Indiana High Court Requires Continuity of Ownership in Successor Liability Claim

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Business asset buyer not liable to seller creditor under Indiana’s de facto merger or mere continuation successor liability exceptions to the successor liability doctrine.

M&A Stories

April 30, 2021

Introduction

Successor liability is an important issue when pricing a business asset acquisition. Generally, a buyer is only responsible for seller liabilities assumed in the asset purchase agreement. However, there are some federal and state successor liability risks.

The deal

The South Bend, Indiana seller in this case manufactured utility and cellular towers. The buyer was a bank that the seller owed $10 million to under a bank loan that was secured by a first lien on the … (the seller’s) … assets. The … (the seller’s) … owners had personally guaranteed the loan.

The seller was in financial difficulty. The liquidation value of the … (the seller’s) … assets was about $3.1 million.

In November 2017, the seller agreed to the buyer acquiring the … (the seller’s) … assets by foreclosure. “Afterward, … (the buyer) … continued operating from … (the seller’s) … former location without publicly announcing either the transition or the transfer of assets from … (the seller) …. (The buyer) … retained about ninety percent of … (the seller’s) … employees, including senior management. Although senior management had owned the lion’s share (at least ninety-five percent) of … (the seller’s) … shares, none of … (the seller’s) … shareholders owned any equity interest in … (the buyer) … As part of the transition, … (the buyer) … agreed not to enforce the personal guarantees against … (the seller’s) … four senior officers, all of whom agreed to remain in their positions at … (the buyer).”

The lawsuit

A creditor had installed piping in the seller’s South Bend facility in early 2016 but had not been fully paid for its work. It made a claim against the buyer in an Indiana trial court. Both the trial court and the intermediate appellate court held the buyer liable to the creditor under Indiana successor liability doctrine, even though none of the seller owners had an ownership interest in the buyer.

The Indiana Supreme Court, in a unanimous decision reversed: “In a typical asset purchase, the buyer acquires the seller’s assets but not its liabilities. The general rule is not absolute, however, and this case turns on two exceptions. The first exception arises when the acquisition of assets amounts to a de facto merger; the second, when the buyer is a mere continuation of the seller. If either exception applies, the buyer is on the hook for all the seller’s liabilities … (W)e hold that continuity of ownership is necessary for the de-facto-merger and mere-continuation exceptions to apply. Because there was no continuity of ownership between … (the seller) … and … (the buyer) …, we reverse the trial court’s entry of judgment for … (the creditor) … and remand with instructions to enter judgment for … (the buyer) …”

This case is referred to as New Nello Operating Co., LLC v. CompressAIR, Supreme Court Case No. 20S-CC-578, Supreme Court of Indiana, (Argued: December 3, 2020. Decided: April 22, 2021). 

Comment

Generally, successor liability requires that the seller owner has an ownership stake in the buyer. But some states don’t always require continuity of ownership.

By John McCauley: I help people manage M&A legal risks.

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 continuity of enterprise exception, continuity of ownership, de facto merger exception, successor liability Tagged with: ,

Court Says Buyer Prepared LOI That Seller Signed Is Probably Unenforceable

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Although the seller signed the buyer prepared LOI, it included additional terms which were never agreed to by the buyer.

M&A Stories

April 30, 2021

Introduction

A letter of intent (or LOI) is often used in a private deal to summarize the key business terms of a proposed transaction. This summary is contained in a nonbinding section of the document. There are usually some binding terms. A common binding term prohibits the buyer from soliciting the seller’s employees.

The deal

This case involved a failed deal between competitors in the mortgage lending industry. The buyer and seller key executives negotiated the major business terms of a proposed acquisition in 2019. The buyer’s president left the details to be worked out by the buyer’s COO/chief legal officer.

The buyer sent a draft LOI to the seller. The seller signed it but included a “lengthy addendum” which would prohibit the buyer from soliciting or hiring any seller employees for 2 years. The buyer was willing to include a nonsolicitation restriction but not a prohibition of hiring seller’s employees where the buyer did not solicit the seller employee.

The lawsuit

The deal never happened. Later the seller and buyer ended up a Minnesota federal district court with a claim by seller that the buyer solicited and hired its employees in violation of a letter of intent. The seller wanted the court to restrain the buyer from soliciting and hiring its employees while the seller and buyer battled in court.  The court refused because the buyer probably never agreed to refrain from soliciting or hiring seller employees.

The court noted that the seller’s signed LOI was not binding upon the buyer because the seller had added additional terms. The seller’s “proposed revisions effectively created a third draft of the letter of intent.” That third draft LOI was a seller offer that would only be binding on the buyer when and if the buyer accepted the revisions by signing the LOI as revised by the seller. The buyer never did that.

This case is referred to as American Mortgage & Equity Consultants, Inc. v. Everett Financial, Inc., No. 20-cv-426 (ECT/KMM), United States District Court, D. Minnesota, (February 28, 2020). 

Comment

The takeaway. Assume that a LOI is not binding (to the extent of the binding provisions in the LOI) until both the buyer and the seller have signed an LOI that contains the same terms and conditions.

By John McCauley: I help people manage M&A legal risks.

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 letter of intent, signing LOI with revisions by signer Tagged with: ,

Asset Buyer Fights Claim That It Assumed Liability for Product Line Containing Asbestos

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Buyer only purchased certain product lines of seller but also purchased the trade name that seller used for all product lines including a steam turbine product line that contained asbestos which the seller did not sell to the buyer.

M&A Stories

April 20, 2021

Introduction

One major advantage of an asset purchase over a stock acquisition is that the buyer can generally pick and choose what liabilities the buyer wishes to assume. However, a seller creditor may still sue the buyer when the financial claim is significant.

The deal

The buyer in this deal purchased 2 product lines from the seller in 1987. The purchased product lines were “the Commercial and Industrial heating and Make-Up Air business”. The buyer expressly assumed seller’s liabilities for the purchased product lines.

The buyer also purchased the trade name that the seller used in its business operations. This trade name had also been used by the seller before the closing, for the product lines retained by the seller. Those lines were the “Heat Recovery Wheel business and a… Draft Inducer business …”  After the closing, the seller could not use the trade name for those product lines because the trade name had been sold to the buyer

The lawsuit

In 2019, a claimant filed a petition for damages against a customer of the seller. He alleged that the seller sold a steam turbine to this customer, a company that manufactured ships for the military, which contained asbestos. The claimant alleged that he was recently diagnosed with malignant mesothelioma, and that his mesothelioma was caused by exposure to asbestos from several sources, including asbestos allegedly brought home on the work clothes of his father, who worked at the ship manufacturer from 1943 to 1945.

The seller’s customer sued the buyer arguing that the buyer had assumed this liability because it had expressly assumed in the asset purchase agreement the liabilities associated with the business, purchased from the seller, and the business included the seller trade name.

The buyer filed a motion for summary judgment asking the court to dismiss the ship manufacturer’s claim against it, saying that it did not purchase the steam turbine product line and in fact never manufactured steam turbines.

The court denied the buyer’s motion for summary judgment: “This Court agrees that … (the buyer) … has not established that it is entitled to summary judgment as a matter of law on the issue of whether it acquired the assets and liabilities associated with the steam turbines and turbine-driven blowers. Genuine issues of material fact exist as to what assets and liabilities … (the buyer) … intended to acquire from … (the seller) … and what assets and liabilities it legally assumed.

This case is referred to as Egendre v. Lamorak Insurance Company, Civil Action No. 19-14336, United States District Court, E.D. Louisiana, (March 31, 2021). 

Comment

Liability for asbestos products sold decades before a closing can still be a problem for business asset buyers.

In this case it would seem a stretch to say that the buyer assumed the liabilities for the offending steam turbine line simply because it purchased the seller’s trade name; especially if there is convincing evidence that the steam turbine products were part of seller’s retained assets.

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

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

Telephone:      714 273-6291

 

Legal Disclaimer

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

Posted in buyer assumption of seller liability, successor liability Tagged with: ,

Seller Has Post-Closing Problem with His Pre-Closing Guaranty of Target Lease

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Target falters after closing and stops paying rent to its landlord. The seller sues the target and the buyers to manage his exposure because of a personal guaranty he gave to landlord.  

M&A Stories   

April 14, 2021  

Introduction  

It is very common for the owner of a company to guaranty the company’s office or facility lease. This personal guaranty is a source of risk for the owner when selling the company. The deal below illustrates the problem  

The deal  

The seller in this deal previously founded the target which executed a commercial office lease with the landlord. As a condition of the lease agreement, the seller also executed a guaranty, under which he personally promised to pay rent due under the lease agreement in the event the target failed to perform its obligations under the lease. Two years later, the seller sold a majority interest in the target to the buyers pursuant to the terms and conditions of a stock purchase company.   

The target began experiencing financial difficulty and its last rent payment under the lease agreement was about a year after the closing. Five months later the landlord commenced an action against target and the seller alleging breach of contract against the target for breach of the lease agreement and against the seller for breach of the guaranty agreement.   

The lawsuit  

The seller sued the target and the buyers in a New York state court. Notably there was no claim that the buyer or target breached any promise in the stock purchase agreement to indemnify the seller for a target breach of the lease.   . 

This case is referred to as 950 Third Ave. LLC v. Theirapp, Inc., Docket No. 653316/2020, Third-Party Index No. 595747/2020, Motion Seq. No. 001., Supreme Court, New York County, (April 1, 2021). https://scholar.google.com/scholar_case?case=9776270755032175666&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2020  

Comment  

The seller does not appear to be in a strong legal position from what we know of the facts.    

So, how can a seller deal with a personal guaranty of his company’s lease when selling his company?  

The best M&A legal risk management tool would be for the seller to get the landlord to release the seller from his or her personal guaranty before the closing. Failing that, the seller could require the target and buyer to indemnify the seller for any loss the seller suffers under the guaranty. This risk management tool would be significantly enhanced by some sort of meaningful security for the indemnification, such as a letter of credit or an adequately funded escrow arrangement.  

By John McCauley: I help people manage M&A legal risks.  

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 shareholder personal guaranty of target lease, stock purchase agreement Tagged with: ,

Buyer Accuses Timeshare Business Seller of Signing Credit Risk Members Before Closing

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Delaware Court denies seller’s motion to dismiss buyer’s claims that seller changed practice before closing by signing up customers with low FICO scores.  

M&A Stories   

April 13, 2021  

Introduction  

A buyer uses past performance and future projections to help price a target business. The purchase agreement usually contains representations and warranties that the seller has not changed practice since the last available financial statements. This deal illustrates why those representations and warranties help manage that risk. 

The deal  

This deal involved the acquisition of timeshare resort assets. The buyer purchased the timeshare business and existing contracts with the timeshare members and the seller retained the majority right to the payment stream on those existing contracts. The buyer was responsible for collecting from the timeshare members.  

The seller represented and warranted in the purchase agreement that since the lasted audited financial statements it had not changed, “in any material respect, any credit policies or policies or practices relating to the collection of the Timeshare Installment Contracts and Accounts Receivable or payment of payables; … (or changed) … in any material respect, the underwriting standards or other credit criteria for the sale and/or financing of the sale of Timeshare Interests …”  

The lawsuit  

After the closing the buyer sued the seller in Delaware state court. One of its claims was that the buyer discovered after the closing that the seller had in fact changed its underwriting practice after the date of the last audited financial statements by lowering its underwriting standards for new members by signing up members with much lower FICO scores than it had in the past. The buyer claimed that seller fraudulently induced the buyer to sign the purchase agreement by not telling the buyer of the changed underwriting practice.  

The seller’s motion to dismiss this claim was denied and the litigation will continue.  . 

This case is referred to as CRE NIAGARA HOLDINGS, LLC v. RESORTS GROUP, INC., C.A. No. N20C-05-157 PRW CCLD , Superior Court of Delaware, (Submitted: February 19, 2021. Decided: April 7, 2021.).  

Comment  

The buyer also sued the seller for breach of the above representations and warranties. However, the breach of representations and warranties claim is subject to an agreed upon indemnification cap. Damages for fraudulent inducement should be free of the indemnification cap.  

By John McCauley: I help people manage M&A legal risks.  

Email:  jmccauley@mk-law.com 

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

Telephone:      714 273-6291  

Legal Disclaimer 

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

Posted in exclusive remedy, fraud carveout, fraud in business sale, fraudulent inducement Tagged with: ,

Asset Buyer Can’t Enforce Employee Nonsolicitation Covenants

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Oklahoma federal court refuses to enforce several employee non-solicitation post-employment covenants because they were either non-assignable, had no term, applied to indirect solicitation or were not restricted to established customers.

M&A Stories

April 11, 2021

Introduction

One buyer M&A risk is for seller’s employees to walk out the door after the closing taking seller customers. One tool to manage this risk is get the employees to sign an agreement promising to not solicit the seller’s customers after employment termination. However, the enforcement of a non-solicitation provision depends upon applicable state law, which varies from state to state.

The deal

The buyer in this deal is a national lawncare company that provides residential and commercial customers across the United States with lawn, tree and shrub care, among other services. The target was an Oklahoma based competitor.

The target agreed to sell its assets to the buyer pursuant to an asset purchase agreement. The transaction closed October 9. 2019.

Prior to entering into the APA, Seller had its employees sign non-solicitation agreements. Some seller employees signed an agreement prohibiting the employee from directly soliciting seller’s established customers for two years after employment termination. The other form of agreement prohibited an employee from directly or indirectly soliciting any customer who the employee had been in contact with. These agreements were part of the assets acquired by the buyer.

The buyer also had all seller employees it hired sign agreement which prohibited the employee from directly or indirectly soliciting a buyer customer which the employee had actual contact for 1 year after employment termination.

After the closing several seller employees who were hired by buyer, left and competed against the buyer. Some of these employees signed one version of the seller nonsolicitation agreement and others signed the other seller nonsolicitation agreement. They all signed the buyer nonsolicitation agreement.

The lawsuit

The buyer sued these former employees in federal district court claiming that they violated a seller nonsolicitation agreement and the buyer nonsolicitation agreement.

The former employees asked the court to dismiss the nonsolicitation claims and the court granted their request.

The court noted that a nonsolicitation provision is only enforceable in Oklahoma for the prohibition of “direct” solicitation of “established” customers. The buyer’s provision failed because it prohibited “indirect” solicitation which would include for example advertising or meeting a former customer at a trade show.

The one seller nonsolicitation agreement failed because it had no term; the other because the seller could not assign it to the buyer without the employee consent.

This case is referred to as TruGreen Limited Partnership v. Oklahoma Landscape, Inc., Case No. 20-CV-71-TCK-CDL, United States District Court, N.D. Oklahoma, (March 17, 2021). 

Comment

Be careful to comply with local law if you want to restrict seller customers competing against you.

The buyer also had a noncompete provision which under Oklahoma law is only permissible when the noncompete is given by someone selling a business.

By John McCauley: I help people manage M&A legal risks.

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 nonsolicitation of employees and customers, nonsolicitation of former customers Tagged with: ,

DOL sues Target Directors for Breach of Fiduciary Duties in ESOP Transaction

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DOL claims that independent ESOP trustee overpaid for the majority owner’s stock and sued the company’s directors for breach of fiduciary duty.  The purchase price was 2.5 times higher than the prior 5 years ESOP valuations.

M&A Stories

March 29, 2021

Introduction

One exit strategy for a retiring business owner is to sell his or her company to an ESOP. However, there are ERISA risks for transaction participants if the ESOP overpays for the owner’s stock.

As a result, it is common for the target’s board of directors to appoint an independent ESOP trustee to purchase the owner’s stock for the ESOP. Nevertheless, target directors may have ERISA liability if the independent ESOP trustee overpays for the stock.

The deal

The target in this deal was a Minneapolis based manufacturer. The son of the founder was the board chairman and owned 76% of the company and in 2010 was about 80 years old. The ESOP owned the rest.

The ESOP stock valuation for the five years before the closing fluctuated from $14 to $34 per share. The target had a 5-member board which included the president, VP of Finance and VP of Human Resource. All directors served as ESOP trustees.

The board began looking at an ESOP transaction in the spring of 2011. The seller brought a financial advisory firm to the board for consideration of a sale of his stock to the ESOP in March or April of 2011 that had experience in ESOP transactions.

On April 28, 2011, the firm made a presentation to the board. In its presentation, the firm estimated that the seller’s stock was worth $28.7 million, or about $63 per share. The firm’s presentation noted that the benefits of an ESOP transaction included the key officers’ retention of their positions as officers and directors and supplemental incentive compensation for them.

The advisory financial firm revised its estimate to $74 per share on June 24; $84 per share on June 30; and $85 per share on July 11th.

Management worked on financing for the deal with a bank. On July 18 the bank advised management that its projections on which the financial advisory firm’s valuations were based were “very aggressive when compared to past performance” and observed that the “figures considerably exceed actual performance for each of the last 6 years.”

Four days later, the directors resigned as ESOP trustees and appointed an independent trustee to serve as the ESOP’s trustee, that was recommended by the financial advisory firm. The deal closed October 5, 2011 with the ESOP paying seller $39 million, or $85 per share.

The lawsuit

The Department of Labor or DOL sued the independent trustee and the three officers, in their capacity as directors, for various ERISA violations. The three directors challenged the claims by way of summary judgment.

The DOL claims that the directors’ actions in the transaction amounted to a breach of their duties of loyalty and prudence to the ESOP; accusing the directors of being aware of evidence suggesting that the selling price was unreasonably high.

The DOL’s claims against the directors included allegations that the directors orchestrated an overpriced sale to the ESOP and failed to monitor the independent trustee’s behavior in the transaction.

The court reviewed the DOL’s detailed allegations and concluded that director liability could not be settled by summary judgment.

This case is referred to as Scalia v. Reliance Trust Company, No. 17-cv-4540 (SRN/ECW), United States District Court, D. Minnesota, (March 2, 2021). 

Comment

The takeaway here is that an independent ESOP trustee may not insulate management from ERISA liability for an unreasonably overpriced deal. The red lights should have gone off in management’s heads when management provided unreasonably high projections for the transaction and when the 2011 purchase price of $85 per share was 2.5 times higher than any of the 2006 through 2010 ESOP valuations.

By John McCauley: I help people manage M&A legal risks.

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 director liability, independent trustee, sale of business to ESOP

Court Permits Mere Continuation Successor Liability Claim Against Buyer

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Buyer purchased assets of seller for cash including a distributor agreement. Buyer did not assume any liability for seller’s breach of the distributor agreement. The court nevertheless permitted distributor to sue the buyer for breach of the distributor agreement for an alleged pre-closing breach, under a mere continuation successor liability theory, in part because seller’s president held himself out as president of a buyer division.

M&A Stories

March 08, 2021

Introduction

There is a risk that a seller creditor may sue the cash buyer of a seller’s business assets for a liability that the buyer did not assume under the asset purchase agreement under a successor liability theory.

The deal

This deal was a strategic acquisition in the printer equipment manufacturing industry. The buyer purchased the assets of the seller, an Illinois based Delaware corporation, for cash. This included a distributor agreement. However, the buyer did not assume any liabilities for seller’s pre-closing breach of a specific distributor agreement.

The lawsuit

After the closing the distributor sued the buyer and seller for defective printers delivered before the closing and also for printers that the seller failed to deliver before the closing.  The distributor claimed that the buyer was liable to the distributor under the mere continuation successor liability theory.

The buyer argued that it could not be liable because it only acquired the seller assets for cash and did not assume any seller liabilities for seller’s breach of the distributor agreement under the asset purchase agreement. The court, citing Delaware cases said: “The court concludes that the proposed amended complaint plausibly alleges a mere continuation theory of successor liability. ‘Mere continuation requires that that the new company be the same legal entity as the old company.’ … ‘The test is not the continuation of the business operation; rather, it is the continuation of the corporate entity.’ … ‘The `primary elements’ of being the same legal entity . . . include `the common identity of the officers, directors, or stockholders of the predecessor and successor corporations, and the existence of only one corporation at the completion of the transfer.’ … ‘(I)mposition of successor liability is appropriate only where the new entity is so dominated and controlled by the old company that separate existence must be disregarded.’”

The court found these allegations in the distributor’s complaint sufficient for a mere continuation successor liability claim: “Here, it is undisputed that … (seller) … sold virtually all of its assets pursuant to the Asset Agreement … After the Asset Agreement’s execution, … (seller’s) … only assets consisted of bank deposits, accounts receivable, and prepaid expenses. … (The seller’s president) … sent correspondence to … (the distributor) … on … (the seller’s) … letterhead following the Asset Agreement’s execution, and represented that he was the President of … (a buyer division) … In addition, the proposed amended complaint alleges that … (the buyer continued) … to employ all of … (the seller’s) … employees, and with … (the seller’s president) … continuing both to fill the same role as … (the seller’s president) … and to work from … (the seller’s) … building (which … (the seller) … sold in the Asset Agreement).”

This case is referred to as Fujifilm North America Corporation v. M&R Printing Equipment, Inc., Civil No. 20-cv-492-LM, United States District Court, D. New Hampshire, (February 24, 2021). 

Comment

This case is disturbing because the court said: “Mere continuation requires that that the new company be the same legal entity as the old company.”  That was clearly not the case here, as after the closing, the business was operated by a buyer legal entity. The seller Delaware corporation did not operate the business after the closing.

Mere continuation successor liability is weak in this case also because no seller officer, director or owner served as an officer or director of buyer or owned an interest in buyer.  The only arguable fact was that the seller president told the distributor that he was now the president of a buyer division.

In 20/20 hindsight, the buyer should not have permitted the seller president to call himself president of a buyer division. Also, a buyer should not give a seller officer, director or owner a title that includes any of these words: director, chief executive officer, chairman, secretary, treasurer or chief financial officer; even if it only applies to an unincorporated buyer division.

By John McCauley: I help people manage M&A legal risks.

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 mere continuation, mere continuation exception, successor liability Tagged with: ,

Target Incorrectly Applies New Accounting Standard – May Cost Buyer $38 Million

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Target’s estimate of tangible net worth at closing for purposes of a purchase price adjustment was $38 million too low because it was based upon an incorrect application of a new accounting standard. Buyer has uphill fight to avoid making a $38 million purchase price adjustment payment to seller.

M&A Stories

March 04, 2021

Introduction

Purchase price adjustments based upon a post-closing calculation of a target’s closing tangible net worth is very common and also a source of post-closing disputes.

The deal

This deal was a strategic acquisition in the health insurance industry. The seller agreed to sell the target for a base price of $750 million and an adjusted purchase price based upon the target’s tangible net worth.

The lawsuit

The merger agreement provided for a purchase price adjustment based on whether the target’s tangible net worth at closing exceeded or fell short of the target established at signing. The seller calculated the targeted tangible net worth.

After the closing, the buyer determined that the target’s tangible net worth at closing was actually $38 million more that the seller’s estimate. Most of the difference was explained by the target’s incorrect application of a new accounting standard that it used in calculating its estimate.

The buyer therefore calculated the closing tangible net worth consistent with the target’s incorrect application of the new accounting standard, even though the calculation was clearly in breach of the merger agreement.

The seller balked and initiated the merger agreement’s dispute resolution procedure which would call for binding arbitration by KPMG. The buyer countered by asking the Delaware Court of Chancery to order KPMG to calculate the target’s tangible net worth consistent with the target’s earlier incorrect application of the new accounting standard.

The court refused the buyer’s request because the merger agreement clearly mandates that KMPG correctly apply the new accounting standard in calculating the target’s closing tangible net worth. That means that the buyer will likely pay the seller $38 million for tangible net worth that in fact did not exist.

This case is referred to as Golden Rule Financial Corporation v. Shareholder Representative Services LLC, C.A. No. 2020-0378-PAF, Court of Chancery of Delaware, (Submitted: October 30, 2020. Decided: January 29, 2021). 

Comment

In 20/20 hindsight, the buyer should have had its accounting team verify the accuracy of the target’s calculation of the estimated closing tangible net worth before signing the merger agreement.

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

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

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Posted in purchase price adjustment, tangible net worth Tagged with: ,

New York Trying to Impose Sales Tax on Acquisition of Equity of LLC

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Buyer acquires all equity of the target, an LLC, and a disregarded entity. NY Division of Tax Appeals upholds NY’s $125K sales tax assessment on target’s tangible personal property.

M&A Stories

February 26, 2021

Introduction

M&A lawyers know that there will be no sales tax in a stock acquisition because sales tax only applies to an asset acquisition, the acquisition of tangible personal property. Why? Because sales and use tax only applies to the sale of tangible personal property, and stock is intangible personal property. Same when buying the equity (that is membership interests) in a limited liability company. LLC membership interests are also intangible property. But maybe not in New York.

The deal

The New York based buyer, provides online business and investment information to its customers through numerous subscription products.

It became interested in acquiring a New York based target in 2012. The target is a media company that publishes sophisticated coverage of the mergers and acquisitions environment, primarily through a leading digital provider of transactional information services.  The target provides its products and services through print, online, and in-person platforms.

The buyer offered to purchase the target’s assets. The target countered with an offer to sell its equity. The target was a single member limited liability company and a disregarded entity for federal and state income tax purposes.

On September 11, 2012, the buyer purchased all of the target’s membership interests from the seller for $5.8 million, pursuant to the terms of an “Equity Interest Purchase Agreement”. The target continued business operations after the closing as a single member LLC and as a disregarded entity for federal and state income taxation purposes.

The tax controversy

New York’s Division of Taxation performed a sales tax audit of buyer and target in 2014. Based upon the audit New York proposed a $125K sales tax assessment on the target’s tangible personal property. The taxpayer, to no avail, protested that it purchased the target’s equity not the target’s assets.

The dispute ended up before an administrative law judge of New York’s Division of Tax Appeals. After a hearing the Administrative Law Judge upheld the $125K sales tax assessment.

The judge said that the transaction was an acquisition of assets. It pointed to the fact that there was an allocation of purchase price in the purchase agreement, and that the buyer commingled the target assets on its balance sheet.

This case is referred to as In the Matter of the Petition of Thestreet.Com, Inc. (a/k/a The Streete, Inc.) DTA NO. 828467, State of New York, Division of Tax Appeals, (February 4, 2021); https://www.dta.ny.gov/pdf/determinations/828467.det.pdf 

Comment

This decision can’t be right. The auditor and administrative law judge were persuaded by facts that do not establish that the target sold its assets to the buyer.

The purchase agreement’s requirement for a purchase price allocation did not change this equity acquisition into an asset acquisition. It was used because the target was a disregarded entity for federal and state income tax purposes and thus (for federal and state income tax purposes) the deal was a sale of assets by the target to the buyer and not a sale of the target equity by the target’s owner to the buyer.

New York could have passed a law saying that a disregarded entity in New York is disregarded not only for New York income taxes but also New York sales and use tax. No such law was mentioned in the administrative law judge’s decision.

The other fact that New York latched on to was that the target assets were included in the buyer’s balance sheet, post-closing. I don’t know if post-closing commingling target assets on the buyer’s balance sheet is consistent with generally accepted accounting principles, but that does not convert an equity acquisition into a asset acquisition.

By John McCauley: I help people manage M&A legal risks.

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 sales tax imposed on equity sale of DRE Tagged with: ,

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