Buyer’s purchase price adjustment mechanism based upon a post-closing inventory audit survives seller challenge in court

Posted on by John McCauley

Seller was a distributor of compressed gases and welding supplies in Indiana. Seller sold substantially all of its assets to Buyer including its stock of asset cylinders, pursuant to an October 2014 asset purchase agreement. As part of the asset purchase agreement, Buyer paid Seller $1.6 million for Seller’s assets, of which the primary assets were its asset cylinders.

Seller rented the asset cylinders to businesses in need of compressed gas for use in their operations, including restaurants or convenience stores which rented carbon dioxide cylinders for soda fountains that must then be refilled on a regular basis. As a result, a critical factor in determining the appropriate price for the sale of Seller’s assets was the number of asset cylinders that could be transferred.

The sales price was based in part on Seller’s representation that there were approximately 6,500 cylinders. Buyer and Seller could not ascertain a precise count of the cylinders that would be transferred at the closing because many cylinders were “out in the field” with customers. Therefore, the asset purchase agreement provided that Buyer would conduct a post-closing audit of the cylinders.

The agreement purchase agreement further called for a purchase price adjustment based upon the post-closing audit of the cylinders. The purchase price would be increased if the audit found more than 6,500 cylinders at the rate of $125 per cylinder; or decreased at the same rate to the extent the audit found less than 6,500 cylinders.

Buyer’s risk that the Seller’s cylinder inventory was between 5,300 and 6,500 cylinders was secured by Buyer holding back $150K of the purchase price. Buyer had to complete the audit by April 15, 2015. The audit took longer than planned and Seller orally agreed to extend the audit and it was completed on May 22, 2015, before expiration of the extended deadline.

The audit found that Seller had under 4,700 cylinders; well below the Seller’s representation of approximately 6,500 cylinders. Furthermore, Buyer’s $150K holdback of the purchase price protected Buyer for part of the shrinkage, leaving Buyer exposed to a loss of about 700 cylinders at $125/cylinder (that is, the difference between Buyer’s loss down to 5,300 cylinders and the number of cylinders the audit said Buyer purchased from Seller; approximately 4,700 cylinders).

As a result of the audit Buyer kept the $150K holdback. Seller sued Buyer in an Indiana federal district court for the $150K holdback. Buyer counterclaimed saying that it should not only keep the $150K of held back purchase price but Buyer was also entitled to receive damages for the additional 600-cylinder shortfall computed at the rate of $125/cylinder. The trial court agreed with Buyer and Seller appealed.  Seller also lost on appeal.

This case is referred to Arc Welding Supply Co., Inc. v. American Welding & Gas, Inc., No. 18-1546, United States Court of Appeals, Seventh Circuit., (Decided February 14, 2019).

Comment. Purchase price adjustments are commonly used. In this case the real unknown at closing was the number of Seller’s cylinders; cylinders being a major value factor for the business. An inventory audit after the closing helped determine the correct purchase price.  And securing the risk that Seller’s inventory level representation and warranty was optimistic with a Buyer $150K holdback of the purchase price helped minimize Buyer’s exposure to that risk.

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 purchase agreement Tagged with: , ,

Seller of auto dealership franchise sues auto maker for violation of state’s auto dealer law regulating consent to franchise sales

Posted on by John McCauley

Seller owned a GM automobile dealership in Pennsylvania since 1985. In 2016, Seller began exploring the sale of Seller’s assets to potential buyers. Seller subsequently began negotiations with Buyer, who owned and operated several GM dealership line-makes in the state.

In the fall of 2016, Seller and Buyer agreed that Buyer would purchase Seller’s assets. As part of the purchase, Buyer planned to effectively close Seller’s Buick franchise and consolidate it with Buyer’s existing Buick franchise dealership. Buyer also planned to relocate the GMC Truck franchise to Buyer’s dealership.

On November 17, 2016, Seller and Buyer entered into a written asset purchase agreement where Buyer agreed to purchase all of Seller’s new vehicles and new parts inventory and goodwill for $750,000.

As required by Seller’s dealer franchise agreement with GM, closing on the sale was conditioned upon GM’s approval of the sale to Buyer, and upon GM’s approval of the relocation of the GMC Truck dealership to the Buyer’s dealership facility. Seller notified GM of the proposed sale to Buyer and Seller and Buyer submitted the November 2016 asset purchase agreement and all required forms for GM’s consideration by January 20, 2017, except for Buyer’s pro forma balance sheet for which Buyer needed GM to provide the capital requirements.

Over the course of the next several weeks, GM made multiple requests to Buyer for additional information relative to GM’s application and approval process, including a criminal background check of Buyer’s owner. All requested information was provided to GM. During this same period, Seller contacted GM on multiple occasions to inquire as to the status of GM’s approval process. Seller advised GM that, as word of the proposed sale was becoming known, Seller was losing customers and key employees, and that Seller had little inventory to sell. Thus, Seller advised GM that monthly operating losses were mounting.

On April 19, 2017, GM issued a letter to Seller, with a copy to Buyer, advising that GM refused approval of the November 2016 asset purchase agreement.  Although Seller and Buyer disagreed with GM’s decision, on June 27, 2017, Seller and Buyer entered into a new and revised asset purchase agreement for the sale of Seller dealership assets. The substantive terms of the November 2016 asset purchase agreement and the June 2017 asset purchase agreement were essentially the same, with two material exceptions: (i) the June 2017 asset purchase agreement no longer contemplated the relocation of Seller’s dealership assets to the Buyer’s dealership facility; and (ii) the purchase price for the value of Seller’s dealerships was reduced from $750,000 to $600,000.

The June 2017 asset purchase agreement was forwarded to GM on June 27, 2017. On September 5, 2017, GM approved the June 2017 asset purchase agreement.

After the closing Seller sued GM in a Pittsburgh federal district court. Seller claimed that it lost $150,000 on the sale of the goodwill (blue sky) value of its Buick and GMC Truck dealerships to Buyer; and in excess of $850,000 as a direct result of GM’s actions in denying the proposed sale to Buyer through the November 2016 asset purchase agreement and its further delay in processing the June 2017 asset purchase agreement.

GM asked the court to dismiss the claims on the grounds that Seller’s factual allegations, if true, were not enough to make out legal claims against GM. The court agreed with GM.

The court said that the primary question in deciding a motion to dismiss was not whether Seller would ultimately prevail, but rather whether Seller was entitled to offer evidence to establish the facts alleged in the complaint. The purpose of a motion to dismiss being to streamline litigation by dispensing with needless discovery and factfinding.

In this case the court said that Seller had not made out allegations of a legal claim; but permitted Seller to amend its complaint with additional factual allegations.

Seller had accused GM of violating Pennsylvania’s auto dealer law because GM delayed in responding to a request for consent to the terms of the November 2016 asset purchase agreement. This law is a comprehensive statute governing the relationship between automobile manufacturers and their franchise dealers.

The court said that GM would violate this law if GM failed to respond in writing to Seller’s request for consent to a sale of Seller’s franchise to Buyer within 60 days of receipt of a written request on the forms generally utilized by GM for such purposes and containing the information required. Furthermore, if GM required additional information to complete its review, GM should have notified Seller within 15 days of the receipt of the forms. In no event should the total time period for GM’s approval exceed 75 days from the date of the receipt of the initial forms.

However, the court found that Seller was not clear when all required forms were submitted to GM; meaning that it was not clear when GM’s had to either timely request more information, deny or consent to the transfer. Specifically, Seller alleged that on January 20, 2017, Seller and Buyer notified GM that they had completed all the electronic application forms, except for the pro forma balance sheet, for which Buyer was waiting for GM to provide it with the capital requirements necessary to complete the pro forma balance sheet. Thus, Seller still had not submitted all information on the forms that it was required to provide.

Given the absence of specific dates for when the final forms, containing the information required, were submitted, the court concluded that Seller had not pleaded with enough specificity to permit calculation of the deadlines for GM’s response. However, the court said Seller could fix this problem by amending its complaint.

GM next argued that Seller failed to sufficiently state its claim for $850,000 in damages, associated with GM’s denial of the November 2016 asset purchase agreement. Under Pennsylvania’s dealer law, GM can’t unreasonably withhold consent to Seller’s sale of its franchise to Buyer if Buyer was capable of being licensed as a new GM dealer under reasonable requirements for appointment as a dealer.

Seller alleged that Seller’s sustained $850,000 in damages resulting from the rejection of the November 2016 asset purchase agreement. GM argued that Seller offered only conclusory assertions that it lost in excess of $850,000 as a result of GM’s actions in denying the proposed sale. GM said that Seller did not allege facts to support its damages assertions or identify any grounds for its purported loss.

The court decided that Seller’s complaint lacked specific factual allegations to identify what comprised the $850,000 claim or how such damages relate to GM’s alleged unreasonable withholding of consent of the November 2016 deal. Accordingly, the court dismissed this claim, but Seller was permitted to amend its complaint with more specific allegations.

This case is referred to Brooks Automotive Group, Inc. v. General Motors LLC,  No. 2:18-CV-00798-MJH, United States District Court, W.D. Pennsylvania, Pittsburgh, (February 5, 2019). https://scholar.google.com/scholar_case?case=4437674053633974867&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment. Often the acquisition of a business cannot close without the consent of a third party. This is generally true when purchasing a franchised business, and especially an auto dealership.

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 Tagged with: ,

Inventor of product sues seller of product for unauthorized use of inventor’s name for commercial purposes

Posted on by John McCauley

Inventor has a Ph.D. in physical pharmacy and specializes in the formulation of topical creams for various health and wellness needs. He is the CEO of Seller and the public face of the company throughout the pharmaceutical industry. In April 2012, Buyer engaged Seller and Inventor to develop a topical cream used to treat men with sexual dysfunction. Under the agreements between Seller and Buyer, Seller and Inventor formulated a commercial product and assigned all their rights to the invention to Buyer. As a result of their partnership, Buyer launched the product on April 13, 2013.

On April 19, 2013, Buyer and Current Seller entered into an asset purchase agreement under which Current Seller acquired the global rights to market the product, and Buyer retained the right to commercialize the product in the United States. Current Seller commercialized the product under a different trade name.

Inventor claimed that although Inventor never gave permission to Current Seller to use his name, image, identity, or likeness in connection with the product, Current Seller marketed the product with Inventor’s name and implied endorsement. Specifically, Inventor alleged Current Seller circulated advertisements and marketing materials in newspapers, magazines, pamphlets, and on social media sites; suggesting, implying, and/or outwardly stating that Inventor endorsed the product. Further, Inventor alleged that some of these publications falsely attributed quotes to Inventor, placed Inventor in a false light, and falsely claimed Inventor offered a satisfaction guarantee on the product.

Inventor sued Current Seller in a Chicago federal district court for reputational harm suffered as a result of Current Seller’s use of Inventor’s name in its advertising program. Inventor accused Current Seller of the unauthorized use of Inventor’s identity for commercial purposes in violation of Illinois publicity law (the Illinois Right of Publicity Act), federal trademark law and the Illinois false light law.

Current Seller moved to dismiss the complaint arguing that Inventor would have no legal claim against it even if Current Seller’s had used Inventor’s name in its advertising program in the manner alleged by Inventor. The court disagreed and denied Current Seller’s motion to dismiss. In another words, Inventor, if it can prove it, has a claim against Current Seller.

This case is referred to Yeager v. Innovus Pharmaceuticals, Inc.,  No. 18-cv-397., United States District Court, N.D. Illinois, Eastern Division, (February 5, 2019).

Comment. With 20/20 hindsight Inventor should have made sure that Buyer promised in the assignment agreement between Seller and Buyer, not to use Inventor’s or Seller’s name for commercial purposes; and to promise to prohibit by written agreement any Buyer licensee, buyer or assignee of the product from using the names of Inventor or Seller for commercial purposes.

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 sale of product line Tagged with:

Health club buyer fights with seller’s landlord over ownership of some health club assets

Posted on by John McCauley

Seller operated a health club in Georgia. It leased the building from Landlord.

Seller ended up in financial trouble, filed for bankruptcy and sold its assets out of bankruptcy to Buyer. Buyer did not lease Landlord’s building. After the closing, Buyer started removing the health club’s assets.

Landlord went into bankruptcy court to stop Buyer from removing the health club’s lockers, mirrors, a nonmovable and freestanding sink, and T.V. stands. Landlord claimed that it owned those assets.

The court agreed that Landlord owned the mirrors glued to the walls and lockers affixed to the walls located in the new edition of the club, noting that Landlord owned those assets because it installed the lockers and these mirrors when it built a new edition to the health club.

As to the sinks, a juice bar was installed by a third-party planning to operate a juice/smoothie bar for the gym patrons. The third party ultimately backed out of the venture. Seller allowed the third party to leave the juice/smoothie bar with Seller in return for Seller not taking any action against the third party. There were two sinks associated with the juice bar. One sink was built into the cabinets; and the other was a plastic freestanding sink on 4 legs which was attached by plumbing for hot and cold water and a drain but was easily removable.

Landlord claimed that both sinks were fixtures and that under the lease, Landlord owned the fixtures. The court agreed with Landlord as to the nonmovable sink which was built into the health club cabinets because it was more permanent and was a fixture, even if installed on behalf of Seller by a third party.

On the other hand, the court awarded the freestanding sink to Buyer because it was not a fixture given its ease of detachment, and no evidence that removal would damage Landlord’s building. Same for the T.V. stands.

There were other mirrors in the old edition of the health club. No one knew who installed them. Landlord said they were wall coverings and under the health club lease Landlord owned the wall coverings. The court disagreed and said that they were trade fixtures which under the lease belonged to Seller as tenant, (which Buyer purchased from Seller). They were trade fixtures because the mirrors were easily removable without causing substantial damage to Landlord’s building.

This case is referred to IN RE SCIENCE FITNESS, LLC,  Case No. 14-12297, Adversary Proceeding No. 16-01035., United States Bankruptcy Court, S.D. Georgia, Augusta Division, (February 1, 2019).

Comment. This case demonstrates what a grey area is out there when it comes to landlord or tenant ownership of fixtures. A lesson for a buyer of a business that operates out of a leased facility would be to determine in due diligence if there are any valuable business assets that may be subject to an ownership claim by seller’s landlord.

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 Tagged with: ,

Seller of business had no contractual duty to indemnify buyer for asbestos claims

Posted on by John McCauley

In 1993, Buyer purchased from Seller the business operations related to certain lines of fragrance and cosmetic products pursuant to an asset purchase agreement. Among the product lines Buyer purchased were talcum powder products, which later became the subject of product liability suits asserting personal injury claims allegedly caused by asbestos contained in the powder.

Buyer and Seller disagreed over who was responsible for the talcum powder products liability claims for product sold prior to the closing. The dispute ended up in a Connecticut federal court. Buyer alleged that Seller retained liability for and was required to indemnify Buyer from such asbestos claims. Seller moved to dismiss the majority of Buyer’s claims, arguing that Buyer expressly assumed all liability for the claims.

At the outset, Buyer conceded that it assumed certain liabilities for product liability relating to the fragrance products produced by Seller prior to the closing, but only did so for claims accruing and products sold after the closing.

Simply put, under section 1.3 of the asset purchase agreement, Buyer assumed all product liability claims, when the first written notice of the product liability claim was received at least 18 months after the closing date. This assumption language did not was not limited to products produced by Seller before closing but sold by Buyer after closing.

Section 1.4 stated that Buyer did not assume any of Seller’s liabilities except for the liabilities referred to above in section 1.3. Section 1.4 went on to say that Buyer was not assuming liabilities of Seller that were incurred prior to the closing date. This section 1.4 went on to emphasize that Buyer did not assume any liability of Seller to the extent based upon an event that occurred prior to the closing date or after the closing date in the case of claims in respect of products sold by Seller prior to the closing date and attributable to acts performed or omitted by Seller prior to the closing date.

Buyer argued that under section 1.4 of the asset purchase agreement with Seller, Buyer specifically disclaimed products liability claims related to talcum powder products sold by Seller prior to closing. Buyer maintained that it had assumed liability only for talcum powder products sold after the closing.

Seller disagreed, stating that Buyer in Section 1.3 specifically assumed Seller’s product liability claims with no exclusion for those sold before closing if the claim was made more than 18 months after the closing.  Seller noted that “product liability” claims are not mentioned in section 1.4, which meant that Buyer’s non-assumption of Seller’s liabilities applied to “liabilities” other than the “product liability” claims referred to in section 1.3; which Buyer agreed to assume.

The court agreed with Seller.

Seller had also said that Buyer waited too long for seeking indemnification from Seller. Section 8.2 of the asset purchase agreement stated that Seller was not be responsible for indemnifying Buyer for the products liability claims unless asserted by Buyer within 5 years from the closing date, or in 1998.

Buyer responded that the imposition of the five-year limitation on indemnification was unreasonable, because the asbestos claims that were the subject of this dispute simply did not exist until 2015. Buyer contended that enforcement of the 5-year limitations period would make a timely lawsuit for indemnification impossible.

The court did not agree with Buyer saying that it should have been clear to Buyer that claims arising in 2015 fall outside the indemnification window that closed 5 years after the 1993 closing date.

This case is referred to Parfums De Coeur LTD. v. Conopco, Inc.,  No. 3:18-cv-00749-WWE., United States District Court, D. Connecticut, (January 31, 2019).

Comment. In 20/20 hindsight Seller would have wanted clearer provisions in the asset purchase agreement describing what liabilities of Seller that Buyer was assuming and not assuming. Language matters.

In this case you might say in one section (not like here in two sections) that Buyer is not assuming any of Seller’s liabilities except for a list of specified liabilities.

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 Tagged with: , , , ,

$10 Billion lawsuit over bitcoin mining business

Posted on by John McCauley

Dave, an American computer security expert, and Dave, an Australian computer scientist, met in or about 2003. Their relationship centered around their mutual interest in cyber security, digital forensics, and the future of money. Dave and Craig began to speak about ways to use peer-to-peer file sharing to solve issues in cryptography.

On October 31, 2008, a white paper authored under a false name titled bitcoin: A Peer-to-Peer Electronic Cash System was posted to a mailing list of cryptography enthusiasts. This paper detailed novel methods of using a peer-to-peer network to generate what it described as a system for electronic transactions without relying on trust.

Bitcoin is a decentralized digital currency that uses a ledger to track the ownership and transfer of every bitcoin in existence. This ledger is called the bitcoin blockchain. In order to complete a transaction with bitcoins, you must have a bitcoin wallet. Wallets are computer files dedicated to storing bitcoin information. Each bitcoin wallet has a public key that is used as the address to receive bitcoin from others. Each wallet is also assigned a private key. To send bitcoin out of a wallet, an individual must have the private key associated with that bitcoin wallet.

There are two methods of acquiring bitcoins. The first is simply receiving bitcoins from someone. The second way one can acquire a bitcoin is by mining them. Bitcoin is designed without a centralized authority in charge of the blockchain. Therefore, mining is a process through which anyone with internet access can update the ledger and mine bitcoins by employing computer power to solve a complex computer problem. The first miner who solves the problem gets the right to update the ledger by adding a block of recent transactions to the blockchain. The protocol pays the successful miner in newly minted bitcoins, the number of which is determined by a pre-existing algorithm.

For the next several years, Dave and Craig worked together in developing bitcoin in 2009 and 2010. Through their collaboration they mined over a million bitcoins together, then worth a few hundred thousand dollars and now worth billions. These bitcoins were stored in specifically identifiable bitcoin wallets.

On February 14, 2011, Dave formed Company in Florida as a limited liability company.  The Company’s articles of organization, filed with the state of Florida, listed Dave as the managing member and registered agent. Dave and Craig created Company to mine bitcoin and develop intellectual property.

However, the partners (legally referred to as members) did not complete the organizational paperwork. The partners never agreed upon the terms and conditions of an operating agreement, which is like a partnership agreement. An operating agreement typically specifies who manages Company; what say does each partner have in the management of Company; how are profits and capital divided up among the partners; what happens if a partner dies; and many other matters.

There were also no agreements as to who owned the bitcoins and intellectual property developed before the formation of Company, and what happens to Company’s bitcoins and intellectual property when Company is dissolved.

Dave passed away in April of 2013.

Company and Dave’s estate filed a $10 billion lawsuit in a Florida federal court, alleging that Dave created the bitcoin intellectual property on his own and through Company and that his estate and/or Company owned all this intellectual property.

After Dave died, Craig was accused of unlawfully and without permission taking control of well over a million bitcoins from the estate and Company by taking exclusive possession of the private keys necessary to own, move, or sell the bitcoins; and ultimately transferring the bitcoins to various international trusts. Craig allegedly did this by forging Dave’s signatures and falsifying dates on legal documents to commit the embezzlement.

Craig asked the court to dismiss the lawsuit. The court refused to do so; saying that the allegations were sufficient and if proven as true in trial, could result in judgment against Craig.

This case is referred to Kleiman v. Wright, Case No. 18-CV-80176-BLOOM/Reinhart., United States District Court, S.D. Florida, (December 27, 2018).

Comment. This case is a lesson for startups.  Get the business set up right in the beginning because it could help if the business takes off big; like this one.

20/20 hindsight says that a comprehensive written agreement between Dave and Craig about management of their business, and ownership of the bitcoins and intellectual property (both pre and post formation of the limited liability company) would have been very helpful after Dave died.

Also, perhaps there could have been internal controls that could manage the risk of bitcoin embezzlement.

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 bitcoin, blockchain Tagged with: ,

Cryptocurrency customer can’t sue software developer for fraud

Posted on by John McCauley

Customer and Developer entered a software development and maintenance agreement dated February 28, 2018. Under the software development and maintenance agreement, Developer was to develop a web platform for Customer that would permit individuals to purchase a cryptocurrency.

According to Customer, Developer represented it was skilled and competent and capable of designing a professional website.  Customer alleged that, contrary to those representations, Developer had no proficiency in website design. It alleged that had Customer known that Developer could not design a website, it would not have retained Developer.

Moreover, according to Customer, Developer manufactured a dispute over money with Customer, and used that dispute as a pretext for breaching the software development and maintenance agreement.  Customer alleged that Developer quit without delivering any of the requested software and kept $68K that it had already received.

For its part, Developer asserted that it performed or substantially performed all its obligations under the software development and maintenance agreement, but Customer refused to pay all amounts due under the agreement.

This dispute ended up in a New York state court. Customer sued Developer for breach of the software development and maintenance agreement, but also for fraud. Developer asked the court to throw out the fraud claim because Customer’s allegations even if true didn’t amount to fraud. The court agreed with Developer.

In order to state a claim of fraudulent inducement, Customer must allege that Developer intentionally made a material misrepresentation of fact in order to defraud or mislead Customer, and that Customer reasonably relied on the misrepresentation and suffered damages as a result.

Generally, Customer’s opinion about the caliber of work to be performed by Developer or Developer’s ability to perform a task is not fraud. Developer’s statements that Developer was skilled and competent and capable of designing a professional website were not misrepresentations of verifiable objective facts but rather statements concerning Developer’s ability or intent to perform. These Developer statements do not amount to fraud.

The court noted, however, that Customer alleged that Developer made specific factual representations in its website that Developer performed work for other specified prestigious companies such as Goldman Sachs. These were the type of representations if not true could make out a fraud claim, but Customer did not allege that those Developer factual representations were false.

This case is referred to CC Pay Operations Ltd. v. Alokush, Docket No. 653002/2018, Motion Seq. Nos. 001, 002, Supreme Court, New York County, (January 2, 2019). https://scholar.google.com/scholar_case?case=8724220917456737726&q=blockchain&hl=en&scisbd=2&as_sdt=2006

Comment. The lawsuit is not over. Customer also has a claim against Developer for breach of the software development and maintenance agreement. Customer must prove that Developer failed to satisfy its obligations under the software development and maintenance agreement.

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 blockchain Tagged with: ,

Court may unwind owner sale of company to ESOP because price too high

Posted on by John McCauley

Company is a Hawaii architectural firm. On April 27, 2018, the U.S. Department of Labor filed a lawsuit in a Hawaii federal district court alleging that ESOP Trustee and Owners caused the Company’s ESOP to purchase the Company’s shares from Owners for more than they were worth.

The Department of Labor alleged that Owners met with an attorney in the summer of 2012 to discuss the creation of an ESOP to divest themselves of their ownership interests in the Company.  In the fall of 2012, Owners provided information about the Company to Valuation Firm.  Valuation Firm produced a valuation report and a fairness opinion, both valuing the Company at $40 million.  The Department of Labor alleged that the valuation report was flawed in several respects. For example, the reports applied a 30% control premium even though there would be no change in control of the Company (because Owners as officers and directors, maintained control), and the valuation report used unreasonable revenue projections that went far beyond the Company’s historical average.

In the meantime, Owners told ESOP Trustee, a lawyer with a California law firm specializing in ESOP fiduciary services, that they wanted him to serve as the trustee of the ESOP. The Department of Labor alleged that, at the outset of ESOP Trustee’s involvement with the transaction, Owners stated that the purchase price was $40 million.

According to the Department of Labor, on December 10, 2012, Owners offered to sell their Company shares to the ESOP for $41 million, payable over 20 years at 10% interest. This offer to the ESOP was communicated to ESOP Trustee. After negotiating for a day, ESOP Trustee and Owners allegedly agreed that the ESOP would purchase the Company’s shares for $40 million payable, over 25 years at 7% interest. On December 11, 2012, the ESOP was formed with a retroactive date of January 1, 2012, and ESOP Trustee was named as its trustee. On December 14, 2012, ESOP Trustee and Owners allegedly caused the ESOP to purchase the Company’s shares for $40 million dollars pursuant to the terms and conditions of an ESOP stock purchase agreement.

The Department of Labor alleged that ESOP Trustee and Owners did not carry out a meaningful review of the Valuation Firm valuation report, which the Department of Labor claimed was obviously defective and significantly overvalued the shares of the Company, and that Owners and ESOP Trustee knew or should have known that the reports should not have been relied upon to justify the ESOP transaction. Owners allegedly provided unreasonable and inflated Company revenue projections to Valuation Firm, knowing that such projections were inaccurate, and allegedly failed to monitor ESOP Trustee to assure that he acted in the best interests of the ESOP’s participants and beneficiaries; that is Company’s employees.

Relying on these allegations, the Department of Labor asserted that Owners and ESOP Trustee breached their fiduciary duties under ERISA, the applicable federal law, and asked the court to essentially unwind the transaction.

Owners filed a motion to dismiss the lawsuit on June 12, 2018. Owners essentially said that if the ESOP overpaid for their stock that it was the legal responsibility of ESOP Trustee alone, and not Owners, who owed no fiduciary duty to the ESOP.

The court disagreed and refused to let Owners out of the lawsuit. First Owners, as the primary decision-makers as owners of the Company and the sole members of its board of directors, had authority and control under the law and documents, over the ESOP, and thus owed fiduciary duties to their employees as ESOP participants, to abide by standards of conduct, responsibility, and obligation to protect the Company employees’ ESOP retirement assets. These standards included the duties of loyalty and care and a prohibition against self-dealing.

The court said that the Department of Labor’s allegations if true were enough to establish that Owners breached their duty to monitor ESOP Trustee’s performance by permitting ESOP Trustee to accept a $40 million purchase price for Owners stock which was allegedly much higher than its actual value due to the inaccurate, overly aggressive and optimistic Company projections and the inappropriate use of a 30% control premium.

This case is referred to Acosta v. Saakvitne, Civ. No. 18-00155 SOM-RLP, United States District Court, D. Hawaii, (January 18, 2019).

Comment. Selling your company to an ESOP can be an attractive exit strategy. However, if you are going to do it you must do it right.

With 20/20 hindsight, Owners should have hired a lawyer who is highly regarded in the ESOP community (part of the ESOP mafia) who has extensive experience in doing ESOP transactions. This lawyer would have told Owners that the purchase price must be fair, and the Company projections must be reasonable.

This ESOP lawyer would also tell Owners to select a highly respected trustee for the ESOP that would skeptically review the valuation and purchase price.

These actions would probably have resulted in a reasonable purchase price and would probably not risk the deal being unwound.

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 sale of business to ESOP Tagged with: , , ,

Delaware court refuses to submit dispute to expert determination by accountant

Posted on by John McCauley

Buyer and Seller executed a merger agreement on April 13, 2018. Pursuant to the merger agreement, Buyer acquired Target from its selling security holders, including Seller, a New York investment management company. Buyer paid a base price of $125 million, $23.1 million of which was placed in escrow at closing. Release of the escrowed funds depended on Target Subsidiary entering post-closing into a qualifying contract with the Chicago Public Schools. The section of the merger agreement governing the release of the escrowed funds delegated certain matters to the independent accountant for resolution. Buyer and Seller disputed whether their disagreement concerning a qualifying contract with the Chicago Public Schools must be referred to the independent accountant.

This dispute ended up in the Delaware Court of Chancery. Buyer asked the court to order Seller to resolve this dispute by an independent accountant. The court refused.

The court noted that the merger agreement designated the independent accountant “an expert, not an arbitrator.” Under settled Delaware case law, the court said that such language called for an expert determination, not an arbitration. In the court’s view, expert determination provisions were fundamentally different from arbitration provisions. Expert determination limited the scope of the accountant’s authority to factual disputes within the accountant’s expertise. Arbitrations typically conferred upon the arbitrator broad authority similar to that of judicial officers. By invoking language calling for an expert determination, the merger agreement narrowed the accountant’s scope of authority to factual disputes within an independent accountant’s expertise.

The court found that Buyer and Seller’s escrow dispute did not fit within the independent accountant’s narrow authority. To determine who is entitled to the escrow funds, one must determine whether the Chicago Public Schools and Target Subsidiary entered into a qualifying contract. This issue raised the primarily legal question of whether a certain contract met the definition of a qualifying contract. The court concluded that the question was not within the scope of the independent accountant’s expertise. Accordingly, Buyer was not contractually entitled to require Seller to submit this dispute to the independent accountant.

This case is referred to Ray Beyond Corp. v. Trimaran Fund Management, LLC, C.A. No. 2018-0497-KSJM, Court of Chancery of Delaware, (Decided: January 29, 2019).

Comment. Buyers and sellers need to be careful when submitting M&A agreements to alternative dispute resolution.  Submitting a dispute to expert determination can result in a different outcome than submitting a dispute to arbitration.

With 20/20 hindsight if Buyer wanted to submit a dispute over whether a contract was qualified or not to alternative dispute resolution, then Buyer should have specified in the merger agreement’s dispute resolution provision that the dispute must be submitted to arbitration.

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 alternative dispute resolution, M&A agreement Tagged with: , ,

Fraud carve out saves buyer in “as-is where-is” in divestiture

Posted on by John McCauley

Seller manufactures over-the-counter pharmaceutical products. On June 17, 2016, it sold one of its product lines to Buyer. The terms of that sale were memorialized in an asset purchase agreement.

At the time of the sale, there was a class action suit pending in California that related to one of the products in the transferred product line. Under the terms of the asset purchase agreement, Buyer agreed to assume all future liability arising from that matter. After the class action suit resolved, however, Buyer refused to do so. Seller sued Buyer in a Delaware federal district court.

After Seller filed a complaint alleging that Buyer had breached its asset purchase agreement indemnification duties, Buyer responded with several counterclaims. In those counterclaims, Buyer alleged that, prior to the sale, Seller told Buyer that the class action plaintiffs had offered to settle for “a few hundred thousand dollars,” when in fact those plaintiffs had never offered to settle for less than two million dollars. Buyer also alleged that, during negotiations, Seller failed to disclose several hundred thousand dollars in “store allowance fees” charged by one of the customers of the transferred product line (a fee charged by the customer in order to have Seller’s product placed on the customer’s shelves). These two acts, Buyer argued, were deliberate misrepresentations or intentional concealment of the truth, and as such, constituted what in legalese was called actionable torts—specifically, fraud and intentional concealment. Buyer also included a breach of asset purchase agreement counterclaim for Seller’s alleged failure to disclose certain liabilities at closing, in violation of the net working capital purchase price adjustment provision of the asset purchase agreement.

Seller asked the court to dismiss Buyer’s tort-based counterclaims for fraud and intentional concealment. The court refused to do so.

Seller argued that Buyer’s tort claims for fraud and intentional concealment were really breach of asset purchase agreement claims in disguise and were therefore barred by Delaware law.

First, Seller argued that the damages alleged in the fraud and intentional concealment tort claims were duplicative of the damages alleged in the breach of asset purchase agreement claim. The court disagreed. In its breach of asset purchase agreement claim, Buyer alleged that Seller breached the asset purchase agreement by failing to disclose certain outstanding liabilities at closing (some of which happened to be outstanding “store allowance fees” mentioned above), which—because of the net working capital purchase price adjustment provision in that agreement— caused Buyer to overpay Seller by the exact amount of those undisclosed liabilities. The alleged asset purchase agreement damages, then, were the exact amount of those undisclosed liabilities.

In its fraud and intentional concealment tort claims, by contrast, Buyer alleged that Seller, through fraud or intentional concealment, caused Buyer to agree to an inflated overall price for the transferred business. The alleged fraud and intentional concealment tort damages, then, were the exact amount the “true” price was inflated by Seller’s deception. Though all claims rest on Buyer’s dissatisfaction with paying too much for the transferred business, the fraud and intentional concealment tort and breach of asset purchase agreement claims seek to recover separately overpaid amounts.

Second, Seller argued that any duty owed to Buyer by Seller arose solely from the asset purchase agreement. The court again disagreed, stating that Delaware law itself imposed a duty on Seller to not commit fraud or intentionally conceal material liabilities in a transaction.

Next, Seller argued that the fraud and intentional concealment claims were barred by provisions in the asset purchase agreement that stated (1) that the purchased product line was transferred “as-is where-is”; (2) that Seller made no representations or warranties about the product line; and (3) that all other representations or warranties were expressly disclaimed.  The court rejected this argument because the asset purchase agreement explicitly reserved Buyer’s rights in the case of fraud.

Finally, Seller argued that Buyer’s fraud and intentional concealment tort claims were barred by the economic loss doctrine. The court rejected this argument also. Generally, the economic loss doctrine would limit Buyer’s economic damages to Seller’s alleged breach of the asset purchase agreement’s net working capital purchase price adjustment provision. While this doctrine does generally limit Buyer’s ability to recover in a fraud and intentional concealment tort (which is not based upon the asset purchase agreement) to losses accompanied by bodily harm or property damages and prohibits recovery for losses that are solely economic in nature, there are certain exceptions to this doctrine, including for claims of fraudulent inducement and intentional concealment.

This case is referred to Perrigo Company v. International Vitamin Company, No. 1:17-CV-01778., United States District Court, D. Delaware, (January 28, 2019).

Comment. A seller often wants a buyer to agree that the buyer will only sue the seller for breach of representations and warranties made in the purchase or merger agreement; not misrepresentations made by the seller during negotiations or in information supplied in the seller’s data room. A buyer will often agree to this but with an exception for the buyer’s fraud.

This kind of language all sounds like useless boilerplate, but it can be important to a buyer in circumstances like the deal Buyer found itself in.

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 "as is where is", fraud in business sale Tagged with: , ,

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