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

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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.

Email:             jmccauley@mk-law.com

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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

Posted on by mklaw_admin

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.”

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

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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.

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

Posted on by mklaw_admin

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.

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

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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.

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

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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.

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

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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.

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: , , , ,

Insolvent Nonprofit Hospital’s 363(f) Sale Was Free of a $305 Million Cost Imposed by CA AG

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Introduction

The sale of the assets of a nonprofit hospital in California requires the permission of the state’s attorney general.

The deal

This deal involves the Bankruptcy Code Section 363(f) sale of four California nonprofit hospitals in bankruptcy for $610 million. I talked about this deal already in connection with the bankruptcy court’s ruling that the sale would be free of $50 million of seller’s Medi-Cal liabilities. See Buyer’s Section 363 Purchase of Bankrupt Hospital Assets Is Free of Medi-Cal Liabilities; http://www.mk-law.com/wpblog/buyers-section-363-purchase-of-bankrupt-hospital-assets-is-free-of-medi-cal-liabilities/

The lawsuit

Under California law, nonprofit hospitals can’t be sold without the approval of the state of California; which can impose conditions to its consent. Here, California consented to the sale, subject to various conditions. In particular, two of the conditions imposed an additional financial burden upon the buyer of approximately $305 million. First, the conditions required that the buyer continue to operate one of the hospitals as a licensed general acute care hospital through December 2024. The buyer had agreed to maintain the hospital’s general acute care license only through December 2020. The buyer estimated that continuing to operate the hospital as a general acute care hospital for an additional four years would cost approximately $285 million.

Second, the conditions required another of the hospitals to provide annual charity care in an amount of $13 million for six fiscal years. The required charity care amount is approximately $6.4 million more than the charity care that this hospital provided in fiscal year 2019. The charity care requirement imposed an additional incremental cost of approximately $20 million.

The buyer would not close the sale absent an order finding by the bankruptcy court that the hospitals can be sold free and clear of these conditions pursuant to § 363(f) of the Bankruptcy Code.

The seller was facing very significant liquidity constraints. Recently, California began withholding certain Medi-Cal fee-for-service payments owed to the seller, for the purposing of recovering alleged Medi-Cal overpayments. As of the beginning of October 2019, California had withheld approximately $4.5 million. The seller did not have the ability to borrow under any debtor-in-possession financing facility. At this time, the seller was financed by a by agreement between the seller and the principal secured creditors. Termination of the asset purchase agreement with the buyer would constitutes an event of default under this financing agreement. The court found that it was unclear whether the seller would be able to obtain alternative financing. Further, the seller must begin the expensive process of closing the hospitals while it still possesses a significant cash buffer. In short, the failure of this sale would probably necessitate the closure of three of the four hospitals.

Under these facts, the court permitted the sale of the hospitals free and clear of California’s $305 million worth of conditions under Bankruptcy Code 363(f).

This case is referred to as In Re Verity Health System of California, Inc., Lead Case No. 2:18-bk-20151-ER, Jointly Administered With No. 2:18-bk-20162-ER, No. 2:18-bk-20163-ER., 2:18-bk-20164-ER, 2:18-bk-20165-ER, 2:18-bk-20167-ER, 2:18-bk-20168-ER, 2:18-bk-20169-ER, 2:18-bk-20171-ER, 2:18-bk-20172-ER, 2:18-bk-20173-ER, 2:18-bk-20175-ER, 2:18-bk-20176-ER, 2:18-bk-20178-ER, 2:18-bk-20179-ER, 2:18-bk-20180-ER, 2:18-bk-20181-ER, United States Bankruptcy Court, C.D. California Los Angeles Division (October 23, 2019)  

Comment

The court noted another bankruptcy acquisition where section 363(f) was very useful in the context of seller liabilities to a state. That transaction involved Massachusetts unemployment taxes.

The taxes were computed based on the seller’s “experience rating,” which was determined by the number of employees it had terminated in the past. Because the bankrupt seller had terminated most of its employees prior to selling its assets, its experiencing rating, and corresponding unemployment insurance tax liabilities, were very high.  The court approved a section 363(f) sale to its buyer free of the seller’s very high unemployment insurance tax liabilities.

Email:              jmccauley@mk-law.com

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

Telephone:      714 273-6291

 Legal Disclaimer

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

Posted in bankruptcy sale, distressed business acquisitions, Section 363 sale, state approval of nonprofit hospital Tagged with: , ,

Buyer to Indemnify Business Seller for 3rd Party Asbestos Claim Punitive Damages

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Introduction

Liability for asbestos claims is a common risk with manufacturing companies. Sophisticated buyers and sellers of manufacturing businesses are aware of the risk and usually manage it through an allocation between the buyer and the seller in the acquisition documents.

The deal

Here, the seller owned a division engaged in the business of manufacturing and remanufacturing brake parts for vehicle brake systems. Specifically, this division manufactured and sold automotive friction products (i.e., brake shoes), some of which were made using asbestos-containing friction lining from outside vendors.

For several years prior to the 1986 transaction with the buyer, civil lawsuits were filed against the seller alleging bodily injury as a result of alleged exposure to asbestos contained in its friction products. The seller disclosed the existence of these asbestos claims to the buyer during the due diligence that preceded the 1986 divestiture, and the parties expressly accounted for these types of actions in allocating liabilities arising out of post-closing product liability claims.

Basically, the buyer agreed to indemnify the seller for certain asbestos claims.

The lawsuit

This arrangement worked for 33 years when a California jury returned a $6 million punitive damages award in favor of a plaintiff in an asbestos case filed against the seller. The buyer claimed that punitive damages were not part of its indemnification obligation.

The seller then sued the buyer in an Ohio federal district court to resolve the dispute.

The buyer first argued that the indemnification provision in the asset purchase agreement did not refer to punitive damages, let alone expressly impose an obligation to indemnify against such damages for asbestos claims.

Construing the plain language of the asset purchase agreement, the court found that it was not ambiguous regarding liability and indemnification for punitive damages. The court said that the APA’s assumption of liabilities provision was broadly worded to include all liabilities and obligations of the seller, except for certain specified excluded liabilities; and punitive damages were not specified as excluded liabilities. The court found the asset purchase agreement’s broad assumption of all liabilities and obligations of the seller necessarily included claims for punitive damages in asbestos cases.

The court further noted that the assumption of liabilities and indemnification provisions of the asset purchase agreement were carefully negotiated between the buyer and seller and their counsel, and expressly allocated the parties’ relative liabilities as to the seller’s asbestos claims. The court found that the buyer and seller, through their counsel and with knowledge that many asbestos claims had already been filed and were currently pending, agreed that the buyer would assume all liabilities and obligations of the seller (including the seller’s asbestos claims) and indemnify the seller for from and against any and all liabilities, damages, losses, and claims.

The buyer next argued that, even if the asset purchase agreement extended indemnity to punitive damages such a provision would be void `because Ohio law prohibits the indemnification of monies paid to an award of punitive damages arising out of the insured’s own conduct. The buyer asserted that, because the punitive damages in the recent suit against the seller arose from the seller’s intentional conduct, Ohio’s public policy forbids their insurance by a third party.

The court rejected the buyer’s public policy argument stating the APA’s indemnification provision is not void as against public policy because it relates solely to the seller’s past conduct. Thus, the indemnification agreement was not a form of insurance against the seller’s future acts, but rather a negotiated solution for the financial consequences of actions that had already occurred.

In other words, the asset purchase agreement did not allow the seller to continue to engage in tortious conduct without fear of financial consequences in the form of punitive damages. Rather, the asset purchase agreement was limited solely to allocating responsibility for the seller’s past conduct. Accordingly, Ohio’s public policy concern that indemnification of punitive damages would diminish the deterrent effect of punitive damages awards, is not implicated under the circumstances presented.

This case is referred to as Parker Hannifin Corp. v. Standard Motor Products, Inc., Case No. 1:19cv00617, United States District Court, N.D. Ohio (October 23, 2019)  https://scholar.google.com/scholar_case?case=3437809212237959578&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment

The buyer and seller did not foresee any risk of punitive damages for third party asbestos claims when they allocated the asbestos risk in the 1986 asset purchase agreement. And over 30 years of post-closing experience confirmed that judgment.

For new deals, however, the buyer and seller will have to decide whether third party punitive damages will be an assumed liability or excluded liability; and expressly provide for that allocation in the purchase agreement.

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 asbestos claims, indemnification, punitive damages Tagged with: , ,

Business Buyer’s Suit Against Seller is Hampered by Missing Due Diligence Binder

Posted on by mklaw_admin

Introduction

Buying a company has many legal risks for a buyer. One of the most important tools to manage the risks of buying a business is to conduct a thorough due diligence investigation of the company.

The deal

This case involved a $2 million dollar acquisition of a California kitchen remodeling business. The seller limited the buyer’s access to his company’s documents, ostensibly to avoid employees leaving the company if they learned a sale was likely.

Thus, the buyer was limited to reviewing company documents during a meeting at the seller’s attorney’s office that were in a binder. The buyer was not permitted to keep the binder.

The lawsuit

The buyer sued the seller after the closing in a California federal district court. The buyer claimed that many of Seller’s stock purchase agreement representations were false, and that the seller’s company had significant undisclosed debts, paid many of its employees outside of formal payroll to avoid pay deductions, and lacked basic financial records.

The seller argued that the buyer should have been aware of any payroll or accounting irregularities at the seller’s company as a result of the due diligence process, and specifically as a result of Bank of the West and American Express account statements that the seller claimed were included in the due diligence binder that the buyer reviewed in the seller’s attorney’s office.

The buyer apparently did not think that the due diligence binder included this information and asked the seller to produce the binders during the discovery phase of the litigation. The seller said that he did not have them and did not know where they were.

The buyer asked the court to sanction the seller for not producing the binder by issuing an order excluding the seller from introducing any evidence of the documents that the seller claimed were made available for the buyer to review in the due diligence binder. The buyer argued that this information, especially the Bank of the West and American Express bank records procured later were not a substitute for the actual collection of documents that the buyer reviewed in the due diligence binder before closing the deal.

The court refused prohibit the seller from offering this information in evidence because the seller had no duty to preserve the binder.

This case is referred to as Cardinal v. Lupo., Case No. 18-cv-00272-JCS, United States District Court, N.D. California (September 17, 2019)   https://scholar.google.com/scholar_case?case=5341473029730680698&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment

In 20/20 hindsight, the buyer would have insisted upon keeping the due diligence binders or at a minimum add a provision in the stock purchase agreement requiring the seller to preserve the due diligence binder for a reasonable period of time after the closing.

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 preservation of due diligence materials Tagged with: , , ,

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