Allegations were enough, if true to establish that business sellers breached their noncompetition, nonsolicitation and confidentiality covenants

Buyer is a full-service specialty contract manufacturer of automotive, household, insecticide, and pesticide aerosols, based in St. Clair, Missouri, about 50 miles southwest of St Louis. Target is a specialty chemical contract packager, which manufactures aerosols, liquids, and bag-on-valve products, and is based in the greater Atlanta area.

Sellers, Chris and Maria, were owners of Target. On December 15, 2015, Buyer acquired Target from Sellers for $100 million pursuant to a stock purchase agreement. Sellers, in the stock purchase agreement, represented and warranted that Sellers had not received any bribe, kickback payment or other illegal payment.

Sellers, in the stock purchase agreement also agreed to not compete against Target, through several restrictive covenants, including non-compete, non-solicit, and confidentiality provisions. Buyer and Sellers agreed that specific performance, an injunction, or other equitable relief was necessary to enforce these provisions of the stock purchase agreement.

After the closing, Sellers continued to work at Target, but the relationship soured. Sellers’ employment with Target ended 3 ½ months after the closing.

About 2 months later, Buyer and Target sued Sellers in a Delaware court, in part, seeking damages for breaching the kickback payment representation. Buyer and Target’s complaint also accused Sellers of breaching its confidentiality covenant and claiming that Sellers started a competing business and attempted to solicit employees from Target. Buyer and Target asked the court to order Sellers to stop this competitive behavior.

Sellers asked the court to dismiss these claims, arguing that the factual allegations contained in the complaint, even if true, do not establish that Sellers breached those provisions of the stock purchase agreement. The court did not agree.

It first found that the following allegations against Sellers, if true could establish a breach of the noncompetition and nonsolicitation covenant.

In early January 2016, Chris, asked another Target employee to research whether Target names “First Brands’ and “Best Brands’ were already in use. Then, in a series of emails throughout January, February, and March 2016, Chris emailed multiple financial advisors about acquiring new companies and/or opening investment credit lines, noting, for example, “the truth is I am interested to buy another company.” In addition, in email correspondence throughout February and March 2016, Chris indicated an intention to purchase tanks and/or concrete pads for heptane tanks at some point in the future. Then, days before his departure from Target, Chris directed a Target employee to circulate technical calculations for a heptane concrete pad in order to talk the same language, cautioning “send it from your cell phone and don’t cc me.”

In the summer of 2016, Chris—through a former Target vice president—bid on used aerosol equipment auctioned off by another chemical company. Shortly thereafter, the former Target VP began working for a new company, which, in June 2016, had its principal office in Thomaston, Georgia—one mile from the site of a former Target manufacturing plant which Sellers, through their holding company, owned at that time. On October 5, 2016, this new company’s webpage began indicating that it had a manufacturing plant in Thomaston, Georgia. Shortly thereafter, this new company began leasing equipment for its Thomaston plant.

In late February and early March 2017, Sellers—through their holding company—sold the former Target manufacturing plant in Thomaston to the new company. Sellers financed part of new company’s purchase. Shortly after that sale, the former Target VP, on behalf of his employer, the new company, contacted a major supplier of aerosol propellant tanks about purchasing two 10,000-gallon aerosol tanks.

Over the Easter holiday in April 2017, Chris invited the new company’s Chief Executive Officer, Zach, to his home. Chris also invited the former Target VP and two current Target employees, as well as another Target customer, who all attended. At the Easter dinner, Chris introduced Zach to a current Target executive as his “very dear friend Zach,” and, when discussing the new company’s business with Target’s employees, Chris referred to the new company as “we,” further indicating his involvement with the new company. At the same dinner, Zach told a Target employee about the new company’s plans for the Thomaston site, including that the new company plans to “run’ aerosols and to fill “anything our customers want.” Chris also told a current Target employee to “listen to the new company CEO Zach,” and that if Zach wanted the employee to be his president, then the employee should be his president—even going so far as to shout out salary figures in front of the employee’s family.

The court concluded that all these allegations if true, made it reasonably conceivable that (1) Sellers through the new company was competing with Target in violation of their noncompetition covenant; and (2) Sellers attempted to induce an employee of Target to leave Target in violation of their nonsolicitation covenant.

Also, the court found that the following allegations against Sellers, if true could establish a breach of Seller’s confidentiality covenant.

When Chris departed his employment with Target, he asked a Target employee to send him an investor presentation from Target’s files that contained Target’s confidential information, which he probably never returned to Target, and if true, violated his confidentiality covenant.

Also, in late March 2016 Maria emailed from her Target business email account to a personal email account a host of Target documents containing, among other items, information related to Target’s accounts receivable and accounts payable. And shortly before her separation from Target, Maria instructed a Target IT manager to send her a critical set of documents containing Target’s confidential information. Taking these facts as true and considering them in the context of all the facts, the court concluded that “it is, just barely, reasonably conceivable” that Maria used this confidential information in violation of her confidentiality covenant.

Finally, the court found that Buyer and Target had alleged the following facts that if true could establish Sellers’ breach of their representation in the stock purchase agreement that they had not received any kickback payments.

The complaint alleged that Chris caused Target to enter into a fictitious long-term lease arrangement with a longtime associate, pursuant to which Target paid over $300,000 for copiers that were never delivered to Target. The complaint further alleged that Chris profited personally from the sham arrangement by receiving all or most of the money Target paid for the copiers

This case is referred to as Plaze, Inc. v. Callas, Civil Action No. 2017-0432-TMR, Court of Chancery of Delaware (Decided: March 29, 2018).

Comment. Buyer is often concerned that a seller of the business will compete with the business after the closing. Part of managing that risk is getting the seller to promise not to compete with the purchased business. That is done through a noncompetition covenant, but also by covenants prohibiting the seller from hiring away the employees, solicitating business customers or using business confidential information.

And those provision have teeth. Here Sellers are facing an expensive and time-consuming litigation that could potentially result in the loss of what may be their post-closing business venture.

By John McCauley: I help people start, grow, buy and sell their businesses.

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 covenant not to compete, hiring seller's employees, no kickback or bribe rep, nondisclosure agreement, trade secret misappropriation

Buyer of construction company obtains judgment against stock seller for target’s pre-closing noncompliance with minority business participation program

Seller and another shareholder, each owned 50% of Target, a large heavy construction company based in the New York City area. Buyer, a Spanish group of companies, purchased all of Target stock from the two shareholders pursuant to a stock purchase agreement.

After the closing, the federal government made a claim against Target for violations of federal law in connection with construction work done by Target prior to the closing on some of New York’s biggest infrastructure projects: 2 subway stations and a water treatment plant. These projects all involved federal financing which included requirements for a certain percentage of project participation by minority- or women-owned subcontractors or those certified by government agencies as disadvantaged.

The violations involved Target repeatedly sending reports to the Metropolitan Transit Authority and the New York City Department of Environmental Protection that inaccurately said that Target was complying with the federal government’s minority business participation rules. As a result, Target, after the closing, paid out $22.4 million to the federal government.

Also, after the closing Buyer learned that Target had received prior to closing, a subpoena from the Metropolitan Transit Authority. No one informed Buyer of the existence or receipt of that subpoena prior to the closing. This subpoena included a request for “documents related to Women Business Enterprise, Minority Business Enterprise or Disadvantaged Business Enterprise status” of certain subcontractors. Moreover, the subpoena was discussed at a Target executive committee meeting days after it was received.

The deal ended up in a lawsuit in a New Jersey federal district court and Buyer sued Seller for damages for breach of representations and warranties Seller had made in the stock purchase agreement that Target’s books and records were accurate and that there were no government investigations of Target pending nor was Target was under government investigation. The court awarded damages to Buyer.

On appeal the appellate court affirmed the award of damages to Buyer, finding that Buyer’s settlement payment and costs of dealing with the settlement were the direct result of Seller’s breach of his representation and warranty that Target’s books and records were accurate, and that Target was not under investigation by any government.

This case is referred to as Schiavone v. Dragados, SA, Nos. 16-2219, 16-2439, United States Court of Appeals, Third Circuit (Opinion filed: April 3, 2018).

Comment. Businesses that work on public projects with federal funding often rely on complying with minority business participation programs. There is a risk the such a business may be audited by a governmental entity, partly because there is a lot of gaming of the system. Those audits can result in substantial monetary payments.

Buyer certainly was helped in this case, by having representations and warranties to help it cut its losses from the pre-closing violations of federal law.

Also, due diligence can help. A buyer looking to buy a business that uses minority business participation programs should consider getting help from an expert to review any potential risks in this area.

By John McCauley: I help people start, grow, buy and sell their businesses.

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, minority business participation program, no pending government investigations or inquiries, representations and warranties, stock purchase agreement

Signing closing documents before closing acquisition results in costly litigation

In 2016, the parties negotiated a stock purchase agreement by which Seller would sell Target, a car dealership, to Buyers and another colleague in two phases. First, Buyers and their colleague were to purchase 21% of Target for $500,000 cash. Second, and only after Target’s debt was paid down to a specific amount, Buyers and their colleague would acquire the remaining 79% for $3 million pursuant to a promissory note secured by the shares.

The closing for phase one was to occur May 31. Deliverables at closing included a shareholders’ agreement, employment agreements for Buyers, their colleague and Seller, a lease amendment, stock certificates, and the purchase price. However, on May 31, Buyers and their colleague still hadn’t secured financing to pay the purchase price and needed additional time to do so.

As a result, on that date, the parties executed the stock purchase agreement and closing documents, Seller signed the share certificates, and all were placed in escrow with Seller’s counsel pending payment. The parties disputed whether and to what extent Seller agreed to extend the time for payment. Buyers claimed that Seller granted them an undefined extension and then refused one of Buyers’ offer to write a check on June 27. Seller expressly rescinded (that is, cancelled) the entire transaction by email later that day (June 27). Buyers tendered a cashier’s check July 18; Seller rejected it.

Buyers sued Seller for breach of contract in a Missouri trial court, asking the court to order Seller to complete the sale. After evidence was submitted, but before submission to the jury, Seller argued that even if Buyers’ evidence that Seller breached the stock purchase agreement was true, Buyers had no right to compel Seller to complete the sale. The trial court agreed, concluding that Buyers had an adequate remedy to seeks monetary damages from Seller for his breach of the stock purchase agreement.

Buyers appealed to an intermediate appellate court. That court ruled for Buyers.

The appellate court said that the general rule of the law of contracts is well settled that, in certain cases, a breach of contract may give rise to two remedies. One is an action at law for monetary damages for the breach; the other is a suit in equity for the specific performance of the contract.

The appellate court held that Buyers’ evidence of breach of the stock purchase agreement (if believed by a jury) gave Buyers a right to compel Seller to complete the sale because the evidence showed that Buyers’ control of the dealership was a rare opportunity and Buyers could not be made whole by monetary damages.

This case is referred to as Payne v. Cunningham, Nos. ED 105712 and ED 105850., Missouri Court of Appeals, Eastern District, Division Four (Filed: April 24, 2018).

Comment. In 20/20 hindsight, Seller and Buyers would have saved themselves a lot of grief by waiting to sign the closing documents until Buyers had lined up its financing.

By John McCauley: I help people start, grow, buy and sell their businesses.

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 breach of contract, closing, damages, specific performance, stock purchase agreement

Court finds that buyer of a California union skilled nursing facility had no constructive knowledge of seller’s multi-employer pension plan withdrawal liability

This is a follow up to a discussion of an earlier June court decision involving the same business buyer. http://www.mk-law.com/wpblog/buyer-of-a-california-union-skilled-nursing-facility-faces-multi-employer-pension-plan-withdrawal-liability-if-buyer-had-constructive-knowledge-of-the-potential-liability/

Buyer purchased a 99-bed skilled nursing facility located Santa Clarita, California from Seller through an asset purchase agreement that closed on January 5, 2015

After the closing Buyer was sued by a multi-employer pension plan (union pension plan) for Seller’s unfunded multi-employer pension plan obligation. Buyer asked the federal district court to throw out the suit because Buyer did not have actual or constructive knowledge of the unfunded pension liability.

The district court concluded that Buyer had no actual or constructive knowledge of Seller’s unfunded pension liability. The court recited the evidence.

Buyer and its principal, Henry, had not previously purchased, owned, or operated an entity affiliated with a labor union or participating in a multi-employer pension plan. Nor was Buyer aware that as a buyer of assets, Buyer could be held responsible for Seller’s unfunded union pension liability.

Buyer did know that that Seller had a collective bargaining agreement with the Teamsters. But Seller warranted in the asset purchase agreement, that Seller did not sponsor, maintain, or contribute to any pension or benefit plans. And a company can have a collective bargaining agreement without participating in a union pension plan. Nor did the fact that Buyer negotiated a broad indemnification provision which covered liabilities arising under the applicable federal law (ERISA) suggest actual knowledge of a multi-employer pension plan or potential liability for an unfunded union pension obligation.

In the absence of evidence of actual knowledge, the union pension plan argued that, once the collective bargaining agreement was disclosed, Buyer had a duty to investigate further to determine whether Seller was participating in a multi-employer pension plan and whether Seller had an unfunded pension obligation which may become Buyer’s responsibility.

Specifically, the union pension plan argued that a thorough reading of the collective bargaining agreement would have shown that Seller misrepresented this important fact and may have led Buyer to the plan administrator, which could then have provided information regarding Seller’s potential withdrawal liability.

The court noted that Buyer was not assuming any right or obligations under the collective bargaining agreement, however: given the information Buyer had, further investigation was simply not indicated. Thus, the court found that Buyer did not have actual or constructive notice of Seller’s potential withdrawal liability at the time of the asset purchase; and that the imposition of withdrawal liability on Buyer in these circumstances would be unfair even when balanced against the congressional interest in preventing underfunding in multi-employer pension plans.

This case is referred to as NORTHWEST ADMINISTRATORS, INC. v. SANTA CLARITA CONVALESCENT CORPORATION, No. C17-1001RSL, United States District Court, W.D. Washington, Seattle (November 9, 2018).

Comment. In 20/20 hindsight, Buyer would have saved itself a lot of grief by getting a good lawyer with experience in dealing with union benefits, to help with due diligence once Buyer knew that a union was involved.

By John McCauley: I help people start, grow, buy and sell their businesses.

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 asset seller's liabilities, constructive knowledge, due diligence, federal multiemployer pension plan withdrawal liability, multi-employer pension plan, post asset purchase issues, successor liability, union liabilities

Delaware Court says that alleged material breach of stock purchase agreement by seller of target company does not excuse buyer from making post-closing payments to seller

On August 31, 2016, Buyer and Sellers entered into a stock purchase agreement in which Buyer agreed to purchase all of Sellers’ shares of Target stock for $93.5 million, subject to certain post-closing adjustments. The transaction closed on October 3, 2016.

The stock purchase agreement provided that Sellers would indemnify Buyer after the closing for all of Buyer’s losses that arise from any inaccuracy in or breach of any representation or warranty made by Target in the stock purchase agreement. Under the terms of the stock purchase agreement and an accompanying escrow agreement, a $7.5 million escrow fund was established, which set aside funds to pay for indemnification obligations.

The stock purchase agreement also obligated Buyer to remit to Sellers certain tax refunds and insurance proceeds for the pre-closing period promptly after their receipt.

After the transaction closed, Buyer allegedly discovered various misrepresentations Sellers made during due diligence and in the stock purchase agreement itself. These alleged misrepresentations generally concerned three subjects: (1) Target’s compliance with immigration laws, (2) the condition of Target’s production equipment, and (3) the production capacity of its pasteurizers. Buyer filed a claim notice asking for indemnification under the stock purchase agreement for the entire amount of the escrow fund based on these alleged misrepresentations. Sellers rejected this demand.

After the closing, Buyer received tax refunds and insurance proceeds for the pre-closing period of about $1 million. After Buyer failed to remit these tax refunds and insurance proceeds to Sellers, Sellers submitted claim notices for indemnification to Buyer, requesting that these amounts be remitted to Sellers.  Buyer refused to do so.

About one year after the closing, Buyer sued Sellers in a Delaware state court for fraud and for breach of Target’s representations and warranties in the stock purchase agreement. Sellers then filed counterclaims to recover from Buyer the approximately $1 million in tax refunds and insurance proceeds pertaining to the pre-closing period.

Sellers asked the court to promptly order Buyer to remit the $1M in tax refunds and insurance proceeds. Buyer resisted saying that it was excused from paying those amounts over to Sellers because Sellers had made material inaccurate representations and warranties about the Target business.

The court held that Buyer was not excused from making the tax refund and insurance proceed payments to Sellers even if Buyer believes it has valid claims against Sellers for indemnification.

The court noted that under applicable Delaware law, Buyer may be excused from performance under the stock purchase agreement if Sellers were in material breach of the stock purchase agreement. However, the court said that Buyer may not refuse to perform its contractual obligation to pay Sellers the tax refunds and insurance proceeds after Sellers’ material breach while simultaneously retaining the benefits of the stock purchase agreement by utilizing the indemnification process in the stock purchase agreement and seeking the funds in the escrow account that were set aside to pay for valid indemnification claims.

This case is referred to as Post Holdings, Inc. v. NPE Seller Rep LLC, C.A. No. 2017-0772-AGB, Court of Chancery of Delaware (Date Decided: October 29, 2018).

Comment. Buyer had minimized the risk of discovering problems about the business of Target by providing for a $7.5 million escrow.

However, apparently, the problems Buyer found amounted to more than the escrowed amount. Buyer also wanted to not pay Sellers the $1 million tax refund/insurance proceed payment it was obligated to pay Sellers promptly upon collection. The court said no.

However, with 20/20 hindsight, Buyer could have tried to put an offset or setoff provision in the stock purchase agreement that would give Buyer the right to offset any claims it is making for indemnification against any tax refund/insurance proceed payments it was obligated to pay Sellers after the closing.

By John McCauley: I help people start, grow, buy and sell their businesses.

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, offset or setoff provision, stock purchase agreement

Court finds that buyer of lead paint manufacturer assumed seller’s liabilities for lead paint poisoning

This case involved a lawsuit filed by Plaintiffs, several individuals in a Wisconsin federal district court against Buyer for injuries allegedly incurred from ingesting white lead carbonate pigments contained in paint manufactured by Seller.

Buyer purchased the assets of Seller in 1983 and had assumed all liabilities of Seller except for certain excluded liabilities described in the asset purchase agreement. Plaintiffs asked the court to rule that Buyer, under the 1983 asset purchase agreement, had assumed liabilities of Seller for the lead poisoning Plaintiffs claimed were caused by paint manufactured by Seller.

The court looked at the assumption language in the asset purchase agreement and found nothing in the language of the document that would exclude Plaintiff’s lead poisoning claims from Buyer’s assumption of Seller liabilities. Thus, the court ruled that Buyer had assumed in the asset purchase agreement, any liability of Seller for lead poisoning claims filed by Plaintiffs for ingesting lead from lead paint manufactured by Seller.

This case is referred to as Burton v. American Cyanamid, Case Nos. 07-CV-0303, 07-CV-0441, 10-CV-0075, United States District Court, E.D. Wisconsin (November 2, 2018).

Comment. The actual language used to describe what Buyer assumed was ambiguous enough to give Buyer a shot at avoiding responsibility for this lawsuit. However, the court saw through the ambiguities to interpret what the court felt was the intent of Buyer and Seller.

One of the most important benefits in doing an asset deal over a stock deal is that the buyer can generally pick and choose what seller liabilities buyer will assume. Often the agreement will say that buyer is assuming no liabilities of seller except for certain specified liabilities.

The language in this 1983 asset purchase agreement was much more favorable to Seller.

By John McCauley: I help people start, grow, buy and sell their businesses.

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 asset buyer's assumption of seller's liabilities by contract, asset seller's liabilities, asset vs stock deal, assumed liabilities, excluded liabilities, successor liability

Buyer did not terminate employment agreements with owners of selling accounting firm for cause

In November 2014, Buyer, an accounting firm in Plymouth, Indiana (about 27 miles south of South Bend, Indiana) acquired Seller, an accounting firm in South Bend, through an asset purchase agreement. At the closing Buyer entered into employment agreements with Greg and John, both accountants, and the owners of Seller. The employment agreements included two-year restrictive covenants preventing John and Greg from competing with Buyer if Buyer terminated their employment for cause.

In February 2016, after reviewing the accounting work performed by John and Greg during the 2015 tax season, Buyer found numerous errors that John and Greg had allegedly made, including:

  • John took a $36K deduction for taxes on a return that the client had never paid.
  • John failed to report $119K of income on a Michigan tax return resulting in $8,000 more in taxes for the client.
  • John missed a $198K capital loss carryover for a client resulting in a significant increase in tax.
  • Greg failed to record $3.2 million in loans on a client’s balance sheet or to disclose those loans in the notes of the financial report.
  • Greg and John concealed from Buyer that they were making thousands of dollars in payments to clients to settle penalties those clients had incurred due to poor accounting work.

In May 2016, Buyer notified John and Greg that Buyer was terminating their employment for cause. Under the employment agreement, “for cause” included termination of employment for inaccurate work or late work, or any other conduct that is injurious to or adverse to the employer-employee relations. However, there could be no termination for cause unless John and Greg’s performance had a meaningful effect on Buyer’s ability to serve its clients.

John and Greg challenged (in an Indiana state court) Buyer’s “for cause” termination of John and Greg’s employment with Buyer, in order to avoid the 2-year noncompetition covenant. The trial court said that John and Greg’s errors were not beyond normal; and that no actual harm to Buyer’s clients was demonstrated; nor did the errors have a meaningful effect on the ability of Buyer to serve its clients. Thus, the trial court concluded that Buyer had not terminated the employment of John and Greg for cause, as that term was used in the employment agreements.

The Indiana Court of Appeals, in upholding the trial court decision, noted that Buyer presented evidence that John and Greg committed numerous errors, some of which may have been sufficient grounds to fire John and Greg if there had been not been an employment agreement with a requirement that Buyer only terminate John and Greg for cause (as defined in the employment agreements).

The appellate court held that John and Greg’s employment agreements controlled this dispute and agreed with the trial court that the evidence established proof of John and Greg’s inaccurate work and other errors, but that such inaccuracies and errors did not have a meaningful effect on the ability of Buyer to serve its clients.

Therefore, the appellate court held that Buyer did not have cause to fire John and Greg within the meaning of the employment agreements. The result, John and Greg could compete against Buyer.

This case is referred to as Weidner and Company, PC v. Jurgonski & Fredlake CPAS, PC, No. 18A-MI-535, Court of Appeals of Indiana (October 31, 2018).

Comment. Buyer needed to establish that John and Greg’s employment with Buyer was terminated for cause (as defined in the employment agreements) in order to enforce a 2-year noncompetition covenant.

In many cases, a seller’s owner would promise not to compete with the business sold. This promise would be in the business purchase agreement and this noncompetition covenant’s enforceability would probably not depend upon whether or not the buyer breached any employment agreement it had with the seller’s owner.

By John McCauley: I help people start, grow, buy and sell their businesses.

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 covenant not to compete, employment agreement, for cause termination

Buyer does not acquire patent license agreement from chapter 7 bankruptcy trustee

This case involved the purchase of a patent license agreement out of bankruptcy of several related companies. For purposes of illustration the facts have been modified by describing the sale out of bankruptcy of a patent license agreement from just one company. This modification does not impact the validity of the lesson learned from this story.

The story begins before Seller filed for bankruptcy. Licensor held a patent on a system, software, and related methods of remote pharmaceutical dispensing. In 2010, it sued Seller for infringing this patent by using Seller’s own remote pharmaceutical dispensing machines to remotely dispense pharmaceuticals from the machines to nurses in long-term care facilities. Seller counterclaimed challenging Licensor’s patent.

Licensor and Seller agreed to settle the litigation, entering into a license agreement, granting a non-exclusive perpetual license to Seller for so long as the patent was valid and enforceable. Seller agreed to pay a one-time licensing fee of $4,000 for each Seller machine placed into operation after the execution of the agreement, and to provide quarterly reports reflecting all new machines placed in service.

Later, Seller filed for reorganization under chapter 11 of the bankruptcy laws in a Texas bankruptcy court. The case was later converted to a liquidation proceeding under chapter 7 of the bankruptcy laws. Despite the bankruptcy requirement that Seller schedule all assets and creditors, however, Seller did not list the license agreement or Licensor on Seller’s bankruptcy schedule.

Buyer had a security interest in Seller’s collateral. Buyer agreed to purchase the collateral from Seller’s bankruptcy estate. Buyer and Seller laid out the terms of sale in an asset purchase agreement, and the sale was approved by the bankruptcy court in a separate sale order.

The asset purchase agreement did not explicitly reference the license. The sale order approved the sale of Seller’s property—providing that to the extent that any of the property was an executory contract, the executory contract was hereby assumed by Seller’s bankruptcy estate and immediately assigned to Buyer under the applicable provisions of section 365 of the Bankruptcy Code.

Buyer and Seller agreed that Buyer was not aware of the license until after the bankruptcy court approved the sale.

Later, Licensor filed a petition in Texas state court against Seller, alleging that Seller had failed to comply with Seller’s obligations under the license agreement to provide quarterly reports and pay licensing fees for new machines. Buyer intervened and removed the proceeding to the bankruptcy court, arguing that Seller’s estate had assigned or otherwise transferred the license to Buyer.

The bankruptcy court and then the federal district court held that Buyer had not acquired the license agreement. Buyer appealed the decision to the federal court of appeals.  Buyer struck out there too.

The court of appeals first said that Buyer’s fate on this dispute depended upon whether the license agreement was an “executory contract” under the bankruptcy law.

The court said that the license agreement would be an executory contract if performance remains due to some extent on both sides (both Seller and Licensor) and if at the time of Seller’s bankruptcy filing, the failure of either Seller or Licensor to complete performance would constitute a material breach of the license agreement, thereby excusing the performance of the other party.

The court had no problems finding the license agreement to be an executory contract. It noted that Licensor had an ongoing obligation under the license agreement to refrain from suing Seller for patent infringement for machines placed into service after execution of the license agreement. The court further concluded that Seller licensee had ongoing material obligations because Seller was required to provide quarterly reports as to new machines, pay a one-time licensing fee of $4,000 to Licensor for each new machine, and refrain from making public statements about a settled lawsuit.

The court then explained why the licensing agreement being an executory contract was bad for Buyer. Under the bankruptcy law, the court noted that the trustee of Seller’s bankruptcy estate had 60 days after Seller’s case was converted to a bankruptcy chapter 7 liquidation from a chapter 11 reorganization to accept or reject the license agreement. Buyer would have acquired the license agreement if the trustee had accepted the license agreement during this 60 day window. The trustee, however, did not accept the license and so under the bankruptcy law, the license agreement was deemed rejected by the trustee and thus not an asset of the estate which the trustee could sell to Buyer.

Buyer then made an argument for justice, saying that trustee did not know about the license agreement because Seller had not scheduled the license agreement or the Licensor on its bankruptcy schedules. The court was not persuaded, noting that the trustee had a fiduciary duty to look for unscheduled assets for the benefit of the bankrupt estate’s creditors.

This case is referred to as In The Matter Of Provider Meds, LLC, No. 17-11113, United States Court of Appeals, Fifth Circuit (October 29, 2018).

Comment. Unfortunate outcome for Buyer. Apparently, Buyer did not know about the license agreement until it was too late.

I am not an insolvency lawyer, so I don’t know whether or not Buyer could have realistically learned about this problem through due diligence.

By John McCauley: I help people start, grow, buy and sell their businesses.

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 bankruptcy sale, distressed business acquisitions, executory contracts

Buyer of business strikes out after protracted litigation trying to recover lost profit damages from seller

Buyer wanted to enter the annual $5 billion revenue back-to-school season market for the sale of school supplies. Since Buyer needed inventory, licenses, and retailer relationships to get the ball rolling, it decided to buy the stationery division at Seller, a well-established consumer-goods wholesaler.

Seller’s assets were an attractive target. Seller held licensing agreements with entities like Lego, Universal Studios [Universal], and pop sensation One Direction. These popular brands would likely lead to large sales with school-age kids. And Seller agreed to help transfer these licenses to Buyer as part of the deal.

Things went awry shortly after the companies finalized the sale. According to Buyer, Seller failed to help transfer its licensing agreements. Buyer sued Seller in a Michigan federal district court to recover damages, including for lost profits arising out of Seller’s breach of the asset purchase agreement.

After a long drawn out litigation, Seller argued that Buyer was not entitled under applicable New York law to recover its lost profits from Seller’s alleged breach of the asset purchase agreement.

The court said that for Buyer to prove loss of future profits as damages for Seller’s breach of the asset purchase agreement under New York law, Buyer must have demonstrated, among other things, with certainty that the lost profits have been caused by Seller’s breach of the asset purchase agreement.

The court looked at the evidence to see if Seller caused Buyer lost profits. Under the asset purchase agreement Seller agreed to use “commercially reasonable efforts” to help Buyer obtain the transfer of each license from Seller to Buyer. Thus, the court said that Buyer must establish, on a license-by-license basis that, but for Seller’s alleged failure to use commercially reasonable efforts, Buyer would have obtained individual licenses — which Seller did not guarantee would be transferred.

The court found this evidence missing in action. The court noted there was no statement from any licensor to the effect that if Seller had done X, then Licensor A would have transferred the license to Buyer.

The court noted what the evidence showed. That beyond Buyer obtaining the Lego license, a dispute existed between Buyers’ principals as to whether to enter into any other licenses. This dispute resulted in Buyer twice rejecting a license from Nickelodeon and not contacting any licensor other than Universal after the initial request for transfer of the licenses were sent out. Further, Buyer admitted that Universal decided for its own reasons not to assign the license to it, but to instead another company in the industry.

The court concluded that there was simply no evidence in the record that, taken as true, would allow the conclusion that Universal (or any other licensor) would have offered Buyer a license even if Seller had provided the reasonable commercial efforts Buyer says it did not, or that, unlike with Nickelodeon, Buyer would have accepted the license.

This case is referred to as My Imagination, LLC v. MZ Berger & Co., Case No. 14-13321, United States District Court, E.D. Michigan, Southern Division (October 29, 2018).

Comment. An acquisition gone sour may get a buyer to look for ways of cutting its losses by looking for seller breaches of the purchase agreement.  However, finding a seller breach of the purchase agreement will probably not help the buyer unless the breach caused buyer to suffer provable damages.

In this case Buyer could not convince the court that Seller had breached the asset purchase agreement. That was the end of Buyer’s claim. However, the court also said that even if Seller had failed to use commercially reasonable efforts to assist Buyer in transferring its licenses to Buyer, Buyer failed to prove that such a breach caused Buyer lost profits.

And finally, the court noted that even if Buyer could prove that Seller’s breach caused Buyer lost profits; Buyer would still have to overcome a provision in the asset purchase agreement that may prevent Buyer from recovering lost profit damages from Seller.

By John McCauley: I help people start, grow, buy and sell their businesses.

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 breach of contract, commercially reasonable efforts, Covenants, damages

Business seller fights all the way to Texas Supreme Court to challenge validity of purchase agreement

Seller owns Target, a wholesale distributer of candy and tobacco products. Target had contracts to buy tobacco products directly from Supplier 1 and Supplier 2, which will be referred to collectively as Suppliers. In April 2012, Seller approached Buyer, the vice president of Competitor, a convenience store distribution business, about purchasing Target. Competitor did not have a direct contract with Suppliers, thus it bought those companies’ tobacco products through middlemen and paid higher prices for them than did Target.

Because Suppliers ordinarily would not enter into new contracts to sell directly to wholesalers, businesses that wanted to buy directly from them usually sought to do so by buying companies that had direct contracts. But the Suppliers direct-purchase contracts would not necessarily transfer if Target was sold: both Suppliers reserved the right to discontinue direct sales to Target absent their approval of its purchaser.

Buyer and Seller reached an agreement regarding the sale of Target and signed a letter of intent. The closing date was listed as immediate, subject to preapproval from Suppliers. Supplier 1 initially refused to approve the application to transfer Target’s ownership but did so after Buyer and Seller resubmitted the application.

While waiting on approval from Supplier 2, Buyer and Seller executed a stock transfer and asset purchase and sale agreement by which Seller agreed to sell to Buyer all Target stock shares along with other assets used in the business such as land, buildings, inventory, vehicles, fixtures, and equipment. The purchase price for the stock was $500K, subject to the contingency that if Seller was unable to obtain written approval from both Suppliers for the direct contracts to remain in force, the price would be reduced to $250K. Because Supplier 1 had approved the change of ownership, the sales price hinged on Supplier 2’s approval.

The purchase agreement provided that the sales price for the furniture, fixtures, and equipment such as stamping and packing machines would be their value as mutually agreed upon by Buyer and Seller prior to the closing date, and the price of the land and building would be the value set by an appraisal to be accomplished before the closing date. Closing was to take place on or before July 1, 2013.

On June 28, 2013, Supplier 2 notified Buyer that it would not approve the change in ownership. Seller and Buyer discussed resubmitting the application to Supplier 2 as they had done with Supplier 1. Seller also proposed postponing the July 1 closing date, but Buyer would not agree to the change. At that point, Seller and Buyer had not come to an agreement as to the value of the furniture, fixtures, and equipment, and Seller disputed the value of the land and building as determined by the appraisal.

Buyer appeared for the closing on July 1, but Seller did not. Instead, on July 2, Seller sued Buyer in a Texas trial court seeking a declaratory judgment that the purchase agreement was unenforceable and void because Buyer and Seller did not agree on all its essential terms. Buyer counterclaimed against Seller, asserting various claims including a claim for damages because Seller had indeed breached the purchase agreement.

The case was tried to a jury and the jury found that Seller had an obligation under the purchase Agreement to sell the business to Buyer. The jury also found that Buyer suffered $900K in lost profit damages. The trial court awarded attorney’s fees to Buyer.

Seller asked the court to disregard the jury’s finding, arguing that the validity of the purchase agreement was a question for the trial judge and not the jury. Neither the trial judge or a Texas intermediate court of appeal would consider Seller’s argument, holding that Seller had waived its right to make this argument.

The Texas Supreme Court, however, disagreed, and ordered to lower courts to consider Seller’s argument that the determination of the legality of the purchase agreement was up to the trial judge and not the jury.

This case is referred to as Musallam v. Ali, No. 17-0762, Supreme Court of Texas (Opinion delivered: October 26, 2018).

Comment. Seller had to spend a lot of time and money to get the court system to consider his legal argument that the purchase agreement was not enforceable.

In 20/20 hindsight, Seller and Buyer could have probably eliminated this dispute by signing an agreement that had set an agreed upon purchase price for the business land, buildings, inventory, vehicles, fixtures, and equipment.  Of course, valuing these assets would have taken time, would have slowed up the signing of the purchase agreement, and risked losing the deal.

By John McCauley: I help people start, grow, buy and sell their businesses.

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 deferred closing, post signing asset valuation

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