

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Sale of business failed to close because spouse of the founder refused to sell.

M&A Stories

February 23, 2021

Introduction

Business brokers can help you sell your business. However, the broker listing or engagement agreement creates legal obligations which need to be understood by the seller before signing.

The deal

The seller here operates a Texas based business which provides patent drawings and other services to customers. The founder decided to sell the business and entered into a listing agreement with a broker.

The broker brought a buyer to the table and the seller and buyer executed a letter of intent for a $6.5 million acquisition. But the deal did not close. The founder’s wife, about two weeks before expected date of the execution of the asset purchase agreement and closing, announced that she refused to sell.

The lawsuit

The seller did not pay a commission to the broker and that resulted in a broker $600K lawsuit against the founder in a Nashville federal district court. The founder moved to dismiss the lawsuit.

The court looked at the listing agreement which said: “In the event the Broker finds a willing buyer and the Company decides not sell, [sic] the Broker will still be owed full commission described above. This is to protect all of the time and expenses the Broker is investing into this process.”

That language clinched it for the court, and it denied the founder’s motion to dismiss the broker’s $600K claim: “Therefore, the Court finds that Broker has plausibly alleged that he found a “willing buyer” and that he is entitled to damages.” 

This case is referred to as Ross v. Kirkpatrick, No. 3:20-cv-00536, United States District Court, M.D. Tennessee, Nashville Division, (February 12, 2021)  

Comment

As a seller’s lawyer I would want the broker to be paid only if there is a closing. Then I know there will be no dispute over whether the broker should be paid because there could be no fight over whether the closing occurred or not.

However, would not it be fair to pay the broker if he or she brought a willing and able buyer to the table at the right price, even if the deal does not close? The listing agreement in this deal said yes.

However, the “willing buyer” term is, as described by the court in this case, an ambiguous term. A seller should look to see if this kind of term is in their proposed broker agreement, because if it is, the seller may be on the hook for a broker’s commission even if a sale does not close.

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in investment banker/business broker, willing buyer or procuring cause Tagged with: ,

Asset Buyer’s Substance Over Form Argument Wins $3 Million Amortization Deduction

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The IRS challenged the buyer’s $3 million amortization deduction in an asset acquisition based upon the structure chosen by the parties to the transaction. The tax court however, allowed the amortization deduction based upon the economic substance of the transaction.   

M&A Stories

February 18, 2021

Introduction

The IRS often is successful in squeezing more taxes out of an acquisition by arguing that the economic substance of a transaction is more important than the form chosen by the parties. But not in this case.

The deal

The target media business focused on popular and emerging trends in style, sneakers, food, music, sports and pop culture. The seller sought additional financing and the buyer agreed to acquire the assets of the business for stock.

However, friction developed between the buyer investors and one seller partner. This resulted in a restructuring of the deal where the purchase price would be paid with a mix of buyer stock and $3 million cash. The cash would be used to redeem the one seller partner’s interest in the seller.

Unfortunately, the transaction’s structure was not that straight forward. The documents required the buyer to purchase the seller business assets from the seller for buyer stock. Then the buyer was required to repurchase some of the stock from the seller for approximately $3 million in cash. Then the seller was required to redeem the one seller partner’s interest in the seller for approximately $3 million in cash.

The lawsuit

The buyer claimed a $3 million amortization deduction. The IRS challenged this position arguing that the buyer was tied to the form of the transaction which was a tax-free acquisition of assets solely for stock; meaning no $3 million amortization deduction.

The buyer filed a petition with the Tax Court. It argued that the substance of the transaction was an acquisition of the seller’s assets for approximately $3 million in cash plus buyer stock. The Tax Court agreed and held that the second step repurchase of the buyer stock from the seller for approximately $3 million cash was a buyer payment to the seller for the seller’s assets: “(The buyer’s) … issuance and immediate redemption of 1,875,000 common shares had no economic substance and thus … (is) … disregarded under the step transaction doctrine, with the cash … treated as additional consideration for the assets … (the buyer) … acquired from … (the seller) …. 

This case is referred to as Complex Media, Inc. v. Commissioner Of Internal Revenue, Docket Nos. 13368-15, 19898-17.[1], United States Tax Court, (Filed February 10, 2021)  

Comment

Have a hunch that the tax experts were not consulted when the deal was restructured. Normally, a court would not let a taxpayer use the substance over form argument. The substance over form argument usually only words for the IRS.

The lesson here is to make sure that the form of the deal lines up with the substance of the transaction. Best way to do that is to have your tax advisors in the loop from start to closing.

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in amortization, form over substance, substance over form, Taxation Tagged with: ,

“No Harm No Foul” M&A Language Extended Time to Make Indemnification Claim

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APA excused business buyer’s failure to make indemnification claim by expiration of the survival period because there was no “actual and material prejudice” to the seller.

M&A Stories

February 15, 2021

Introduction

Agreements for the acquisition of private companies usually contain comprehensive representations and warranties of the seller that survive the closing. However, the buyer usually must make its indemnification claim by the expiration of a “survival period.”

The deal

This deal was a strategic agtech acquisition. A St Louis based buyer purchased the assets of an Iowa based seller engaged in the business of soybean research and breeding for $14 million, pursuant to an asset purchase agreement and related documents. There was a purchase price adjustment based upon the difference between the estimated and actual closing accounts payable, and it was secured by a $250K escrow.

There was also a $750K escrow to secure the seller’s indemnification obligations.

The lawsuit

The buyer and seller relationship soured after the February 9, 2019 closing. The seller’s founder was hired as the buyer’s chief technology officer. According to the buyer, shortly after the closing the seller’s founder hatched plans to compete with the purchased business; began soliciting its customers and disclosing his competitive plan in the process; and began sharing Buyer’s confidential and proprietary information. Buyer terminated the employment of the seller’s founder within 2 months of the closing.

In addition, the buyer discovered that the seller and its founder engaged in pre- and post-closing conduct that allegedly breached certain APA representations. For example, the buyer learned that the seller failed to disclose material contracts and their attendant obligations, as well as encumbrances on certain accounts receivable, and that the seller potentially misrepresented that it had not been violating or infringing any intellectual property by conducting its business.

As a result, the buyer made a claim for indemnification against the $750K indemnification escrow and this dispute ended up in the Delaware Court of Chancery. The seller asked the court by way of a motion for summary judgment, to release the $750K indemnification escrow fund to the seller because the buyer failed to make an indemnification claim within the time period required by the acquisition documents.

The court agreed with the seller that the buyer’s claim was late, by several days of the specified deadline of the first anniversary of the closing. However, it refused to release the funds because there was language in the acquisition documents that excused the buyer’s tardiness if the seller was not “materially prejudiced” by the delay. The court so held, and thus the $750K indemnification escrow will remain in escrow pending the resolution of the litigation.

This case is referred to as Schillinger Genetics, Inc. v. Benson Hill Seeds, Inc., C.A. No. 2020-0260-MTZ, Court of Chancery of Delaware, (Submitted: October 5, 2020. Decided: February 1, 2021).  

Comment

Buyers should consider putting this kind of “grace period” language in their acquisition agreements. Nevertheless, buyers should also remember to carefully follow indemnification deadlines, including the procedure for making indemnification claims.

The buyer here also wanted to claw back $80K in a purchase price adjustment from the $250K escrow which was to secure the accounts payable purchase price adjustment mechanism. However, it forfeited its right to do so because it was two months late in giving the seller its calculation of the closing accounts payable. There was no “grace period” for being late in the purchase price adjustment mechanism.

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in escrow, excuse for untimely indemnification claim, indemnification Tagged with: ,

Idaho Wants $1.4 Million in Taxes Claiming Share of $120 Million Gain from Sale of Equity in Virginia Pass-Through

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Idaho argues that gain from the sale of a majority interest in Virginia pass through LLC was apportionable business income, not nonbusiness income allocable to Virginia as reported by the Virginia owner.

M&A Stories

February 9, 2021

Introduction

Selling a successful business means federal and state income taxation of the gain. One risk of selling a business with multistate operations is the risk that more than one state will lay claim to taxing the same gain.

The deal

The taxpayer in this case was a Virginia S corporation formed by a former U.S. Navy SEAL. The founder started the corporation’s business in his garage, designing and manufacturing a variety of gear for military, law enforcement, and recreational use.

For about a decade, his company manufactured and sold tactical gear until 2003 when the founder transferred the net assets of his Virginia S corporation to a new company of his creation, a Virginia limited liability company or LLC, in exchange for about 79% of the company. The rest of the LLC was owned by others. The LLC was a pass-through entity meaning that the LLC did not elect to be treated as a C corporation.

As a result of the 2003 transaction, the founder’s Virginia S corporation was a holding company for his majority interest in the Virginia LLC. The S corporation also leased some Virginia real property to the LLC.

The Virginia LLC established a physical presence in Idaho in 2004 when it purchased and developed real property, commenced sales of its products, and hired employees in Idaho. Then, in 2007, the LLC leased a factory in Boise to serve as its “operation center” for the West Coast. The Boise factory was one of four U.S. factories that produced product. By 2010, the LLC “operated in substantially all of the states” and held approximately $20 million worth of real and personal property in Idaho. In contrast, the founder’s Virginia S corporation, never owned any real property in Idaho.

The founder exited the business in 2010 by causing his holding company Virginia S corporation to sell its interest in the Virginia LLC for $120 million. The S corporation reported its gain on its Idaho tax return but allocated all of the gain to Virginia as nonbusiness income. Meaning the Virginia S corporation seller paid no Idaho tax on the gain.

The lawsuit

Idaho proposed a $1.4 million tax deficiency claiming that the S corporation’s gain was business income and partly taxed in Idaho. The selling Virginia S corporation said that the gain from the sale of the interest in the Virginia LLC was not taxable by Idaho because the gain was nonbusiness income, allocable to Virginia and taxable only by Virginia.

The dispute ended up in court. Both the trial court and Idaho high court agreed with the taxpayer. The Idaho Supreme Court held that the S corporation was a passive holding company and thus gain from the sale of its interest in the LLC was nonbusiness income and not business income. However, two justices of the five member Idaho Supreme Court dissented.

This case is referred to as Noell Industries, Inc. v. Idaho State Tax Commission, Docket No. 46941, Supreme Court of Idaho, Boise, January 2020 Term, (Opinion filed: May 22, 2020)  

Comment

The case is not over. Idaho has asked the U.S. Supreme Court to reverse the result.

The law in this area is not settled. There is a risk that a selling owner of an interest in a multistate business may be subject to double taxation.

However, there is a process for mediation and arbitration of this kind of dispute under the Multistate Tax Compact. In this case the process would involve a dispute resolution procedure involving the Virginia S corporation, Virginia and Idaho. See INSIGHT: Persistence Pays Off in Sale of Idaho Pass-Through Entity https://www.bradley.com/-/media/files/insights/publications/2020/07/sup-materialsarticle-persistence-pays-off-in-sale-of-idaho-passthrough-entity-bely-july-2020.pdf

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in nonbusiness income, state and local tax Tagged with: ,

Tax Due Diligence May Save Buyer Time and Money in Stock Acquisition

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Buyer of business was told by target owner that all taxes had been paid prior to the signing of the stock purchase agreement. Buyer ends up paying significant pre-closing target tax liabilities after closing and suing target owner for fraud.

“Trust, but verify.” Old Russian proverb.

M&A Stories

January 29, 2021

Introduction

Buying the equity of a business, whether a corporation or a limited liability company means that you are also assuming all of the target company’s unpaid tax liabilities.

The deal

The target in this deal was a corporation that specialized in the human resource placement of software engineers. The target owner agreed to sell the target to the buyer in a stock sale. Before the stock purchase agreement was signed, the target owner told the buyer “that all taxes [were] paid up to date.”

The deal closed in early 2019. In late 2019, the buyer received notice of several outstanding tax obligations for target dating back to 2017

The lawsuit

That and other deal problems resulted in a Florida federal district court lawsuit. One of the buyer’s claims against the target owner was for misrepresenting that all target taxes had been paid in full. The target owner tried to get the fraud claim dismissed. That was unsuccessful but cost the buyer time and legal costs in keeping the claim alive. 

Now, the buyer will now have to spend time and money in preparation for a trial in order to obtain reimbursement from the target owner for the pre-closing target taxes, along with legal costs.

This case is referred to as SYRAINFOTEK, LLC v. SAKIRROLA, Case No. 8:20-cv-797-T-33CPT, United States District Court, M.D. Florida, Tampa Division, (June 3, 2020). 

Comment

When you buy all of the equity of a company, you are buying all of the company’s tax liabilities, including federal, state, and local taxes; including income, sales, use, employment, and property taxes. A target’s tax liabilities include all unpaid taxes reported on the target tax returns. It also includes all taxes not reported on tax returns and all taxes owed on tax returns that should have been filed, but were not.

Ideally, the best way to minimize a buyer’s risk to pre-closing tax liabilities is to perform tax due diligence. Tax due diligence is a comprehensive examination of the different types of taxes that may be imposed upon a particular business, as well as the various taxing jurisdictions in which it may have sufficient connection to be subject to such taxes.

The goal of tax due diligence is to uncover significant potential tax exposures. That is, an amount of potential tax exposures that would affect a buyer’s negotiations or decision to proceed with a transaction.

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in due diligence, tax Tagged with: ,

Hospital Buyer and Seller Fight Over Medicare-Medicaid $2.4 Million Payment

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Court interpreted APA as giving the hospital buyer the right to a $2.4 million interim lump sum adjustment determined by audit of seller services.

M&A Stories

Try to make you’re M&A documents user friendly: “Please, speak as you might to a young child, or a golden retriever” — From the film “Margin Call”

January 22, 2021

Introduction

A common issue in an acquisition is how to handle post-closing settlements with customers for pre-closing sales and services. The solution depends upon the target business.

The deal

This deal involved the acquisition of the assets of two hospitals. These hospitals received a significant amount of their revenue from Medicare and Medicaid. The hospital received Medicare and Medicaid payments every two weeks. The payments were calculated by Medicare and Medicaid based upon the overall projected claims for payment for the full year. These payments were an estimate based upon the seller hospitals’ budget and projections and was susceptible to upward or downward adjustments during the course of a year.

The payments were reconciled on an interim and final basis to ensure that the payments accurately reflect the actual value of the claims processed by the seller hospitals. In the event that the interim and final review of payments reflects that the seller hospitals had been underpaid, Medicare/Medicaid can modify the amount of every two-week payment and/or issue a lump sum adjustment to bring payments received in line with reality and updated projections. If the review indicates that the hospitals has been overpaid, the seller hospitals must remit funds back to Medicare directly or via offsets to future payments.

About two months before the closing, the Medicare auditor sent its report to the seller which contained an analysis of the payments made to the seller in the first six months of 2019, along with a projection of services the seller was expected to provide for the balance of the calendar year. Based upon that analysis, the auditor determined that the two hospitals were entitled to a lump sum adjustment payment in the amount of $2.4 million.

Payment of the amount to the seller was delayed due to the seller’s bankruptcy filing. The deal closed September 30, 2019.

The lawsuit

The seller received the $2.4 million lump sum adjustment 2 days after the closing. Subsequently, in April 2020, the seller prepared their final cost report which reflected amounts due to Medicare/Medicaid in the amount of $2.3 million. The overpayment liability was owed by the buyer to Medicare/Medicaid under the asset purchase agreement.

The buyer claimed that it was entitled to the $2.4 million lump sum adjustment that the seller received from Medicare 2 days after the closing.

The dispute ended up in a Delaware bankruptcy court. The court said that the $2.4 million lump sum adjustment received by the seller was not a receivable (which is an excluded asset under the APA and not acquired by the buyer). Instead, was a “settlement” asset purchased by the buyer.

The court supported its decision by the words of the asset purchase agreement: a receipt “(i) relating to supplemental, disproportionate share or waiver payments, or Medicaid GME funding with respect to time periods prior to the Closing Time; (ii) relating to the Seller Cost Reports or Agency Settlements (whether resulting from an appeal by Sellers or otherwise) and other risk settlements with respect to time periods prior to the Closing Time …” 

This case is referred to as In Re Hospital Acquisition LLC, Case No. 19-10998 (BLS), United States Bankruptcy Court, D. Delaware, (December 21, 2020). 

Comment

Certainly, it is fair result since the buyer had to pay back the overpayment. Don’t know if the APA language quoted by the court gets you there, but maybe. That language was hard to follow.

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in post-closing adjustments for pre-closing sales and services, receivables Tagged with: ,

SEC Sues Target Officers for Fraud, Seeking Millions of Dollars in Damages

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SEC accuses Target’s CEO and CTO of lying to the buyer about owning a game changing product and overstating the target backlog and pipeline.

M&A Stories

Taking the high road in M&A negotiations is good business: “It’s a rough road that leads to the heights of greatness.” — Lucius Amnaeus Senaca

January 19, 2021

Introduction

The purchase price in an acquisition is usually based upon the target’s future earning potential. It is important that target management be honest in the representations of material facts that it makes in support of the forecasts it provides to a buyer. Because, there may be serious consequences for target management if the material representations of fact are not true.

The deal

The target was an Israeli privately held company that sold cell phone and satellite interception products. The buyer is a public company, a Florida based blank-check, or special-purpose acquisition company. The target was acquired by the buyer in 2015 in a merger transaction resulting in target becoming a public company.

Prior to closing, the target officers claimed $148 million in backlog and pipeline revenue and forecast fiscal year 2016 revenue of $108 million. Furthermore, the officers said that the target owned a game changing product.

The lawsuit

Unfortunately, after the closing, the target recognized only $16.5 million of 2016 revenue and posted a 2016 net loss of $8.1 million.

As it turned out the target did not own the game changing product. Instead, it had a reseller arrangement with the owner where it was would earn 50% of product revenues. And the claimed backlog in the words of the SEC complaint “was, in fact, not supported by actual, signed purchase orders. In addition, and also unbeknownst to the shareholders, a large part of the order backlog was with … (the target’s) … largest and most significant customer – a Latin American police agency – that were based only on oral agreements with management who had been terminated as a result of the then-recent prison escape of a notorious international narcotics trafficker.” 

The SEC wants to recover the officers’ profits from the deal, plus, interest and penalties. The SEC also wants the target CEO permanently barred from serving on as an officer or director of a public company.

The federal district court in Manhattan denied the officers’ motion to dismiss the SEC action and the litigation continues.

This case is referred to as Securities and Exchange Commission v. Hurgin, No. 19-cv-5705 (MKV), United States District Court, S.D. New York, (September 4, 2020) 

Comment

There are questions for both buyers and sellers from this deal. Could the buyer have discovered, in due diligence, that the game changing product was not owned by the target and that the product revenues would have to be shared equally with the product owner under a reseller agreement? Could the buyer have compared the claimed backlog and pipeline with target’s signed purchase contracts?

If the SEC claims are true, was it worth it to the CEO and CTO to lie about the target company if they have to give up their profits, and for the CEO, if he has to give up permanently, the right to serve as an officer and director of a public company?

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in fraud in business sale Tagged with: ,

Judgment Against Buyer CEO for Lying to Target Is Nondischargeable in Bankruptcy

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Target principals’ judgement against Buyer CEO for fraudulently promising them buyer stock and royalties generated from post-merger sale of target products not dischargeable in Buyer CEO’s personal bankruptcy.

M&A Stories

Taking the high road in M&A negotiations is good business: “It’s a rough road that leads to the heights of greatness.” — Lucius Amnaeus Senaca

January 14, 2021

Introduction

Lying to make an acquisition happen can come back to bite you. And even personal bankruptcy might not save you.

The deal

The target in this deal developed and marketed computer software. It was acquired by a publicly traded technology company. As part of the deal the buyer CEO promised the target principals that they would receive buyer stock and royalties generated from post-merger sale of target products.

They did not receive stock or royalty payments.

The lawsuit

The two target principals obtained a judgment against the buyer CEO for intentional misrepresentation and a claim for violation of the Connecticut Unfair Trade Practices Act. They obtained judgments against the buyer CEO for judgment for over $1.3 million, which included punitive damages and attorneys’ fees, and interest, accruing on the judgment at the rate of 4% per annum from February 17, 2011.

The buyer CEO filed for personal bankruptcy. The target principals objected to the discharge of the judgment in personal bankruptcy and the bankruptcy court determined that the target principals’ judgment against the buyer CEO was nondischargeable. Meaning that the buyer CEO still owes the target principals (including interest) about $1.8 million. 

This case is referred to as In Re Parrella, Case No. 18-51613 (JAM), Adv. Pro. No. 19-5008 (JAM), United States Bankruptcy Court, D. Connecticut, (October 28, 2020). 

Comment

There is a simple lesson here. When buying a company, don’t lie. Keeping your promises is hard enough. But, if things go bad, you can probably file for bankruptcy.

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

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Shareholder Can’t Challenge Board Merger Approval Because No Change of Control

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A shareholder could not sue his directors for accepting a merger proposal for a claimed lower price than offered by another suitor because each target shareholder was to exchange each target share of stock for 1/3rd cash and the other 2/3rd of consideration in shares from a company “in a large, fluid, public market.”

M&A Stories

January 13, 2021

Introduction

No event is more important to a company than when considering a sale or merger. And the responsibility to manage this process falls directly on the board of directors. Not surprisingly, some shareholders may not like the board’s course of action

The deal

The target in this deal was a publicly traded Maryland corporation that operated a Michigan community bank. The directors of the target accepted the offer by a much larger publicly traded community bank to merge the target into the buyer where each target share currently trading at about $42 would be exchanged for $14 cash and buyer stock.

The lawsuit

A target shareholder filed a lawsuit in a Michigan state court against the board after the board had approved the merger and submitted a proxy to the shareholder for approval. The shareholder sued to stop the deal on that grounds that the board had breached its duty to the shareholders to maximize shareholder value. The shareholder alleged that the board had turned down a higher offer from another suiter.

The trial court dismissed the lawsuit and the shareholder appealed to a Michigan intermediate court of appeal. The court of appeal affirmed the dismissal. The court said that under applicable Maryland law, the shareholder could only sue the directors directly for breach of their duty to maximize shareholder value if the proposed merger was a change of control transaction.

In this case, the target shareholders were receiving 2/3rd of their consideration from a widely held public company. This, the court held was not a change of control transaction. 

This case is referred to as Finke v. Vanderkelen, No. 345621, Court of Appeals of Michigan, (May 21, 2020)  unpublished, per curiam. 

Comment

A director duty to maximize a shareholder transaction was first recognized in 1986 by the Delaware Supreme Court in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). The “Revlon Doctrine” is currently recognized by at least 9 states (California, Delaware, Illinois, Kansas, Maryland, Michigan, Minnesota, Missouri, and New Hampshire).

But when does it apply? Clearly in any all-cash transaction. Also, any stock transaction where, or—in the case of a stock-for-stock acquisition—an acquisition in which a widely held public stock is exchanged for shares of a company in which there is a controlling shareholder. The principal transaction type that does not trigger Revlon is the stock-for-stock deal in which the post-closing entity remains widely held by stockholders.

By John McCauley: I help people manage M&A risks involving privately held companies.

Email:              jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in Change of Control, Revlon doctrine Tagged with: ,

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