Buyer did not terminate employment agreements with owners of selling accounting firm for cause

In November 2014, Buyer, an accounting firm in Plymouth, Indiana (about 27 miles south of South Bend, Indiana) acquired Seller, an accounting firm in South Bend, through an asset purchase agreement. At the closing Buyer entered into employment agreements with Greg and John, both accountants, and the owners of Seller. The employment agreements included two-year restrictive covenants preventing John and Greg from competing with Buyer if Buyer terminated their employment for cause.

In February 2016, after reviewing the accounting work performed by John and Greg during the 2015 tax season, Buyer found numerous errors that John and Greg had allegedly made, including:

  • John took a $36K deduction for taxes on a return that the client had never paid.
  • John failed to report $119K of income on a Michigan tax return resulting in $8,000 more in taxes for the client.
  • John missed a $198K capital loss carryover for a client resulting in a significant increase in tax.
  • Greg failed to record $3.2 million in loans on a client’s balance sheet or to disclose those loans in the notes of the financial report.
  • Greg and John concealed from Buyer that they were making thousands of dollars in payments to clients to settle penalties those clients had incurred due to poor accounting work.

In May 2016, Buyer notified John and Greg that Buyer was terminating their employment for cause. Under the employment agreement, “for cause” included termination of employment for inaccurate work or late work, or any other conduct that is injurious to or adverse to the employer-employee relations. However, there could be no termination for cause unless John and Greg’s performance had a meaningful effect on Buyer’s ability to serve its clients.

John and Greg challenged (in an Indiana state court) Buyer’s “for cause” termination of John and Greg’s employment with Buyer, in order to avoid the 2-year noncompetition covenant. The trial court said that John and Greg’s errors were not beyond normal; and that no actual harm to Buyer’s clients was demonstrated; nor did the errors have a meaningful effect on the ability of Buyer to serve its clients. Thus, the trial court concluded that Buyer had not terminated the employment of John and Greg for cause, as that term was used in the employment agreements.

The Indiana Court of Appeals, in upholding the trial court decision, noted that Buyer presented evidence that John and Greg committed numerous errors, some of which may have been sufficient grounds to fire John and Greg if there had been not been an employment agreement with a requirement that Buyer only terminate John and Greg for cause (as defined in the employment agreements).

The appellate court held that John and Greg’s employment agreements controlled this dispute and agreed with the trial court that the evidence established proof of John and Greg’s inaccurate work and other errors, but that such inaccuracies and errors did not have a meaningful effect on the ability of Buyer to serve its clients.

Therefore, the appellate court held that Buyer did not have cause to fire John and Greg within the meaning of the employment agreements. The result, John and Greg could compete against Buyer.

This case is referred to as Weidner and Company, PC v. Jurgonski & Fredlake CPAS, PC, No. 18A-MI-535, Court of Appeals of Indiana (October 31, 2018).

Comment. Buyer needed to establish that John and Greg’s employment with Buyer was terminated for cause (as defined in the employment agreements) in order to enforce a 2-year noncompetition covenant.

In many cases, a seller’s owner would promise not to compete with the business sold. This promise would be in the business purchase agreement and this noncompetition covenant’s enforceability would probably not depend upon whether or not the buyer breached any employment agreement it had with the seller’s owner.

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 covenant not to compete, employment agreement, for cause termination

Buyer does not acquire patent license agreement from chapter 7 bankruptcy trustee

This case involved the purchase of a patent license agreement out of bankruptcy of several related companies. For purposes of illustration the facts have been modified by describing the sale out of bankruptcy of a patent license agreement from just one company. This modification does not impact the validity of the lesson learned from this story.

The story begins before Seller filed for bankruptcy. Licensor held a patent on a system, software, and related methods of remote pharmaceutical dispensing. In 2010, it sued Seller for infringing this patent by using Seller’s own remote pharmaceutical dispensing machines to remotely dispense pharmaceuticals from the machines to nurses in long-term care facilities. Seller counterclaimed challenging Licensor’s patent.

Licensor and Seller agreed to settle the litigation, entering into a license agreement, granting a non-exclusive perpetual license to Seller for so long as the patent was valid and enforceable. Seller agreed to pay a one-time licensing fee of $4,000 for each Seller machine placed into operation after the execution of the agreement, and to provide quarterly reports reflecting all new machines placed in service.

Later, Seller filed for reorganization under chapter 11 of the bankruptcy laws in a Texas bankruptcy court. The case was later converted to a liquidation proceeding under chapter 7 of the bankruptcy laws. Despite the bankruptcy requirement that Seller schedule all assets and creditors, however, Seller did not list the license agreement or Licensor on Seller’s bankruptcy schedule.

Buyer had a security interest in Seller’s collateral. Buyer agreed to purchase the collateral from Seller’s bankruptcy estate. Buyer and Seller laid out the terms of sale in an asset purchase agreement, and the sale was approved by the bankruptcy court in a separate sale order.

The asset purchase agreement did not explicitly reference the license. The sale order approved the sale of Seller’s property—providing that to the extent that any of the property was an executory contract, the executory contract was hereby assumed by Seller’s bankruptcy estate and immediately assigned to Buyer under the applicable provisions of section 365 of the Bankruptcy Code.

Buyer and Seller agreed that Buyer was not aware of the license until after the bankruptcy court approved the sale.

Later, Licensor filed a petition in Texas state court against Seller, alleging that Seller had failed to comply with Seller’s obligations under the license agreement to provide quarterly reports and pay licensing fees for new machines. Buyer intervened and removed the proceeding to the bankruptcy court, arguing that Seller’s estate had assigned or otherwise transferred the license to Buyer.

The bankruptcy court and then the federal district court held that Buyer had not acquired the license agreement. Buyer appealed the decision to the federal court of appeals.  Buyer struck out there too.

The court of appeals first said that Buyer’s fate on this dispute depended upon whether the license agreement was an “executory contract” under the bankruptcy law.

The court said that the license agreement would be an executory contract if performance remains due to some extent on both sides (both Seller and Licensor) and if at the time of Seller’s bankruptcy filing, the failure of either Seller or Licensor to complete performance would constitute a material breach of the license agreement, thereby excusing the performance of the other party.

The court had no problems finding the license agreement to be an executory contract. It noted that Licensor had an ongoing obligation under the license agreement to refrain from suing Seller for patent infringement for machines placed into service after execution of the license agreement. The court further concluded that Seller licensee had ongoing material obligations because Seller was required to provide quarterly reports as to new machines, pay a one-time licensing fee of $4,000 to Licensor for each new machine, and refrain from making public statements about a settled lawsuit.

The court then explained why the licensing agreement being an executory contract was bad for Buyer. Under the bankruptcy law, the court noted that the trustee of Seller’s bankruptcy estate had 60 days after Seller’s case was converted to a bankruptcy chapter 7 liquidation from a chapter 11 reorganization to accept or reject the license agreement. Buyer would have acquired the license agreement if the trustee had accepted the license agreement during this 60 day window. The trustee, however, did not accept the license and so under the bankruptcy law, the license agreement was deemed rejected by the trustee and thus not an asset of the estate which the trustee could sell to Buyer.

Buyer then made an argument for justice, saying that trustee did not know about the license agreement because Seller had not scheduled the license agreement or the Licensor on its bankruptcy schedules. The court was not persuaded, noting that the trustee had a fiduciary duty to look for unscheduled assets for the benefit of the bankrupt estate’s creditors.

This case is referred to as In The Matter Of Provider Meds, LLC, No. 17-11113, United States Court of Appeals, Fifth Circuit (October 29, 2018).

Comment. Unfortunate outcome for Buyer. Apparently, Buyer did not know about the license agreement until it was too late.

I am not an insolvency lawyer, so I don’t know whether or not Buyer could have realistically learned about this problem through due diligence.

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 bankruptcy sale, distressed business acquisitions, executory contracts

Buyer of business strikes out after protracted litigation trying to recover lost profit damages from seller

Buyer wanted to enter the annual $5 billion revenue back-to-school season market for the sale of school supplies. Since Buyer needed inventory, licenses, and retailer relationships to get the ball rolling, it decided to buy the stationery division at Seller, a well-established consumer-goods wholesaler.

Seller’s assets were an attractive target. Seller held licensing agreements with entities like Lego, Universal Studios [Universal], and pop sensation One Direction. These popular brands would likely lead to large sales with school-age kids. And Seller agreed to help transfer these licenses to Buyer as part of the deal.

Things went awry shortly after the companies finalized the sale. According to Buyer, Seller failed to help transfer its licensing agreements. Buyer sued Seller in a Michigan federal district court to recover damages, including for lost profits arising out of Seller’s breach of the asset purchase agreement.

After a long drawn out litigation, Seller argued that Buyer was not entitled under applicable New York law to recover its lost profits from Seller’s alleged breach of the asset purchase agreement.

The court said that for Buyer to prove loss of future profits as damages for Seller’s breach of the asset purchase agreement under New York law, Buyer must have demonstrated, among other things, with certainty that the lost profits have been caused by Seller’s breach of the asset purchase agreement.

The court looked at the evidence to see if Seller caused Buyer lost profits. Under the asset purchase agreement Seller agreed to use “commercially reasonable efforts” to help Buyer obtain the transfer of each license from Seller to Buyer. Thus, the court said that Buyer must establish, on a license-by-license basis that, but for Seller’s alleged failure to use commercially reasonable efforts, Buyer would have obtained individual licenses — which Seller did not guarantee would be transferred.

The court found this evidence missing in action. The court noted there was no statement from any licensor to the effect that if Seller had done X, then Licensor A would have transferred the license to Buyer.

The court noted what the evidence showed. That beyond Buyer obtaining the Lego license, a dispute existed between Buyers’ principals as to whether to enter into any other licenses. This dispute resulted in Buyer twice rejecting a license from Nickelodeon and not contacting any licensor other than Universal after the initial request for transfer of the licenses were sent out. Further, Buyer admitted that Universal decided for its own reasons not to assign the license to it, but to instead another company in the industry.

The court concluded that there was simply no evidence in the record that, taken as true, would allow the conclusion that Universal (or any other licensor) would have offered Buyer a license even if Seller had provided the reasonable commercial efforts Buyer says it did not, or that, unlike with Nickelodeon, Buyer would have accepted the license.

This case is referred to as My Imagination, LLC v. MZ Berger & Co., Case No. 14-13321, United States District Court, E.D. Michigan, Southern Division (October 29, 2018).

Comment. An acquisition gone sour may get a buyer to look for ways of cutting its losses by looking for seller breaches of the purchase agreement.  However, finding a seller breach of the purchase agreement will probably not help the buyer unless the breach caused buyer to suffer provable damages.

In this case Buyer could not convince the court that Seller had breached the asset purchase agreement. That was the end of Buyer’s claim. However, the court also said that even if Seller had failed to use commercially reasonable efforts to assist Buyer in transferring its licenses to Buyer, Buyer failed to prove that such a breach caused Buyer lost profits.

And finally, the court noted that even if Buyer could prove that Seller’s breach caused Buyer lost profits; Buyer would still have to overcome a provision in the asset purchase agreement that may prevent Buyer from recovering lost profit damages from Seller.

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 breach of contract, commercially reasonable efforts, Covenants, damages

Business seller fights all the way to Texas Supreme Court to challenge validity of purchase agreement

Seller owns Target, a wholesale distributer of candy and tobacco products. Target had contracts to buy tobacco products directly from Supplier 1 and Supplier 2, which will be referred to collectively as Suppliers. In April 2012, Seller approached Buyer, the vice president of Competitor, a convenience store distribution business, about purchasing Target. Competitor did not have a direct contract with Suppliers, thus it bought those companies’ tobacco products through middlemen and paid higher prices for them than did Target.

Because Suppliers ordinarily would not enter into new contracts to sell directly to wholesalers, businesses that wanted to buy directly from them usually sought to do so by buying companies that had direct contracts. But the Suppliers direct-purchase contracts would not necessarily transfer if Target was sold: both Suppliers reserved the right to discontinue direct sales to Target absent their approval of its purchaser.

Buyer and Seller reached an agreement regarding the sale of Target and signed a letter of intent. The closing date was listed as immediate, subject to preapproval from Suppliers. Supplier 1 initially refused to approve the application to transfer Target’s ownership but did so after Buyer and Seller resubmitted the application.

While waiting on approval from Supplier 2, Buyer and Seller executed a stock transfer and asset purchase and sale agreement by which Seller agreed to sell to Buyer all Target stock shares along with other assets used in the business such as land, buildings, inventory, vehicles, fixtures, and equipment. The purchase price for the stock was $500K, subject to the contingency that if Seller was unable to obtain written approval from both Suppliers for the direct contracts to remain in force, the price would be reduced to $250K. Because Supplier 1 had approved the change of ownership, the sales price hinged on Supplier 2’s approval.

The purchase agreement provided that the sales price for the furniture, fixtures, and equipment such as stamping and packing machines would be their value as mutually agreed upon by Buyer and Seller prior to the closing date, and the price of the land and building would be the value set by an appraisal to be accomplished before the closing date. Closing was to take place on or before July 1, 2013.

On June 28, 2013, Supplier 2 notified Buyer that it would not approve the change in ownership. Seller and Buyer discussed resubmitting the application to Supplier 2 as they had done with Supplier 1. Seller also proposed postponing the July 1 closing date, but Buyer would not agree to the change. At that point, Seller and Buyer had not come to an agreement as to the value of the furniture, fixtures, and equipment, and Seller disputed the value of the land and building as determined by the appraisal.

Buyer appeared for the closing on July 1, but Seller did not. Instead, on July 2, Seller sued Buyer in a Texas trial court seeking a declaratory judgment that the purchase agreement was unenforceable and void because Buyer and Seller did not agree on all its essential terms. Buyer counterclaimed against Seller, asserting various claims including a claim for damages because Seller had indeed breached the purchase agreement.

The case was tried to a jury and the jury found that Seller had an obligation under the purchase Agreement to sell the business to Buyer. The jury also found that Buyer suffered $900K in lost profit damages. The trial court awarded attorney’s fees to Buyer.

Seller asked the court to disregard the jury’s finding, arguing that the validity of the purchase agreement was a question for the trial judge and not the jury. Neither the trial judge or a Texas intermediate court of appeal would consider Seller’s argument, holding that Seller had waived its right to make this argument.

The Texas Supreme Court, however, disagreed, and ordered to lower courts to consider Seller’s argument that the determination of the legality of the purchase agreement was up to the trial judge and not the jury.

This case is referred to as Musallam v. Ali, No. 17-0762, Supreme Court of Texas (Opinion delivered: October 26, 2018).

Comment. Seller had to spend a lot of time and money to get the court system to consider his legal argument that the purchase agreement was not enforceable.

In 20/20 hindsight, Seller and Buyer could have probably eliminated this dispute by signing an agreement that had set an agreed upon purchase price for the business land, buildings, inventory, vehicles, fixtures, and equipment.  Of course, valuing these assets would have taken time, would have slowed up the signing of the purchase agreement, and risked losing the deal.

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 deferred closing, post signing asset valuation

Court says asset buyer of business can sue seller for failure to disclose its union contract obligation

In this post-closing lawsuit, Unions comprised four jointly-managed multiemployer employee benefit plans. Seller was a Nebraska corporation which performed waterproofing, concrete and masonry restoration, and roofing services in Nebraska and the Midwest.

Buyer was also a Nebraska corporation, performing commercial and industrial waterproofing and concrete and masonry restoration services in Nebraska and the Midwest. In November 2014, Seller sold its assets to Buyer.

According to Buyer, during the 2014 negotiations prior to its purchase of Seller assets, Seller’s owner told Buyer that only a few of Seller’s employees belonged to a union. Seller’s owner told Buyer that Seller’s company was non-union, and although there may have been a union contract many years prior, it was no longer valid. Buyer claimed it requested a copy of the union contract, but none was produced.

In April 2016, Unions filed suit against Seller in a Wichita, Kansas federal district court, claiming Seller was obligated by collective bargaining agreement to pay fringe benefits contributions for its employees. Unions alleged Seller insufficiently contributed to the employee benefit plans in violation of certain ERISA]statutes (the federal employee benefits law).

During the course of discovery in this case, Unions realized Buyer may also be liable for Seller’s employee benefit plan contributions. Unions added Buyer to its lawsuit against Seller.

Unions alleged Buyer was a successor to Seller and was therefore liable for Seller’ contractual obligations to Unions. But Buyer, by way of defense, alleged Seller made misrepresentations during the asset purchase negotiations. Buyer contended Seller presented itself as a non-union company, and told Buyer there was no current collective bargaining agreement of any kind in place at the time of sale.

Buyer asked the court to permit it to sue Seller as part of the lawsuit. Essentially, Buyer claimed Buyer made clear to both the sale broker and Seller that it was interested only in purchasing a company without union contracts in place. Buyer maintained Seller did not disclose the then current collective bargaining agreement and misrepresented Seller’s involvement in such a contract.

The court concluded that Buyer’s allegations about Seller’s pre-closing statements in its proposed lawsuit against Seller were plausible on their face and thus permitted Buyer to sue Seller in the litigation.

This case is referred to as BAC Local Union 15 Welfare Fund v. Williams Restoration Company, Inc., Case No. 16-2242-KHV-GEB, United States District Court, D. Kansas (October 26, 2018).

Comment. Buyer is fighting this post-closing claim on two fronts. Buyer is fighting Unions direct claim against it on the grounds that Buyer did not know of the union contract. Unions can recover against a buyer of the assets of a business for the seller’s union obligations, but the union must prove, among other things, that the buyer “knew” about the union liability. What facts amount to a buyer’s knowledge of a seller’s union contract is often a matter of dispute.

Buyer is also suing Seller directly for any loss it suffers for Seller’s alleged failure to disclose its Union obligations.

With 20/20 hindsight, Buyer could have insisted upon seeing the union contract before closing and have an expert on this kind of union liability analyze and review this issue. For Seller, a reminder that full disclosure to a buyer minimizes the risk an expensive, time-consuming and stressful post-closing fight with the buyer.

By John McCauley: I help people start, grow, buy and sell their businesses.

Email: jmccauley@mk-law.com

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

Telephone:      714 273-6291

Legal Disclaimer

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

Posted in due diligence, fraud in business sale, post asset purchase issues, representations and warranties, successor liability, union fringe benefits, union liabilities

Sellers of company receiving stock of buyer could not sue buyer’s owners for federal securities fraud omissions committed during negotiation

This dispute stems from a written purchase agreement between Sellers and Buyer. Under this agreement, Sellers sold their interest in their technology consulting company, Target, to Buyer.

In the summer of 2012, Sellers began marketing their company for sale. Shortly thereafter, Sellers began negotiating the sale of Target with representatives from Buyer. Over the course of eleven months, the two sides negotiated and finalized the agreement whereby Buyer would purchase Sellers’ interest in Target in exchange for $3.15 million, stock in Buyer, and other compensation.  The deal closed sometime between June 25 and June 27 of 2013.

Apparently, one of Owners of Buyer, the CFO of Buyer, resigned before the deal closed, and therefore, Buyer was obligated to pay the CFO over $1 million in severance benefits, which impacted the value of Buyer stock received by Sellers.

Sellers sued Owners of Buyer on June 23, 2016 in a Dallas federal district court for, among other claims, federal securities fraud; in particularly accusing Owners of Buyer of not telling Sellers about Buyer CFO’s planned pre-closing resignation.

Owners of Buyer argued that the purchase agreement had a disclaimer of reliance clause where Sellers had agreed to rely only on representations and warranties of Owners of Buyer that were contained in the purchase agreement. And therefore, anything said or not said during negotiations could not be grounds for a federal securities fraud claim, unless backed up by a purchase agreement representation and warranty.

The court held that Sellers could not sue Owners of Buyer under the federal securities fraud law for not telling Sellers about the CFO’s resignation.

The court ultimately said that whether the disclaimer of reliance clause barred Sellers’ federal securities fraud claims came down to whether it was reasonable for Sellers to rely upon what Owner of Buyer said during negotiations and due diligence that was not backed up by purchase agreement representations and warranties.

And whether it was reasonable to rely on statements made in negotiation and due diligence included looking at the complexity and magnitude of the deal, the sophistication of Sellers and Owners of Buyer and the contents of the purchase documents.

Applying this approach here, the court found that the purchase agreement disclaimer-of-reliance clause barred Sellers for suing for federal securities fraud for what was said or not said during negotiations and due diligence, as opposed to what was said in the purchase agreement representations and warranties.

The court concluded that it was not reasonable for Sellers, sophisticated and experienced in business, to rely on statements made outside the four corners of the purchase agreement. Even more so, as Sellers hired experts as consultants to aid them during negotiations and due diligence.

In addition, the court noted that Sellers and Owners of Buyer spent months negotiating the agreement and included six pages of representations that Owners of Buyer specifically warranted as correct and true, as well as financial documents, disclosure sheets, and balance sheets attached to the agreement.

This case is referred to as O’Connor v. Cory, Civil Action No. 3:16-CV-1731-B, United States District Court, N.D. Texas, Dallas Division (October 19, 2018).

Comment. A seller of a business that takes any part of the purchase price in equity of the buyer is also buying a business. Accordingly, a seller in those shoes must not only do due diligence on the buyer but also ask buyer to make representations and warranties about the condition of buyer’s business in the purchase agreement.

In this case Sellers wanted to sue Owners of Buyer under the federal security fraud laws for what was said and not said about the CFO resignation. However, the disclaimer of reliance upon statements made outside the purchase agreement, barred Sellers from doing so.

In 20/20 hindsight, Sellers could have included what is called a full disclosure representation in the purchase agreement where Owners of Buyer would represent and warrant that Owners of Buyer did not have knowledge of any fact that may materially adversely affect Buyer, that had not been disclosed in the purchase agreement.

Sellers could also have tried to include a “fraud carve out” in the disclaimer of reliance clause which would permit Sellers to make fraud claims against Owners of Buyer for statements they made which were not backed up with a representation and warranty in the purchase 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 anti-reliance clause, fraud in business sale, full disclosure rep, reliance

Buyer of business not barred from pre-closing products liability indemnification because 2-year survival provision applied only to rep & warranty breach

Buyer (based 15 miles east of South Bend, Indiana) provides restraint systems for applications, including child seats, school buses, trucks, recreational and construction vehicles, and agricultural equipment. Target (based out of Oklahoma City) manufactures and supplies seat belts and seat belt assemblies for automotive and non-automotive equipment in North America, South America, and internationally.

Buyer contracted to purchase Target from Seller on January 30, 2013. The deal was set out in a stock purchase agreement. The stock purchase agreement included indemnification provisions which required Seller to indemnify Buyer for damages related to any injury to individuals or property resulting from or arising out of the ownership, possession or use of any product manufactured, sold, leased or delivered by Target on or prior to the closing date.

Seller also promised in the stock purchase agreement to indemnify Buyer for breach of any Seller representation or warranty. Seller’s liability to Buyer for breach of any Seller representation or warranty survived the closing and continued in full force and effect until the 2nd anniversary of the closing.

Buyer brought a claim against Seller on October 9, 2015 for indemnification of damages resulting from products liability claims made against Buyer for product sold by Target prior to the closing. Seller asked a federal district court in Delaware to rule that Buyer was too late since Buyer’s claim was made more than 2 years after the closing.

Buyer countered that the stock purchase agreement’s 2-year period only applied to Buyer’s claim for a Seller breach of a Seller representation or warranty. The 2-year period did not apply to a breach by Seller of its covenant or promise to indemnify Buyer for any loss Buyer suffers arising out of products Target sold prior to the closing.

The court agreed with Buyer, concluding that the 2-year post-closing provision only applied to a breach by Seller of a Seller representation or warranty; noting that Seller’s representations and warranties were contained in a different section of the stock purchase agreement than Seller’s promise to indemnify Buyer for loss Buyer suffers arising out of Target’s pre-closing product sales.

This case is referred to as Ark Group, Inc. v. Shield Restraint Systems, Inc., Civil Action No. 1:18-cv-00755-RGA, United States District Court, D. Delaware (October 10, 2018).

Comment. It is common to require a seller of a business to make representations and warranties about the business. It is also common to limit seller’s exposure to a buyer for seller’s breach of a representation or warranty to claims made before a deadline date (such as 18 months or 2 years after closing); which is a shorter than the deadline for making claims contained in the applicable statute of limitations (for example 4 years).

However, it is also common for a seller of a products business to be responsible for problems arising out of Target’s pre-closing product sales for as long as the applicable statute of limitations permit.

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 indemnification, survival of reps and warranties

Court says buyer of assets of business can enforce noncompetition agreement seller had with former employee

Seller, based in Billerica, Massachusetts (20 miles NNW of Boston) manufactured computer peripheral equipment.

Former Seller Employee started working at Seller in 1982. He was promoted several times over the course of his employment, eventually becoming program manager in the sales department. That position entailed responsibility for the largest and most important of Seller’s accounts.

Accordingly, in 1997, Former Seller Employee was required to sign a non-compete and non-solicitation agreement.

Buyer, based in Tucson, Arizona, through its subsidiaries, manufactures cable assemblies, wire harnesses, and electro-mechanical assemblies.

In 2014, Seller entered into an asset purchase agreement with Buyer. Pursuant to the asset purchase agreement, Seller sold its assets, including its tradename to a Buyer subsidiary.

In 2016, Former Seller Employee left his job with Buyer and was hired as a general manager by Competitor. Competitor is a Salem, New Hampshire company, that provides manufactured electronics assembly services for a range of industries and is a competitor with the Seller business purchased by Buyer.

Thereafter, Buyer sued Former Seller Employee, in part for breach of his agreement to not compete against the Seller business. Former Seller Employee convinced the trial court that Buyer had no right to enforce the noncompetition agreement he entered into with Seller because Buyer did not buy the noncompetition agreement from Seller. The trial court agreed with Former Seller Employee and Buyer appealed.

The New Hampshire Supreme Court reversed, holding that Buyer purchased the noncompetition agreement and had a right to enforce it because under the asset purchase agreement, Seller sold all its contracts to Buyer.

This case is referred to as Atronix, Inc. v. Morris, No. 2017-0318, Supreme Court of New Hampshire (Opinion Issued: October 23, 2018).

Comment. No surprise in the outcome. A buyer can purchase  a seller’s contracts.

However, a buyer needs to check each contract to see if there is a prohibition on assignment or whether assignment requires the consent of the other party to the contract. Also, there are certain contracts that may require consent of the other party even if the contract itself does not require that. This is generally the case when the seller is assigning intellectual property licenses to a buyer.

Finally, some states, like California, will not enforce a noncompetition agreement, unless given as part of a sale of a business.

By John McCauley: I help people start, grow, buy and sell their businesses.

Email: jmccauley@mk-law.com

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

Telephone:      714 273-6291

Legal Disclaimer

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

Posted in Assignment, assignment of contracts, covenant not to compete

Court says buyer was barred from pursuing claim for seller breach of software representation by settling purchase price adjustment dispute

Buyer, a Jacksonville, Florida based insurance company, purchased Target, a Ft. Lauderdale, Florida based private insurance company and its subsidiaries from Seller pursuant to a stock purchase agreement. In the stock purchase agreement, Seller represented and warranted, that a software application that a Target software application vendor had contracted to develop for Target was in adequate operating condition and repair.

Pursuant to the stock purchase agreement, Seller provided Buyer with a closing date statement setting forth Target’s adjusted book value as of the day before the closing. The adjusted book value was used as a mechanism for adjusting the purchase price, up or down, based upon the difference in the book value of Target the day before the closing to the book value of Target as of an earlier date.

After receiving the closing date statement, and pursuant to the dispute resolution procedures laid out in the stock purchase agreement, Buyer submitted its objections to the closing date statement prepared by Seller. One of Buyer’s objections was Seller’s inclusion of the software application at its fully amortized cost as of the closing date. Buyer claimed the software application was defective and thus worthless.

The accounting firm selected pursuant to the stock purchase agreement to decide this dispute, did not agree with Buyer, saying that the software application was correctly booked at its fully amortized cost as of the closing date. On other issues, the accounting firm found for Buyer. Subsequently, Buyer and Seller agreed in a signed release, that payment by Seller to Buyer of approximately $1.6 million would be payment in full satisfaction of all claims raised in the Buyer’s objection to Seller’s closing date statement.

Later, Buyer sued Seller for damages in a New York court, claiming that Seller breached its representation and warranty that the software application was in adequate operating condition and repair, when in fact it was defective and thus worthless. Seller asked the court to dismiss this claim, claiming that Buyer was barred from pursuing the claim because Buyer and Seller agreed that payment by Seller to Buyer of approximately $1.6 million fully satisfied all claims raised in Buyer’s objection, including Buyer’s claim that the software application was defective and thus worthless.

The court agreed with Seller and dismissed the claim.

This case is referred to as Cypress Group Holdings, Inc. v. Onex Corp. v. Schreiber, 7020, 653408/15, Appellate Division of the Supreme Court of New York, First Department (Decided October 9, 2018).

https://scholar.google.com/scholar_case?case=2531804600051984423&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment. There is often a significant lag between execution of a purchase agreement and the closing. Buyer and Seller often want to adjust the purchase price to reflect the change in the value of the business between signing and closing.

There are many ways to adjust a purchase price. Changes in book value or working capital are common.  The buyer and seller may not agree upon the adjustment and there usually is a dispute resolution procedure often involving a neutral accounting firm.

However, the complexity involved in a purchase price adjustment mechanism creates risks. In this case, a release given by Buyer when settling the purchase price adjustment dispute, barred Buyer from pursuing a claim for a breach of a Seller representation about the condition of an important Target application software.

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 book value adjustment, purchase price, purchase price adjustment

Court finds that a CEO of buyer had no duty to disclose speculative patent infringement litigation when CEO sold thermometer technology to buyer from CEO’s selling company

Buyer is a public company with its principal place of business in Lafayette Parish, Louisiana. Buyer, through its subsidiaries, engages in sale and distribution of medical devices; and sale of branded generic pharmaceutical drugs in the United States and the United Kingdom.

Buyer’s CFO and Buyer’s CEO/board of director member owned a majority of Buyer.

Seller owned the exclusive rights to distribute certain non-contact thermometers in North, Central, and South America. Buyer’s CFO and Buyer’s then CEO/board of director member were majority owners of Seller.

In March 2014 Buyer purchased Seller’s exclusive rights to distribute the thermometer technology through an asset purchase agreement. Buyer paid for the rights with Buyer’s stock, representing about a 50% interest in Buyer. Seller had the right to designate who was to receive that stock and it designated that Buyer issue part of this stock to Buyer’s CEO/director, both directly and to a trust for his benefit.

After the closing, Buyer discovered patent infringement issues that significantly impaired the value of the distribution rights.

On January 31, 2017, Buyer sued Buyer’s now former CEO/director and part owner of Seller in a Louisiana federal district court, alleging, among other items, that he failed to disclose possible patent infringement litigation that significantly impaired the value of the distribution rights assigned to Buyer. Buyer claimed that this failure violated the Buyer CEO/director’s fiduciary duty that he owed to Buyer as an officer and director of Buyer.

The court said that to prevail on a claim for breach of fiduciary duty under Louisiana law, Buyer had to prove that there was a fiduciary duty owed to Buyer by its CEO/director, the CEO/director acted in a way to violate that duty, and that Buyer was damaged as a result of those actions.

The court noted that is well established that fiduciary duties are owed when there is a relationship between a director or officer and a corporation. However, the court said that there is no violation of fiduciary duties when there is no duty to disclose.

In this case the court held that there was no duty to disclose the patent infringement problems because it amounted to speculative litigation. Specifically, the court said that at the time of the court’s decision, there had been no patent infringement claims brought against Buyer. The court rejected Buyer’s conclusory allegations that Buyer would have been sued had it sold the thermometers.

Therefore, the court granted summary judgement in favor of Buyer’s former CEO/director.

This case is referred to as RedHawk Holdings Corp. v. Schreiber, Civil Action No. 17-819, United States District Court, E.D. Louisiana (October 15, 2018).

Comment. There are risks when a company does a deal with one of its officers or directors. In this case, the court did not think that disclosing potential patent infringement problems was required because no infringement claims had been made. Can’t tell from the written decision whether any infringement claims had been threatened.

The better practice in this case would have been to disclose the potential patent infringement problem in the asset purchase agreement. Best to resolve the issue before closing and minimize the risk of post-closing litigation.

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 doing deal with company's officer or director, officer or director's fiduciary duty to disclose

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