Ambiguous APA Forum Selection Clause Did Not Waive Right to Remove to Federal Court

January 10, 2020

Introduction

Acquisition documents often have a forum selection clause. And like any provision ambiguity can invite a dispute if litigation breaks out after the closing.

The deal

The seller was a manufacturing company located in Butler County, Ohio. It sold its assets to the buyer in a multi million-dollar deal, which was documented by an asset purchase agreement.

The lawsuit

After the sale, seller sued the buyer in the Butler County Court of Common Pleas in anticipation of an alleged breach of the asset purchase agreement. The buyer removed the suit to a federal court sitting in Cincinnati, which is not in Butler County.

The seller asked the court to remand the lawsuit back to the state court in Butler County. The buyer resisted the request and both buyer and seller referred to the asset purchase agreement’s forum selection clause to support its position.

The provision said: “ANY LEGAL SUIT, ACTION, OR PROCEEDING ARISING OUT OF OR BASED UPON THIS AGREEMENT, THE OTHER TRANSACTION DOCUMENTS, OR THE TRANSACTIONS CONTEMPLATED HEREBY OR THEREBY MAY BE INSTITUTED IN THE FEDERAL COURTS OF THE UNITED STATES OF AMERICA OR THE COURTS OF THE STATE OF OHIO IN EACH CASE LOCATED IN THE COUNTY OF BUTLER, AND EACH PARTY HERETO IRREVOCABLY SUBMITS TO THE EXCLUSIVE JURISDICTION OF SUCH COURTS IN ANY SUCH SUIT, ACTION, OR PROCEEDING . . . . THE PARTIES HERETO IRREVOCABLY AND UNCONDITIONALLY WAIVE ANY OBJECTION TO THE LAYING OF VENUE OF ANY SUIT, ACTION, OR ANY PROCEEDING IN SUCH COURTS AND IRREVOCABLY WAIVE AND AGREE NOT TO PLEAD OR CLAIM IN ANY SUCH COURT THAT ANY SUCH SUIT, ACTION, OR PROCEEDING BROUGHT IN ANY SUCH COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM.”

The court said that the forum selection clause was ambiguous. The clause said that any asset purchase agreement dispute should be resolved in a federal or state court in Butler County. However, the federal court does not sit in Butler County.

Given that ambiguity the court concluded that the most reasonable interpretation of the forum selection clause was that the parties agreed to resolve disputes in either a state court located in Butler County or a federal court having jurisdictions for Butler County disputes.

Given that conclusion, the seller argued that the buyer had waived its statutory right to remove the case to federal court. The court disagreed finding that buyer did not waive this right of removal. In other words, the lawsuit remained in the Cincinnati federal court.

This case is referred to as The Bidwell Family Corporation v. Shape Corp., Case No. 1:19-cv-201, United States District Court, S.D. Ohio, Western Division (December 9, 2019).  

Comment

The lesson here is clear. Be precise. If the seller wanted to litigate in Butler County alone the forum selection clause should not also provide for a federal court venue. Furthermore, the parties should have expressly waived the right to remove a Butler County state court dispute to a federal court.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

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 forum selection clause, waiver of removal to federal court Tagged with: , , , ,

No Seller Indemnification Obligation to Buyer for Recall of Pre-Closing Product

December 19, 2019

Introduction

The buyer of a manufacturing company runs the risk of having to repair or replace a product made by the seller before the closing. One risk is the cost of a recall of a product line to deal with a significant design flaw.

The deal

The seller in this deal made recreational boats. It sold three brands of its bass fishing boats to a national outdoor recreational equipment retailer, for $260 million. $2.6 million of the purchase price was placed in escrow to secure the seller’s indemnification obligations under the Membership Interest Purchase Agreement. The escrow funds not required by indemnification had to be released to the seller by the first anniversary of the closing.

The lawsuit

After the sale, the buyer discovered that several purchasers of a particular line of boats included in the sale had presented warranty claims to the seller after noticing that the hulls of the boats had cracked or delaminated. The seller did not disclose the warranty claims or increase its warranty reserve in the financial statements provided to the buyer in connection with the purchase agreement.

The buyer determined the cracks and delamination in the hulls resulted from the seller having manufactured the boat hull with fewer layers of laminate than was called for in the boat’s design. The buyer also concluded that this production flaw affected an entire production run of boats and, therefore, case-by-case repairs would be inadequate to solve the problem. Instead, the buyer elected to replace the hulls of every boat produced with the allegedly defective hull. This decision prompted the buyer to initiate a “Replacement Program” whereby it recalled and replaced the hulls of every affected boat at an estimated total cost of $5 million.

The buyer notified the seller before the expiration of the one year escrow expiration period of a claim for indemnification under the purchase agreement, asserting that the seller’s failure to disclose the manufacturing defect and account for it in its financial statements breached certain of the purchase agreement’s representations and warranties. The buyer stated that its expected damages caused by the breach were $5 million.

The seller did not agree and after expiration of the one year escrow period demanded that the buyer consent to release the $2.6 million escrow fund. The seller refused and the dispute ended up in the Delaware Court of Chancery.

After trial the court concluded that the buyer had not proved that a product recall was not justified, because the problem could be solved by a much less costly repair or replacement of defective hulls on a case by case basis. Furthermore, the court found that the seller did not breach its financial, undisclosed or MAE rep, because the problem was not material. And although the seller breached a rep by not disclosing, the warranty claims, it was “no harm, no foul” because the seller’s reserve in its financial statements were more than adequate to cover the known claims.

The result? The court ordered the buyer to consent to the release of the escrow funds.

This case is referred to as Project Boat Holdings, LLC v. Bass Pro Group, LLC, C.A. No. 2018-0429-KSJM, Court of Chancery of Delaware (Decided: May 29, 2019. Revised: June 4, 2019)  

Comment

We don’t know whether the buyer asked a law firm experienced in post-closing M&A disputes, what the chances were that the buyer could recover the costs of the $5 million recall from the seller.

Also, we don’t know whether the buyer tried to include a provision in the purchase agreement obligating the seller to indemnify the buyer for any buyer loss arising out of any boats produced by the seller before the closing. That provision would have given the buyer more time to assess its exposure for the defective hulls; provided that the escrow agreement said that giving notice of product defects would extend the escrow period for an additional agreed term.

This additional language would have avoided all the fight about whether the seller breached its financial, undisclosed liability, MAE and warranty rep. Also, this provision is not breached until a claim is made and so does not accrue until then, not at closing.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

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 representations and warranties, financial representation and warranty, indemnification, indemnification for pre-closing product loss, MAE rep, No Undisclosed Liabilities, representations and warranties

Buyer’s Indemnification Claim Notice Tolled 1 Year Contractual but Not 3 Year Statutory Limitations Period

December 11, 2019

Introduction

The buyer of a privately held business often has a deadline to make an indemnification claim for the breach of a seller representation and warranty. This survival period in an acquisition agreement often expires sometime from the 1st to 2nd anniversary of the closing.

The deal

This deal was a stock acquisition. The target company designs and manufactures oil analyzers, which it sells and ships to customers.

Before closing, the target shipped approximately 640 analyzers containing unlicensed software owned by Microsoft. Neither the target nor the seller disclosed these facts to the buyer prior to the closing. To the contrary, the target and the seller represented and warranted in the stock purchase agreement that the target was authorized to use the software, had obtained all necessary licenses, and was in compliance with all laws (the “IP representations”).

The transaction closed on November 28, 2014. The buyer discovered the license problem after the closing. The buyer determined that of the 640 shipped analyzers containing unlicensed software, approximately 330 (the “legacy units”) remained in worldwide use after the closing.

On November 16, 2015, the buyer sent a letter to the seller claiming indemnification for breach of the IP representations. The claim notice cited the target’s “failure to procure and maintain appropriate software licenses” for its analyzers as the basis for the buyer’s claim.

On May 25, 2016, the buyer entered into a settlement with Microsoft. In exchange for a payment of $66,000, Microsoft released both the buyer and the target from claims relating to the unlicensed software used in the legacy units. Microsoft, however, did not release the end users of the 330 legacy units. This left the buyer and the target exposed to licensing related claims by the end users of the legacy units, particularly those end users who Microsoft may contact or sue.

On July 28, 2016, the buyer notified the seller of the buyer’s settlement with Microsoft with a demand for reimbursement for the amount the buyer paid Microsoft. The buyer also reserved its right to seek indemnification or future losses.

The lawsuit

The seller did not agree to indemnify the buyer and the dispute ended up in the Delaware Court of Chancery, with the buyer making a claim for indemnification, partly for breach of the IP representations. This claim was made on July 23, 2018. In that lawsuit the buyer claimed that it had suffered damages from the seller’s breach by settling with Microsoft and will probably also suffer further damages if Microsoft goes after the target’s end users of the legacy unlicensed software.

The seller asked the court to dismiss the indemnification claim for breach of the IP representations because it was made too late. The court said that under Delaware law, this claim accrued on the day of closing, November 28, 2014, and that the default statute of limitations was three years.  Thus, the court concluded, absent tolling, the statute of limitations barred the buyer’s July 23, 2018, indemnification claim for breach of the IP representations, because it was made after November 28, 2017— the 3rd anniversary of the closing.

In addition to the three-year statute of limitations, the court pointed out that the stock purchase agreement imposed a shorter one-year contractual limitations period for breach of the IP representations; meaning that the buyer had to make its indemnification claim for breach of the IP representations by November 28, 2015.

The buyer argued that its November 16, 2015 indemnification claim notice tolled both statutory 3 year and contractual 1 year limitations periods. In support of its tolling argument, The buyer pointed to a stock purchase agreement provision that said that the seller’s representations and warranties would survive the end of the agreement’s one year survival period if buyer gave notice of its claim to the seller prior to the expiration of the 1 year period.

According to the buyer, this provision served to toll both the contract’s one year and Delaware’s 3 year limitations periods until resolution of its indemnification claim. The court rejected this argument.

The court said that although parties may contractually agree to permit an indemnification notice to toll limitations periods until the underlying claim is resolved, this provision did not do that. This provision did not expressly provide for tolling Delaware’s three year statutory limitations period until the indemnification claim is resolved; just the tolling of the contractual one year limitation periods.

The result was the buyer’s July 23, 2018 indemnification claim for breach of the IP representations was time barred/

This case is referred to as Kilcullen v. Spectro Scientific, Inc., C.A. No. 2018-0429-KSJM, Court of Chancery of Delaware (Decided: July 15, 2019)  

Comment

In the end it did not matter. That is because the stock purchase agreement also said that the seller had to indemnify the buyer for any loss the buyer suffered resulting from product shipped by the target before the closing.

Claims under this indemnification provision were not time-barred. “Indemnification claims based on third-party claims do not accrue until the underlying third-party claim is finally decided. In this case, the third-party claims by Microsoft were finally decided when … (the buyer) … settled those claims on May 25, 2016, and the three-year statute of limitations therefore ran until May 25, 2019—nearly a year after… (the buyer) … brought its … (indemnification claims) …. The potential, unasserted third-party claims by the legacy units’ end users are of course not finally decided, and the statute of limitations therefore has not yet begun to run on this aspect of” the buyer’s indemnification claims.

One other takeaway when Delaware law applies.  A buyer wanting the longest survival periods from indemnification should specify that an indemnification claim tolls both the probably shorter contraction limitation period contained in the purchase agreement and Delaware’s statute of limitation. Even more so since Delaware has extended the 3 year statute of limitations for contracts to 20 years for deals at least $100K in size. See 10 Del. Code § 8106(c)

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 extension by contract in Delaware, indemnification, Intellectual Property, statute of limitations, survival of covenants, survival of reps and warranties, tolling Tagged with: ,

Monthly Financial Statements Not Covered by Financial Representation Covered by Books & Records Representation

Introduction

In mergers and acquisitions agreements, the seller generally represents and warrants that the target’s financial statements for its most recent fiscal year and its most recent interim financial statements are accurate and complete, consistent with operations, and prepared in according generally accepted accounting principles, consistently applied. The seller also represents and warrants in a separate provision that the target’s books and records are complete and correct.

The deal

This case involved the $224 million stock acquisition of an information services company from the sellers, father and son.

The lawsuit

After the closing the buyer claimed that the target had significantly overstated revenue in monthly financial statements that the sellers furnished the buyer which buyer reviewed before buying the company. These financial statements were not covered in the financial statement representation and warranty given by the sellers to the buyer.

Nevertheless, the buyer, in its Delaware lawsuit claimed that these monthly financial statements were covered by the representation and warranty of the sellers that the target’s books and records were accurate and complete.

The sellers denied liability claiming that the monthly financial statements were not “books and records” within the meaning of the books and records representation and warranty and could only be covered under their financial statement representation and warranty. The sellers argued that since their financial statement representation and warranty applied only to specifically enumerated financial statements and that the monthly financial statements were not included as part of the enumerated financial statements covered by the financial statement representation and warranty.

The Delaware Court of Chancery rejected the sellers’ argument: “I conclude … (the books and record representation and warranty) … covers the Monthly Financials to the extent the Monthly Financials are not included in … (the financial statements representation and warranty’s) … more specific representations. Consistent with foundational principles of contract interpretation, this construction harmonizes and gives meaning to both provisions at issue, obviating any need to prefer one over the other.”

This case is referred to as Hill v. LW Buyer, LLC., C.A. No. 2017-0591-MTZ, Court of Chancery of Delaware (Decided: July 31, 2019)  

Comment

This is not a surprising holding. The financial statement representation and warranty and the books and records representation and warranty both say that the covered material is correct and complete. But the financial statements representation and warranty goes farther saying that specified financial statements were also prepared according to GAAP, consistently applied.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 books and records rep and warranty, financial representation and warranty Tagged with: , ,

Court Rules That EY Earnout Calculation Was Arbitration Not Expert Determination

Introduction

There are often post-closing calculations that must be made in an M&A deal. Examples are working capital and earnout calculations. Often the parties agree in advance to a dispute resolution procedure in the M&A documents in the event there is a disagreement over the calculation.

The deal

This case involved the stock acquisition of an Indiana engineering and consulting business. The purchase price was $21 million plus an earnout based upon EBITDA.

The lawsuit

The buyer calculated no earnout in the 2nd and final post-closing year. The seller disputed the calculation and the dispute was submitted to E&Y for resolution pursuant to the stock purchase agreement. E&Y calculated a 2nd year earnout of $3 million. The buyer refused to pay, and the dispute ended up in an Indiana trial court which agreed with E&Y. The buyer appealed to Indiana’s intermediate appellate court.

The stock purchase agreement’s earnout dispute resolution procedure said that E&Y should review “all relevant matters as it deems appropriate” and then deliver its calculation “which shall be final and binding upon” the buyer and the seller. The trial court confirmed this calculation as an arbitration award. The buyer claimed that under controlling Delaware law, the earnout calculation performed by E&Y could be looked at by the court because the dispute resolution procedure used was not an arbitration but an expert determination.

The court said that under Delaware law, the resolution of this issue depended upon whether the parties intended E&Y to act as an expert (meaning that it had authority to resolve factual but not legal issues) or as an arbitrator (which gave it the authority to resolve both factual and legal issues.) The buyer wanted to win the expert determination argument to give it life to poke legal holes in E&Y’s earnout calculation. The buyer’s fight would stop if E&Y acted as an arbitrator because then E&Y’s legal conclusions were final and binding on the court.

The court ruled that E&Y acted as an arbitrator of the earnout calculation dispute: We “have little difficulty concluding that the parties clearly and intentionally agreed to arbitrate earnout disputes … Although the term ‘arbitration’ does not appear, the agreement here delegates to … (E&Y) … broad authority to consider evidence, make determinations, and conclusively resolve any earnout dispute …”

The buyer argued that the earnout dispute resolution language showed that the parties agreed that E&Y’s calculation would be an “expert determination” of earnout disputes. The court rejected this argument. “Specific limiting language providing that … (E&Y) … is acting ‘as an expert and not as an arbitrator’ clearly narrows the scope of … (E&Y’s) … role and evinces the parties’ intentions that the auditor’s decision constitute an expert determination and not an arbitration. … There is no such stipulation or limiting language in the parties’ agreement here, leaving only language that clearly gives … (E&Y) … full and complete authority to act as an arbiter and issue a final and binding decision as to an earnout dispute.”

This case is referred to as SGS North America, Inc. v. Mullholand, No. 19A-PL-1283, Court of Appeals of Indiana (November 14, 2019)  

Comment

The bottom line is that the buyer did not get another shot to litigate the dispute in court. The judge noted what language in the purchase agreement would probably have won the buyer’s argument: “use of the expression `as an expert and not as arbitrator’ is now so common that it is difficult to conceive of a case in which a court would not treat those words as meaning exactly what they say.”

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 arbitration vs expert determination, dispute resolution provision, earn out, earn out dispute procedure, earn outs Tagged with: , , , , ,

ESOP Bank Trustee & Owner Must Pay $6.5 Million Purchase Price Overpayment to ESOP

Introduction

One exit strategy for a business owner is to sell your company to an ESOP; especially if there are no serious buyers. However, those transactions are highly regulated by the federal government and must be done right.

The deal

Here, the owners, husband and wife, founded their business in 1980. Their company designs and sells equipment such as conveyors and bottling machines for soft drink manufacturers. To retain workers, the company offered generous benefits, including an ESOP and payment of 100 percent of employees’ health care premiums. Over the decades, their company attracted major corporations as customers, including Coca-Cola, Dr. Pepper, and Snapple.

The owners owned a majority of the company stock and served as the executive officers of the company (the husband serving as CEO and the wife as CFO). They were also two of the three members of the board of directors and were two of the three ESOP co-trustees; with the 3rd board member and ESOP co-trustee being a company insider. The husband was the chairman of the board of directors.

There had been some interest from buyers, but no offers were made by November 2010 when the owners decided to sell their majority equity interest in the company to the ESOP. A bank was hired to serve as the ESOP’s transactional trustee. When contacted, the company’s ESOP lawyer told the bank that the estimated purchase price was $21 million.

The transaction closed about 6 weeks later, after the valuation was completed, at a purchase price about $20.7 million. The purchase price was financed by cash of $1.9 million (through a company loan to the ESOP; cash of $8.5 million (from ESOP’s cash reserves); and an ESOP note for $10.3 million.

The bank resigned as ESOP trustee after the closing. Thereafter the husband and wife served on the three person board of directors which was elected by the 3 co-trustees of the ESOP, two of which were the husband and wife. Thus, after the closing the husband and wife controlled the ESOP, the 100% shareholder, that elected the 3 person board of directors; which hired and fired the officers of the company. This control could only change by the voluntary resignation or death of the husband and wife.

The lawsuit

In 2014, amid a downturn in the soda industry, the husband (the wife having passed away in 2011) forgave $4.6 million of the note, and the interest rates associated with the note was reduced to 3 percent. Nevertheless, the United States Department of Labor sued the bank and the husband in a Virginia federal district court, accusing them of facilitating a deal with a purchase price in excess of its fair value.

The court concluded that the ESOP overpaid the owners $6.5 million for their stock and held the bank and the owner jointly liable to repay this amount. The court held that the bank was not prudent in its goal to ensure that the ESOP paid “no more than adequate consideration” for the owners’ stock.

The purchase price of just under $21 million translated to a $406 per share. This contrasted with the previous ESOP valuations that ranged from $215 per share in 2005 to $285 per share in 2009.

The valuation consultant for the deal had also performed the earlier valuations. He used a capitalization of cash flow methodology. His said that the much higher $406 per share valuation was primarily due to a premium for purchase from the owners of control of the company and an add back of ½ of the company’s health care expenses in calculating the capitalized cash flow under the assumption that post closing management would bring health care expenses in line to market by reducing company’s employee health care cost obligation by 50%.

The court found these assumptions flawed because the owners were not giving up control since they controlled the 100% shareholder, the ESOP, serving as 2 of the 3 ESOP co-trustees; which in turn selected the board of directors, which in turn hired and fired the company’s officers.

The court concluded that the bank and the owners should have also known that the valuation was flawed for these reasons, resulting in a significantly overvalued stock price.

The court also found that the bank should have insisted upon projections, since it was aware that the incoming president was apprehensive about the company’s future. In addition, the court said that the bank did not push the valuation consultant to use the discounted cash flow method, finding that it “is, on the margins, a more commonly used and reliable method for evaluating the fair market value of closely-held stock.”

Overall, the court found that the bank did a poor job in its due diligence. The court felt that the bank rushed its process to accommodate the owner’s desire for a year end closing. Also, the court felt that the bank should have only looked out for the interests of the ESOP when in fact the bank’s employees testified that they wanted to be fair to both the ESOP and the owners.

This case is referred to as Pizzella v. Vinoskey, Case No. 6:16-cv-00062, United States District Court, W.D. Virginia, Lynchburg Division (August 2, 2019)  

Comment

The takeaway: using an independent trustee for an ESOP transaction does not ensure that the owner will not have liability for a purchase price that is too high. The owner can manage the risk of a flawed valuation by using ESOP professionals that are experienced and highly regarded and insisting that the ESOP trustee, valuation consultant and ESOP lawyer take enough time to conduct a thorough due diligence process.

But even that may not be enough.  If a valuation is much higher than earlier valuations the owner should be satisfied that the higher price is justified by facts and reasonable assumptions.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 capitalization of cash flow, discounted cash flow or DCF, independent trustee, projections, prudence, sale of business to ESOP, valuation Tagged with: , ,

Business Buyer Loses Claim for $8 Million of Nonrenewed Customer Contracts

Introduction

A crucial part of a potential business buyer’s due diligence is evaluating the seller’s projections. However, those projections often do not materialize, and disappointing projections do not usually amount to a breach of the seller’s acquisition agreement representations and warranties.

The deal

This case involved a private equity firm’s $80 million asset acquisition of a Wichita aircraft parts supplier. The seller’s largest customer was Boeing and their business relationship was governed under many separate parts contracts which had expiration dates. Many expiring contracts had been renewed in the past.

During due diligence the seller prepared projections for revenue which included contracts that would expire but which the seller expected would have an opportunity to renew.

The lawsuit

The seller, however, was not aware at the time it executed the asset purchase agreement and at the closing that it would not have the opportunity to bid on some of the expiring parts contracts because Boeing had already awarded those parts contracts to other suppliers.

The seller and buyer discovered loss of these parts contracts after the closing resulting in a $8 million revenue loss. The buyer accused the seller of breaching its customer, MAE and full disclosure representations and warranties. The seller denied the claim and the dispute ended up in the Delaware Court of Chancery.

The court ruled that the seller had not breached any of these three reps and warranties.

First, the seller represented that since 2015, Boeing had not terminated or materially reduced or altered its business relationship with the seller. There was no breach of this rep because the lost contracts were awarded to other suppliers before the end of 2015.

The seller had also not breached its MAE rep where it said that there had not been any event, occurrence, or development since 2015 that has had, or reasonably could be expected to have, a material adverse effect. The loss of $8M in Boeing contracts may be a MAE but if so, the MAE occurred before the end of 2015.

Finally, the court found that the seller did not breach its full disclosure representation and warranty: “The APA does not include an explicit representation or warranty as to the accuracy of the projections … (the seller) … shared with … (the buyer) … prior to entering into the APA. The parties did not attach … (the seller’s) … sales projections to the APA. The APA does not reference the sales projections, nor does it incorporate them by reference. Nor does the APA guarantee that … (the buyer) … would be able to renew expiring parts, or even that Boeing would allow… (the buyer) … to bid on such parts.”

This case is referred to as Julius v. Accurus Aerospace Corporation, C.A. No. 2017-0632-MTZ, Court of Chancery of Delaware (Decided October 31, 2019)  

Comment

In 20/20 hindsight the buyer could have asked the seller to represent that the business would have an opportunity to bid on the expiring contracts.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 customer and supplier rep, full disclosure rep, MAE rep, projections, representations and warranties Tagged with: ,

Buyer Loses Dispute with Asset Seller Over Responsibility for Deal’s Sales Tax

Introduction

The language used in an M&A deal matters. In a post-closing dispute, the lawyers and judges look to the language of the M&A document to resolve the dispute. And sometimes, the language will work against what a party thought.

The deal

This case involved a $6 million purchase of the assets of a marina. The sale of the marina assets was going to generate a significant sales tax. There was language in the asset purchase agreement that said that the sales tax of the seller from the sale of the marina would be the responsibility of the seller.

The lawsuit

The sales tax turned out to be $91K and the seller refused to pay for it. The dispute ended up in a New York state trial court and then an intermediate court of appeal.  Both courts said that the New York sales tax is imposed by statute on the buyer not the seller. Therefore, the provision in the asset purchase agreement did not come into play because this sales tax was not a sales tax “of the seller.”  It was a sales tax of the buyer. The buyer was stuck with it.

This case is referred to as Gaines Mar. & Servs., Inc. v. CMS Mar. Stor., LLC, 528195, Appellate Division of the Supreme Court of New York, Third Department (Decided October 31, 2019)  

Comment

The buyer should have proposed a sales tax allocation provision that said that any sales tax arising out of the transactions contemplated by the asset purchase agreement would be the responsibility of the seller. Then you don’t have to get into whether the state’s sales tax is the obligation of the seller or the buyer.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 allocation of sales tax from transaction, asset purchase agreement Tagged with: , ,

Court Greenlights Business Seller’s Fraud Lawsuit Over Earnout Dispute

Introduction

Disappointing earnout deals are common.

The deal

This deal involved the stock acquisition of the target, a legal analytics company by a competitor. The price was $9 million cash plus a $3 million earnout potential.  The earnout was based upon hitting certain revenue thresholds over the first two years following the closing.

While the parties were negotiating the level at which the threshold would be set, the buyer presented the sellers with various projections regarding the buyer’s ability to earn certain revenue amounts. The buyer pitched the projections, which according to the sellers depended on the buyer’s commitment and ability to add new target customers as well as its own stability, as “conservative.” But the projections were in fact quite aggressive; relatedly, and unbeknownst to the target shareholders, the revenue earned by the buyer’s business had fallen almost 50% from the first quarter of 2014 to the fourth quarter.

As negotiations neared completion in December 2014, the sellers e-mailed the buyer leadership to confirm that the companies’ objectives with respect to achieving the earnouts were aligned. The buyer, making no mention of its financial condition, responded that it was “committed at all times to making sure we have the tightest alignment possible for every objective we pursue.”

The buyer and sellers signed a stock purchase agreement on January 8, 2015. The buyer and one of the target’s sellers (the target’s co-founder and CEO) also signed a separate master subcontractor agreement and statement of work outlining a variety of post-acquisition services the target CEO would provide to the buyer.

The lawsuit

After the deal closed, the buyer paid the initial purchase price but did not focus on selling the target products and made little effort to achieve the revenue threshold necessary to trigger the earnout payments. During the first earnout period, Buyer delivered less than 20% of its projected revenue amount. Further, the buyer never engaged the target’s CEO to perform post-closing services despite his requests to do so. Then, in December 2015 (less than a year after the acquisition and a few months before the first earnout period ended), the buyer sold its legal division (which included the target) to a competitor, which had no interest in the target’s product.

The post-closing performance of the business did not generate an earnout. The seller sued the buyer in an Illinois federal district court for fraudulently inducing the target shareholders into entering the stock purchase agreement by making false representations about the buyer’s intentions and ability to achieve the earnout payments, in violation the Illinois Securities Law and Illinois common law.

The buyer argued that the shareholders failed to allege facts showing that they were entitled to relief under either the Illinois Securities Law or Illinois common law and asked the court to dismiss the lawsuit. The court concluded that the above alleged facts state a fraud claim under both the Illinois Securities Law and Illinois common law.

This case is referred to as Gruner v. Huron Consulting Group, Inc., No. 18 CV 02143, United States District Court, N.D. Illinois, Eastern Division (August 12, 2019)  

Comment

The court made several observations about Illinois law with respect to two common boilerplate provisions found in M&A documents. An integration clause which was in this stock purchase agreement and an anti-reliance clause which was not.

The stock purchase agreement’s integration clause stated that the agreement set forth the entire understanding of the parties with respect to the transaction and superseded any other agreements and representations. Nevertheless, under Illinois law, this standard integration provision would not protect the buyer from fraudulent representations or omissions, such as the buyer’s aggressive projections.

On the other hand, an anti-reliance provision would have changed the result in this case. In that clause the target shareholders would have contractually promised the buyer that they did not rely upon statements of the buyer made outside the stock purchase agreement’s four corners in deciding to sign the SPA.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 anti-reliance clause, earn outs, integration clause Tagged with: ,

Court Holds That $12 Million Merger Termination Fee Payment Not Exclusive Remedy

Introduction

It is common in M&A deals for the seller to have the right to terminate an agreement by paying a significant termination fee; especially as part of a fiduciary out structure.

The deal

This case involves players in the business wholesaler market. The seller and a suitor, a competitor, began talks about merging. Ultimately, the suitor and a seller entered into a merger agreement which would result in a suitor/seller 51%/49% company.

The agreement contained several protections for the suitor, including a typical non-solicitation provision that prevented the seller from pursuing a competing transaction. The seller also agreed to terminate any discussions concerning competing transactions that had started prior to the execution of the merger agreement.

The seller, however, did have a fiduciary out provision. The seller could talk to others offering a superior proposal if it was not a material breach of the non-solicitation provision. To achieve this fiduciary out protection the seller board was first required to determine “in its good faith judgment” that there was a superior proposal on the table; after consulting with a financial advisor of internationally recognized reputation and external legal counsel.

With that finding the seller was permitted to terminate the merger agreement by paying a $12 million termination fee to the merger suitor and then the seller was permitted to pursue the superior proposal as long as it “did not arise or result from any material breach” of the non-solicitation provision. In such a case the seller would have no liability to the merger suitor except for liability for fraud or willful breach.

Prior to executing the merger agreement, the seller assured the suitor it had no interest in merging with anyone else and that no other entity was interested in a transaction with the seller. But according to suitor, the Staples group had expressed interest in acquiring the seller three days before the execution of the merger agreement. The seller’s board addressed the Staple’s buyer’s pre-signing overture in a meeting held the day before executing the merger agreement but said nothing of it to the suitor until seven weeks after signing the merger agreement.

The lawsuit

Ultimately, the seller terminated the merger agreement and paid the merger suitor the $12 million termination fee. The seller then did a deal with the Staples buyer.

The merger suitor sued the seller for damages in Court of Chancery of Delaware.  The seller moved to dismiss the lawsuit claiming that the merger suitor’s exclusive remedy for breach of the merger agreement was payment of the $12 million termination fee.

The court denied the seller’s motion to dismiss finding that the merger suitor’s allegations if true could satisfy the fraud/willful breach carveout in the exclusive remedy provision of the merger agreement.

This case is referred to as Genuine Parts Company v. Essendant Inc., C.A. No. 2018-0730-JRS, Court of Chancery of Delaware (Decided: September 9, 2019)  

Comment

In 20/20 hindsight, the seller should have kept its merger suitor in the loop about its discussions with Staples; including disclosing Staples’s interest to the merger suitor before signing the merger agreement.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 exclusive remedy, fraud carveout, termination of M&A agreement, termination or breakup fee, willful breach carveout Tagged with: , , , ,

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