Buyer of Chemical Division Sues Seller for Understating Costs

Introduction

There are unique risks for a buyer when purchasing a division of a seller (called a divestiture). It is easier to assess the quality of earnings of a stand alone business than with a division where costs must be allocated to the division from the rest of the company.

The deal

Our seller was an Akron based private equity firm specializing in investments in distressed or underperforming middle market and mature companies. Through subsidiaries, it owned and operated a chemical division that chiefly sold research and development services to biotech, pharmaceutical, food, flavor, fragrance and specialty chemical customers.

The seller sold the chemical division to the buyer for $27 million. The buyer also agreed to pay the seller an earnout of $5.5 million if the business hit an earnings target for the first year after the closing.

The lawsuit

The buyer and seller’s relationship soured after the closing. The buyer was disappointed with the post-closing performance of the chemical division and the seller did not receive its earnout. They ended up in an Ohio federal district court.

The buyer accused the seller of understating the costs of the business. Specifically, the seller had represented and warranted that the 2016 business costs were as stated in a schedule attached to the asset purchase agreement.

The alleged understated costs related to seller’s allocation of companywide costs. There were two categories of disputed costs. One was administrative costs which were primarily, salary and benefits for sixteen employees working in human resources, finance and IT. The buyer said those costs should have been allocated by employee head count. They were not.

The second cost category was support group (quality assurance and product management). The buyer claimed that these costs should have been allocated by revenue. They were not.

The buyer stated that the seller used the headcount and revenue methods in its internal financials to allocate administrative and support group costs to the chemical division before the sale, and that the total of these 2016 costs allocated to the division in the internal financials totaled $2.3 million; not the $500K the seller represented and warranted were these costs in its representations and warranties. The buyer accused the seller of intentionally downplaying the chemical division costs to make the chemical division appear more profitable than it was.

The buyer asked the court to rule that the seller breached its representations and warranties in connection with the 2016 costs.

The seller denied that it misrepresented the costs of the chemical division. It argued that the costs represented in the agreement were not inaccurate because they were “pro forma” income statements. That is, the figures represent the hypothetical costs of the chemical division operated as a standalone company, not the actual costs incurred as a division of the seller. And because the assumptions and projections used to arrive at these pro forma estimates were detailed in the confidential offering memorandum, given to the buyer, the seller argued that the financial representations were sufficiently accurate and reasonable.

The court refused to rule that the seller understated costs at this stage of the litigation, saying that there is a material fact dispute regarding the buyer’s claim. On one hand, the seller stated that the figures represent all or substantially all the cost items of the business for the 12-month period ending December 31, 2016, suggesting that the schedule was meant to represent the chemical division’s actual 2016 costs. On the other hand, the schedule was labeled “Pro Forma FY 2018 income statement” and was described as “estimates” in the offering memorandum. Viewed in the light most favorable to the seller, this labeling sufficiently raises issues whether the seller’s representations were false.

The result is that the litigation goes beyond this preliminary legal skirmish.

This case is referred to Main Market Partners, LLC v. Olon Ricerca Bioscience LLC, Case No. 1:18-CV-916, United States District Court, N.D. Ohio, (April 9, 2019)  https://scholar.google.com/scholar_case?case=4976259500205573361&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017#r[17]

Comment

Could the buyer have discovered the historical cost allocation for the business before signing the asset purchase agreement through due diligence, such as through a quality of earnings assessment?

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 divestitures, due diligence, quality of earnings assessment Tagged with: , ,

Business Seller Accuses Buyer of Earnout Manipulation

Introduction

A seller of a business wants to receive the highest price, and payable in cash at closing. The buyer might want to pay seller’s price but is not sure it is worth that much. How do you bridge the gap?

This can be done by making some of the purchase price based upon the post-closing performance of the business. An example would be the EBITDA performance of the business over the first year after the closing. This payment structure is often called an earnout or earn-out.

The seller may think that the business can perform well enough to trigger the earnout. But will it under the buyer’s management? Is buyer capable of operating the business well enough? More cynically, would the buyer play games with expenses and revenue over the earnout period to avoid triggering the earnout payment?

The deal

Our seller was an Akron based private equity firm specializing in investments in distressed or underperforming middle market and mature companies. Through subsidiaries, it owned and operated a chemical division that chiefly sold research and development services to biotech, pharmaceutical, food, flavor, fragrance and specialty chemical customers.

The seller sold the chemical division to the buyer, a subsidiary of an Italian chemical firm for $8.4 million in cash at closing and assumption of $18.6 million of seller debt. The buyer also agreed to pay the seller an earnout of $5.5 million if the chemical division hit an EBITDA earnings target for the first year post sale year. The buyer promised the seller in the asset purchase agreement to refrain from taking any bad-faith actions to avoid the earnout payment.

The lawsuit

The business did not meet its earnings target and no earnout was paid to the seller. The seller sued the buyer in an Ohio federal district court for allegedly manipulating its earnings and revenue to avoid hitting the earning target.

The buyer claimed that seller’s allegations, if true, did not amount to buyer’s breach of its promise to refrain from taking bad-faith actions to avoid the earnout payment.

The court disagreed. The court said that these seller allegations could establish bad faith. The seller accused the buyer of: (1) steering the chemical division business to the buyer’s Italian parent company, (2) delaying the receipt of customer payments;  (3) incurring $3 million in unreasonable strategic costs during the earnout period; (4) failing to contemporaneously track and account for strategic costs; and 5) obscuring and concealing strategic costs.

The result? The seller gets to push forward in its litigation.

This case is referred to Main Market Partners, LLC v. Olon Ricerca Bioscience LLC, Case No. 1:18-CV-916, United States District Court, N.D. Ohio, (April 9, 2019)  https://scholar.google.com/scholar_case?case=4976259500205573361&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017#r[17]

Comment

Earnout deals come with risk because the seller loses control of the business. Always best to at least consider taking a lesser amount at closing than agreeing to a larger amount payable after the closing that is dependent upon the buyer.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 bad faith, earn outs Tagged with: , , ,

Business Buyer Risks Loss of Assets to Secured Creditor

Introduction

Many companies put their assets up as collateral for financing. A buyer of a company needs to know this before buying the business.

This risk is minimized in part by the seller representing and warranting in the purchase agreement that the assets are free and clear of all liens other than those disclosed in the purchase agreement.

But that seller representation and warranty only gives the buyer a right to sue the seller after the closing for damages for breach of the representation and warranty if it turns out that the assets are collateral for a secured loan that is properly perfected by the filing of a UCC financing statement.

In such a case, the buyer takes those assets subject to the security and can lose this collateral if the seller defaults on the secured loan. At that point the buyer may have a claim against a seller with no assets.

The deal

The seller in this case was a Phoenix based Nevada corporation that made video lottery machines. It borrowed money from a lender and its video lottery machines were collateral for the loan. The lender properly perfected its security interest by filing a UCC financing statement with the State of Nevada. The financing statement lists the seller as debtor, the lender, as secured party, and the assets of the seller as collateral.

Later a buyer purchased the seller’s assets, including the video lottery machines. The seller represented and warranted to the buyer that the video lottery machines sold to the buyer were not subject to any liens.  The buyer did not do a UCC search with the State of Nevada to see if seller (a Nevada corporation) had any UCC financing statement filings against its assets.

The lawsuit

After the closing, the seller defaulted on the loan and the lender sued the seller for $1.5 million in damages. The buyer had taken possession of the video lottery machines and had leased some of them to restaurants in Maryland.

The lender sued the buyer in a Maryland federal district court asking the revenue that the buyer earned from the video lottery games used in the restaurants be placed in a trust account pending the outcome of lender’s suit against the seller.

The buyer argued that it did not know about lender’s collateral interest in the machines; and that the buyer had relied on the seller’s purchase agreement representation and warranty that the machines were not subject to any liens.

The court said too bad.  The lender had valid liens in the video lottery machines since it had properly documented its secured interest through a note, security agreement, and perfected filing of a UCC financing statement in the State of Nevada. Therefore, the earnings from the machines were ordered to be placed in a trust account pending the outcome of lender’s suit against the seller. They will be used to pay down the seller’s loan if the lender wins the suit.

This case is referred to Potts v. Maryland Games, LLC, Civil Action No. CBD-18-3250, United States District Court, D. Maryland. Southern Division, (Filed March 29, 2019)

Comment

The lesson here is clear.  In doing due diligence, run a UCC search on the business you are buying to see if any of the assets are subject to UCC liens. This would be part of the lien due diligence you may need to do; for there may be other lien searches such as liens for taxes.

By John McCauley: I help businesses minimize risk when buying or selling a company.

Email: jmccauley@mk-law.com

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

Telephone:      714 273-6291

Legal Disclaimer

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

Posted in due diligence, liens, UCC search Tagged with: , ,

No Buyer De Facto Merger Successor Liability for Seller Debt

Introduction

One risk in buying the assets of a business is being sued by a seller creditor for a seller liability that the buyer did not assume in the asset purchase agreement. This risk is much higher when buying all the business assets of a seller that liquidates immediately after the closing.

The deal

This happened to a buyer, a Phoenix based luxury motor coach company that provided ground transportation in several states. In this case, the seller was a Torrance, California based corporation that provided transportation services in Arizona, California, and Nevada.

At the closing, the seller was defending claims by several of its commercial landlords for $50K in damages. In financial trouble, the seller had put itself up for sale. It sold most of its assets to the buyer for $14.4 million in cash.

This amount covered the seller’s secured creditors and some of its unsecured creditors. But the seller was still defending itself on the landlord $50K claims.

The closing left the seller with numerous assets and land leases. The seller also continued to fight the  commercial lessors lawsuit for another 6 months. Its owners did not liquidate the seller (a corporation) until 1 ½ years after the closing.

The buyer assumed some trade debts but did not use the seller’s logo or hire any of the seller’s upper management.

The lawsuit

The seller’s commercial lessors were unable to collect against the seller and sued the buyer in a Nevada state court. Ordinarily, a buyer of the assets of a business is only liable for liabilities of the business that the buyer expressly assumes in the asset purchase agreement.

The buyer did not assume any liability seller owed to the commercial lessors under the asset purchase agreement. Nevertheless, the creditors sued the buyer in a Nevada state court, under the de facto merger exception of Nevada’s successor liability rule. The Nevada trial court ruled that the buyer was not liable to the seller’s creditors because the transaction was not a de facto merger.

The creditors appealed to the Nevada Supreme Court and lost.

The Nevada high court said that the de facto merger exception to the successor liability rule applies when the buyer has essentially merged with Seller, even though there was no actual merger. The transaction to be a de facto merger must have 3 out of the following 4 factors.

The four factors are: (1) whether there was a continuation of the seller’s enterprise by the buyer after the closing, (2) whether the seller or its shareholders owned part of the buyer after the closing, (3) whether the seller ceased ordinary business operations after the closing, and (4) whether the buyer assumed the seller’s trade liabilities and post-closing contractual obligations.

The court found that the transaction flunked 3 of the 4 de facto factors.  First, the buyer did not continue the seller’s business because the buyer did not use the seller’s logo or hire any of the seller’s upper management. Second, there was no continuity of shareholders because the transaction was an all cash deal and neither the seller nor its owners owned any of buyer after the closing. And three, the seller did not cease ordinary business operations after the closing, since the seller retained numerous assets and land leases; continued defending the commercial lessees damage claims in courts for 6 months; and did not liquidate until 1 ½ years after the closing.

This case is referred to MOH Management, LLC v. Michelangelo Leasing, Inc., No. 73920, Supreme Court of Nevada, (Filed March 29, 2019)

Comment

The de facto merger risk can be a problem in many asset deals. Even in a cash deal, the buyer often continues the same business with the same people; assumes the seller’s trade payables and contract post-closing obligations; and the seller goes out of legal existence immediately after the closing.

Some states seem to say that you can’t have a de facto merger in an all cash deal (meaning no buyer stock as part of the purchase price): examples are California, Marks v. Minnesota Mining & Mfg. Co., 187 Cal.App.3d 1429, 1436, 232 Cal. Rptr. 594 (1986); Ohio and New Mexico, see my blogs http://www.mk-law.com/wpblog/cash-buyer-of-paper-mill-assets-not-liable-for-sellers-cercla-liability/ and http://www.mk-law.com/wpblog/new-mexico-court-rejects-application-of-de-facto-merger-doctrine-to-buyer-of-assets-of-the-maker-of-hot-tar-holding-tanks/

However, apparently in Nevada buyer’s stock as part of the purchase price may not be enough to save the buyer from the transaction from being treated as a de facto merger.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 all cash deal, de facto merger exception, seller ownership in buyer, successor liability Tagged with: , ,

Prospective Buyer Had No Duty to Negotiate in Good Faith with Seller

Introduction

Selling a business is an involved process. A prospective buyer first usually wants to see some basic financial information about the business. But before that happens, the seller often asks the prospective buyer to sign a confidentiality agreement.

The seller and the prospective buyer may then agree upon a purchase price and payment terms; all subject to the results of due diligence. At that point the prospective buyer and seller often negotiate and sign another preliminary document often called a letter of intent. It summarizes the major deal points: structure (stock or asset sale-and if asset sale what assets and liabilities), purchase price and payment terms.

The letter of intent usually says that the description of the major deal points in the letter of intent does not bind either prospective buyer or seller; and that an agreement to sell is only binding when the parties sign a definitive acquisition agreement. There usually are some binding terms in the letter of intent, such as whether the seller must exclusively deal with the prospective buyer for a term, for example, of 60 days.

After that, the prospective buyer usually conducts more due diligence; and the parties negotiate an acquisition agreement. However, many of the deals that reach letter of intent stage never close; for a variety of reasons.

A seller may feel that it has been damaged if the prospective buyer terminates negotiations; maybe because word has gotten out on the street of the failed deal; and the seller may think that other suitors, employees, customers, or suppliers may view the seller as damaged goods.  In those circumstances a seller is tempted to sue the prospective buyer for breaching a duty to negotiate in good faith.

The deal

This case involved the seller of a tech company and a prospective buyer that signed a confidentiality agreement on September 7, 2016. The confidentiality agreement made clear that neither party was committing to a transaction, or even to continued negotiations.

Due diligence followed and the tech company and prospective buyer signed a letter of intent (which was referred to as an “Indication of Interest”) on January 29, 2017. The deal on the table was a purchase of the tech company’s assets for $24 million, payable at closing, with an earnout potential of $10 million. However, the letter of intent said that those terms are not binding on either the prospective buyer or seller; and only the signing of a definitive acquisition agreement by both prospective buyer and seller would create a binding agreement to do a deal.

The deal continued with due diligence and negotiations over the draft asset purchase agreement. The prospective buyer produced a draft asset purchase agreement that was in line with the financial terms described in the letter of intent. Then, on April 5, 2017, the prospective buyer told the seller that it wanted to buy the tech company’s stock from its owner, instead of buying the company’s assets. Five days later, the prospective buyer notified the tech company that it was not going to buy the company’s business.

The lawsuit

Not surprisingly, the seller was upset. It had stopped talking to other suitors (even though it had not promised to do so) and some word of the pending deal had leaked out to the market. Seller sued the prospective buyer in a Pennsylvania federal district court for damages; claiming that the prospective buyer breached its duty to negotiate in good faith. The prospective buyer moved to dismiss this claim arguing that as a matter of law, the prospective buyer had no duty to negotiate in good faith.

The court agreed with the prospective buyer. Why? Because there was no duty to negotiate in good faith in either the confidentiality agreement or the letter of intent. In fact, those documents permitted the prospective buyer to pull the plug on the deal at any time and with no reason.

This case is referred to CKSJB Holdings, LLC v. EPAM Systems, Inc., Civil Action No. 18-217, United States District Court, E.D. Pennsylvania, (March 29, 2019)

Comment

The court understood why the seller was upset with the prospective buyer. But their legal relationship was defined by the confidentiality agreement and letter of intent. The seller could have insisted on inserting a prospective buyer duty to negotiate in good faith in the letter of intent. It did not and so it must bear the consequences.

The seller’s claim might have survived this preliminary legal skirmish under California law (the court applied Pennsylvania law). California implies in every contract a duty to negotiate in good faith; meaning that the duty does not have to be stated in the contract. Pennsylvania does not.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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, Duty to negotiate in good faith Tagged with: , , , , ,

M&A Confidentiality Term Permitted Seller’s Post Closing Use of Customer Info

Introduction

A buyer of a business often pays a significant part of the purchase price for the company’s confidential information; such as customer contact information, pricing, cost structure and terms. As a result, the seller usually agrees in the purchase agreement not to use the confidential information or to compete against the business after the closing.

The deal

In this case, the company provided commercial and residential waste management services in 10 states. Many of its customers were city and county governments.

The seller sold the company to the buyer in May 2016 for $64 million. As part of the deal, the seller agreed not to use or disclose the company’s confidential information, including customer information.

The buyer and seller had a falling out after the closing. The buyer felt it had overpaid for the company due to seller’s misrepresentations.

Furthermore, the buyer learned that after the closing, the seller bid on a project with a Florida county; and used some of the company’s customer information in its bid—e.g. pricing, names, addresses, and contract terms and conditions.

The buyer contacted the Florida county and informed it that the seller had used customer information of the company in violation of its purchase agreement confidentiality obligations. The seller did not get the contract.

The lawsuit

The soured relations boiled over into a lawsuit in a Delaware court. There were claims and counterclaims. The buyer sued the seller for, among other claims, unlawfully using the company’s customer information in violation of its purchase agreement confidentiality covenant; and the seller sued the buyer for costing it a contract with the Florida county.

The seller admitted using and disclosing the customer information; but claimed that it was permissible under the seller’s confidentiality covenant; because the covenant did not apply to information known by the public. Specifically, the information used and disclosed related to government customers; and that information was public.

The court agreed with the seller that the confidentiality provision clearly did not apply to public information and dismissed buyer’s claim.

This case is referred to Bobcat North America, LLC v. Inland Waste Holdings, LLC, C.A. No. N17C-06-170 PRW CCLD, Superior Court of Delaware, (Decided: April 26, 2019)

Comment

Buyer lost a technical argument about why the public information was not disclosable. An argument that the buyer probably thought was a loser.

So why fight? Because the buyer understandably felt that it had paid the seller for this information; and that other competitors would have to spend time and expense in compiling this customer information from various government records.

Ok so what if the nondisclosure provision extended seller’s nondisclosure obligation to the public information; given the fact that the company derived a lot of its revenue from government customers?

Probably because the court would hold that a provision prohibiting the seller from disclosing public information was unenforceable as contrary to public policy. And more importantly, the court at the same time could declare the confidentiality provision unenforceable in its entirety; unenforceable as to both public and nonpublic information.

In other words, the court could throw the baby (the protectible nonpublic information) out with the bathwater (the public information) if the buyer had tried to extend seller’s nondisclosure obligation to public information.

By John McCauley: I help businesses minimize risk when buying or selling a company.

Email: jmccauley@mk-law.com

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

Telephone:      714 273-6291

Legal Disclaimer

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

Posted in covenant not to compete, public information exclusion Tagged with: , ,

Seller’s Stock Purchase Agreement Disclosure Schedule Blocks Buyer’s $1.4 Million Claim

Introduction

The buyer of a company wants to minimize the risk that it overpays for a company. One way to minimize this risk is thorough due diligence. Find out everything you can about the target business.

In addition, the buyer will want the seller to make comprehensive representations and warranties about the target business in the purchase agreement.

Purchase agreement representations and warranties can go on for page after page. And they are important. The seller is making representations and warranties about the business that the seller says are true. And if a representations and warranty is not true, the seller may be liable to the buyer for any loss the buyer suffers as a result of the misrepresentation.

Some seller representations and warranties are absolute. Such as a representation and warranty that the seller owns the business and has the authority to sell the business to the buyer.

Other statements are conditional. Such as the company’s balance sheet given to the buyer discloses all liabilities of the business except for those liabilities described by the seller on what is called a disclosure schedule. A disclosure schedule is prepared by the seller, reviewed by the buyer, and becomes part of seller’s purchase agreement representations and warranties.

The deal

This deal involved a company that provided health care coverage to members under the Medicaid and Child Health Plus programs in three upstate New York counties. Under the terms of a stock purchase agreement, the buyer agreed to buy all the company’s outstanding stock from the seller for $41.3 million.

The stock purchase agreement was signed on April 19, 2016. In it, the seller represented that there were no undisclosed liabilities of the company other than those disclosed on a disclosure schedule delivered by the company to the buyer before the signing.

About 10 months later, the company got a demand from the New York Department of Health for the company to return $1.4 million of income it has received from the New York Department of Health during the 12 month period that ended in April 2016. In other words, New York wanted the company to return preclosing income.

The lawsuit

The buyer wanted the seller to pay this liability because the seller had not disclosed it and the seller refused. The buyer then sued the seller in a New York state court and lost.

The buyer argued that the seller breached its stock purchase agreement representation and warranty by not disclosing this $1.4 million liability. But the court said that no one knew of the liability at the time of the signing of the stock purchase agreement or when the deal closed. Nevertheless, the seller had disclosed the possibility of this kind of liability in its disclosure schedule when it said that said that based on New York Department of Health reconciliations, the company may need to pay back a portion of payments it received and the exact amount that may be owed is currently unknown.

This was enough seller disclosure for the court because the New York Department of Health liability was clearly disclosed as a potential future liability on the disclosure schedule.

Buyer’s claim was dismissed.

This case is referred to Molina Healthcare, Inc. v. Wellcare Health Plans, Inc., Docket No. 651328/2018, Motion Seq. No. 001, Supreme Court, New York County, (April 8, 2019)  https://scholar.google.com/scholar_case?case=3450975109110859669&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment

Preparation of disclosure schedules are very important for the seller. Disclosing any potential problem about the business in the disclosure schedule minimizes the risk that the seller will have to pay back to the buyer all or a portion of the purchase price.

Nevertheless, the value to the seller of disclosure schedules is often overlooked. Especially because preparation takes a lot of time. And at first blush, are boring. Also, the seller waits until right before they are needed, and in the rush of time are not complete.

On the flip side, the buyer is scrambling to close the deal and often overlooks reviewing the disclosure schedules in order to assess if there are any problems disclosed that need to be addressed before the deal closes.

The lesson for both buyer and seller is not to neglect disclosure schedules.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 disclosure schedule, No Undisclosed Liabilities, stock purchase agreement Tagged with: , ,

Court Restricts Company Seller’s Nationwide Noncompete to 3 States

Introduction

The sale of a company usually comes with its goodwill. In fact, in many cases goodwill is the crown jewel of the business.

The last thing a buyer wants, is to pay top dollar for the business only to have the seller’s owner after the closing start competing against the business. Therefore, the buyer wants the seller’s owner to agree to not compete for several years against the business. And so, the seller’s owner usually signs a covenant not to compete.

The deal

This case involved the $4 million purchase of the stock of a Fresno, California based trucking company that hauls nuts, wine and retail imports from the West Coast; operating mostly in California, but also Oregon and Nevada.

As part of the deal the owner, a California resident, promised not to compete in the trucking business anywhere in the United States for about 5 years.

The owner worked for the buyer after the closing. However, a dispute between the buyer and the owner broke out over the amount of the deal’s earn-out amount. This resulted in litigation and buyer terminated the owner’s employment.

The owner then went to work for a competitor during the 5 year noncompete period.

The lawsuit

The buyer went into a California federal district court to stop the owner from working for the competitor. The owner challenged the legality of his noncompete.

The first battle was over which state law would apply to the noncompete. This is a “choice of law” dispute.

The choice of law language in the stock purchase agreement (which contained the owner’s noncompetition covenant) said that Delaware law applied. The buyer pushed for Delaware law because of California’s more restrictive law on the enforceability of non-competes.

The court held that the more favorable noncompetition law of Delaware would not apply to this case because the sold business was a California business; the owner was a California resident; and California has a strong public policy against enforcing agreements that restrain employment.

However, California does enforce noncompetition covenants given by the seller of the stock of a company to the extent necessary to protect the company’s goodwill purchased by the buyer from the seller.

The owner however, argued that the noncompete was unenforceable because it overreached. Specifically, the noncompete prohibited the owner from working in trucking nationwide, most of which was outside the sold company’s market area of California, Oregon and Nevada.

The court agreed with the owner that the noncompete was unenforceable as written.  However, the agreement authorized the court to reform the noncompete by restricting the noncompete area to California, Oregon and Nevada, the area necessary to protect the good will of the purchased business. This the court did; thus, saving the enforceability of the noncompete.

This case is referred to Roadrunner Intermodal Services, LLC v. TGS Transportation, Inc., Nos. 1:17-cv-01207-DAD-BAM, 1:17-cv-01056-DAD-BAM (consolidated), United States District Court, E.D. California, (March 28, 2019)

Comment

The buyer was lucky here. The court once it decided California law applied could have declared the noncompete unenforceable and refuse to reform it by limiting the noncompete area to the 3 West Coast states.

The lesson is to not be aggressive in defining the noncompete area.  Often buyers include all the buyer’s market area; even if buyer’s market area is much larger that the target’s market area. Doing that risks losing the benefits of the entire noncompete. And you can’t depend upon the court to save your bacon by reforming the noncompete.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 boilerplate provisions, California, choice of law provision, Delaware, noncompete area, reformation Tagged with: , ,

Buyer Stops Post Closing Payments Because of Seller’s Prior APA Breach

Introduction

A buyer of a company often discovers after the closing that he or she overpaid for the business. And many times, it is because the target company did not match up to seller’s purchase agreement representations and warranties.

In that case a buyer who has obligations to make post-closing payments to the seller in the form of deferred purchase price, consulting fees, or noncompetition payments will consider not making those payments; at least to the extent of the buyer’s damages. Is that legal?  Yes; if the buyer has the right to do so under the purchase agreement.

What if the buyer does not have the right to withhold post-closing seller payments under its purchase agreement?

The deal

That was the question for the buyer after it purchased the assets of a seller for $7.4 million. The seller operated public parking lots and garages in Washington, D.C., Virginia, and Maryland. Most of the purchase price was paid at closing. However, the seller was entitled to certain post-closing payments under the asset purchase agreement, and its owner was entitled to consulting fee payments under a consulting agreement.

The lawsuit

After the closing the buyer refused to pay the seller $371.5K under the asset purchase agreement, and its owner $650K under the consulting agreement.  The buyer claimed that it was legally justified to withhold payments because the seller and its owner materially breached representations and warranties they made in both contracts, thereby releasing the buyer from its contractual obligations and entitling it to damages.

The seller and its owner sued the buyer in a Maryland federal district court to obtain the promised $1 million owed under the two contracts.

The buyer argued that the seller and its owner breached the representations and warranties in these contracts as a matter of law through undisclosed fraudulent conduct at one parking lot that resulted in the customer’s post-closing cancellation of its contract with the buyer. And, through the seller and its owner’s failure to disclose, prior to the closing, that four other parking lot contracts faced substantial risk of being canceled, despite the seller and its owner’s awareness of plans for cancellation. (The owners of those 4 lots also cancelled their contracts with the buyer after the closing.)

The court said that the buyer can be excused from paying the seller and its owner the $1 million under the contracts if the seller and its owner’s contractual breaches were material. However, the question of whether those breaches were material is a question of fact for the jury, not a question of law for the court to decide. The result? The case goes on.

This case is referred to Slavin v. Imperial Parking (US), LLC, Civil Case No. PWG-16-2511, United States District Court, D. Maryland, Southern Division, (March 27, 2019)

Comment

The buyer can draw some comfort from the fact that it has some leverage over the seller when negotiating a settlement of the dispute because the buyer holds $1 million that the seller wants.

Much better than paying everything to the seller in cash at the closing; discovering a seller breach after the closing; and suing to recover buyer’s damages from the seller; or probably its owner because the seller has been dissolved.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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, breach of representations and warranties, material rep and warranty breach, prior-material-breach doctrine, Withholding Post-closing payments Tagged with:

Cash Buyer of Paper Mill Assets Not Liable for Seller’s CERCLA Liability

Introduction

A company is responsible under the federal CERCLA or superfund law, and often state law for cleaning up property it contaminates by hazardous waste disposal. However, the buyer of the assets of the responsible company is generally not liable for remediating the contaminated property unless the buyer assumes seller’s environmental liability in the asset purchase agreement.

But the buyer may be liable for seller liabilities the buyer did not assume under certain federal and state laws generally referred to as successor liability laws.  And one of those laws applies to an asset deal which lawyers call a de facto merger.

Basically, a de facto merger is an asset deal where the asset buyer continues the seller’s operations, with seller’s assets and seller’s employees; but usually only when the seller or the seller’s owners end up with an ownership interest in the buyer; and the seller ceases business operations after the closing.

Under those circumstances the buyer may be held liable for seller’s environmental cleanup obligations.

The deal

This deal involved a 100 hundred year old Dayton, Ohio paper mill. The seller had operated the mill for 20 years. Its operations contaminated the property with hazardous waste.

The buyer purchased most of the equipment and other assets of the paper mill from the seller for cash in 1991. It assumed no environmental liabilities.

The buyer hired the seller’s non-management employees and operated the papermill with the purchased assets. It did not purchase the real estate (the paper mill facility) or one of the paper machines.  It also did not hire seller’s senior management or any of the family members that owned the seller.

The lawsuit

The current owner sued the buyer in an Ohio federal district court to recover cleanup costs for the seller’s contamination of the paper mill. The buyer said that it was not responsible for seller’s clean up obligations because the buyer did not assume any of seller’s environmental liabilities in the asset purchase agreement.

The current owner claimed that the buyer was liable for the cleanup costs because its purchase of the seller’s assets amounted to a de facto merger within the meaning of the successor liability law.  The buyer argued that its purchase of the seller’s assets was not a de facto merger because neither seller nor the seller’s owners received buyer stock in the deal. It was an all-cash transaction.

The court agreed with the buyer and ruled that the buyer had no responsibility for seller’s clean up obligation because the transaction was not a de facto merger.

This case is referred to Garrett Day, LLC v. International Paper Co., Case No. 3:15-cv-36, United States District Court, S.D. Ohio, Western Division, (March 25, 2019)

Comment

The court said that buyer’s continuation of the operations of the seller with seller’s non-management employees and most of seller’s assets made this asset deal look like a de facto merger.  However, the court also said that it is a “sine qua non of a de facto merger” that the purchase price includes buyer stock in the deal. Translation: very unlikely that a court would find a de facto merger in an all cash asset deal.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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, asset seller's liabilities, CERCLA or superfund liability, de facto merger exception, successor liability Tagged with: , , , ,

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