Buyer fights responsibility for a $1.5 million judgment against an asset seller of a business

Posted on by John McCauley

Customer is a foreign business organized under the laws of Nigeria, with its principal place of business in Lagos, Nigeria. Seller is a Louisiana Liability Company that was in the business of shipbuilding in Louisiana, until January 4, 2014. Buyer is a Virginia Limited Liability Company, with its principal place of business in Fairfax, Virginia.

On October 2, 2013, Customer sued Seller in a Louisiana federal district court to recover a deposit it paid to Seller, for a vessel that it never received.

In a January 1, 2014 Asset Purchase Agreement and Cash Sale, Buyer acquired the assets of Seller and certain liabilities. At the time of the asset purchase, Seller was owned solely by Seller Owner.

Prior to the asset purchase, Buyer Owner formed Buyer, in Virginia. He was not an owner or member of Seller. Buyer is wholly owned by Buyer Parent Company, a Delaware corporation. Buyer Owner owns 81% of the outstanding stock of Buyer Parent Company He provided the capital, as well as contacts for the business.

Seller Owner Son is the son of Seller Owner. Although he was an employee of Seller, he was not an owner or member of Seller. He owned 19% of the outstanding stock of Buyer Parent Company He provided 25 years of education, knowledge, and experience to the business.

Most of the employees of Seller were retained by Buyer, including supervisory personnel. Seller Owner was not an employee or owner but was a board member and consultant.

Buyer continued to be in the shipbuilding business at the same physical location.

On January 12, 2016, after a trial on the merits, Customer obtained a judgment against Seller in the amount of $1.5 million, plus attorneys’ fees in the amount of $60K, and post-judgment interest. Customer was unsuccessful in collecting this judgment.

Customer then sought to enforce its January 12, 2016 judgment against Buyer, as a mere continuation of Seller. Buyer denied that it had successor liability for the judgment.

Based upon the above facts, and before a full-blown trial, Customer asked the court to hold Buyer liable for the debt Seller owned to Customer. The court said not so fast.

Under applicable Louisiana law, the general rule is that where Seller sells or transfers all its assets to Buyer, Buyer is not liable to Customer for the debt and liability of Seller. However, there are four exceptions to this general rule:

1) Buyer expressly or impliedly agreed to assume the Seller’s liability to the Customer,

2) The circumstances surrounding the transaction warrant a finding that there was a de facto merger of Seller and Buyer,

3) Buyer was merely a continuation of the Seller (the mere continuation exception), or

4) The transaction is fraudulent in fact.

Customer contended that the third exception applied, and that Buyer was a mere continuation of Seller. Thus, Customer contended that Buyer was responsible for the Seller liability owed to Customer.

The court said that there were eight factors typically considered in determining if Buyer was a mere continuation of Seller:

(1) Retention of the same employees;

(2) Retention of the same supervisory personnel;

(3) Retention of the same production facility in the same physical location;

(4) Production of the same product;

(5) Retention of the same name;

(6) Continuity of assets;

(7) Continuity of general business operations; and

(8) Whether the successor holds itself out as the continuation of the previous enterprise.

Having reviewed the evidence, the court said that while many of the factors favored Customer’s position, the court could not find, as a matter of law, at this time that Buyer, is a mere continuation of Seller. The court found, instead, that a trial on the merits was appropriate, so that it may fully evaluate and weigh each factor and judge the credibility of the witnesses who appear at trial.

This case is referred to Hadassa Investment Security Nigeria, LTD. v. Swiftships Shipbuilders, LLC, Civil Action No. 16-1502, United States District Court, W.D. Louisiana, Lafayette Division, (December 28, 2018).

Comment. The lawsuit filed by Customer against Seller was a matter of public record before Buyer purchased Seller’s assets. The court records would have shown a claim by Customer to recover a $500K deposit it paid to Seller for a ship that Seller later sold to another customer.

However, after the closing, Customer amended its complaint to ask for treble damages under the Louisiana Unfair Trade Practices Act. That jumped up Buyer’s risk on this lawsuit from $500K to $1.5 million; and the risk materialized in the form of a $1.5 million judgment against Seller that Customer now seeks to recover from Buyer.

Finally, most states would require in applying the mere continuation exception (in determining whether Buyer is responsible for this Seller Debt) that Seller Owner have an ownership interest in Buyer or a Buyer affiliate in order to stick Buyer with this debt. Apparently, that is not true under Louisiana law. The actual exception applied here (which does not require Seller Owner ownership in Buyer) is really an exception not recognized in many states called the continuity of enterprise exception.

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 purchase agreement, Buyer beware, continuity of enterprise exception, mere continuation exception, successor liability

Seller of company can sue Buyer for making oral fraudulent and negligent misrepresentations

Posted on by John McCauley

Seller’s Owner founded Seller in 2002. Seller was based out of the greater Sacramento, California area. In 2007, Seller began doing business as BenefitsCONNECT. BenefitsCONNECT is an online benefits enrollment and administration system that connects employer groups, insurance carriers, third party administrators, payroll vendors, and brokers. In addition to managing BenefitsCONNECT, Seller’s Owner was working on a new venture named Aurora, which would function as an employee benefits agency. In 2015, Seller’s Owner entered into a licensing agreement with BenefitsCONNECT that would give Aurora the right to use the BenefitsCONNECT source code on its own platform, once that platform became operational.

In 2016, Seller and Buyer began negotiating a potential sale of BenefitsCONNECT to Buyer. Buyer is a cloud-based platform for employee benefits and health exchange services, based out of the Chicago area.

During negotiations and due diligence, Seller’s Owner worked closely with Buyer’s CEO regarding the transaction. An asset purchase agreement was executed on August 4, 2016 between Seller and Seller’s Owner, and Buyer. Per the asset purchase agreement, Seller agreed to sell all assets of BenefitsCONNECT to Buyer, including all intellectual property and source coding.

Buyer’s Private Equity Firm financed the acquisition for Buyer and participated in the negotiation of the deal.

On the same day the parties entered into the asset purchase agreement, and per Buyer’ request, Seller’s Owner terminated the Aurora licensing agreement between Seller’s Owner and BenefitsCONNECT.

On May 21, 2018, Seller and Seller’s owner sued Buyer in a Delaware federal court for, among other claims, alleged fraud and negligent misrepresentation against Buyer. Seller/Seller’s Owner alleged Buyer’s CEO misrepresented via an oral promise that Buyer would license the source code to Seller’s Owner for use in the Aurora venture after the sale of BenefitsCONNECT to Buyer. Approximately three weeks after the asset purchase agreement was executed, Seller/Seller’s Owner contended Buyer’s CEO informed Seller’s Owner that Buyer’s CEO had changed his mind and Buyer would not execute a renewed Aurora licensing agreement with Seller’s Owner. Seller/Seller’s Owner alleged that their reliance on this oral promise resulted in their agreement to a lower sale price and the termination of the Aurora licensing agreement between Seller’s Owner and BenefitsCONNECT.

Buyer asked the court to dismiss these claims because of the asset purchase agreement’s integration clause; which essentially says that the only promises made by Buyer in this deal were contained only in the asset purchase agreement. The asset purchase agreement did not contain the Buyer’s CEO’s promise to license back the source code to Seller’s Owner for use in the Aurora venture.

Buyer alleged that Seller/Seller’s Owner cannot maintain a fraud claim because as parties to the asset purchase agreement represented by counsel, Seller/Seller’s Owner could not have reasonably relied on any oral promises that were not memorialized in the heavily negotiated asset purchase agreement. Buyer pointed to the integration clause and other language in the asset purchase agreement to show that Buyer and Seller/Seller’s Owner expressly agreed that the asset purchase agreement contained all of the terms of the sale of BenefitsCONNECT to Buyer, and such terms could only be modified in a writing, signed by both Buyer and Seller/Seller’s Owner.

The court did not agree. The court said that integration clauses may not prohibit Seller/Seller’s Owner’s reasonable reliance on a fraudulent misrepresentation. Whether Seller/Seller’s Owner’s reliance on the oral statement was reasonable given the integration clause of the asset purchase agreement is a question of fact that is generally not suitable for resolution on a motion to dismiss.

Here, Seller/Seller’s Owner provided enough facts for an inference that Buyer’s CEO had motivation to make the statements alleged in order to gain an advantage in negotiation of the asset purchase agreement. Further, since Buyer’s CEO alone made the statements about the source code both before and after the execution of the asset purchase agreement, the facts lie more within the knowledge of Buyer.

Buyer also asked the court to dismiss Seller/Seller’s Owner’s negligent misrepresentation claim. It is based upon the same oral promise. The big difference about this claim is that Seller/Seller’s Owner did not have to prove that Buyer knew the oral promise was false when made; all Seller/Seller’s Owner had to prove is that Buyer did not use reasonable care when Buyer made the oral statement.

The court refused to dismiss the negligent misrepresentation claim. It first said that the integration clause did not bar the negligent misrepresentation claim, any more than it barred the fraud claim.

Nevertheless, Buyer also argued that it had no duty to Seller/Seller’s Owner to be careful when making this oral promise. The court disagreed saying that Delaware law imposed a duty of disclosure on Buyer when Buyer and Seller/Seller’s Owner were in the midst of a business relationship from which Buyer and Seller/Seller’s Owner expect to derive pecuniary benefits. Buyer had a duty under Delaware law to provide accurate information.

Here, the court said that Seller/Seller’s Owner alleged reliance on information Seller/Seller’s Owner received during negotiation of a transaction from which Seller/Seller’s Owner expected to benefit financially, and the information allegedly changed abruptly after the asset purchase agreement was executed, when Buyer’s CEO purportedly changed his mind.

This case is referred to Underwood v. BENEFIT EXPRESS SERVICES, LLC, C.A. No. 18-347-RGA-MPT, United States District Court, D. Delaware, (December 28, 2018).

Comment. Putting the promise to license back the source code to Seller’s Owner in the asset purchase agreement would have substantially reduced the risk of Buyer not following through with its promise.

Seller/Seller’s Owner had also sued Buyer’s Private Equity Firm for aiding and abetting in Buyer’s CEO’s alleged promise to Seller/Seller’s Owner to license back the source code to Seller’s Owner after the closing. However, the fact that Buyer’s Private Equity Firm financed and helped negotiate the transaction was not enough facts to connect it with Buyer’s alleged fraudulent/negligent misrepresentation; and so, this claim was dismissed by the court.

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 purchase agreement, boilerplate provisions, fraud in business sale, integration clause, no oral modifications of contract, private equity

Buyer’s purchase price may triple post-closing because of underfunded union pension plan

Posted on by John McCauley

Seller was a wire-forming company. A collective bargaining agreement with the union representing its workforce obligated Seller to contribute to a multiemployer pension plan on behalf of the employees.

In September 2013, after Seller determined that it could not stay in business, Seller executed a plant closing agreement with the union; which stated that nothing in the plant closing agreement should be considered or asserted to be a waiver by the union of any Seller withdrawal liability that may be determined and imposed in the future by the union.

The plan was underfunded when Seller withdrew. Federal law (commonly known as ERISA) provides that Seller by withdrawing from the union pension plan remains liable for its share of unfunded vested benefits. One month later, the union pension plan notified Seller that it owed $644K in withdrawal liability. Seller did not contest that assessment and continued to make monthly withdrawal-liability payments until October 2014, shortly after the sale to Buyer discussed below.

One of Seller’s former customers, Buyer, purchased Seller’s assets, in September 2014, for $250,000. This was primarily twenty-six pieces of machinery (such as presses, press brakes, benders, and welders), Seller’s customer list, and its goodwill.

It was undisputed that Seller’s owners never disclosed the withdrawal liability to Buyer. But documents provided to Buyer showed that Seller’s workforce was unionized, that Seller had made contributions to a union-sponsored pension plan, that Seller had since withdrawn from the plan, and that the union was not waiving any withdrawal liability that may be determined and imposed against Seller in the future.

In 2015, the union pension plan sued Buyer in an Ohio federal district court to recover Seller’s withdrawal liability, on the theory that Buyer was a successor employer and therefore responsible for the withdrawal liability.

Buyer asked the court relatively early in the litigation to rule that it was not liable for Seller’s union pension plan withdrawal liability because it did not know about the withdrawal liability. The court ruled that although Buyer did not know about the underfunded pension plan it should have known about it based upon the due diligence it had done.

That means that the union can proceed in its lawsuit to recover Seller’s $644K union pension plan liability. The primary question remaining is whether, under the totality of the circumstances, there is substantial continuity between the operation of Seller’s business by Buyer.

To determine continuity of operations, the court will look to: continuity of workforce; management; equipment and location; completion of work orders begun by Seller; and Buyer continuing to service Seller’s customers.

Based on the totality of the circumstances, the court must determine whether Buyer has acquired substantial assets of Seller and continued, without interruption or substantial change, Seller’s business operations.

Buyer argued that the facts produced at in this early proceeding established that Buyer did not continue Seller’s operations without interruption or substantial change. The court concluded that this issue cannot be determined at this stage of the proceeding; concluding that depending on how one views and weighs the evidence, one might reasonably conclude that Buyer did or did not substantially continue Seller’s business.

Perhaps most importantly, the court noted that Buyer hired all of Seller’s employees, in addition to a former Seller plant manager whom Buyer brought on specifically to get the wireforming operation off the ground. Buyer used Seller’s equipment to start forming wire, and Buyer repeatedly reached out to former Seller customers, whether to solicit their business or allay any concerns about Buyer’s competence in the wire-forming business. Thereafter, a very large number of those customers became Buyer customers.

On the other hand, the court noted that Buyer made a number of seemingly important changes after the asset sale. For one thing, it upgraded, as Seller had (or could) not, its wire-forming equipment. As a result, machine fabrication largely, if not entirely, replaced the kind of hand manufacture that Seller employed. This arguably allowed Buyer’s operations to be more efficient. Also, none of the former Seller employees managed operations at Buyer, and their day-to-day job duties changed to some, and perhaps to a significant, degree.

The court also said that it is also possible to draw conflicting inferences from the evidence regarding Buyer’s use, or in some cases non-use, of Seller’s intangible assets.

For example, Buyer claimed that it had no intention to capitalize on Seller’s goodwill because none existed in 2014. Yet, the court noted that Buyer paid $120,000 — 48% of the total purchase price — for the goodwill and Seller’s customer list. In addition, Buyer insisted that Seller change its name.

This case is referred to Members of the Board Of Administration of the Toledo Area Industries UAW Retirement Income Plan v. Obz, Inc., Administration Case No. 3:15CV756, United States District Court, N.D. Ohio, Western Division, (December 26, 2018). https://scholar.google.com/scholar_case?case=11249101925830503209&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment. The Ohio federal district court followed a recent decision of the 9th Circuit of the U.S. Court of Appeals (a federal appellate court that interprets federal law for federal district courts out west), that a buyer does not have to know that a seller has unfunded union pension plan liabilities to be responsible for the liability. All it takes is if for buyer having enough information that buyer should have known about the unfunded liability.

The lesson: Get expert help to determine if a seller with a union pension plan has an underfunded union pension plan liability. Had Buyer done that in this case, it would probably would have concluded that the purchase price was not $250K, but almost $900K ($250K plus $644K).

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 purchase agreement, constructive knowledge, distressed business acquisitions, federal multiemployer pension plan withdrawal liability, multi-employer pension plan, successor liability, union liabilities

Seller loses $12.7 million jury verdict on appeal for damages for potential buyer’s claimed breach of confidentiality provision in letter of intent

Posted on by John McCauley

In 2010, Seller was an integrated design and manufacturing company specializing in the development, production, installation, repair, and servicing of heavy equipment for use by offshore energy companies in the Gulf Coast region. Seller was founded in 2002 and employed about seventy-five people at Seller’s headquarters in the Houston area.

Potential Buyer is a European company with international affiliates and subsidiaries. One of its affiliates manufactures and sells load handling equipment used in offshore oil exploration and production, including large subsea cranes. Potential Buyer became interested in acquiring Seller so that Potential Buyer could expand its ability to service and repair Potential Buyer’s subsea cranes and other equipment in the Americas.

On December 7, 2010, Potential Buyer and Seller entered into a letter of intent. The letter of intent memorialized Potential Buyer’s nonbinding proposal to acquire Seller’s assets for a price in the range of $18-25 million. This price range was subject to change based upon a valuation determined after appropriate due diligence had been conducted. The parties agreed to use reasonable efforts to negotiate and execute a definitive acquisition agreement on or before February 28, 2011.

The letter of intent included a binding confidentiality provision. It prohibited Potential Buyer from using Seller’s confidential information for any purpose other than evaluating the proposed acquisition, and it specifically prohibited Potential Buyer from using Seller’s confidential information to obtain a commercial, trading or other advantage.

Due diligence began in early February 2011. Potential Buyer team members made several trips to Seller’s Hempstead, Texas facility and interviewed Seller’s principals and employees. Potential Buyer also obtained extensive information from Seller, including Seller’s business plan, technical information, financial documents, customer lists, and equipment sales information.

In the end, Potential Buyer and Seller could not agree upon a purchase price and the deal never closed.

At around the same time, Potential Buyer started up a competing service center in Houston to be headed by an employee of Potential Buyer, who had participated in Potential Buyer’s due diligence review of Seller. The project’s staff also included at least three others from the due diligence team.

Seller became aware of Potential Buyer’s Houston expansion project when Seller learned that Potential Buyer was calling on Seller’s customers. Seller ultimately sold its business to another buyer for $22.5 million.

In December 2012, Seller filed a lawsuit against Potential Buyer in a Houston state court. Seller claimed that it received a depressed price for the sale of its business because of Potential’s Buyer’s unlawful use of Seller’s confidential information, in violation of the confidentiality provision in the letter of intent. A jury awarded Seller $12.7 million in damages, plus attorney fees of $430K.

Potential Buyer appealed to a Houston intermediate state appellate court. This court reversed the jury verdict holding that Seller had failed to prove that it had suffered any loss from Potential Buyer’s claimed actions.

The court noted that Seller did not know of any business that Seller lost to Potential Buyer; that Seller had no firsthand knowledge that Potential Buyer used Seller’s technical information, such as drawings, information, or designs in its Houston expansion project; and that Potential Buyer’s Houston service center did not work on the kind of heavy equipment that Seller did.

Furthermore, Seller’s forensic expert’s testimony that Seller suffered lost profits and diminished value were wrongfully based upon Seller’s bare assumptions of projected revenues and profits in its business plan, unsupported by objective facts, figures, or data establishing that these assumptions were objectively reasonable.

This case is referred to Cargotec Corporation v. Logan Industries, LLC, No. 14-17-00213-CV, Court of Appeals of Texas, Fourteenth District, Houston, (filed December 20, 2018).

Comment. This case illustrates the risk that a seller of a business runs when negotiating with a buyer in the same industry.

The reality is that the seller will have to disclose confidential information to a potential buyer so that the potential buyer can evaluate the business. The risk is that the deal may not materialize, and the potential buyer may use seller’s confidential information to compete against seller’s business. The right to sue the potential buyer for breach of a confidentiality provision helps but proving damages may prove challenging.

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 damages, diminuation of value, lost profits, nondisclosure agreement, nondisclosure provision, strategic acquisition, strategic acquisition

Energy drink asset buyer bound by seller’s formula restriction agreement with 3rd party

Posted on by John McCauley

Manufacturer is the maker and distributor of 5-Hour Energy, a well-known energy shot. In 2004, Manufacturer contracted with Seller to manufacture and package 5-Hour Energy. When Manufacturer ended the business relationship some years later—abruptly and unfairly, according to Seller—Seller had a surplus of ingredients and packaging.

Seller used the surplus to continue manufacturing 5-Hour Energy for an unspecified amount of time after the relationship ended. Seller claimed that Seller’s use of the surplus of ingredients and packaging was justified under the Uniform Commercial Code, which Seller claimed authorized Seller to recover some of Seller’s loss from Manufacturer’s termination of its business relationship with Seller.

Manufacturer and Seller then sued one another, with each claiming, among other claims, that the other had breached the contract. The protracted litigation came to an end almost two years later when Seller was on the verge of bankruptcy. Manufacturer and Seller then entered into the settlement agreement.

The settlement agreement prohibited Seller from manufacturing any new energy drinks that contained certain specified substances used in Manufacturer’s energy drink. In return for these restrictions and admissions, Manufacturer paid Seller $1.85 million.

The $1.85 million cash infusion from Manufacturer was insufficient to enable Seller to regain its financial footing. Thus, Seller talked to the owner of Buyer’s Parent Company, about the possibility of Buyer’s Parent Company acquiring Seller. Buyer’s Parent Company agreed to purchase Seller’s assets and formed a new corporation, Buyer, which entered into an asset purchase agreement with Seller.

The asset purchase agreement provided that Buyer acquired Seller’s listed assets, but Buyer was not responsible for any liabilities, liens, security interests, claims, obligations, or encumbrances of Seller except for those listed on an attached schedule—principally, debt Seller owed to a bank. The asset purchase agreement also included a reference to the settlement agreement. That asset purchase agreement provision said that the formula for energy drinks manufactured by Seller did not include certain substances described in the settlement agreement between Seller and Manufacturer.

After the closing, Buyer went into the energy shot business, under the management of Seller’s former CEO/president. Buyer marketed itself as a continuation of Seller and took on Seller’s old orders and customers. Over the next few years, Buyer produced and distributed energy shots containing substances that Seller was prohibited from using under the settlement agreement.

Manufacturer sued Buyer for breaching the settlement agreement, in a Flint, Michigan federal district court. Buyer argued that it was not bound by the settlement agreement, because Buyer did not sign the settlement agreement. The trial court concluded that Buyer was bound by the energy drink formula restrictions in the settlement agreement by virtue of the settlement agreement’s formula restrictions incorporation into the asset purchase agreement.

Buyer appealed the trial court’s finding that it was bound by the terms of the settlement agreement, once again arguing that it could not be bound by the settlement agreement because Buyer did not sign the settlement agreement. The appellate court held that Buyer was bound by the formula restrictions in the settlement agreement.

The appellate court conceded that reference to the settlement agreement in the asset purchase agreement does not by itself bind Buyer any terms of the settlement agreement. Under applicable Texas law, Buyer would be bound by formula restriction provision in the settlement agreement if the language in the asset purchase agreement indicated an intent by Buyer to be bound by that settlement agreement provision.

And that was the case here. The appellate court said that the asset purchase agreement clearly provided that the formula for energy drinks manufactured by Seller was limited by the settlement agreement between Seller and Manufacturer. The appellate court concluded that Buyer’s acknowledgment in the asset purchase agreement that Buyer’s rights to the formula were limited by the settlement agreement indicated an intent by Buyer to be bound by the settlement agreement’s formula restriction provision.

This case is referred to Innovation Ventures, LLC v. Custom Nutrition Laboratories, LLC, Nos. 17-1734, 17-1771, 17-1911, United States Court of Appeals, Sixth Circuit., (Decided and Filed: December 20, 2018).

Comment. It is important that a buyer of a company, keep a close eye on a company it acquires postclosing, especially, if the acquired company will be run postclosing, by the seller’s former management team. Should be on a post-acquisition integration checklist.

With 20/20 hindsight, for example, the top management of Buyer’s Parent Company, might have prevented the use of Manufacturer’s formula postclosing in the acquired business by Seller’s former CEO/president, had Buyer’s Parent Company tightly controlled management of postclosing operations of the acquired business, at least until Buyer’s Parent Company was comfortable with the former Seller’s CEO/president’s performance.

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 purchase agreement, assumed liabilities, assumption of a contract, assumption of contract by incorporation by reference

Seller of business successfully sues buyer for failure to get personal lease guaranty release

Posted on by John McCauley

Sellers, husband and wife, owned Target, which operated a wine business in Round Rock, Texas (greater Austin area). Target operated out of leased shopping center space. On December 30, 2009, Sellers sold Target to Buyer, effecting the sale through a membership interest purchase agreement, which transferred the lease to Buyer.

That same day, in accordance with the terms of the lease, Sellers sent a letter to the landlord notifying it about the proposed assignment of the lease. In the letter, Sellers agreed to continue the personal guaranty of performance under the lease that Sellers had executed when Target first entered the lease in 2005. The letter was signed by Sellers and Buyer.

Buyer promised in the purchase agreement that Buyer would not extend the term of the Target shopping center lease, without obtaining a release from the landlord of Sellers’ personal guaranty of Target’s obligations under the lease. The purchase agreement went on to say in effect that Sellers would not have done this deal without Buyer’s lease extension promise.

In February 2011, Buyer, as owner of Target, and the landlord extended the shopping center lease term for one year. Buyer did not obtain a release or termination of Sellers’ personal guaranty of the lease obligations from the landlord. In 2012, Buyer and landlord extended the lease until January 2015. Buyer again did not obtain a release or termination of Sellers’ personal guaranty of lease obligations from the landlord.

In 2012, according to Sellers, or 2014, according to Buyer, Buyer sold Target and assigned the lease to the new owners, who eventually closed the business and defaulted under the lease. The landlord sued the new owners and Sellers, as guarantor. Sellers settled with the landlord. Sellers made demand on Buyer for reimbursement of $5,000 expended in defending and settling the new owner’s suit against Sellers. When Buyer did not offer reimbursement, Sellers brought this suit against Buyer in a Texas state court, alleging that Buyer breached the purchase agreement by failing to obtain a termination of the guaranty and by failing to indemnify Sellers.

Buyer pushed back with various arguments but lost at the trial court level. Buyer appealed to an intermediate appellate court. This court agreed with the trial court, but only after spending pages in its opinion dealing with Buyer’s legal arguments involving the statute of limitations, impossibility, estoppel, and waiver.

This case is referred to Gano v. Diaz, No. 03-17-00119-CV, Court of Appeals of Texas, Third District, Austin, (Filed: June 28, 2018).

Comment. With 20/20 hindsight, Sellers could have avoided all the time and expense of litigation by insisting that Sellers get released by landlord at the closing. It may not have been possible, but the tradeoff of doing the deal without immediate release of the lease guaranty was the risk of litigation like this.

 

 

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 Assignment, leases, personal guaranty of lease

Buyer can sue seller of urgent care centers for lost profits from Target’s alleged material breach of 3rd party payor contracts

Posted on by John McCauley

Buyer is based in the greater Baltimore area and operates urgent care centers and clinics throughout central Maryland, Delaware, Pennsylvania, and Virginia. In January 2015, Buyer purchased Target from Seller, a physician. Target operated urgent care facilities in Pennsylvania.

According to Buyer, Target’s third-party payor agreements, including an agreement with Independence Blue Cross, required that a board-certified physician always be on site at Target facilities. After the closing Buyer discovered that Seller’s policy was that a physician be on site unless there was an illness, family emergency, or no show by a physician. As a result, Buyer discovered that there were hundreds of times where no physicians were on site, before closing.

Buyer sued Seller in a Philadelphia federal district court. Buyer claimed that Seller’s representations and warranties that no Target condition existed that in and of itself would result in the suspension of any such third-party payor program, and that Target complied in all material respects with the requirements of all such third-party payors, including Blue Cross, were false. Specifically, Target’s urgent care centers lacked onsite physicians hundreds of times before the closing, in violation of third-party payor contracts.

As a result, Buyer claimed it would not have not paid Sellers as much for Target as Buyer did had it known about the physician onsite absentee problem.

Seller argued that Buyer has no legal claim against Seller even if the alleged facts were true. Seller claimed that the physician absentee problem was not a Target material breach of its third-party payor agreements. The court was not persuaded, concluding that even Seller conceded that board certified physicians were not always present at the urgent care facilities.  Whether this pattern was a material breach of the third-party payor contracts was a question for a later stage of the litigation.

Seller had one other line of attack why Buyer’s breach of contract claim was flawed. In noted that Buyer claimed that because Seller’ representations and warranties on this issue were false, Buyer ultimately overpaid for Target and suffered lost profits. Seller argued that Buyer can’t make a lost profit claim. The court disagreed holding that lost profits may be recovered under applicable Pennsylvania law because (1) evidence can establish the amount that Buyer overpaid for Target with reasonable certainty (2) Buyer’s alleged overpayment for Target was the proximate consequence of the breach of the physician presence requirement in the third party payor contracts, and (3) the amount that Buyer overpaid for Target was reasonably foreseeable from Seller’s alleged misrepresentations.

This case is referred to Gusdorff v. MNR Industries, LLC, Civil Action No. 18-652, Supreme Court, New York County, (July 6, 2018).

Comment. With 20/20 hindsight, Buyer would have preferred to have discovered this problem through due diligence. Then Buyer could have either walked or negotiated a reduced purchase price.

Although Buyer has a breach of contract claim against Seller there might be a cap to Buyer’s damages in the purchase price as low as 10% or less of the purchase price. Buyer’s tried in this case to override the cap by alleging fraud but the court threw out the fraud claim. It is difficult to sue a seller in a purchase agreement for fraud.

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 Buyer beware, due diligence, economic loss doctrine, material contracts, representations and warranties

Israeli pharma buyer’s fraud claim against seller of Mexican pharma company tossed out by court

Posted on by John McCauley

In 2015, Buyer, an Israeli pharma company purchased Target, a Mexican pharmaceutical company, from Sellers, and the intellectual property used by Target from a Sellers affiliate. The total sale price came to $2.3 Billion.

After the closing, Buyer claimed that Sellers lied about and concealed violations of the law which keep Target from selling its products postclosing, and which undermined the value of Target and its intellectual property. Specifically, Buyer learned that Target had engaged in a long-term scheme to sell defective and illegal products and hide these facts from Mexican regulators.

Buyer sued Sellers in a Manhattan state court for among other claims, fraud for Sellers’ misrepresentations in the representations and warranties in the agreements and for providing fraudulent due diligence materials. Buyer in its complaint described the alleged fraud in detail as described below.

Mexican pharmaceuticals must be submitted to the Mexican FDA, similar to the Food and Drug Administration in the United States. Once approved, the product sold must match the approved formulation. Target avoided the Mexican FDA review by creating a fraudulent fast track program, in which it submitted falsified applications for formulations it had not yet developed or tested. It would then sell products under those approved formulations, even if the product was different. Target kept two sets of records of its products, which it called double paperwork, so it would have one set of papers and computer records which would show compliance with the regulations, and one reflecting Target’s true activities. Target also lied to the Mexican FDA about its suppliers and what tests it had performed to determine the shelf life of the products.

Sellers were senior officers of Target, and aware of Target’s actions, including the fast track program and the double paperwork. Sellers lied to Buyer during the acquisition and presented Buyer with the false documents. Sellers were also aware of the falsity of the representation in the acquisition agreement that Target was operating materially in compliance with applicable laws. Buyer relied on those false representations, and the double paperwork prevented Buyer from discovering the fraud.

A week after the transaction closed, Buyer received an anonymous e-mail alerting it to the falsified product registrations, double paperwork, and other issues. Buyer then alerted the Mexican FDA, which inspected the Target plant and ordered Buyer to stop production of 44 different products. Mexican FDA subsequently shut the plant down entirely. It is unknown if and when Target will be able to sell its products again, and Buyer suffered reputational damage, in addition to losing the benefit of its bargain in purchasing Target.

Sellers asked the court to throw out the fraud claims which primarily revolved around Sellers furnishing Buyer during due diligence the false set of Target papers and computer records which showed compliance with the Mexico FDA regulations. Sellers argued that Buyer agreed in the acquisition documents to only rely upon the representations and warranties of Sellers that were contained in the acquisition documents; and not on data room material supplied during Buyer’s due diligence.

The court agreed with Sellers. First the court noted that Buyer was a sophisticated buyer of businesses and performed extensive due diligence on Target before entering into a major transaction, including a site visit and employee interviews. If Buyer had wanted Sellers to represent and warrant the accuracy of the Mexico FDA compliance material, then it could have negotiated for this representation and warranty to be included in the acquisition documents. But Buyer did not.

Buyer responded to this point by arguing that Buyer should be excused under applicable New York law from requiring Sellers to represent and warrant that the Mexico FDA material furnished Buyer was accurate because it was not reasonable for Buyer to suspect that Sellers were lying. The court disagreed saying that if the Mexico FDA compliance materials were not matters peculiarly within Target’s knowledge, and Buyer had the means available to Buyer of knowing, by the exercise of ordinary intelligence, the accuracy of the Mexico FDA material, then Buyer must make use of those means, or Buyer will not be heard to complain that Buyer was induced by Sellers to enter into the transaction by misrepresentations.

Buyer countered by saying that Buyer did not ask Seller to make a representation and warranty that the Mexico FDA materials were accurate because it had no knowledge of the inaccuracy of the Mexico FDA material and no way of discovering that it was inaccurate in the exercise of reasonable diligence. The court agreed that Buyer might be excused if due diligence would have been futile, but the court found that Buyer provided no reason that it could not have discovered the truth.

Specifically, the court noted that Buyer had access to Target’s personnel, facility, and products. The court concluded that Buyer did not allege any reason why Buyer could not have established that the products did not match the formulations.

This case is referred to Representaciones E Investigaciones Medicas, SA De CV v. Abdala, Docket No. 655112/2016, Mot. Seq. Nos. 006, 007 and 009, Supreme Court, New York County, (Filed August 2, 2017). https://scholar.google.com/scholar_case?case=1061886467576930045&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment. Buyer’s loss of the fraud claim was a major blow to Sellers. The remaining Buyer claim was for breach of acquisition agreement representations and warranties such as Sellers’s representation and warranty that it was in compliance with all applicable laws.

However, prevailing on that claim would be at most a Pyric victory in that Buyer had alleged a massive loss on the $2.3 billion purchase price Buyer paid for Target. Damages for a Buyer breach of contract claim win would be limited by the acquisition documents to a cap of $45 million.

In 20/20 hindsight, this case demonstrates that a buyer should borrow from Ronald Reagan’s slogan about doing arms limitation deals with the former Soviets: trust but verify. In this case a deeper dive into the Mexico FDA compliance area may have resulted in no deal; or a deal at a deeply discounted price.

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 compliance with all applicable laws, extra-contractual fraud, fraud in business sale, indemnification cap, representations and warranties

No fraud in alleged buyer’s financial misrepresentations concerning buyer’s equity received by seller of company

Posted on by John McCauley

Seller was two related companies, one, a provider of litigation support and e-discovery services and the other, a provider of temporary legal staffing to law firms and corporations. Seller along with Seller Affiliate, a related company providing various litigation support services to litigators in New York City and Washington D.C., operated under common ownership as part of a litigation support and e-discovery business known as Superior Discovery.

Buyer, based in Chicago, also in the same business, is a wholly-owned subsidiary of Buyer’s Parent Company.

In 2014, Buyer began negotiating for and purchasing a number of e-discovery vendors and similar providers. Buyer’s Financing Source, a business development company, provided Buyer with financing.

After weeks of due diligence and negotiations, Buyer and Seller signed an asset purchase agreement. Buyer acquired substantially all of Seller’s assets for $9.9 million in cash and $2 million in preferred equity in Buyer’s Parent Company.

Among other things, the operating agreement provided for distributions and allocations of profit and loss with respect to the preferred equity. Distributions, however, were subject to any applicable agreement to which Buyer or Buyer’s Parent Company were indebted for borrowed money and to the retention and establishment of reserves for payment to third-parties such as the term loan agreement with Buyer’s Financing Source.

Seller had the right to seek up to $2 million in payment for the preferred equity at any time following the third anniversary of the date of issuance and only once there had been payment in full of all obligations outstanding under the term loan agreement and other term loan documents.

Seller also promised in the operating agreement that Seller would not sue Buyer’s Parent Company until payment in full of all obligations outstanding under the term loan documents.

Pursuant to the asset purchase agreement, moreover, Seller’s preferred equity were pledged to Buyer under a pledge agreement as collateral to secure certain indemnification obligations.

Seller and Buyer had a falling out after the closing. Seller claimed that Buyer before the closing, in supporting a $2 million valuation for the preferred equity to be given in the deal, forecasted Buyer’s Parent Company’s annualized forecasted revenue would be `$40 million in sales and $10 million in EBITDA (earnings before interest taxes depreciation and amortization).

Seller contended that it learned after the closing that such representations were false as Buyer’s Parent Company internal projections of annualized revenue were $33 million and that the figure included increased revenue predictions of acquisitions. Seller contended that that the $40 million figure was a complete fabrication by Buyer in an effort to convince Seller to accept the preferred equity.

Seller also had been told before closing by Buyer other misrepresentations that: (1) Buyer had a $10 million war chest for additional acquisitions, (2) Buyer had secured a $3 million revolving line of credit that would assist financing business operations after the acquisition of Seller and (3) that Buyer had a new lender that would allow for refinancing of the Buyer’s Financing Source loans within weeks.

Seller claimed that it relied on written and oral representations of Buyer, as it was not shown important documents related to the transaction. Seller contended that it was never shown the term loan agreement, on which its rights were contingent, and that Buyer made misrepresentations about its relationship with Buyer’s Financing Source and the term loan agreement. Seller further alleged that documents that were part of the asset purchase agreement and operating agreement and were referred to as exhibits were not actually shown to Seller because Buyer claimed that the documents were confidential due to simultaneous acquisitions and discussions with Buyer’s Financing Source.

Seller sued Buyer in a Manhattan court for fraud, among other claims, and Buyer asked the court to dismiss the fraud claim. The court dismissed the fraud claim.

The court said that Seller’s fraud claim required that (1) Buyer make a material Buyer misrepresentation, (2) Buyer know that the misrepresentation was false, (3) Buyer intend to induce Seller to rely upon Buyer’s misrepresentation, (4) Seller was justified in relying upon Buyer’s misrepresentation and (5) Seller suffered damages.

Buyer contended that the allegation that it issued worthless preferred stock as part of a fraudulent scheme to induce Seller to enter into the asset purchase agreement was not economically plausible because (1) Buyer paid Seller $9.9 million cash and (2) the preferred equity was pledged to Buyer at closing to protect Buyer from the risk of Seller fraud. Therefore, Buyer argued that the fraud claim failed because Seller did not allege any misrepresentation that was material. The court agreed.

The court also held that it was unreasonable for Seller to rely on the two alleged Buyer misrepresentations.

The first misrepresentation was that Buyer expected that by the closing Buyer would have a combined $40 million in annual sales and earnings of at least $10 million a year. Seller claimed that this was a misrepresentation because actual annual sales at the time of closing were only projected to be $33 million.

First, Seller could not explain how the projections were calculated or where the numbers came from. That was because Seller conducted no projections of its own; and though Seller had the means to discover the true value of the preferred stock by the exercise of ordinary diligence; it failed to make use of those means, such as through its legal and financial advisors.

Second, the asset purchase agreement only provided for minimal Buyer warranties that Buyer would have sufficient funds to consummate the transaction and make the cash payment. And, the asset purchase agreement made clear that Seller could not rely on Buyer’s representations unless they were specifically set forth in the asset purchase agreement itself. The court noted that none of the alleged misrepresentations were covered under the asset purchase agreement.

The court also found no fraud claim against Buyer based upon the second misrepresentation. The second alleged misrepresentation, not listed in any agreement, was that Buyer had a $10 million war chest to make additional acquisitions and had secured a $3 million revolving line of credit. Seller again did not reveal any efforts on its part to confirm this information. More importantly, Seller did not disclose how this information was material to its decision to go forward with the transaction in light of the fact that, even if Buyer’s Financing Source was paid back in full by a refinancing (1) the preferred equity were transferred to Buyer as security, and (2) Seller could only demand that the preferred equity be purchased 3 years after their issuance.

To bring its point of Seller’s unreasonable reliance upon Buyer’s misrepresentations the court said that for Seller to rely on Buyer’s representations without seeing documents, which Seller claimed were material, and enter into a multi-million-dollar sale of assets cannot be justifiable. Seller never insisted on any documentation to back up the alleged misrepresentations by Buyer and Seller even signed the asset purchase agreement without insisting on access to documents such as the omitted exhibits to the agreement.

This case is referred to OmniVere, LLC v. Friedman, Case No. Docket No. 154544/2016, Motion Seq. No. 005, Supreme Court, New York County, (December 6, 2018).

https://scholar.google.com/scholar_case?case=2598900280250655757&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment. The lesson for sellers when receiving equity from buyer as part of the purchase price: beware. When you are selling a company and receiving back buyer equity then you are as much a buyer as you are a seller. That means that you and your team must kick the buyer’s tires.

It also means including many more Buyer representations and warranties in the purchase agreement; meaning that the representations and warranties about buyer could be as comprehensive as Seller’s representations and warranties about the business it is selling.

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, fraud in business sale, material, receipt of buyer equity or security, receipt of buyer equity or security, reliance

Seller of golf company battles buyer over right to $16.6 million VAT receivables as tax credit

Posted on by John McCauley

In late 2010, Seller decided to sell Target (a wholly-owned subsidiary engaged in the manufacture and distribution of golf products, including Titleist-brand golf clubs, balls and tees and Footjoy-brand golf shoes) by way of auction. The eventual winning bidder was Buyer and after a period of negotiations, Buyer and Seller formalized the deal in a stock purchase agreement, dated May 19, 2011. A little over two months later, on July 29, 2011, the transaction closed, with Buyer purchasing all of the stock in Target for $1.225 billion, subject to certain postclosing adjustments.

To ensure the sale proceeded promptly and smoothly, Seller decided prior to soliciting bids to remove all issues regarding taxes by creating a bright-line allocation of Target’s preclosing tax liabilities to itself, as seller, and of postclosing tax liabilities to Target and its new owners. While no one from the Seller side explicitly conveyed that intent to Buyer, it was manifestly clear from the structure of the transaction as reflected in the stock purchase agreement.

That said, Buyer and Seller anticipated at least two types of tax situations where further arrangement was required. First, they foresaw that some of Target’s postclosing tax returns would include preclosing tax liabilities. To deal with this situation, Buyer and Seller agreed in the stock purchase agreement that Seller would reimburse Target for any preclosing tax liabilities included in Target’s postclosing tax returns.

Second, Buyer and Seller also anticipated the possibility that amounts related to preclosing tax liabilities might come into Target’s possession after the closing and need to be paid over to Seller. Buyer and Seller addressed this in the stock purchase agreement, which obligated Buyer to pay Seller any tax refunds or tax credits that relate to the period before the closing except to the extent Seller had an indemnification or payment obligation under the stock purchase agreement for taxes that had not been satisfied.

The wrinkle in this dispute concerned value added taxes (VAT), which were clearly taxes within the meaning of the stock purchase agreement, but never discussed during Buyer and Seller negotiations. Nonetheless, Buyer was aware from the outset that Target conducted business in countries that, unlike the United States, utilize a VAT system.

A VAT is a consumption tax, akin to a sales tax. For Target’s golf clubs, the VAT is imposed, in supposed recognition of the “value added,” at each stage of the golf club production or distribution chain. Each initial and intermediary vendor or retailer in the golf club chain, such as Target, pays VAT on Target’s own purchases of raw materials and other necessary products from Target’s suppliers (input VAT), and then bills and collects VAT from Target’s own customers (output VAT), with the final customer in the golf club chain, often a consumer, paying the entire amount of the VAT.

At the end of each VAT tax period Target reports and pays to the applicable taxing authority all of the output VAT that it has billed to its customers during that period, after taking a credit for all of the input VAT that Target has paid during the same tax period. Target’s output VAT is reported and paid to the taxing authority even if the tax has not yet been collected from Target’s customers. In theory, Target should be placed in a “net zero” position with respect to VAT by (1) taking a credit on a Target VAT tax return for the input VAT Target has paid and (2) collecting from its customers the output VAT that Target has paid to tax authorities.

Target reported the estimated amount of output VAT it is owed from customers as a separate line item figure or asset on its balance sheet, labeled “VAT receivable-trade.”  At the time of closing, the estimated amount reported in the “VAT receivable-trade” line item was $16.6 million.

While the words “VAT receivables” do not appear in the stock purchase agreement, those receivables were referenced in the accompanying disclosure schedules. By agreement of Buyer and Seller, a “working capital adjustment” was to be made for any difference between Target’s “base working capital” and the actual amount of its working capital at the time of closing, with a corresponding postclosing payment made by, as appropriate, the seller or buyer. However, the working capital purchase price adjustment mechanism did not include any changes in the amount of VAT receivables.

Three months after the closing, Buyer sent Seller a demand pursuant to the stock purchase agreement, for reimbursement of $19.3 million in taxes that Target had paid, postclosing, to various tax authorities for preclosing tax liabilities. Of the $19.3 million, approximately $3 million was for VAT. On November 1, 2011, Seller reimbursed Target for only $2.7 million, after taking a setoff of $16.6 million — the amount that was reflected in the “VAT receivable-trade” line item at the time of closing. According to Seller, it was entitled to the setoff under the stock purchase agreement because VAT receivables were amounts credited against or with respect to taxes for preclosing tax periods.

Buyer disagreed, and the dispute ended up in a Boston trial court.

The fuss all revolved around whether the of $16.6 million VAT receivable-trade (which represents Target’s estimate of the VAT Target paid by Target pre-closing to its vendors that Target would get back from its customers) was a tax credit or refund that relates to Target’s preclosing operations; which go to Seller under the stock purchase agreement. Buyer argued that the VAT receivables were not refunds or credits because they were owed by customers, (and not by a government) to Target.

The court did not buy Buyer’s argument and Buyer appealed; and lost.

The appellate court said that the transaction, was structured to allocate Target’s tax liabilities and benefits to Seller and Buyer on a pre- and postclosing basis, respectively. And, once again, while the $16.6 million in VAT receivables on Target’s balance sheet were not taxes per se as defined in the stock purchase agreement, they were related to preclosing taxes.

In addition, the appellate court noted, that because the VAT receivables were classified under “other current assets,” Buyer did not pay any additional amounts for those assets as part of the postclosing working capital adjustment. Instead, Target then proceeded, postclosing, to collect nearly all of the VAT receivables from customers. The net effect of Buyer’s interpretation, therefore, would be to hold Seller responsible for paying to the tax authorities the output VAT related to preclosing VAT receivables while barring it from recouping those amounts through the postclosing collection of the same VAT receivables. Such an interpretation the court concluded was at odds with the over-all tax allocation structure of the transaction.

This case is referred to Acushnet Co. v. Beam, Inc., Case No. No. 16-P-1611, Appeals Court of Massachusetts, Suffolk, (February 2, 2018).

Comment. This $16.6 million dispute (about 1% of the purchase price) involved two American based companies battling over what seems like a very esoteric argument over foreign value added taxes. It ended up going through trial and an appeal.

With 20/20 hindsight it would have been helpful had Buyer anticipated and got an express understanding with Seller about how to deal with the VAT receivables. But apparently neither party focused on this complicated issue. The result: It caught Target off guard and put Target in a cash crunch. As Target’s lawyer explained, because of the extremely seasonal nature of Target’s business, Target had to take on a number of loans to keep Target afloat until the next busy season for golf sales.

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 allocation of preclosing taxes refunds and credits, net working capital adjustment, stock purchase agreement, Taxation, value added tax or VAT

Recent Comments

Categories